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Volume III – Writing The Deal
What is this topic about?
Writing the Deal is about contracts. Contracts are the glue that holds real estate deals together. Contracts hold deals together because they are enforceable in a court of law. The coercive power of the state lies just below the surface in every real estate transaction. It makes the process of buying and selling real property more formal and more stressful.
This topic begins with Understanding Contracts. The Understanding Contracts section covers the common law of contracts from formation of the contract to its enforcement including, along the way, everything from the necessary legal elements of a contract to dealing with multiple offers. Also included in the topic is the subject of Standardized Sale Forms. Addendums, a ubiquitous partner of sales forms, are covered in the Addendums section of this subject.
Writing the Deal is about more than just form contracts and addendums, it is also about the performance of contracts. This important subject is explained in the Aiding Contract Performance section. A big part of aiding contract performance is what to do if one party or the other threatens to, or actually does, breach the contract. When that happens, the agent can benefit from the Handling Client Disputes section of this topic.
- Understanding Contracts
- Necessary Elements of Contracts
- Statute of Frauds
- Earnest Money
- Multiple Offers
- Statutory Provisions Affecting Multiple Offers
- Administrative Rules Affecting Multiple Offers
- Explanation of Administrative Rules Involved
- Multiple Offers and Single Agency
- Multiple Offers and Dual Agency
- Handling Multiple Offers
- Standardized Sale Forms
- Aiding Contract Performance
- Agent’s Role in Contract Performance
- The Client’s Contract Performance
- Good Faith Performance of Contracts
- Short Sales
- Multiple Offers and Escalator Clauses in Short Sales
- Dealing with REOs
- Homebuyer Protection Act
Understanding Contracts means knowing something about how courts handle contract disputes. It is contractual disputes which have caused the courts to define the Necessary Elements and Material Terms of contracts. Many contract disputes involve Contract Formation. That means understanding Offer, Acceptance and the misunderstood subject of Acknowledgement. Contract formation also involves Termination of Offers. All these issues are covered in this subject
A big part of any contract for the sale of real property is the earnest money pledged by the buyer. Understanding and handling earnest money is covered in the Earnest Money section. Also covered is the complex and, at times, confusing subject of dealing with Multiple Offers.
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Necessary Elements of Contracts
Contracts are about promises. In fact, one legal definition of a contract is: “a promise or set of promises for breach of which the law gives remedy.” A more abstract definition is that a contract is simply an “enforceable agreement.” Whatever the definition used, when people talk about the necessary or required “elements” of a contract, what they are really talking about is what it takes to make a promise or agreement “valid” so that it can be enforced in a court of law.
Actually, it is misleading in some ways to talk about the elements of a “valid” contract because that suggests some specific magical terms are needed to form a contract. That is not true. Instead, there are certain things courts routinely look for before they will enforce a contract. These things, elements if you will, are “necessary” in the sense that doubt about them creates doubt about the enforceability of the contract. Whether there is a contract in the first place is a matter of contract formation, whether what was formed is valid or enforceable or not. Click here for a discussion of contract formation.
It is often said that every contract must have: 1) capacity; 2) consent; 3) a lawful object and 4) consideration. That is true, as far as it goes, but what is being tested is the social utility of a particular agreement. Capacity, consent and the rest are just things one would expect to find in a bargain that benefits society by helping individuals order their economic life. When one or more are missing, society may decline to enforce the exchange.
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Capacity to Contract
State law protects “minors” (unmarried persons under the age of eighteen) and “incompetents” (those declared by a court to be incapable of handling their own affairs) because they do not have the “capacity” to enter into contracts. Contracts with minors are said to be “voidable” by the minor at any time prior to reaching majority or within a reasonable time thereafter unless the contract is for a “necessity.” No Oregon court has ever ruled on whether real estate is a “necessity” for a minor. Much would depend on the circumstances of the purchase and the nature of the property (e.g., an emancipated minor renting an apartment near the college where they are enrolled).
Contracts with persons already declared incompetent are said to be “void.” Void is just another way of saying courts will not enforce contracts made by incompetents. Where a person is declared incompetent after formation of a contract, the contract, like that with a minor, is said to be voidable. Avoiding a contract altogether on capacity grounds requires proof of incompetence at the time of contract. Incompetence at the time of contract can be seen as another way to attack consent – and that’s where capacity can get messy.
Other than in cases dealing with minors or declared incompetents, capacity is about the ability to understand the nature and consequences of one’s actions. Take, for instance, a person who is falling down drunk or over medicated or suffering memory problems or delirious or just having trouble distinguishing reality. In any of these cases, capacity may become an issue because doubt is cast on the person’s ability to understand what they are doing. Without that understanding, it is hard to say there was “mutual assent” sufficient to form a contract.
Other than in the case of minors or incompetents, capacity is more a formation problem rather than some kind of required element. Thinking of capacity in this way will help you avoid problems. If anything (age, speech, mannerisms, memory, etc.) makes you question a party’s mental capacity, think about whether the contract could later be challenged. If there is doubt, it is time to seek help. At a minimum, close questioning of the person’s understanding of the nature and consequences of what they are doing is in order as is careful documentation of your discussion.
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“Consent” as a necessary element is, in some ways, the same as having the “mutual assent” necessary to form a contract. Consent means to agree willingly. There is a free-will component to consent. Consent to a contract must be free of force, intimidation or trick. Old melodramas where sweet Nell is tricked or forced by the evil villain into signing the deed to the ranch miss the issue of consent. Contracts induced by force, intimidation or trickery are not enforceable, or if you like, they are void.
Another component of consent often overlooked is the idea of mistake. A mistake as to what is being purchased can destroy consent. If I consent to A, but unbeknownst to either party what is really offered is B, can I be said to have consented to B? This issue of mistake is a powerful one and is discussed in detail in the section on Contract Formation.
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You will likely work your whole real estate career and never have any cause to consider the Lawful Object of a contract. The common example of a contract with an illegal object is a contract to have someone murdered. Such contracts are void. Needless to say, this is not a big issue in real estate.
Lawful Object is rarely used as a defense to a real estate contract. Take, for instance, the contract to sell an illegally subdivided lot. It is not illegal to buy or sell an illegally created lot. An attempt to sell a piece of a farm zoned EFU results in a tenancy in common, not an illegal contract. Where the buyer does not know of the illegality, the issue will be mistake or misrepresentation rather than illegality.
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Consideration is one of those wonderful legal concepts that everyone has heard of but few understand. Consideration is not a physical thing like money. It’s not a metaphysical thing like “love and affection.” Strictly speaking, it’s not even a separate “necessary” element of a contract. Consideration is an abstraction developed by courts as a means of determining what kinds of promises the law will enforce.
Consideration is really just a way to demand social utility by limiting the judicial enforcement of promises to those that involve an exchange for value. An exchange for value is another way of saying a real bargain. Asking whether there is consideration for a contract is the same as asking whether there was an actual bargain in which each party promised to give up or receive something of value to them. The legal definition of consideration is, of course, a lot denser.
Courts often claim consideration has multiple (usually three) elements. Accordingly, a promise is said to be “supported by consideration” if: 1) The promisee suffers legal detriment; 2) the detriment induces the promise; and 3) the promise induces the detriment. Just think bargain. My promise to sell you my house (parting with my house is a “legal detriment”) induces you to promise to give me money (parting with money is a “legal detriment”) and that is what induced me to sell you the house. It is simple, really: something for something.
Consideration is so simple a concept that it almost never has anything to do with modern real estate practices. Unfortunately, that hasn’t prevented the development of real estate myths about consideration. The most virulent of these myths is the one that real estate contracts are void unless earnest money is in hand at the time of offer because without earnest money there is no consideration.
Though often repeated, and even taught in some real estate classes, it just isn’t true that you need earnest money to have an enforceable contract for the sale of real property. My promise to sell my house induces your promise to give me money which induces me to sell you my house. The consideration is the promises themselves. Earnest money has nothing to do with consideration, though it is, of course, still a very good idea. Click here for a detailed discussion of earnest money.
One place consideration does sometimes play a role in real estate is in settlements or contract modifications. For instance, parties will often use termination agreements when deals fail. Often, these agreements contain promises not to sue. Often these promises are extended to the agents, not just the parties to the termination agreement.
Courts have ruled that such promises are not enforceable because they are not backed by consideration. They are not backed by consideration, courts reason, because the agents gain benefit without legal detriment. That is the case because the agents have nothing to bargain with for the parties agreeing not to sue them. It would be different if the agents were parties to the termination agreement and, for instance, gave up claim to a commission or right to sue the principals for damages.
Another place you sometimes see lack of consideration play a role in real estate is in contract modifications. If a party, who is already bound to perform under a contract, extracts a modification of some kind from the other party by threatening not to perform, the modification may be found unenforceable for want of consideration. That is the case because the party seeking the modification suffers no legal detriment by performing the contract because they were already legally obligated to do so. Anytime you see a one-sided exchange, think about consideration. Other than that, it is rarely an issue in real estate.
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Material Terms of a Contract
Closely related to the concept of necessary elements is the idea of “material terms.” Material terms of a contract are often called “essential terms.” They are terms that go to the essence of the bargain. Without them, a court cannot enforce the bargain because it cannot be certain what the bargain actually is.
Because the material terms of a bargain are considered essential, they are often thought of as required. You will hear people say that a contract for the sale of real property MUST have this particular term or that particular term or it is “illegal” or “void” or some other unfortunate-sounding term. The truth, of course, is more complicated.
Courts distinguish between the material and subordinate terms of a contract. According to Oregon courts, “[a] term is ‘material’ to an enforceable agreement when it goes to the substance of the contract and, if breached, defeats the object of the parties in entering into the agreement.” All the other terms of a contract are considered “subordinate” and, therefore, not essential to the enforcement of the contract. Such terms are often called “subordinate details of performance.”
Oregon courts have identified six material or essential terms when it comes to the sale or purchase of real property. The terms are: 1) designation of the parties; 2) identification of the property; 3) the promise to sell and buy; 4) the purchase price; 5) how the purchase price will be paid; and 6) a fixed time and place for the delivery of the deed or closing. Courts are quick to point out, however, that depending on the circumstances there may be more material terms. Ultimately, what is or isn’t material to a particular contract depends on the parties’ intent as found in their agreement.
The idea of material or essential terms is relevant only in a dispute about enforcement of a contract. When it comes to real estate, such disputes usually involve specific performance of a promise to sell. Sellers sometimes defend against specific performance by claiming that one or more of the material terms were omitted or insufficient. They almost never win such arguments but real estate agents should know enough about material terms to avoid creating the potential for such arguments.
Although each of the six material terms cited by Oregon courts has been the basis of a defense against specific performance at one time or another, by far the most popular is identification of the property. This is the case because standard real estate forms make it hard (not impossible) to miss the other material terms. Identification of the property, even though still the most common “material term” defect, is not the problem it once was.
Identification of the property was once a bigger problem because of the use of tax lot numbers and street addresses to describe property. Lawyers trying to defeat specific performance claims would use the lack of legal description to argue the identification of the property was too indefinite to support specific performance. Mostly, they lost but lawyers still started including legal descriptions in sale contracts. From there, it was a short step to the real estate myth that a contract was somehow “void” if it didn’t contain the legal description of the property.
Modern real estate forms avoid the whole legal description issue by using lot numbers and addresses but also adding a line that says the parties agree to provide the legal description for the purpose of title and identification. That simple agreement defeats any claim of faulty identity. Agents should be aware, however, that not all forms contain such “saving” provisions to handle identification of the property.
In addition to identification issues, you will sometimes see lack of promise to buy or sell arguments. Such arguments result when real estate transactions are proposed by letter or other non-standard writing. That makes the problem easy to control for real estate licensees who use standard forms. Party identification, purchase price and means of payment are similarly easy to control by using standard real estate forms. That leaves only the time and place of closing to cause trouble.
Real estate deals, especially those involving real estate licensees, close in escrow. That makes the “place” of closing pretty simple. Time, you would think, would be similarly simple but is not. You sometimes hear, for instance, that a contract must have a specific closing date to be valid. Like most easily stated rules, this one is inaccurate. It is a huge leap from requiring a time and place of closing to demanding a specific date.
The time of closing can be implied from the other terms of a contract. It can be stated by reference to performance of another term in the contract. What courts mean when they say the time and place of closing is material is that they have to be able to figure out when performance was due. A date certain helps but that doesn’t mean a contract without one is automatically void. Click here for a recent Oregon Court of Appeals decision discussing the closing date issue.
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Contract Formation is the most important step in a real estate transaction. Notwithstanding its importance, or maybe because of it, the formation of real estate contracts is fraught with uncertainty, myth and superstition. Some of that uncertainty, myth and superstition is the result of the legal complexities of contract law. More, however, is the result of human nature.
Contract formation requires “mutual assent” – a deceptively simple legal concept that means a mutual manifestation of assent to the same terms. Mutual assent is usually established by offer and acceptance. One party proposes the terms of an agreement (the offer) and the other party assents to those terms (the acceptance). Real estate transactions almost always start with the buyer making a written offer to the seller.
Offers tend not to cause many legal problems. That is not the case with acceptance. There are often misunderstandings over communicating acceptance. A recurring problem in real estate is acceptance varying from the offer. This happens when little changes are made to an offer by interlineations prior to “acceptance.” All these issues are covered in this topic.
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Offers are a kind of promise or, if you like lawyer talk, a manifestation of willingness to enter into a bargain. The offer must be made in a way that would justify the other party believing that assent to the bargain is invited and will conclude the bargain. An offer, it is said, empowers the offeree to create a contract by acceptance. An unambiguous offer, therefore, commits the offeror to the bargain they propose subject only to the offeree’s acceptance.
There are, of course, a million ways to make ambiguous offers and, therefore, call into question contract formation. If a doctor says to a patient, “don’t worry, I can fix that,” can the patient sue the doctor for breach of contract if it turns out the doctor couldn’t fix it after all? The answer depends on not just the words used by the doctor, but the context in which they were used. Would the patient be justified in believing their assent to a bargain was invited and that their assent would conclude the bargain? In the context of an interaction between a doctor and a patient, few would believe a bargain was being proposed. If there was no offer, there was no contract and, therefore, no subsequent breach.
In real estate we rarely worry about manifesting willingness to enter into a bargain. That’s all handled by our forms. If you look again at the sale agreement or “earnest money” form you use, you will see express offer and acceptance language. The use of such forms removes doubt about whether an offer is being made. Unfortunately, the parties to a real estate transaction sometimes talk directly with each other and can sometimes make statements that could be taken as an offer.
Suppose a man says to his neighbor, “I’d sell my house if I thought I could get $300,000,” and the neighbor says, “Ok, I’ll have the $300,000 in the morning, you’ve got a deal.” Does the man have to sell his house to his neighbor? What if the owner received a letter from the neighbor saying, “Will you sell me your house for $250,000?” The owner writes back saying, “I wouldn’t even consider selling my house for less than $300,000” and the neighbor writes back: “I accept?” Can the neighbor now force the sale?
In these kinds of cases, courts usually find no offer was made because these are statements of future intentions, hopes or estimates, not promises. But, when parties start communicating, especially in writing, about what price or what terms might be acceptable, watch out. What a court might later make of these communications is not always predictable. Click here for a copy of an Oregon Supreme Court case discussing the legal requirements for an offer to purchase or sell real property.
Because of the unintended offer potential, any written communication discussing the terms or conditions of a sale, that is not intended as an offer, should say right in the document that it is not an offer. The same applies to verbal discussions of price and terms but in a verbal exchange there is the added protection of the Statute of Frauds. It is, however, very unwise to rely solely on the Statute of Frauds. Click here for a detailed discussion of the Oregon Statute of Frauds.
One place where being clear about what is and isn’t an offer can be critical is in multiple offer situations. A seller with multiple offers to consider may want to make counter offers to more than one buyer. Because a true counter offer, like any unambiguous offer, will create the power of acceptance in the offeree, extreme care must be used to avoid creating more than one contract. Various strategies and forms have been developed to deal with multiple offers. Be certain you understand these strategies and forms before countering more than one buyer. Click here a detailed discussion of multiple offers, including sample language.
Another place where clarity is required in offers is where preliminary negotiations are followed by the execution of a separate formal document of agreement. The preliminary negotiation problem plagued real estate for years after the invention of the fax machine. In the early days of fax transactions, there was concern that copies of offers faxed back and forth might not be formal enough to indicate the parties’ intent to enter into a contract because no single written memorial of the agreement existed. To compensate for this concern, brokers for years sent around the “original” offer to get “original” signatures after everyone had agreed to the deal by fax.
This manner of doing business created uncertainty in the formation of real estate contracts because either party could argue that no contract was intended until the “original” was signed. Otherwise, what purpose was served by sending around the original?
To solve the problem, a “multiple counterparts” clause was added to real estate contracts saying the documents could be signed in multiple counter parts with the same effects as signing one document. Such clauses are now obsolete because of state and federal electronic transaction legislation but you will still see them in real estate contracts today.
An offer, however signed, can offer a unilateral contract or a bilateral contract. Both types are used in the practice of real estate. The cooperation agreement between brokers formed through a multiple listing service is formed on the basis of a unilateral offer of compensation. The listing broker promises to pay a coop commission to any broker who procures a buyer for the broker’s listing. The offer is unilateral because only the listing broker makes a promise.
A cooperating broker cannot accept the unilateral offer by promising to procure a buyer, they must actually procure one. Unilateral offers are accepted by performance, not promise. That means the cooperating brokers are under no obligation to procure a buyer and the listing broker, though bound by their promise, can withdraw their offer at any time prior to the other broker’s actual performance. Click here for a detailed discussion of offers of compensation. This manner of contracting is very different from the way buyers and seller deal with each other.
Bilateral contracts, like a sale agreement between a buyer and a seller, involve the exchange of promises. An exchange of promises is sufficient consideration for a bilateral contract and no other consideration in the form of money or property is necessary. Click here for a detailed discussion of the role of earnest money in real estate contracts. Because bilateral contracts are binding without additional consideration, an offer of a bilateral contract creates in the offeree the power to bind the offeror by giving nothing more than a promise. This places special emphasis on the acceptance, revocation and performance of bilateral contracts. Acceptance is the next subject in this topic.
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“Acceptance,” according to a well respected legal journal, is “a voluntary act of the offeree whereby he exercises the power conferred upon him by the offer and thereby creates a set of legal relationships called a contract.” In plain English, that means acceptance transforms an offer into a contract. Acceptance also terminates the offeror’s power to revoke the offer. Taken together, these two aspects of acceptance (cutting off revocation and creating a contract) make acceptance a matter of supreme importance.
The law favors the voluntary apportionment of economic interests. The law, therefore, strives to make certain that individuals cannot avoid voluntary contracts nor be forced into involuntary ones. Generally, contract rules, and those regarding acceptance are no exception, are designed to enforce individual intent. Did the offeror intend to create the power of acceptance? Did the offeree intend to accept it? These are the kinds of intent questions upon which contract formation often turns.
Intent is, of course, notoriously hard to prove. To compensate, the law of contracts adopts what is called the “objective theory of contracts.” Under the objective theory, it is not what a person actually intends that matters, it is what a reasonable person in the same circumstances would reasonably believe they intended that matters. Applied to acceptance, the objective theory says that if the offeree makes the promissory acceptance requested they will be held to their acceptance whether they intended to accept or not unless the offeror knows or should know they did not intend to accept.
The enforcement balance between being bound to voluntary contracts but not to involuntary ones underlies most of the rule of acceptance. For instance, if the offeror makes an offer to two people (e.g., husband and wife), only those two people can accept. Acceptance cannot be transferred, even if performance later can. One person cannot “accept” for another unless the person accepting has the express authority to bind that person to the kind of contract being offered and expressly accepts on that person’s behalf.
Offers to husbands and wives signed by only the husband or only the wife are not uncommon in real estate. Mostly, the lack of acceptance by one of two joint offerees doesn’t become an issue because the offeree who did not accept intends to and does perform the contract. When, however, the lack of acceptance by one of two or more joint offerees becomes an issue, you can have a real mess. Generally, when the husband and wife are buyers, the seller can enforce the contract against the signing spouse. Neither spouse however, will be able to enforce the contract against the seller unless the seller ignores the lack of acceptance by the joint offerees and goes forward with the contract.
When the husband and wife are the sellers, you have bigger issues because spouses often hold title as tenants by the entirety. A buyer who does not obtain the signatures of both husband and wife may be unable to enforce the contract against the non-signing spouse (unless the spouse who didn’t sign authorized the other spouse to sign for them or ratified the contract by his or her actions after formation). The buyer can, however, always sue the accepting spouse for breach of contract if they cannot deliver title as promised in the contract.
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Probably the place “intent to accept” is most likely to arise is in communicating acceptance. It is common law that the acceptance of a bilateral contract must be “communicated” to the offeror or his agents to be effective. Communication brings up means and timing issues. What does it take to “communicate” acceptance and when is that acceptance effective? These are big questions because the offeror has the right to revoke an offer at any time prior to acceptance.
Most courts, including Oregon courts, hold that acceptance is effectively communicated when it is put out of the possession of the offeree. At common law, this concept was known as the mail box rule. In the famous 1818 English case of Adams v. Lindsell, a common law court ruled that acceptance mailed (placed in a public mailbox) prior to receipt of revocation was effective even if the revocation was received before the offeror received the acceptance.
Mailboxes, other than as an application of the rule, don’t really have much to do with communicating acceptance anymore. The more general rule is that if an offer is accepted by a medium that is reasonable in the circumstances (mail, fax, telegraph, etc.), it is effective when it is put out of the possession of the offeree. This often comes as something of a shock to real estate licensees because real estate rules and form contracts focus on the date and time the acceptance is signed rather than when acceptance is communicated.
The focus on signing has lead to considerable grief in Oregon real estate. Two scenarios are common. In one, the seller gets a better offer from buyer #2 after countering buyer #1 and tries to revoke the counter, only to find out buyer #1 has already “signed.” In the second popular scenario, the fact that the buyer or seller has “signed” or “accepted” is communicated by one agent talking to another agent on the phone. In both these situations contract formation is very much in doubt.
Communication of acceptance requires putting the acceptance out of the possession of the offeree. In the first scenario, the signed acceptance is still in the buyer’s possession. Signing is not enough. The signed document must be “communicated” or “dispatched;” that is, placed out of the seller’s possession and into the buyer’s (assuming no counter offers). How is that done? Typically, nowadays, an accepted written offer is placed out of the seller’s possession into the buyer’s when it is faxed to the buyer’s agent. The date and time on the fax will be an excellent record of when acceptance took place.
It is easy to see why the law requires communication of acceptance if you think about the seller revocation/buyer acceptance scenario. The seller’s agent calls up the buyer’s agent and says “the seller revokes.” The buyer’s agent calls the buyer and says “hey, you better have signed that counter offer because the seller is trying to revoke.” The buyer, being no dummy, says “no sweat, I signed it an hour ago.” Allowing this kind of process would seriously undermine the goal of supporting voluntary contracts. Hence the rule that acceptance is not effective until communicated.
The second scenario where one agent tells the other agent on the phone that their client has “signed” or “accepted” raises questions about how acceptance can be communicated. The general rule is that acceptance can be communicated by “any means reasonable in the circumstances.” What is reasonable in the circumstances usually depends on things like how these parties have communicated previously, how communications are usually handled in the business or industry involved, the time given for acceptance and so on.
In the case of real estate contracts, the means of communication is often set by the offer itself. In Oregon, most real estate contracts contain a term stating the offer (or counter offer) can be accepted “only in writing.” It is black-letter common law that when the place, time or medium of acceptance is prescribed by the offer, no contract is formed unless the terms of the offer are followed. It follows that when the offer states that acceptance can be accomplished “only in writing,” a verbal exchange between agents isn’t going to meet the terms of the offer.
Once you understand “acceptance,” you can see that there is no occasion for an agent to ever say to someone that an offer has been “accepted.” Until communicated in writing, there is no acceptance. Once the acceptance in writing is communicated, there is no need to tell someone it is accepted – they already know. It would be very wise for agents to remove “my client has accepted” from their vocabulary. It would be even wiser for agents to explain to clients that if they want their acceptance to be effective, they need to have a way to communicate it to the seller as soon as they sign it.
All this is not to say a court will never enforce a verbal acceptance in a real estate transaction. Formation of a contract is ultimately a matter of intent, not bright-line legal rules. Limitations on the means of acceptance can be waived by conduct. The Statute of Frauds can be avoided in special cases based on past performance or detrimental reliance. Click here for a discussion of Statute of Frauds issues. In short, communicating acceptance verbally is always risky and never predictable.
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Acceptance Varying From Offer
You wouldn’t think that contract formation problems resulting from an acceptance that varies from the offer would be a problem in real estate. You would be wrong. It is still a common, if completely misguided, practice for agents to allow (or even suggest) clients make (and initial) changes to an offer or counter-offer prior to “accepting.” These agents evidently believe that minor changes made in this way are “easier” than making a counter offer. That is not the case and this manner of conducting business is extremely dangerous. Here’s why.
It is the most basic of common law contract rules that an acceptance which adds qualifications or conditions to an offer operates as a counter offer and, therefore, a rejection of the offer. Any attempt by the offeree to add or subtract anything from the offer will result in uncertainty in the formation of the contract if for no other reason than that there is no place on standard forms for the offeror to accept a counter offer made in this way. All this leaves formation of the contract very much up in the air when additions or deletions are made to an offer before it is “accepted.”
Just how much up in the air changing the terms of an offer can leave formation is illustrated by the famous Oregon case of Painter v. Huke. Huke listed his property with a broker who obtained an offer from the Painters. Huke countered for more money down. The Painters were OK with the increased down but wanted more time to close. So the agent had the Painters change the closing date, initial the change and “accept” Huke’s counter offer. She then sent a copy of the signed counter offer to Huke and started working to close the deal.
About a month later when the closing in Huke’s counter offer came due, Huke asked the broker why the Painters weren’t closing. That’s when he learned of the changed closing date. Not happy with any of this, he sold the property to another buyer. That’s when the Painters sued him and won at trial. On appeal, the Oregon Court of Appeals ruled against the Painters, holding they had no contract with Huke because their initialed change to Huke’s counter offer added to the terms of the offer and, therefore, was a rejection and counter offer by the Painters. The Court could find no evidence that Huke accepted the Painters’ counter offer and, therefore, found there was no contract. Click here for a copy of the Painter v. Huke case.
For years, preprinted real estate contracts have contained a warning to sellers and their agents to not make any modification to the offer. The next time you see that warning, think of Painter v. Huke. Making alterations to an offer, whether those alterations are initialed or not, destroys the power of acceptance. Returning the altered form to the offeror is a counter offer. Click here for a discussion of counter offers. Acceptance varying from the offer always creates the potential that a court will later rule no contract was ever formed.
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There is no such thing as “acknowledgment” of a contract from a legal point of view. Contracts are formed by offer and acceptance alone. That form contracts in Oregon contain an “acknowledgment” clause is a misunderstood accident of history – not a legal requirement. Only in Oregon has “acknowledgment” become intertwined with offer and acceptance.
Years ago, the Real Estate Agency, in a effort to force better recordkeeping, adopted a number of administrative rules dealing with offers. These rules, now codified in OAR 863-015-0135, demanded, among other things, that licensees give buyers copies of their offers as well as copies of the seller’s response to the offer even if the response is rejection. Click here for a copy of OAR 863-015-0135. Soon thereafter, real estate sale forms in Oregon began to include “acknowledgment” clauses.
The original idea of an acknowledgment clause was to create proof that real estate agents had provided the buyer with a copy of the seller’s response to the buyer’s offer as required by administrative rule. Acknowledgment was a matter of agent recordkeeping and had nothing whatever to do with formation of the contract. The acknowledgment clause was placed below the signatures of parties so as not to be confused with a term of the contract itself. That approach evidently was too simple because confusion is exactly what resulted.
Two major contract formation myths have grown up around the acknowledgment clause. The first, that there is no contract until the buyer signs the acknowledgment, is pure myth. The exact origin of the acknowledgement myth is lost in time but the most likely origin is a court case where a lawyer used the buyer acknowledgment signature not to prove a contract existed but to satisfy the more narrow requirements of the Statute of Frauds. Click here for a detailed discussion of the Statute of Frauds. Whatever the origin of the myth, there is no such thing as “acknowledgment” of acceptance in contract law.
The other major contract formation myth that has grown up around acknowledgment involves using acknowledgment as acceptance when a seller makes changes to an offer or “accepts” the offer after it has expired. Unlike the pure myth that acknowledgment is required to form a contract, the myth that acknowledgment can be used in place of acceptance has at least some legal traction. As we know from the discussion of acceptance, intent plays a large role in acceptance. It follows that an acknowledgment clause signed with the proper intent could be evidence of acceptance.
The problem with using an acknowledgment clause as evidence of acceptance is that such clauses typically contain no words of promise. Because of its recordkeeping origin, the Oregon acknowledgment clause, in its original form, simply said “Buyer acknowledges receipt of a copy of Seller’s written response to this Agreement.” Acknowledging receipt of a copy of response says nothing about the buyer agreeing to the contents of the response – just that they got a copy of the response, whatever it was. The acknowledgment clause, therefore, was as originally written poor evidence of acceptance of changes to an offer or late acceptance.
Notwithstanding the contract formation problems inherent in using acknowledgment to prove acceptance, the practice proved too convenient to forego. It became standard practice for agents to consider the buyer’s acknowledgment as evidence of their acceptance of alterations to the buyers’ offer or the seller’s late acceptance. By the time it was called into question by attorneys, the practice of using acknowledgment for the buyer’s acceptance when the seller “accepts” the offer after it has expired was so widespread that the acknowledgment clause was changed to accommodate the practice.
An unintended consequence of changing the acknowledgment clause to accommodate late acceptance by the seller has been to perpetuate confusion. The pure myth that acknowledgment is “required” before there is a real estate contract continues in the industry notwithstanding a complete absence of legal support. Now that the acknowledgement clause actually is used for acceptance in the case of expired offers, you can expect acknowledgment myths to survive well into the future.
Termination of Offers
Because an offer creates the power of acceptance in the offeree, termination of offers is an important subject. Offers can be terminated by the passage of time, death of the offeror or by rejection. Unless specifically made irrevocable, offers are revocable by the offeror any time prior to acceptance. Each of these means of termination of offers raises its own set of legal issues.
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Lapse of Time
The general rule is that an offer is deemed open for the time specified in the offer or, if no time is specified, for a reasonable time in the circumstance. Given the rule, lapse disputes take two forms. If a time is specified, lapse arguments typically revolve around how the specified time is to be counted. If no time is specified, the argument will be about what is a reasonable time for the offer to be open in these circumstances.
What is reasonable in the circumstances depends on a number of factors. Market dynamics are a big factor. How long a reasonable buyer will allow an offer to last is not the same as how long a reasonable seller will allow a counter offer to last. What is reasonable depends on the specific buyer or seller in the specific market seeking the specific property at the specific time. Basically, what a court wants to know is how long do these kinds of offers in this market typically last.
If an offer expires on a certain date, the question is whether the offer expires at a minute after midnight of the day before the date or at midnight on that date. If an offer allows a certain number of days for the seller to accept, the question is when the days allowed start to run. Is it the date the offer is made or date it is received? Once that is settled, disputes can arise over whether the offer ends at midnight on the last day or at the same time of day the offer was made or received. These same counting issues arise when the expiration is expressed in hours.
Because counting issues can cause so much confusion, most real estate forms express the offer deadline as a date and time of day. This manner of expressing the offer deadline eliminates counting disputes. An offer which expires on January 1, at 5 p.m. must be accepted (signed AND communicated) no later than 5 p.m. on that date. There are no “if ands or buts.” Holidays don’t matter. There are no excuses or conditions, period. Acceptance communicated at 5:01 p.m. on January 1 would be too late.
Because offers expire automatically if not timely accepted, late acceptance communicated to the offeror acts as a counter offer. For a contract to form, the original offeror must accept the “counter offer” and communicate that acceptance to the offeree. Typically, there is no place on form contracts for the offeror to accept the offeree’s late acceptance. For that reason, it has been the practice of Oregon real estate licensees to use the “acknowledgment” clause as “acceptance.” Eventually, standard forms were changed to accommodate the use. Click here for a detailed discussion of the acknowledgment issue.
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Death or Lack of Capacity
The power of acceptance is terminated if the offeror dies before the offeree can accept. This is the case whether the offeree knows of the offeror’s death or not. Do not confuse this rule with the performance of contracts. If one party to a contract already formed dies, the contract is typically binding on their heirs. But that is not the case if the offeror dies before the contract is formed. If the offeree dies before accepting an offer, the deceased’s heirs or representatives cannot accept the offer on the deceased’s behalf nor for their estate.
Incapacity, like death, can affect contract formation. As with death, the incapacity must arise after the offer is made but before it is accepted. For that to happen, there must basically be a legal judgment of insanity. That is a rare case. In cases where the issue of capacity is in doubt, most courts will hold in favor of formation of a contract unless the offeree knows of the offeror’s incapacity. As with death, the representatives of a person who lacks the capacity to contract cannot accept on that person’s behalf unless they have the specific written authority to do so, i.e., a power of attorney.
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Revocation is the manifestation of the intent not to enter into the contract proposed by an offer. A “manifestation” of intent can be oral or written or, as discussed shortly, even indirectly. Unless an offer is specifically made irrevocable, it can be revoked at anytime prior to acceptance.
Revocation is effective when received. This, of course, leads to endless argument about what it means to have “received” something. Legal texts dealing with the law of contracts define “received” as “when a writing comes into the possession of the person addressed, or of some person authorized by him to receive it for him, or when it is deposited in some place which he has authorized as the place for this or similar communications to be deposited for him.”
As you can see from the definition, “receipt” does not require that the writing come into the possession of the person to whom the revocation is addressed. Possession by the addressee is but one of three ways to have receipt. Typically, buyers and sellers deal through agents. So the question is whether agents are “authorized” to accept revocations. The answer is very simple: If they are authorized to receive offers and acceptances, they are authorized to receive revocations unless the principal specifically limits their authority.
If agents are authorized to receive revocations, revocations are effective when agents receive them. This is true whatever the means by which the revocation is communicated. Agents should, however, keep in mind that things done verbally can end up being worth about as much as the paper they are [not] written on. These two factors suggest that the best way to handle a revocation for a client is to call the other agent and tell them your client revokes and to check their fax machine because your clients’ written confirmation of the revocation should be printing out as we speak.
When you can’t reach the other agent, the third part of the definition of “receipt” (“when it is deposited in some place which he has authorized as the place for this or similar communications to be deposited for him”) comes into play. Notice that the third part of the definition of “receipt” includes deposit where “similar communications” are deposited. What is similar to a revocation? How about communications (offer, counter offer, acceptance, etc.) regarding formation of the contract? Basically, a revocation can be “deposited” any place the recipient has authorized the deposit of other communications regarding the formation of the contract. Typically, that is their real estate agent’s office.
How does one “deposit” something at a real estate office? Handing it to a person and getting a receipt is a best case scenario (easy to prove and very certain). Sending it to a person during business hours by a means of communication commonly used for that purpose is another way but can raise “I never got it” issues. Sending it to a fax machine after hours raises even more issues. Slipping something under the front door after hours is at the far end of the “deposit” spectrum (hard to prove and very uncertain).
A good way to think revocation is to analogize it to the deposit of money in a bank. When you go to the bank during banking hours and hand the money to a teller and get a receipt, you are very sure the money has been “deposited.” If you drop it in an ATM and get a receipt, that’s pretty good. Dropping it in a night deposit box designated for that purpose works but you won’t have a receipt. Shoving money under the front door after hours might work if it is discovered by an honest person but you wouldn’t want to bet on it. In short, revoking is pretty easy but you need to think about proof.
The ease (assuming adequate proof) with which an offer can be revoked is probably made most clear by the common law doctrine of indirect revocation. The doctrine originated in the 1876 English common law case of Dickerson v. Dodds. Dodds made an offer to sell his property to Dickerson. Before Dickerson could accept, Dodds made an offer to sell the property to Allan. Allan accepted. When Dickerson learned Allan had accepted, he quickly “accepted” the offer he had and sued Dodds. The court held the offer to Dickerson was indirectly revoked when Dickerson received reliable information that Allan had accepted.
The result in Dickerson v. Dodds upsets real estate agents and lawyers alike. How, they wonder, could the court find that the offer to Dickerson was revoked? If you think about it, however, you will see that the holding is a logical consequence of the idea that contracts are voluntary private agreements. Dickerson knew when he attempted to accept that the property was already sold to Allan. He, therefore, knew that Dodds did not want to sell to him. That is, he knew prior to his acceptance that Dodds had revoked his offer to sell by selling to someone else.
The result in Dodds should not give agents comfort. Creating multiple offers for the same property at the same time is so dangerous it calls into serious question the agent’s diligence. That a court might later, depending on the circumstances (remember Dickerson v. Dodds only worked for Dodds because Dickerson knew of Allan’s acceptance before he tried to accept), rule for one or the other of the offerees is irrelevant. A diligent real estate agent representing a seller will not depend on the vagaries of common law to protect their client.
Had Dodds been represented by a competent real estate licensee, two things would have happened. First, the agent would have made every effort to revoke using the best means available under the circumstances and understanding that revocation is valid only upon “receipt.” Click here for a detailed discussion of revocation. Second, the agent would have made the second offer contingent on revocation of the first. Revocation, as you can see from the discussion thus far, is simply too fact specific to take a chance with. If you do your best to revoke and then make the second offer contingent on the revocation of the first offer, you will never be responsible for your seller ending up with two deals.
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Rejection of an offer terminates the offer. You cannot reject an offer and then later accept it. The very same rule applies to counter offers. A counter offer revokes the original offer. Thus, a seller cannot counter the buyer’s offer seeking more money and, when the buyer rejects the counter, then turns around and accept the original offer. Similarly, a buyer may not counter a seller’s counter offer and, when their counter is rejected, try to go back to the seller’s counter offer. Notwithstanding these most basic rules of offer and acceptances, both buyers and sellers will sometimes try to counter and, when that goes nowhere, try to accept the original offer.
Counter offers can sometimes be confused for “grumbling assent” or “counter inquiry.” Grumbling assent is acceptance with some comment like: “I accept but still think the price is too high.” A counter inquiry is acceptance with a proposal for new terms. For instance: “I accept but would you consider less money?” A grumbling assent or counter inquiry is not a counter offer, it is acceptance. The key here is clear acceptance and a request or comment, not a demand or other statement that would call into question the willingness to proceed with the terms proposed in the offer.
This same issue of request versus demand is central to understanding the real estate myth that a contract, once formed, can be terminated if one party requests changes to the contract that are “rejected” by the other. Basically, there is no such thing as a counter-offer to a contract that has already formed. Once the contract has formed, subsequent requests for modifications that do not threaten non-performance are just that: requests. If rejected, nothing happens. Click here for a detailed discussion of the difference between modification requests and threats of non-performance.
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Statute of Frauds
There are few provisions of state law affecting real estate as misunderstood as the Statute of Frauds. The statute is just that: a statute. The statute is commonly thought to “require” certain contracts, including real estate sale agreements and listings, to be in writing. That is, unfortunately, far too simple and misleading an interpretation of the statute.
Certainly, real estate contracts should be in writing. REALTORS® have long demanded written agreements in all of their activities on behalf of clients through Article 9 of the Code of Ethics. That is just good business and diligent representation. The Statute of Frauds is not about good business. Instead, it is an arcane rule of evidence that can affect the outcome of disputes over contracts. With that basic understanding, we can turn to an examination of the statute itself and its impact on the real estate industry.
Statutory Provision Involved
ORS 41.580 Statute of Frauds Certain types of agreements are void unless the agreement, or some note or memorandum thereof, expressing the consideration, is in writing and subscribed by the party to be charged.
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Explanation of the Statute
The operative language of the Statute of Frauds in Oregon reads: “In the following cases the agreement is void unless it, or some note or memorandum thereof, expressing the consideration, is in writing and subscribed by the party to be charged, or by the lawfully authorized agent of the party; evidence, therefore, of the agreement shall not be received other than the writing, or secondary evidence of its contents in the cases prescribed by law.” Three of the eight types of contracts named in the statute involve real estate.
The three types of real estate contracts affected by the Statute of Frauds are: (1) An agreement leasing property for longer than one year, or for the sale of real property, or of any interest therein; (2) an agreement concerning real property made by an agent of the party sought to be charged unless the authority of the agent is in writing; and (3) an agreement authorizing or employing an agent or broker to sell or purchase real estate for a compensation or commission. In other words, leases longer than a year, sale agreements, powers of attorney, and listings all fall under the Statute of Frauds.
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Understanding the Statute of Frauds
It is important to notice first that the Statute of Frauds says absolutely nothing about the formation of contracts. The statute doesn’t address the enforceability of a contract directly. Instead, it establishes a rule of evidence for use in Oregon courts. The common understanding that the Statute of Frauds makes certain contracts that are not in writing “illegal” is simply wrong.
What the Statute of Frauds says in reality is that certain evidence cannot be admitted in court to prove the existence of particular kinds of agreements. Without the required evidence, the agreement is considered void. “Void” here means of no legal force or effect. So the Statute of Frauds says certain agreements will not be enforced (not that they don’t exist) unless the proper evidence is introduced in court. As you can see, that has nothing whatever to do with the contract itself.
Not only does the Statute of Frauds have nothing to do with the contract itself, it requires more than just that the “contract” be “in writing.” Indeed, the Statute doesn’t even mention “contracts.” Instead, it speaks in terms of an “agreement” or some “note” or “memorandum” of an agreement. This agreement or note or memorandum must “express” the consideration for the agreement and be “subscribed by the party to be bound.” “Subscribed” means signed at the end of a document.
A more accurate restatement of the Statute of Frauds, for real estate purposes, might be that an agreement for the sale of real property, lease for a year or more or a listing, or some note or memorandum regarding the sale, lease or listing, must be in writing, express the consideration and the person against whom you want to enforce the agreement must have signed at the end of the document. This restatement is important because it draws out a number of unintuitive aspects of the Statute.
First, the Statute of Frauds is asymmetrical. That is the case because the only signature necessary is the signature of the person against whom the agreement is being enforced. For instance, a seller who signed a sale agreement accepting an offer a buyer did not sign could not use the Statute of Frauds to defend against a suit by the buyer, but the seller could not enforce the contract against the buyer. This asymmetry makes possible the other important unintuitive aspect of the Statute of Frauds: you don’t really need a written contract at all.
As mentioned above, the Statute of Frauds talks about an “agreement or some note or memorandum thereof.” Suppose I drop my mother a note that says “I agreed to sell my house to Bill Smith for $250,000” and I sign the letter. Can Bill Smith use the letter to my mother as evidence of an agreement to sell my house? Yes, he can! Can I use the letter against Bill if he backs out of the deal? No, I cannot because he didn’t sign anything. How about using an addendum signed by both parties that references a sale agreement neither signed? Sure, either party could use it to satisfy the Statute of Frauds but that doesn’t mean there was actually a contract. Whether there was actually a contract in the first place is never a Statute of Frauds issue.
As you can see, the Statute of Frauds is not as straight-forward as commonly believed. Actually, the worse is yet to come. Because the Statute of Frauds is a rule of evidence, courts do not consider it a substantive provision of law that makes all agreements that fall within its preview void if they do not meet the requirements of the Statute. Instead, courts will consider whether there is other evidence of the existence of an agreement and if there is, and injustice would result from not enforcing the agreement, they will take the agreement “out of the Statute of Frauds.” This neat judicial trick makes it very unwise to rely on the Statute of Frauds to avoid a contract that actually existed.
A person who uses the Statute of Frauds to avoid a contract actually agreed to is committing a fraud himself. They are using a rule of evidence to avoid doing something they actually agreed to do. Courts do not like being party to such manipulation and will avoid it if they believe it to be happening. It is for this reason courts hold that a contract the terms of which have been partially performed, is “taken out of the Statute of Frauds.” Courts will also enforce an oral agreement notwithstanding the Statute of Frauds if there is other evidence there was a contract and one party relied on the contract to their detriment. In an ordinary real estate transaction or listing agreement, either or both of these factors will come into play almost immediately – which explains why such contracts are almost never successfully avoided using the Statute of Frauds.
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Earnest money is a critical part of real estate sales. The collection, retention and disbursement of earnest money is something every real estate agent must understand and deal with. The subject is fraught with peril for the unwary agent. Disputes between buyers and sellers over earnest money are common and brokers are often caught in the middle. The use of checks and promissory notes further complicate the handling of earnest money.
A number of state laws and rules dictate the handling of earnest money from initial collection to final disbursement. The rules are arcane, complicated and not altogether consistent. Practices have grown up in the industry which complicates the handling of earnest money even more. All these factors work together to make earnest money a complicated subject.
Statutory Provisions Involved
ORS 696.241 Clients’ Trust Accounts; notice to agency; authority to examine account; branch trust account; interest earnings on trust account; when broker entitled to earnest money; funds not subject to execution; rules.
ORS 696.241 is the state statute that controls broker client trust accounts. As such, it implicates the collection, holding and disbursement of earnest money. Under ORS 696.242(1), each principal real estate broker must maintain in the state a clients’ trust account in which all trust funds received from clients must be deposited, unless the parties agree in writing to place the funds directly in escrow. If the parties do agree to place the funds directly into escrow, the licensed escrow must be in Oregon.
It is not hard to see the impact of ORS 696.241 on earnest money practices. The law demands deposit of earnest money received or handled by a real estate licensee in a clients’ trust account or, with the written agreement of the parties, into a licensed neutral escrow depository. There are no other choices. The statutory requirement immediately raises the issue of how long an agent can hold funds before they must be deposited as required under the statute. It also raises the issue of whether it is “better” to put earnest money into a client trust account or directly into escrow.
Whether to place earnest money directly into escrow is a business issue discussed in the Understanding Earnest Money section of this subject. The time an agent can hold earnest money is handled by administrative rule and is discussed in the Administrative Rules Affecting Earnest Money section of this subject. These holding rules depend upon the form of the earnest money: for instance, earnest money in the form of a check or a promissory note or cash.
Whatever the form of the earnest money, the single biggest issue with earnest money is always who gets it when the deal fails. This issue has plagued real estate brokers for years. It is for that reason that ORS 696.241 was amended by the Legislature in 2005 to require that the Real Estate Agency establish a procedure for the disbursal of disputed funds held in client trust accounts. See ORS 696.241(10).
According to the statute, the administrative rule must allow for disbursal to the person who gave the broker the money within 20 days of a request for disbursal. The disbursal, however, does not affect entitlement to the money. In effect, the Legislature directed the Real Estate Agency to develop a procedure by which brokers could move disputed earnest money out of their client trust accounts in an expedited manner. The Real Estate Agency responded with OAR 863-015-0186, an administrative rule to accomplish the legislative mandate. The rule is discussed in depth in the Administrative Rules Affecting Earnest Money section of this subject.
ORS 696.243 Substituting copy for original canceled check allowed; electronic fund transfers.
ORS 696.243 is a relatively new provision of real estate law made necessary by modern electronic banking practices. Under the statute, real estate agents who are required to maintain canceled checks used to disburse money from a licensee’s clients’ trust account may substitute a copy of the original canceled check with an optical image or other process that accurately reproduces the original or forms a durable medium for reproducing the original. In addition, brokers and property managers may use electronic fund transfers for the deposit into or for withdrawal from a clients’ trust account established under ORS 696.241. The statute was thought necessary to authorize modern banking practices and has no substantive effect on earnest money rules.
ORS 696.581 Written escrow instructions or agreement required; statement; instructions containing blank prohibited; one-sided escrow.
ORS 696.581 is the state law under which escrow is opened and closed. Two provisions of the law affect earnest money. According to the statute, an escrow agent may not accept funds in any escrow transaction without dated, written escrow instructions from the principals to the transaction or a dated executed agreement in writing between the principals to the transaction. Typically, escrow is opened on a dated executed agreement in writing in the form of a sale agreement. It is for this reason that how earnest money is to be handled, if it is to go to escrow, must be detailed in the sale agreement itself.
The second way ORS 696.581 affects earnest money is in its disbursal. An escrow agent may not close an escrow or disburse any funds or property in an escrow without obtaining “dated, separate escrow instructions in writing from the principals to the transaction.” This provision effectively traps earnest money in escrow if there is a dispute. That is the case because escrow can release the earnest money only if the parties separately agree to that result, unless earnest money is to be released pursuant to a court order.
Because ORS 696.581 requires “separate” signed written instructions, there is no way to have an a priori agreement regarding the disbursal of earnest money. Thus, a provision in a sale agreement that dictates who will receive the earnest money under what circumstances is ineffective if the parties to that agreement refuse to sign separate disbursal instructions in escrow.
The effect of ORS 696.581 is seen in commonly used termination agreement forms. A significant part of such agreements are the escrow cancellation and disbursement instructions. On the form, the parties agree to the disbursal of the earnest money. Notwithstanding agreement to disburse the funds, the parties also “mutually agree to sign any further documentation, including a release of Escrow for making the above disbursement reasonably required by the Principal Broker or Escrow.”
One of the “further documents” is the separate instructions required by ORS 696.581. Thus, the release of earnest money from escrow remains in doubt even after the parties have signed a termination agreement. These matters are discussed further in the Understanding Earnest Money section of this subject.
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Administrative Rules Affecting Earnest Money
OAR 863-015-0135 Offers to Purchase.
OAR 863-015-0135 is the administrative rule the Real Estate Agency has developed to dictate how real estate licensees will handle offers to purchase. Among the provisions of the rule, is language dealing with earnest money. Under OAR 863-015-0135(5), the type of earnest money, whether in the form of cash, a check or promissory note must be stated in the “document serving as the earnest money receipt.”
In the old days, buyers were given a separate “earnest money receipt.” Over time, these “receipts” became part of “earnest money agreements.” Today, the “document serving as the earnest money receipt” is the sale agreement form. The requirement contained in OAR 863-915-0135(6) is incorporated into the sale agreement in the form of a “receipt for earnest money” clause.
Further, OAR 863-015-0135(7) requires that if a promissory note is used for earnest money, “a licensee must make the note payable upon the seller’s acceptance of the offer or payable within a stated time after the seller’s acceptance.” This requirement is based on the legal requirement that promissory notes must be due at a “time certain.” Making a note “due on closing” violates the rule because “closing” is not certain to happen. There are endless variations on the contingent due date theme. This and other problems associated with the use of promissory notes are covered in the Understanding Earnest Money section of this subject.
The Real Estate Agency has also seen fit to admonish licensees in OAR 863-015-0135(7) that “absent a written agreement to the contrary, the note must be made payable to the seller” This advise is based on the fact that a note can be enforced only by its “holder.” The holder of the note is the person the note is made out to or the person a previous holder has transferred the note to.
OAR 863-015-0135(7) says the seller is ordinarily the holder of a note for earnest money. The “in the absence of a written agreement to the contrary” language accommodates an industry tradition of having the note made out to the broker. This tradition is facilitated in commonly used note forms. The utility and wisdom of this practice is discussed in the Understanding Earnest Money section of this subject.
OAR 863-015-0186 Clients’ Trust Accounts — Disbursal of Disputed Funds.
OAR 863-015-0186 is a provision of real estate law concerning disbursal of disputed funds held in a client trust account. The rule is a direct response to the problem of earnest money being held hostage by the seller when a buyer backs out of a transaction. Prior to enactment of this rule, brokers were often dragged into nasty disputes between buyers and sellers over who was entitled to the earnest money when a deal failed. Such questions are legal questions and, therefore, beyond the expertise of a real estate broker. OAR 863-015-0186 acknowledges this reality and forces the parties to either settle their differences by mutual agreement or initiate legal action within a short period of time after a dispute arises.
Under OAR 863-015-0186, a real estate broker may disburse disputed funds (typically earnest money) held in their client trust account simply by giving notice to both parties and waiting twenty (20) days before returning the money to the buyer. “Disputed funds” are funds delivered to the broker pursuant to a written contract and the parties dispute entitlement under that contract. Disbursal under the rules is completely discretionary with the broker who remains free to hold or disburse the funds as they might have before OAR 863-015-0186 was enacted.
In order to use the new rules, the broker must, as soon as practicable after receipt of a demand for the disbursal of disputed funds, deliver written notice to all parties that a demand has been made and that such funds may be disbursed to the party who delivered the funds to the broker within 20 calendar days of the date of the demand. The form of the notice to be given is set out in the rule and must include a warning that the broker has no authority to resolve the dispute and that the funds will be disbursed unless the parties reach agreement or initiate legal action within 20 days of the date of demand. Both parties must be warned to seek legal advice. Oregon Real Estate Forms publishes a form for brokers to use.
Dispersal of earnest money under this rule does not affect anyone’s legal claim to the money. There is no requirement that brokers use this procedure but if they do, their responsibility for the earnest money is ended. The rule applies only to disputed funds and does not prevent disbursement of funds in other situations or prevent brokers from handling disputes in other lawful ways, including filing an interpleader action. The provision is simply a way to prevent disputed earnest money from being held hostage in broker client trust accounts.
OAR 863-015-0255 Records: Client Trust Account Requirements.
OAR 863-015-0255 is the Real Estate Agency’s records rule. Records include records for the broker’s client trust account. Because earnest money often ends up in a client trust account, many of the provisions of the rule affect the handling of earnest money. Earnest money ends up in client trust accounts because under OAR 863-015-0255(3) a real estate agent must transmit to their principal real estate broker any money, checks, drafts, warrants, promissory notes or other consideration that comes into their possession. Once money is in the principal broker’s possession, ORS 696.241 forces the principal broker to put it in the client trust account unless provisions have been made for direct deposit to escrow.
Earnest money can be deposited directly to escrow only if the office has a written company policy to that effect, or the parties agree in writing to that result. Almost all brokers have written company policies allowing direct deposit in escrow. Standard contract forms universally contain provisions for deposit directly to escrow. It is, therefore, common in Oregon for earnest money to be deposited directly in escrow. Indeed, it is believed that less than half of all brokerages even have client trust accounts. Trust account or not, the real estate broker is still required to track the earnest money deposit from the buyer to the escrow depository.
When earnest money is not directly deposited in escrow, holding onto the money becomes an issue under OAR 863-015-0255. If a check is used as earnest money, the real estate broker may hold the check until the offer is accepted or rejected if the sale agreement used allows that and states where and when the check will be deposited upon acceptance of the offer. Form contracts in common use in Oregon contain the necessary language for holding earnest money checks until acceptance. However, once there is acceptance, the check must be deposited into a clients trust account or escrow “before the close of the third banking day following acceptance of the offer or a susequent counter offer”
If a promissory note is used for earnest money, the broker must record and track the transfer of the note by a ledger account or by other means including, but not limited to, written proof of transmittal or receipt retained in the real estate broker’s offer or transaction file. The use of promissory notes for earnest money is now the most common way earnest money is handled in Oregon. That practice is not without its difficulties, many of which are discussed in Understanding Earnest Money.
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Understanding Earnest Money
Earnest money has been part of real estate sales for longer than anyone can remember. It is, therefore, surprising how poorly earnest money is understood in real estate today. For years, it was common to hear that a contract for the sale of real property was “illegal” or “void” unless the buyer paid earnest money at the time of contract. It was thought that without earnest money there was no consideration to support the contract. It is simply not true as a matter of contract law that a contract for the sale of real property must have earnest money to be valid or enforceable.
The origin of the “must have earnest money at the time of offer to be valid” myth is lost in time. There are, however, some clues that may point to the origin of the myth. Historically, (we are talking 19th century here) in the commercial sale of goods, the part payment of the purchase price, or delivery of part of the goods, was taken as evidence or ratification of the sale. This part payment or delivery was called “earnest” or “earnest money.” Earnest was a convenient and speedy way to evidence agreement in a sale of goods made by A verbal offer to sell, standard order form or handshake.
Prior to the wide availability of lender financing after World War II, most real estate was purchased on a financing contract with the seller. Seller finance contracts were essentially installment contracts where the seller retained title until, and unless, the buyer made all the payments. The negotiation and drafting of such installment contracts made purchasing property uncertain because it took time to work out the details (it still does and modern real estate contracts now contain express seller financing or land sale contract clauses). During the time a land sale contract was being worked out, the buyer had no real claim to the property. “Earnest money agreements” were an early solution to this problem borrowed from the tradition of “earnest” in the commercial sale of goods.
Early earnest money agreements were essentially offers to make a contract. They were more like a modern letter of intent, where the parties agree they will make a contract in the future than a modern contract for the sale of real property. Pre-WWII, earnest money agreements were not bilateral contracts for the sale of the property and, therefore, (like a modern letter of intent) not enforceable unless backed by some consideration. The necessary consideration was the “earnest money” pledged and receipted for in the earnest money agreement. It was paid at the time the earnest money agreement was offered so that, if accepted, the agreement to form a contract would be backed by consideration.
It is easy, given this history, to see how earnest money became tied to consideration for the contract. As “earnest money agreements” morphed over time into true bilateral contracts, the need for earnest money as consideration disappeared. Earnest money itself, of course, did not. The reason it did not disappear can be seen in the modern legal definition of “earnest money: A sum of money paid by the buyer at the time of entering into a contract to indicate the intention and ability of the buyer to carry out the contract.”
Put simply, earnest money is used by buyers today to show sellers they are serious. Signaling to sellers that the buyer is serious about carrying out the purchase is a felt business need on both sides of a real estate contract. This, and the vagaries of contract law, explains the survival of the practice of the buyer pledging earnest money in a contract for the sale of real property. It does not, however, explain the manner in which earnest money is handled in the real estate industry today.
The administrative rules promulgated by the Real Estate Agency assume collection of earnest money, in one form or another, by the licensee writing the offer prior to the offer being presented to the seller. Click here to view the applicable administrative rules. Until the advent of buyer agency in the late 1980s, earnest money was collected from the buyer by the seller’s agent. This, in effect, transferred the money from the control of the buyer to control of the seller.
The transfer of control of earnest money to the seller’s agents was not completely consistent with the intent and ability purpose of earnest money. It was, however, completely consistent with the sales industry idea that earnest money should be available to compensate the seller for taking the property off the market, making repairs and otherwise changing position in reliance on the buyer’s intent to purchase. It is this dual purpose – evidence of ability and intent, and source of compensation if the deal fails – that complicates the way earnest money is handled.
In order for this seller compensation purpose to work, the money had to be placed out of the control of the buyer so it was available if the seller became entitled to it. At the same time, earnest money had to be out of the control of the seller so it could be returned to the buyer if the transaction failed through no fault of the buyer. Two solutions to this dilemma quickly evolved. One was for the seller’s agent, or subagent, to place the money in a client trust account opened and operated by the broker. The other was to place the money in escrow as soon as escrow was opened on the contract. Both methods placed the earnest money out of the unilateral control of either party.
Initially, almost all earnest money was kept in broker client trust accounts. This was an extremely efficient way to handle earnest money. There were, however, problems. One problem was what to do about agents holding the money while they waited to see if the seller would accept. Another was the broker getting caught in the middle of a dispute over the earnest money if the deal later failed. The first problem was solved by administrative rules detailing how various forms of earnest money were to be handled. Click here to view the applicable administrative rule. The second problem was papered over for years but never resolved.
The idea that earnest money should compensate the seller if the buyer failed to perform transformed earnest money from a positive indication of financial wherewithal to an a priori measure of damages. Rather than simply an indication of intent and ability to perform, earnest money became the source of funds to pay damages if the deal failed. The shift from a source of confidence in the buyer’s financial position to the source of funds to pay damages is subtle but critical to understanding the modern use of earnest money.
Using earnest money as an a priori measure of damages raises the legal issue of “liquidated damages.” Liquidated damages are the sum a party agrees to pay if the party breaches a contract. Liquidated damages must be a good faith estimate of the actual damages anticipated by a breach. They must be reasonable in light of the anticipated or actual harm caused by the breach. If liquidated damages are set too high, that is if they are unreasonable, they risk being declared a penalty and are not enforceable.
There is no bright line between a reasonable estimate of damages and a penalty. There is a famous Oregon court case where a forfeiture of $50,000 in earnest money on a $500,000 purchase is considered a penalty and not enforced. On the other hand, $5,000 forfeitures on $500,000 properties are routine and rarely contested as penalty. Somewhere between these extremes is the line between reasonable estimate and penalty.
Wherever the line between estimate and penalty may exist, forfeit of earnest money is rarely a simple matter. Although often missed by sellers (and sometimes their agents) the seller has no right to earnest money other than as specified in the contract. There is no general rule that the seller gets the earnest money if the buyer doesn’t perform. Instead, the seller gets the earnest money if the contract pledges the money to the seller under certain circumstances and those circumstances are proved to have occurred.
The circumstances under which a seller may claim earnest money under a real estate contract vary with the contract. It is, therefore, necessary to read the contract to determine the legitimacy of a particular claim to legal entitlement to the money. Reading contracts to determine the validity of a legal claim is the practice of law. Real estate licensees cannot practice law. It is never a good idea for a real estate licensee to advise a buyer or a seller on entitlement to disputed earnest money.
Most earnest money disputes fall within the $10,000 or less jurisdictional limit for small claims court actions. The sale forms used in Oregon direct claims within the jurisdiction of small claims courts to the small claims court exclusively. Given that most earnest money is now held in escrow where it cannot be released without separate signed instructions from either parties, most earnest money disputes end being resolved by one side or the other simply giving up, or the parties reaching some compromise or a small claims trial.
Small claims courts are county courts, making earnest money disputes strictly local matters. Attorneys are not allowed in small claims court. Filing a small claims action is not free but it is not expensive either. Each county has a separate small claims department but the process is standardized across the state. Most counties now have websites that explain the process and even provide copies of the necessary forms.
Earnest money disputes most often involve disagreements over failed contingencies. Disputes arise, for instance, when the seller believes the buyer has not used the inspection contingency correctly, or when the deal fails at the last minute due to financing. Often, these disputes involve serious misunderstandings of the law or assumptions regarding buyer or seller motivation. The inability of real estate licensees to give legal advice makes it extremely foolish for an agent to offer any opinion regarding the likely outcome of a small claims action over earnest money.
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“Addendum” has no special legal meaning. If you look the word up in a legal dictionary, it will say the same thing it does in a regular English dictionary. An addendum is “something added.” That’s it! An addendum is something added to something.
Because the word “addendum” has no special legal meaning, the legal effect of a document entitled “addendum” will depend on the context in which the document is used, not what it is called. This simple concept causes no end of trouble in real estate transactions. Addendums, and addendum forms, are used for all kinds of different purposes in real estate transactions. It is the confusion among those purposes that causes trouble.
Addendums are attached to offers and to counter offers as well as to contracts that have already been formed. Addendums are used to give notice, make disclosures, communicate waivers and even just to make a request of the other party. There are special purpose addendums like the lead-based paint addendum. Addendums are also used to create special contingencies for financing, title inspections and more.
Formation Addendums are used to add additional terms to an offer or counter offer. Addendums used to create special contingencies or otherwise modify the terms of existing agreements are Mutual Agreement Addendums. Agents will often use an addendum form to make disclosures, give notice or make waiver statements. Such Single Party Addendums can cause significant confusion if they are mistaken for formation or mutual agreement addendums. Finally, there has arisen in recent years broker-generated addendums, Disclosure Addendums or Do Nothing Addendums, that make various general disclosures about real estate without having anything to do with the transaction to which they are attached.
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If you look at a standard addendum form, you will usually see checkboxes across the top where the person using the form can indicate what the addendum is being added to. Typically, the checkbox choices are: real estate sale agreement; the seller’s counter offer; and the buyer’s counter offer. Whatever the exact choices, addendum forms always contain separate signature blocks for both buyer and seller.
In real estate, a “sale agreement” is just the buyer’s offer until it is signed by the seller. The same goes for the seller’s or buyer’s counter offer: they are just offers until signed by the other party. An offer or counter offer becomes a contract upon acceptance. Acceptance and, therefore, formation of the contract happen when the offeree signs the offer and dispatches it to the offeror. Click here for a detailed discussion of acceptance. Adding addendums to offers, especially addendums with signature blocks of their own, can cause serious problems if not handled properly.
Formation addendums are really additional terms to an offer proposed by one party. Say, for instance, the buyer wants their offer to be contingent on a due diligence period during which they will perform certain inspections. The contingency they want is too complicated to be written into the “additional provisions” clause of their offer, so they attach an inspection addendum form to their offer. Now there are four signature blocks on the offer – two on the sale agreement form and two on the addendum.
Hopefully, the buyer signs both the sale agreement signature block and the addendum signature block when they use an addendum form to add terms to their offer. Hopefully, the same is true of the seller but the truth is, the seller has the opportunity to sign only the offer, only the addendum or, as they should, both. Human nature being what it is, each of the three options actually happen in real estate transactions.
Only when both parties sign both documents is there no problem. Any other variation will result in formation problems. If the buyer fails to sign the addendum, questions are raised about whether the addendum was a term of the offer. Clearly, if transmitted at the same time as the offer itself, it is intended as part of the offer. What then when the seller accepts the sale agreement form without signing the addendum? Is the result different if the seller signs only the addendum?
We know contract formation is about mutual assessment and mutual assessment is about intent. Click here for a detailed discussion of contract formation. We also know that writings and signatures are required by the Statute of Frauds, but that the Statute is asymmetrical, riddled with exceptions and has nothing to do with whether a contract exists or not. Click here for a detailed discussion of the Statute of Frauds. Thus, a contract formed with addendums that is not signed by all parties create complicated legal issues of intent and application of the Statute of Frauds.
So unpredictable are cases concerning intent to form a contract and the Statute of Frauds that about all that can be said is that real estate licensees must do everything they can to avoid such situations. If mistakes are made, do not be quick to believe they can be used to advantage to get out of a contract or avoid a term the other side believes has already been agreed to. Do not be quick to jump to the conclusion that you have an enforceable contract either. If the proper signature cannot be gained, it is time to advise your clients to seek the advice of a lawyer.
Formation addendum problems can arise at any stage of the contract formation process. A particularly common place for problems, however, is the buyer’s counter to the seller’s counter. It is tempting at this point for a seller who wants to make changes to the buyer’s counter offer to “accept” the counter offer and attach to it an addendum with the desired changes. This manner of doing business creates real confusion because the seller intends another counter offer, but the paper work looks like acceptance coupled with a separate request for a mutual agreement addendum.
The solution to formation problems stemming from the use of standard addendum forms is diligence. Be aware of the use intended when using addendum forms and make sure that use is clearly communicated to the other party. Make certain the needed signatures are obtained on both sides. Do not be quick to declare terms included or contracts “dead.” If a disagreement over the meaning of addendums used during the formation of a contract cannot be resolved by the parties, it is time to advise legal consultation.
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Mutual Agreement Addendums
Mutual agreement addendums are used to modify existing agreements. Unfortunately, the same form with the same three checkboxes is used as is used to make an addendum to an offer or counter offer. The potential confusion is exacerbated by the practice of using the name “sale agreement” for both the buyer’s offer and the resulting contract once there is acceptance. Basically, rather than agreements to modify and additional terms forms, one “addendum” form is used for both uses.
Because the use is not clear from the content of the form, only the context in which the form is used tells you what it is. When used to make modifications to an existing contract, mutual agreement addendums do not normally affect the formation, validity or enforceability of the underlying contract. Typically, mutual agreement addendums propose a modification that may be accepted or rejected by the other party without calling into question the existing agreement between the parties.
Like everything else in law, there are exceptions to the general rule that requests for modification of an existing contract has no affect on the contract itself. When it comes to modifications of existing contracts, the exception that is implicated is created by the doctrine of repudiation. Repudiation is a positive statement refusing to perform an otherwise binding agreement. Repudiation raises the issues of anticipatory breach of contract. Click here for a detailed discussion of anticipatory breach issues.
Under the doctrine of anticipatory breach, a positive statement of intent not to perform a contract can sometimes be considered a material breach excusing the other party’s duty to perform the contract. This arcane legal doctrine is probably at the bottom of one of the most ill-founded and long-running real estate myths ever to appear. That myth is that a request for repairs made through a mutual agreement addendum is somehow a “counter offer” which, if the seller “rejects,” ends the transaction.
An addendum to an already formed contract, requesting repairs or anything else, is not going to affect the underlying contract except under the most unusual of circumstances. Instead, a mutual agreement addendum is simply a request to modify the terms of the contract. The other party to such a request is, of course, free to reject the request. They can counter with different or additional terms; all without having any affect upon the existing agreement. In that sense, but only in that sense, it is like offer and acceptance. What you are looking for is a meeting of the minds – not on the contract – but on the modification itself.
Because proposing changes to an existing contract is like offer and acceptance, all the problems associated with offer and acceptance apply. Click here for a detailed explanation of contract formation. So, for instance, if the buyer sends the seller an addendum proposing new terms and the seller accepts the addendum by signing it, but also crosses out one of the terms, you have acceptance varying the terms of an offer or a counter offer. Single signature problems, grumbling assent and all the rest of the problems that can arise in offer and acceptance can arise in mutual agreement addendums.
The key, as with formation addendums, is to always understand the context in which an addendum form is being used. Here, that context is a request for modification. Don’t think generically: “addendum.” Think contextually: additional terms to offer or modification request. In that way, many of the problems associated with the use of generic “addendum” forms can be avoided.
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Single Party Addendums
Single party addendums are statements, disclosures, waivers, notices and the like that are associated with a real estate deal. Strictly speaking, sure things are not “added” to an offer or a contract or anything else. They are stand alone additional documents exchanged between the parties during a transaction.
Take a document used to give notice for instance. “Notice” is simply a statement informing someone of a fact. Notice does not require agreement of any kind. Notice is given because one party has a right to some information and the other the duty to communicate it. A document used to give notice is, for that reason, an example of a single party document.
Using standard addendum forms to communicate single party statements, disclosures, waivers, or notices can cause confusion. Because addendum forms are intended to add terms to offers or modify existing contracts, they contain agreement language and signature blocks for both parties. It is, therefore, not uncommon to see one party try to “reject” the other party’s notice or disclosure or for agents to run around after the deal has closed trying to get additional signatures on documents that require only one signature.
Using mutual agreement forms in single party situations is common when deals go bad. For instance, a buyer or seller who wants to terminate a transaction because a contingency has failed or the other party has not performed will often use a mutual agreement addendum in the form of a termination agreement to accomplish their end. When the other side rejects the addendum, the whole deal goes into limbo casting doubt on the disbursement of the earnest money and the marketability of the property. Click here for a detailed discussion of contract termination issues.
The key to avoiding confusion in the use of single party addendums is to always ask whether what is being communicated requires the other party’s agreement. A disclosure, for instance, is just a form of notice. It, therefore, does not require agreement signature blocks. That is not to say that it might not be a good idea to have a way for the other side to acknowledge receipt, just that there is no need for agreement to disclosures. This problem is discussed more fully in the next section of this subject when dealing with Disclosure Addendums or Do Nothing Addendums.
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Disclosure Addendums or Do Nothing Addendums
Disclosure addendums are a relatively recent development in the real estate industry. For years, real estate agents have used their client’s contract as a risk management vehicle for themselves. For instance, most real estate sale forms contain clauses in which the parties waive reliance on the statements of the agents. Sales forms often contain warnings of legal consequences – for instance: “Buyer’s election to waive the right of inspection is solely the Buyer’s decision and at the Buyer’s own risk.” Acknowledgement of legal rights, like the seller’s obligation to make a property disclosure and the buyer’s right to revoke their offer under state property disclosure statutes, are common as well.
Such warnings, waivers, disclosures and statements of consequences are thought to protect the agents from both misrepresentation and lack of diligence claims by buyers and sellers. For example, requiring the parties to acknowledge their rights and obligations under the state property disclosure laws is thought to protect agents who fail to explain these rights and obligations to their clients. Statements of consequences, on the other hand, are thought to undermine the client’s reliance on the diligence of their agent. Waivers are similarly aimed at the reasonableness of the client’s reliance on the statements, or lack of statements, by the agent. Such form contract tactics are common in sales industries where the transaction is conducted on forms provided by the salesperson.
Disclosure addendums are a natural extension of the use of the client’s contract for the agent’s risk management. As the number of potential problems in real estate sales has increased to include everything from the type of siding to the type of smoke alarms, brokers have responded with their own homemade addendums chock full of warnings, disclosures, consequence statements, waivers and the like. Some of these addendums run to several pages. It is not uncommon today to see competing multi-page addendums from both brokers appended to deals and signed by all parties.
Disclosure addendums, because they are attached to all transactions, have no real bearing on the specific transaction to which they are attached. Although universally presented as mutual agreement addendums, they are in fact single party addendums. That is the case because they do not propose additional substantive terms or seek to modify the parties’ agreement. Disclosure addendums, because they contain only general statements applicable to all property, rather than statements specific to the property actually purchased, have no real affect on agent liability.
Agent liability in a real estate transaction flows either from misrepresenting the property or failing to protect the client’s interests. A general statement, for instance, that houses can sometimes contain mold that may be harmful to humans, says nothing about the condition of any specific property. An agent who misses telltale signs of mold while showing a house, or fails to disclose that the seller had mold cleaned and painted over, will not be helped by a general warning to buyers about mold contained in a Disclosure Addendum. Their liability, with or without the addendum, will be based on what they knew or should have known about this particular piece of property.
The effect (actually lack of effect) of Disclosure Addendums on professional malpractice claims is even worse. Diligence is about using training and knowledge to protect and advance the client’s interest. An addendum warning generally about mold and siding and smoke alarms and asbestos and radon and oil tanks and wells and insulation and so on serves to warn the agents as much as it serves to warn the buyer or seller. If the buyer should be unfortunate enough to purchase a home infested with mold or having “illegal alarms” or defective siding, or asbestos or any thing warned of in the Disclosure Addendum, the agents will have to explain what steps they took, given the potential risk cited in the addendum (e.g., suggested inspections, reported of similar incidents in the area, were diligent in listing the property, called the buyer’s attention to “red flags” during showing, etc.).
As if the effectiveness, or lack thereof, and even the danger to agents created by Disclosure Addendums were not enough, they also can create problems in formation of the contract. Buyers are often, as they should be, reluctant to sign Disclosure Addendums. Deals may then flounder, not on terms of the transaction proposed for the benefit of the buyer or seller, but on those proposed for the benefit of the agents.
There is little the individual agent can do about Disclosure Addendums. The practice is well established and brokers are often willing to forgo transactions if a buyer is unwilling to sign the company’s addendum. Although Disclosure Addendums are usually legally ineffective, a real estate licensee cannot offer an opinion on their legal effectiveness without risking the unlicensed practice of law. For that reason, most agents just present the things with a vague explanation that the other company “requires” the addendum.
Hopefully, Disclosure Addendums will become a thing of the past as the industry matures into a professional services industry and leaves its “sales” origin behind. In a professional services industry, client risk management is done between the professional and their client in private and is never made part of the client’s business with third- parties. Providing general information and even warnings to one’s own client in private is common in the provision of professional services.
Eventually, buyer and seller advisories, client information letters, engagement letters, diligence checklists and the like will be developed to manage client risk. Disclosure will then return to being deal specific. In the meantime, about all an agent can do is be aware that Disclosure Addendums are not good risk management tools because they are ineffective, have the potential to increase agent risk, and may interfere with bringing the parties together.
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Multiple offer situations arise when two or more buyers make (or express an interest in making) an offer to purchase the same property at the same time. Multiple offers create a serious risk management problem. For that reason, a thorough understanding of contracts and agency relationships is necessary. If you have not done so recently, please review the Understanding Contracts section of this Topic. A review of the Agency Relationship section of Working With Clients is also advisable.
The existence of multiple offers does not change license law, contract law, agency law or the REALTOR® Code of Ethics. Contrary to popular belief, there are no “special” rules about multiple offers. That is not to say multiple offers do not present unique license law, contract law, agency law and ethical issues. Multiple offers present all these issues and more.
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Statutory Provisions Affecting Multiple Offers
Statutory Provisions Involved
Oregon Revised Statute 696.800 Agent’s Obligations – Definitions
Oregon Revised Statute 696.805 Real estate licensee as seller’s agent; obligations
Oregon Revised Statute 696.810 Real estate licensee as buyer’s agent; obligations
Oregon Revised Statute 696.815 Representation of both buyer and seller; obligations
Explanation of Statutes Involved
The statutes most affecting multiple offers are those that establish the agent’s duties to the parties to the transaction. The statutes set out duties owed not just to clients but to other principals and agents involved in a transaction. Click here for a detailed discussion of statutory agency duties.
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Administrative Rules Affecting Multiple Offers
Oregon Administrative Rule 863-015-0135 Offers to Purchase
Oregon Administrative Rule 863-015-0200 Agency Relationships
Oregon Administrative Rule 863-015-0205 Disclosed Limited Agency
Explanation of Administrative Rules Involved
Administrative Rules concerned with agency relationships and disclosed limited agency flesh out the statutory duties but add no additional requirements. The Administrative Rules concerning offers, however, do impose additional requirements on licensees. In particular, the Rules demand prompt tender of all offers and a written record of the date and time of the tender as well as the date and time of any response.
The duty to include all the terms and conditions in the offer can also come into play in a multiple offer situation. In multiple offer situations, there is a tendency for the agents to discuss how things will or should be handled. When those discussions cross the line into points of agreement affecting an offer, the agreed-to terms or procedures must be included in the offer itself. Click here for a detailed discussion of offers.
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Multiple Offers and Single Agency
Representing the Seller Only
If you represent only the seller in a multiple offer situation, your primary duties to the seller are loyalty, confidentiality and due diligence. Your duties to the buyers involved are honesty, disclosure and fair dealing. Simply put, you must place your client’s interest first and protect and advance those interests to the fullest extent possible considering your legal duties to other parties.
Listing agents tend to see multiple offer situations as dangerous situations that place the agent in a conflict situation. They worry that the obligations of loyalty, confidentiality and due diligence owed the seller will conflict with the duties of honesty, disclosure and fair dealing owed to other parties. Fortunately, that is not really the case. In multiple offer situations, the seller’s agent can meet most of their legal obligations by simply presenting all offers in a timely manner, recording the date and time of the presentation and making certain all the terms of the agreement are in writing.
The seller’s interest in obtaining the best price for the property does not conflict with the duty to present all written offers. Every buyer wants the seller to see their best offer and the seller wants to see every offer. There is no conflict. Nor is there any conflict between the duty to deal honestly and in good faith and the seller’s desire for the best price as long as no one is deceived or cut out of the transaction without business justification.
In every multiple offer situation there are going to be one or more buyers who don’t get the property. There is nothing the listing agent can do about that. What the listing agent can do something about is making certain they can prove they met their duties to the seller without violating any duty owed to the buyer.
The listing agent in a single agency multiple offer situation needs to think about how they can show anyone who may be interested (a Real Estate Agency investigator, a lawyer for one of the disappointed buyers or their own client) that they fulfilled their legal duties when dealing with the offers. To their own client, that means proving loyalty, confidentiality and due diligence. To the buyers involved, that means proving honesty, disclosure and fair dealing.
Loyalty and confidentiality to the seller are no different in multiple offer situations than they are in any offer situation. Diligence to the seller means developing a business strategy that results in turning multiple offers into a closed transaction that is satisfactory to the seller. That’s it. That’s the whole deal as far as the seller is concerned. The seller doesn’t want to leave money on the table or lose a good offer while trying to get more. Tips and tools for listing agents to accomplish that (and prove they did) are included in the Handling Multiple Offers section of this Topic.
The disclosure, honesty and fair dealing obligations the listing agent owes to buyers can be overwhelming in multiple offer situations unless the listing agent has a procedure in place and follows that procedure. It is tempting for the seller to play one buyer off against the others in a multiple offer situation. This can take the form of “shopping” the best offer or secretly encouraging low bidders to “strengthen” their offer while the seller sits on the best offer or presenting offers in a way that favors one buyer.
None of the procedures just mentioned are actually in the seller’s interest and each puts the listing agent at risk. Whatever the seller’s strategy for obtaining the best price, the process should involve documentation and an even playing field for all buyers. Giving each buyer a fair chance to purchase meets the seller’s needs and protects all concerned from claims by disappointed buyers. Tips and tools for establishing a multiple offer process are included in the Handling Multiple Offers section of this Topic.
One of the things a good multiple offer process must consider is how to deal with escalator clauses. Escalator clauses are used in offers to automatically increase the purchase price if there are competing offers. Such clauses raise very serious agency duty issues. So serious, in fact, that a separate explanation of these clauses and the problems they cause is required. Click here for an explanation of escalator clauses.
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Representing the Buyer Only
If you represent a buyer in a multiple offer situation, your main concern (just like the listing agent’s) is due diligence to your client. Diligence means doing the best you can to see to it that your client gets the property they want at the best price in the circumstances. If your client got their best offer on the table and another buyer beat it, that’s one thing. If they didn’t get their best offer on the table, that’s quite another.
As the buyer’s agent, you don’t want misreading the market or making a low-ball offer to be your fault. That means evidence in your client file that shows a discussion of the market and how the terms of the offer were arrived at. If multiple offers are common in the market, one would expect the buyer to have been warned – in writing. Of course, as with any offer, a CMA goes a long way toward showing diligence in helping the buyer craft an offer. Tips and tools for buyer agents are included in the section on Handling Multiple Offers.
Disappointed buyers, and their agents, are quick to believe they have been the victims of deceit in multiple offer situations. This belief is especially likely if one of the competing buyers is represented by an agent in the same company as the listing agent. It is almost certain to be the belief if the listing agent also represents one of the competing buyers. However, given the risk to the seller’s agent, it is very unlikely there are as many shenanigans in the presentation of offers in multiple offer situations as is sometimes believed.
Whatever the actual rate of shenanigans in the presentation of offers, there isn’t much a buyer’s agent can do, other than to take advantage of MLS presentation rules and state law. Most multiple listing services have rules on presentation of offers – know them and follow them. Oregon, like most states, requires the seller’s agent to present all offers “in a timely manner.” State law also requires the listing agent to have a “written record” of the date and time an offer is presented.
Taken together, MLS rules and state law make it exceedingly foolhardy for a listing agent to sit on an offer and relatively easy for real estate investigators to catch them if they do. What MLS rules and state laws won’t do, however, is guarantee that any particular buyer, even if they might ultimately be willing to pay the most for the property, will actually get the property. This uncertainty, always part of any contract formation situation, has lead to the growing use of “escalator clauses.”
Escalator clauses sound good to buyers forced into hot markets but there are problems. These problems can trap an unwary selling agent. Certainly, no agent should ever suggest the use of such a clause without having discussed the drawbacks of such clause with their client. That discussion, as with any discussion involving potential breach of agency duties, must be documented. Click here for a full explanation of escalator clauses. Tips for dealing with escalator clauses are also included in Handling Multiple Offers.
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Multiple Offers and Dual Agency
Far and away the most dangerous agency situation when dealing with multiple offers is representation of both the buyer and the seller under a “disclosed limited agency” agreement. Disclosed limited agency is just another name for dual agency. That is, a situation in which a single agent represents both the buyer and the seller in a real estate transaction.
A disclosed limited agent owes both the buyer and the seller the same statutory duties as a single agent. In addition, the disclosed limited agent has the duty to not disclose either party’s motivation or financial position or certain confidential information as defined by ORS 696.800(3). According to the definition, “confidential information” is anything the agent learns from or about the client, the deal or the client’s motivation but does not include what the client wants disclosed or what the law requires to be disclosed.
In addition to a heightened duty of confidentiality, the duties of a disclosed limited agent also include the duties imposed on what are called “designated agents.” In a transaction where one agent in a firm represents the seller and another agent in the same firm (i.e., has the same principal broker) represents the buyer, the agents’ principal broker is a disclosed limited agent but the individual agents continue to represent only the buyer or only the seller.
Designated agency is not well understood and can cause severe problems in multiple offer situations. While it is true that only the principal broker is a disclosed limited agent in a designated agency situation, the individual agents representing only the buyer or only the seller still have additional duties to all parties. Those duties are to disclose any conflict of interest in writing to all parties, to take no action adverse or detrimental to either party’s interest in the transaction and to obey the lawful instructions of both parties.
Because it may be in the seller’s interest to disclose to other buyers the existence, or even the terms, of a buyer’s offer to other potential buyers, any type of dual agency that creates confidentiality or non-detrimental action duties will put the agents involved in the untenable position of either harming the seller they represent or the buyer they represent.
For that reason, multiple offer situations should be avoided in which one of the agents or the principal broker represents both the seller and one of the competing buyers. Situations in which one of the agents, or the company, represents two competing buyers must be avoided at all costs.
When an agent represents both the seller and a buyer, or two buyers, in a multiple offer situation, the agent owes their buyer(s) full fiduciary duties, including diligence and confidentiality. If the seller wants to use the terms of that buyer’s offer to trigger a bidding war among potential buyers, the agent cannot serve both the seller’s lawful interests and that of their buyer. If the agent suggests to the seller that the seller reject all offers and seek new offers from all potential buyers, the agent harms their buyer(s). At the same time, if the agent doesn’t advise the seller to consider seeking better offers, the agent harms their seller.
There is no safe way to be involved in a multiple offer situation where both the seller and one of the buyers is represented by the same agent or agents supervised by the same principal broker. It follows that in a hot market every offer made by a company buyer on a company listing creates the potential for serious trouble. All that is needed to make that trouble all too real is another offer to be made, either from within or without the company.
The only way to avoid that kind of trouble is to have already received the client’s agreement on how the situation will be handled. Since we are talking about dual agency situations here, the disclosed limited agency agreement signed by the clients is the logical place to seek that agreement. This could most efficiently be done by attaching an explanation of how the company will handle multiple offer situations as an addendum to the disclosed limited agency agreement. A complete explanation of this approach, along with samples of the forms and policies necessary, is included in the section on Handling Multiple Offers.
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Handling Multiple Offers
The first step in dealing with multiple offers is to have an office policy that specifically deals with the subject. The policy should cover multiple offers from both the seller and buyer perspectives. The company policy should tell agents exactly how the company intends to handle multiple offers and reference any disclosures or notices used to inform clients and customers of the policy. A sample multiple offer office policy, consistent with the procedures discussed in this section, is included in the Model Office Policy Manual developed by the Oregon Association of REALTORS®. Click here to obtain a copy of the Association’s Model Office Policy Manual.
In a single agency situation where the agent represents the seller, the obligation to present “all written offers” in a timely manner is critical. There is still some misguided idea in real estate that offers can, or even should, be presented in the order received. Such a process not only violates the written offer presentation requirement of agency rule and statute, but can, and probably does, violate the basic agency duties of loyalty and diligence.
The most basic duty of a seller’s agent is to help the seller get the best price and terms. Getting the best price and terms means the seller must know of not only all offers made, but all offers that can reasonably be anticipated. Remember also, that the seller’s agent owes the buyer, as well as the seller, the duty to timely present all written offers. Given these duties, it is clear that sitting on one written offer while the seller accepts another offer is a very bad practice.
Multiple offers must be dealt with as multiple offers, not one at a time. It is this consequence of presentation and agency duties that drives most multiple offer dilemmas. From an ethical point of view, the dilemma is how to be fair to the seller and each of the buyers. Fairness in multiple offer situations is usually taken to mean everyone should have an equal chance to get the property.
Equality is a wonderful concept, but it depends entirely on what you mean by “equal.” Buying and selling things is about money. Not everyone has the same amount of money or the same willingness to spend it. Moreover, when dealing with buyers and sellers, what may be fair to the buyer is not necessarily fair to the seller. Fairness, therefore, as an organizing principle, is not of much use when it comes to multiple offers.
The seller’s expectation (multiple offers or not) is to get the best price possible in the situation. Every buyer expects to have a chance to get their best offer in front of the seller for consideration. All problems with multiple offers stem from ignoring or thwarting one of these expectations. Dealing with multiple offers is, therefore, a matter of developing practices and procedures that give the seller a chance to get the best price possible in the situation and the buyer the chance to get their best offer in front of the seller.
Looking at multiple offers in terms of best price in the situation places the focus right where it needs to be: on the situation. Every transaction is different. Handling multiple offers means explaining the specific situation to your client, whether your client is the buyer or the seller. To the seller, the situation includes the viability of each of the offers, the likelihood of getting better offers, the risk involved in trying to get those offers and the methods that can be used to solicit them. To the buyer, the situation includes formulating the best offer and getting it presented in a timely manner.
A seller looking at multiple offers has three basic choices: (1) take the best existing offer; (2) counter one or more of the offers; or (3) reject all offers and ask for new offers. That’s it, just three possibilities. Which is best? On the listing side, that’s where business judgment and, therefore, diligence comes in.
Taking the best existing offer assures the seller a deal. If one of the offers on the table contains terms the seller would otherwise find acceptable, rejecting it to seek better offers creates the risk the seller will end up with no deal at all. Does that mean the seller should take the best offer on the table if they would have taken that offer had it been presented alone? No, of course not, the fact that there are other offers must be considered.
The strength of the best offer is the starting, not ending, point for a diligent assessment of multiple offers. If none of the offers is acceptable, the seller is going to have to pursue one of the other two options anyway. If the best offer on the table is acceptable, the seller must calculate the risk of foregoing an otherwise acceptable offer in favor of trying to get a better offer. That assessment depends on: (1) the strength of the best offer; (2) how close competing offers are to the best offer; (3) how “hot” the general real estate market is; (4) the marketing history (how long on market, level of interest) of the property; and (5) the seller’s circumstances (motivation to sell).
If the seller decides it is best to take one of the existing offers, the listing agent needs to document for their client file the information the agent provided to the seller and the seller’s rationale for not seeking better offers from the other buyers. Such documentation may be needed to later prove diligence with respect to the client or honest and good faith dealing to the disappointed buyers.
If the seller, having considered all the factors, decides (it is the seller who must do the deciding, not the listing agent) to seek a better offer, the question becomes how best to accomplish that objective. “Best” in this circumstance means more likely to result in a better offer than no offers at all. Whatever the means chosen, the seller will have to forego all existing offers and open communication with one or more of the potential buyers. It is at this point that the listing agent’s duties to other parties and agents come to the fore.
The big question, when responding to buyers, is what can, or should, the seller tell one buyer about another buyer’s offer. There is a general real estate myth that one buyer’s offer cannot be shared with another buyer. As a matter of Oregon law, that is not true. In Oregon, as in many states, the seller can disclose the terms of an offer to other buyers. Disclosing the terms of an offer to other buyers is sometimes called “shopping” the offer.
The seller’s legal ability to disclose the terms of offers they receive does not mean shopping the best offer to all other buyers is good business. A major risk to the seller in a multiple offer situation is that the buyers will move on to another property rather than engage in a bidding war. Even if that doesn’t happen, the buyer who discovers their offer was shopped is likely to be mad enough to complain to someone. Such complaints have a way of taking on a life of their own, even if the thing complained of isn’t itself a violation.
Fortunately, there is no business reason to shop an offer. When the seller decides to seek better offers in a multiple offer situation, they have two choices: (1) they can reject and counter offers one at a time; or (2) they can reject all offers and ask each buyer to make a new “best” offer. Neither of these options requires telling competing buyers the exact price or terms others are offering.
Rejecting all offers and asking each buyer to make a new best offer is the most straightforward way to proceed from a contract law standpoint. All that is necessary is for the seller to send each buyer a rejection that informs the buyer there are multiple offers, all offers have been rejected and that each buyer has been given an opportunity to make their last best offer. The rejection should state a deadline for new offers and can contain a minimum price to be considered. Click here for a sample rejection and last best offer clause.
Contrary to popular belief, there isn’t any way to “counter” multiple offers other than one at a time. Counter offers, real ones that is, create the power of acceptance in the offeree. Do that for more than one person at a time and you risk creating more than one contract. At the same time, countering multiple offers one at a time pretty much defeats the purpose because the seller cannot be sure which buyer is willing to pay the most. Other multiple counter offer procedures, like first acceptance wins, have the same best price uncertainty and can create verification problems of nightmare proportions.
The problems associated with using counter offers in multiple offer situations have lead to the development of “multiple counter offer clauses.” A multiple counter offer clause is really just a variation on the rejection and request for new offers theme, but they are formatted and worded to look like a counter offer. Despite the contractual slight of hand involved, multiple counter offer clauses can be effective because they reduce the effort required of the buyer. As with rejection and new offer, using a multiple counter offer clause removes any need to shop offer prices.
There is little a selling agent can do in multiple offer situations other than communicate effectively with their client and take advantage of whatever presentation rules their MLS has in place. Client communication begins with the potential for multiple offers. If there is any potential for your buyer to become involved in a multiple offer situation, you need to make them aware of the possibility. In particular, the buyer must be aware that if they offer less than they are willing to pay for a property in a hot market, they may never get a chance to offer what they are actually willing to pay.
There is a tendency in multiple offer situations for buyers to believe there is some “trick,” other than offering their best price and terms, which will give them an advantage. There is no such trick. Escalator clauses are no exception. In fact, such clauses prove there are no exceptions by either placing the buyer at risk of paying more than they otherwise would have to or signaling the seller they will pay more than they are offering. Click here for a full explanation of escalator clauses.
If the offer being presented does not represent the buyer’s best offer, the buyer is gambling that, although not their best offer, it will be better than anyone else’s offer. The buyer needs to understand this gamble, especially in multiple offer situations. The seller may, at any point (even at the first offer stage), decide to take an offer rather than continue negotiations with multiple buyers.
Real estate agents, especially in multiple offer situations, can become fixated on the price term. Price is a major factor in any offer, but it is not the only factor. The seller is looking for the “best” offer, not necessarily the one for the most money. Financing terms are, of course, a critical factor. The closing date, need for repairs, existing home sale contingencies and so on are important considerations for the seller. So, too, may be the buyer’s motivation. All of this needs to be explained to the buyer.
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Standardized Sale Forms
What is this topic about?
Writing the deal means using standard forms. Chief among these forms is the Residential Real Estate Sale Agreement form. There are separate sale forms for farms and ranches, commercial real estate and new construction. No attempt is made here to explain particular forms or their use. Such form specific information is available from form publishers. Click here to view an explanation of clauses found in the commonly used Oregon Real Estate Forms, LLC residential sale agreement form.
Rather than a “how to” explanation for particular forms, this subject contains an overview of common clauses found in such forms and the issues and problems surrounding the subject matter of such clauses. These subjects include: Final Agency Acknowledgment, continuing through Financing, Title, Inspections, Dispute Resolution and Closing.
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Final Agency Acknowledgment
Real estate sale forms typically begin with a statutorily required Final Agency Acknowledgment form. The acknowledgement is strictly a creature of statute. The statute, ORS 696.845, reads as follows:
696.845 Acknowledgment of existing agency relationships form; rules. When signing an offer to purchase, each buyer shall acknowledge the existing agency relationships, if any. When a seller accepts or rejects an offer to purchase in writing, each seller shall acknowledge the existing agency relationships, if any. An agent to the real property transaction shall obtain the signatures of the buyers and the sellers to the acknowledgment, which shall be incorporated into or attached as an addendum to the offer to purchase or to the acceptance. The Real Estate Agency shall prescribe by rule the form and content of the acknowledgment of existing agency relationships.
As required by ORS 696.845, the Real Estate Agency has developed a form for final agency acknowledgement. The acknowledgment appears at the top of most standardized real estate contracts. If acknowledgement is not incorporated into the sale form itself, it must be appended to the contract as an addendum. Whether incorporated or appended, the acknowledgement must be in substantially the following form:
(1)___________(Name of Selling Licensee) of ______________ (Name of Real Estate Firm) is the agent of (check one) __ The Buyer exclusively. __ The Seller exclusively (“Seller Agency”). __ Both the Buyer and the Seller (“Disclosed Limited Agency”).
(2) ____________________ (Name of Listing Licensee) of ______________ (Name of Real Estate Firm) is the agent of (check one) __ The Seller exclusively. __ Both the Buyer and the Seller (“Disclosed Limited Agency”).
(3) If both parties are each represented by one or more licensees in the same real estate firm, and the licensees are supervised by the same principal broker in that real estate firm, Buyer and Seller acknowledge that said principal broker shall become the disclosed limited agent for both Buyer and Seller as more fully explained in the disclosed Limited Agency Agreements that have been reviewed and signed by Buyer, Seller and Licensee(s).
Buyer shall sign this acknowledgment at the time of signing this Agreement before submission to Seller. Seller shall sign this acknowledgment at the time this Agreement is first submitted to Seller, even if this Agreement will be rejected or a counter offer will be made. Sellers signature to this Final Agency Acknowledgment shall not constitute acceptance of the Agreement or any terms therein.
Buyer: ________ Print _________________Dated: ________
Buyer: ________ Print _________________Dated: ________
Seller: ________ Print _________________Dated: ________
Seller: ________ Print _________________Dated: ________
The statute requires the buyer to acknowledge the existing relationships when signing their offer. The seller must sign the acknowledgement when they accept or reject the offer. The first question, of course, is does the buyer acknowledge the seller’s agent or just their own? How about the seller? Is the seller acknowledging their relationship with the listing agent or that and the buyer’s relationship with the selling agent? Does it matter?
It is unlikely the Legislature actually intended the final agency acknowledgement form to have anything to do with the creation or termination of agency relationships. At the time the law was enacted (1993), a big issue in the industry was buyers assuming the agent they were working with represented them when, in fact, the agent represented the seller as a subagent of the listing agent. This sub-agency relationship applied even when the agent did not work for the listing firm. The final agency disclosure was intended to inform the buyer of the true status of the agent assisting them in writing the offer. It was little more than an after thought that the seller should acknowledge the same thing.
Today’s complicated agency relationships make the agency acknowledgment all but a relic of the past. In most transactions, the buyer has their own agent and the seller their own. Increasingly, both these agency relationships are already acknowledged in formal documents like listings or buyer service agreements. When dual agency is involved, the parties will have already signed disclosed limited agency agreement that spell, out in complete details, the relationships involved. The final agency acknowledgment assumes relationships that are not based on explicit consent. Such relationships are rare in real estate today, calling into question the continued utility of the acknowledgement requirement.
Notwithstanding the questionable utility of a final agency acknowledgement, it will likely be around for many years to come. Careful explanation of actual agency relationships at the time they are formed will continue to make dealing with final acknowledgment a simple mechanical filling in of the blanks. Although in most situations filling in the blanks themselves present few problems, there is some confusion around unrepresented parties and the difference between disclosed limited agency and designated agency.
The final agency acknowledgment form drafted by the Real Estate Agency assumes the buyer and seller are each represented. When one or the other is unrepresented, the blanks in the form are simply inapplicable. For that reason, the best approach is marking each blank “NA” or “NONE” when dealing with an unrepresented party. That way, no blanks are left to create confusion or room from subsequent inappropriate entries. Filling in the final agency acknowledgement properly is, however, not enough when dealing with an unrepresented party. Additional special procedures should always be used when dealing with unrepresented parties. Click here for a detailed discussion of those procedures.
The final agency acknowledgment requirement predates the development of disclosed limited agency and designated agency. Click here for an explanation of disclosed limited and designated agency. The advent of disclosed limited and designated agency was handled by adding to section (3) to the acknowledgment form. The agency relationships to be selected by the buyer and seller did not, however, change. The choices of agency relationship remained: buyer exclusively, seller exclusively and both buyer and seller on the selling side and seller exclusively and both buyer and seller remained the choices on the listing side. This has lead to some confusion about how to fill out the acknowledgment in designated agency situations.
As explained in Working With Clients, designated agency is a special statutory form of dual agency. By statute, however, only the principal broker becomes a disclosed limited agent. The listing and selling agents represent only the party with whom they already have an agency relationship. ORS 696.815(4). Under the statute, the brokers acting as designated agents “continue to represent only the party with whom the broker has an agency relationship unless all parties agree otherwise in writing.” Because the designated agents continue to represent only the principal they already have, their representation is “exclusive” for purposes of filling out the final agency acknowledgment.
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Financing is at the heart of the real estate business. Indeed, it is fair to say that without modern real estate financing, the real estate industry simply would not exist as it does today. It is the leverage financing provides that makes it possible for a significant percentage of the population to own their own homes. Accordingly, financing is a critical part of almost every residential real estate purchase.
The central and critical nature of financing is usually reflected in real estate forms. In California, for instance, the residential real estate form used by REALTORS® contains more than two pages of financing provisions. In Arizona, the REALTOR® sale form is supplemented by a standard Financing Options Addendum that covers everything from a new conventional first loan to seller financing. Whether in the form of a separate addendum or not, real estate finance provisions tend to be pretty standardized.
Finance provisions typically benefit the buyer by protecting them from being required to perform the contract if they cannot obtain the necessary financing prior to the closing date. Sellers, however, are as interested in the financing provisions as are buyers. It is for this reason financing provisions are usually written to address both the concerns of the buyer and the concerns of the seller. Buyers tend to be concerned about the details (interest rate, points, etc.) of the loan. Sellers, on the other hand, are usually more interested in the loan process than details of the loan.
To protect the buyer, financing provisions in form contracts usually specify the amount of money the buyer wants to borrow, the term of the loan, the type of loan (fixed, adjustable, conventional, VA, etc.) and the maximum interest rate and points. To protect sellers, financing provisions typically specify that the buyer must apply for the loan within a fairly short period of time following acceptance, use best efforts to obtain the necessary loan and notify the seller of conditional approval of the loan within a specified period of time. A simple way to accomplish seller notification of loan status is to require the buyer to provide the seller with a loan application status form. The Oregon Residential Loan Application Status form, developed by Oregon lenders and the Oregon Association of REALTORS®, is such a form. Click here to download a copy of the loan status form. It is the felt need to balance the interests of the buyer and the seller that makes finance contingencies both lengthy and important.
Whether representing the buyer or seller, an agent should be familiar with and able to explain to their client the finance provisions of the form contract they use. Most form contracts make the entire transaction contingent upon the buyer obtaining “the loan” they need to meet the purchase price. For that to work, the details of “the loan” must be spelled out in the financing provisions. If not, bitter fights over earnest money (when the buyer fails to close for want of financing) are inevitable.
A seller, off the market for months while waiting for word that the buyer has the money they agreed to pay as the purchase price, will usually not be very understanding when, on the day of closing, the buyer announces they couldn’t get a loan after all. It is to prevent these kind of late-in-the-day surprises that most finance provisions in form contracts spell out the exact terms of the loan sought, require early loan application, best efforts and some sort of conditional approval letter from the buyer’s lender prior to closing. Where the form contract does not spell out financing details, agents should consider a separate standard financing addendum that does.
The failure to spell out financing details in the contract may disadvantage the buyer or the seller or both. For instance, if the contract is made contingent on the buyer obtaining a loan without regard to amount, type, interest rate, points or other factors, a seller may claim the buyer’s withdrawal in bad faith because a loan could have been obtained by simply paying more. On the other hand, if the transaction is made contingent on the buyer obtaining a loan “satisfactory to buyer” or one of “buyer’s choice,” the seller may find they have been off market with no recourse if the buyer simply changes his mind. Financing provisions in form contracts are about balancing these needs.
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The object of a real estate transaction is the transfer of legal title to the property. This is done by a “deed” from the seller to the buyer. There are a number of different kinds of deeds depending on the title warranties the seller can or is willing to make. Generally, residential real estate is transferred with what is called a “statutory warranty deed.” If something less that a statutory warranty deed (quit claim, bargain and sale, special warranty deed, trustee deed, etc.) is proposed, the buyer should be advised to seek legal counsel.
A “warranty deed” is a deed in which the seller guarantees (warrants) the chain of title and their ability to transfer full rights in the property. In a statutory warranty deed, the warranty is set out in statute and, therefore, clearly defined. In Oregon, as in the rest of the Western United States, the title to real property is usually insured at the time of transfer. Title insurance protects both the buyer and the seller.
Standard real estate forms contain “title insurance” clauses. For the most part, these clauses contain “contingencies with cure” provisions. A contingency with a cure provision is one in which the buyer can object to the state of the title but cannot cancel the contract if the objections can be cured by the seller. Objection and cure deadlines are common and must be understood and met. An agent should always know and explain these deadlines to their client.
In order to object to the state of the title, the buyer must know the state of the title. That is the purpose served by the preliminary title report issued by the title insurer named in the contract. The seller’s prompt delivery of a preliminary title report and copies of any covenants, conditions or restrictions (CC&Rs) is an important term of any title contingency clause. The report and CC&Rs will tell the buyer of any defects, exceptions or limitation affecting the seller’s title to the property.
For the most part, the legal affect of title defects, exceptions and limitations are beyond the scope of the real estate licensee’s expertise. By statute, a real estate licensee has no duty to investigate “the legal status of the title.” That does not mean a licensee can simply ignore the preliminary title report. What it means is that the agent is not required to have legal knowledge. Most title contingency clauses have an express provision stating that agents are not qualified to advise clients on the legal status of title. Such clauses can be very helpful when reviewing the title report and CC&Rs with clients.
Title contingencies in a residential real estate sale forms are usually “review and approval” type contingencies. Such contingencies allow the buyer to object to anything in the report or CC&Rs the buyer finds “unacceptable.” This manner of handling title objections allows the buyer great latitude to object to anything found in the report or CC&Rs, but does not allow the buyer to use the title contingency as a “weasel clause.” That is the case because of the duty to perform contracts in good faith. Click here for a detailed discussion of the obligation of good faith in contract performance.
Good faith performance limits the buyer’s ability to terminate the contract based on the preliminary title report or the CC&R’s. Title and CC&R objections must be “reasonable.” Reasonableness in the law is judged on an objective standard. An objection is reasonable if a hypothetically reasonable person in the same circumstances might object to the same thing. Thus, an easement for a 5KMV interstate electrical transmission line might reasonably be objected to, but a common utility easement for the house or even the subdivision would not.
CC&R provisions are fertile grounds for objections under title contingencies. That is the case because they limit the owner’s use of their own property. So, for instance, a CC&R provision demanding review and approval by an architectural control panel might, at the preliminary title stage, be reasonably objected to by a buyer who intends extensive remodeling. The same would be true of pet restrictions, RV parking bans and any of a host of other common limitations found in CC&Rs.
Objections to preliminary title reports and CC&Rs often cannot be cured and, therefore, can cause deals to fail. It is for that reason that title objection deadlines are typically very short – often as little as five days. The short deadline puts pressure on title report and CC&R review. Although failure to object to specific items usually results in waiving the objection, it does not relieve the seller of the obligation to convey “marketable title.” That obligation – to deliver marketable title – is usually contained in a separate “deed” clause, independent of the title contingency clause.
Marketable title is a term of art. Courts understand that the title to real property is rarely, if ever, perfect. Prior conveyances, divorces, deaths, conflicting descriptions, misspellings and a host of other defects make the state of legal title less than completely certain. To compensate, courts demand that the seller convey marketable title. Marketable title need not be free of all defects. Instead, the title must be “free of all reasonable risks of attack.” Obviously, such an assessment is far beyond the expertise of a real estate licensee. A claim of unmarketable title is, therefore, always a matter for attorneys.
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A buyer who does not have a house inspected is taking a serious risk. For that reason, all real estate sale forms contain inspection clauses. Typically, the transaction is made contingent on the buyer in some way “approving” of the condition of the property as revealed in an inspection report or after a “due diligence” period during which the buyer is allowed to satisfy himself as to the condition of the property.
Residential real estate forms tend to use inspection contingencies that demand “professional inspections,” establishes strict disapproval criteria and requires formal affirmative disapproval by the buyer. Commercial transactions, on the other hand, tend to use general “due diligence” provisions that basically allow the buyer a specified period of time in which to satisfy themselves as to the desirability of the property. Because the residential approach to inspections is formal, expensive and strict, it is the source of a good deal of strife.
The inspection clauses used today in residential real estate forms evolved from simple “material defect” and “required repair” provisions. Historically, a residential purchaser could terminate a transaction on the basis of an inspection only if the inspection revealed “material defects.” As a result, termination under the inspection contingency was a rare and, for the most part, uncontested event.
What was less rare, historically, in residential transactions was the lender demanding certain “repairs” as a condition of making the loan. If the seller was unable or unwilling to make the lender-required repairs, the deal would fail on the loan contingency, not the inspection contingency. Standard forms from that era anticipated lender-required repairs by containing provisions for the seller to agree upfront to the amount of money they were willing to spend on “required” repairs. Thus, inspections and repairs were related but still separate provisions. Click here for a detailed discussion of the evolution of inspection clauses in residential contracts.
Modern inspection contingencies typically combine inspections and repairs in one clause. The most common way that is done in other states is to give the buyer an express right to propose repairs and then approve, or not, of the seller’s response to the repair request. Under such clauses, the buyer always has the last say on whether to go forward based on the seller’s response (or lack of response) to their repair request. Oregon does not use this approach to inspections or repairs.
In Oregon, common inspection contingencies propose an “inspection period” during which the buyer and seller may negotiate over “matters disclosed in any inspection report.” If the buyer and seller do not reach agreement on matters disclosed in an inspection report, the buyer can terminate the transaction by unconditionally disapproving of the property based on any inspection report(s). Such disapproval must be made prior to the end of the inspection period.
To place pressure on the seller, some buyer agents use “repair” addendums that say the buyer will not approve of the inspections unless the seller repairs the items listed in the addendum. This an old way of dealing with repairs and should not be used with modern inspection clauses. You will also sometimes see contingent disapproval addenda in which the buyer unconditionally disapproves, but agrees to proceed if the seller agrees to the included list of repairs. There are also homemade repair addenda out there that list the repairs desired and “disapprove” as of the last date of the inspection period if the seller has not first signed the addenda.
The problem with contingent disapproval approaches is the risk of the contract automatically terminating if the seller does not respond to the addendum. It is either that or run the risk of the buyer accepting the condition of the property without repairs by failing to disapprove within the inspection period. Standard “buyer’s repair addendum” forms used in Oregon avoid the contingent disapproval problem by simply requesting repairs without any disapproval, contingent or otherwise. The forms do, however, contain the follow warning: Warning: If the Inspection Period specified in the Sale Agreement is not properly extended, Buyer failure to provide written disapproval of the Buyer’s inspection report(s) by midnight on the last day of the Inspection Period could be deemed acceptance of the condition of the property.
The Buyer’s Repair Addendum warning is well taken. Unless the repair addendum is signed or the Inspection Period extended, the buyer must separately disapprove of the property condition based on an inspection report or accept the condition of the property. This, of course, make the Inspection Period deadline a critical date. On that date, without fail, the agent must have a copy of a signed repair addendum in their possession or a written extension of the inspection period or the buyer’s decision on whether to unconditionally disapprove or accept the condition of the property. There are no other viable alternatives.
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Standard real estate forms sometimes contain private dispute resolution clauses. Such clauses dictate the process to be used if there is a dispute over the transaction. Common forms of private dispute resolution are mediation and arbitration. Mediation is assisted negotiation with the mediator acting as a facilitator for the parties’ attempt to resolve their dispute by mutual agreement. In arbitration, the arbitrator is the decision maker and decides the resolution of the dispute after a hearing in which each party presents their evidence and arguments.
Dispute resolution clauses that dictate private arbitration limit the parties’ access to civil courts, including the ability to appeal adverse decisions. As a result, arbitration clauses in real estate contracts are somewhat controversial. In Oregon, the most commonly used real estate sale agreement form contains the following all-caps warning:
“BY CONSENTING TO THE PROVISIONS HEREIN, BUYER AND SELLER ACKNOWLEDGE THAT THEY ARE GIVING UP THE CONSTITUTIONAL RIGHT TO HAVE THE CLAIM TRIED BY A JUDGE OR JURY IN STATE OR FEDERAL COURT.”
In actuality, there is no right to appeal an “arbitration decision” at all if what that is understood to mean is an appeal on the merits of the decision itself. An arbitrator’s decision, whether right or wrong, cannot be appealed. Instead, Oregon law allows challenges to enforcement of an arbitration decision only if the process used was patently unfair or the arbitrator clearly biased. Such a procedural challenge is not an “appeal” of the “decision” in the ordinary sense of these words.
Although Oregon law favors the use of private dispute resolution, courts do sometimes refuse to enforce arbitration clauses in form contracts. They do so when they believe the clause is “unconscionable” because of “substantial disparity in bargaining power, combined with terms that are unreasonably favorable to the party with the greater power.” Generally, arbitration clauses in standard real estate contracts survive judicial scrutiny. There are some caveats.
At least one Oregon court has struck the arbitration clause from a standard form contract where the form was used by a builder. Because the form was provided by the builder, not an agent in an existing home transaction, the disparity between the buyer and the builder was a major factor. Also taken into consideration was the fact that the consequences of the clause were not explained to the buyer. This case, however, was decided prior to the all-cap warning being included in the commonly used Oregon forms.
Whether the dispute resolution clauses found in common Oregon real estate forms are subject to challenge today is an open question. Certainly, the warnings now found in the form itself are helpful. Agents should, at a minimum, point out to clients the existence of the dispute resolution clauses in the contract. Although an agent cannot practice law by explaining the legal consequences of the clauses, they can point out to the client the functional provisions of the clause.
For instance, common Oregon forms require any dispute within the jurisdiction of small claims courts to be brought there exclusively. Small claims jurisdiction in Oregon is a dispute involving a claim for $10,000 or less. Dispute resolution clauses in Oregon forms often require mediation between buyer and seller if there is a dispute that is not within small claims jurisdiction. Recently, the form most in use by REALTORS® has adopted separate provisions for disputes between buyer and seller and those involving real estate licensees or firms. These separate licensee or firm provisions, unlike the buyer/seller provisions, do not include mandatory mediation and do not allow the client attorney fees if they prevail in the dispute.
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The closing provisions found in standard real estate sale agreement forms are usually quite simple. Generally, the closing clause itself does little more than establish a closing date. This simplicity belies the fact that closing clauses are among the most misunderstood and abused clauses found in real estate form contracts.
Strictly speaking, a “closing date” is not required in the sense that a date certain must be stated in the contract. Click here for a detailed discussion of the material terms of a real estate contract. Form real estate contracts, however, universally provide for a date certain for closing the transaction. This, of course, is very helpful if the parties actually close on that date. When they don’t, a not uncommon occurrence in residential real estate, you may find out just how misunderstood and abused a closing clause can be.
Contrary to popular belief, there is nothing special or magical about the closing clause. All things being equal, the closing clause, and the date it contains, is just another provision of the contract no more or less important than other clauses in the contract. That is not to say the closing date is unimportant, just that it is not unique or special in the eyes of the law. The parties simply agree at the time they enter the contract to conclude the contract not later than a certain date. It is no different in that respect than agreeing when to make the loan application or conduct the inspections or provide the preliminary title report or any of the host of agreed-to actions that go into a real estate transaction.
The closing clause in a form real estate contract is a sequencing provision. Like any number of clauses, the closing clause orders the parties performance by setting deadlines for performance. The closing deadline takes on importance only because it sets the time for the final performance of both parties. Closing dates matter because failure to perform the entire contract by that date is a breach of contract.
Breach of contract, though certainly serious, is less than half the story. It is a rare contract indeed that is performed exactly according to its express terms. Courts understand this and differentiate between those breaches which matter and those that don’t. A breach of contract that matters is considered a “material breach.”
A material breach is one that deprives the other party of an essential benefit of the bargain. Because it deprives the other party of the benefit of the bargain, a material breach excuses the performance of the non-breaching party. It is this little understood principal of contract law that gives closing dates their mythic quality. If the closing date is material, the buyer’s failure to close on time is a material breach which will excuse the seller’s performance. The seller can refuse to sell to a buyer who does not close the transaction on the required date – assuming, of course, that the closing date is “material.”
There are a variety of ways real estate forms make the closing date material. The old fashioned way, and the one still used in Oregon, is to preface the closing clause with the phrase “time is of the essence.” “Time is of the essence” is a legal term of art. Deadlines prefaced with the phrase are considered material. A more modern approach is to spell out the exact consequences of failing to close right in the closing clause. For instance, the closing clause used in the Arizona residential forms contain the following: “The parties to this Contract expressly agree that the failure of any party to comply with the terms and conditions of this Contract by the scheduled Close of Escrow will constitute a material breach of this Contract rendering the Contract subject to cancellation [under the cancellation provision of this Contract].”
In Oregon there is a common belief that the buyer’s failure to close by the date stated in the contract automatically cancels the contract. This virulent Oregon real estate myth is often expressed by saying the buyer is “out of contract.” “Out of contract” has no legal meaning. It is just slang. To the extent it is used to say one party thinks the other party is in breach, “out of contract” adds nothing. To the extent it is used to say the contract has somehow automatically terminated, it is mistaken and dangerous. The situation when it comes to the buyer missing the closing date is far more complex.
Using “time is of the essence,” instead of an express statement of materiality and cancellation, puts the burden on the seller to enforce the closing date. This is the case because courts are quick to find a seller who has not enforced the closing date has waived it. When, as is not infrequently the case, the buyer finds they cannot obtain the loan or clear a contingency by the closing date, they often ask for more time. Sometimes this is done in the form of an extension addendum. Other times, the buyer’s agent simply calls the listing agent and says the buyer is having some problem but will close as soon as the problem is solved. Either way, what has to happen, but usually isn’t happening, is the seller communicating an unequivocal intent to enforce the contract.
Absent an unequivocal intent to enforce the contract, the closing date can quickly become ambiguous. In the well known case of Tarlow v. Kelly, a jury found the seller had waived the “time is of the essence” clause simply because the seller allowed the buyer to continue efforts to find financing for some fifteen days after the closing date. According to the court, evidence that the seller did not demand timely performance and knew the buyer was continuing efforts to purchase after the closing date had passed, was sufficient to present a question of fact for the jury. The jury, the court ruled, “could conclude from them [the facts] that both parties proceeded after August 15 as though that date had no affect on the validity of their agreement and that [the seller] thereby voluntarily tolerated plaintiff’s late performance.” Click here to read the court’s full decision in the Tarlow case.
Enforcing a closing date, even with a “time is of the essence” clause, is about not tolerating late performance. The easiest way to create evidence that late performance was not tolerated is to give notice of the intent to enforce and then, based on that notice, enforce the deadline. Click here to view a sample notice of intent and notice of termination clauses. The only viable alternative to notice and enforcement, is a mutually agreed to written extension of the closing date. Anything less creates ambiguity.
Ambiguity can be avoided when the closing date approaches by explaining to the seller that there are only three possible outcomes on that date. The first, and by far the preferable one, is that the buyer performs the contract. The second is a mutually agreed upon written extension. The third is that the seller terminates the contract if the buyer fails to perform as required. It is in the exercise of the third option that real estate licensees have trouble.
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Aiding Contact Performance
Aiding a client or customer in performing the sale contract is a big part of being a REALTOR®. In Oregon, as in most states, no commission is earned until and unless the buyer consummates the transaction by closing. It is hardly surprising then that much of the work of a REALTOR® takes place between acceptance and closing.
Aiding contract performance means understanding the Agent’s Role in Contract Performance. The responsibilities of an agent in aiding contract performance depends to a large extent upon the Client’s Contract Performance. The client’s contract performance is dictated by the law of contract, not real estate license laws.
Oregon courts have imposed a duty of Good Faith Performance of Contracts. Real estate agents should understand contract performance at least enough to know when to advise the client to see an attorney. It is for that reason that no discussion of contract performance would be complete without some mention of non-performance or, in legal terms, Breach of Contract.
Breach of contract is a more complicated subject than most REALTORS® believe. Some breaches of contract are material and some are not. A Material Breach is, of course, more serious than a non-material breach, but few REALTORS® can tell the difference between the two or what that difference means to contract performance. As if material and non material breaches of contract were not enough, every agent should have at least some understanding of the difficult subject of Anticipatory Breach.
No discussion of aiding the parties in the performance of their contract would be complete without some discussion of Handling Client Disputes. Client disputes include Pre-Closing Disputes as well as Post-closing Disputes. Post-closing disputes raise the possibility of Disputes Involving the Agent.
Finally, no discussion of real estate disputes would be complete without some discussion of Formal Dispute Resolution processes. Dispute resolution in residential real estate transactions usually means being involved in a mediation/arbitration process of some kind. If the dispute is strictly over money and the amount is not large, the dispute may end up in a Small Claims Court. REALTORS®, of course, are not expected to act as lawyers when a dispute arises. It is, however, important that REALTORS® know enough about formal dispute resolution processes to point their clients, or themselves, in the right direction should a dispute be unavoidable.
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Agent’s Role in Contract Performance
The time from acceptance to closing can be a difficult time in a real estate transaction. It is during this time that problems with the deal or the property usually arise. It is during this time that both buyers and sellers can have doubts about the wisdom of their undertaking. It is during this time that real estate agents, in a very real sense, earn or lose their commission.
The role an agent plays in contract performance depends on a number of variables. First among these are the wants and expectations of the parties. Some people want to be in charge and do it all themselves. Others expect the whole thing to be handled for them by the agents without any personal inconvenience. Most clients and deals fall somewhere between these extremes.
Where, between these extremes, the actual services delivered by a real estate agent falls, is mostly a matter of business practices. An agent is, however, at a minimum required to make reasonable efforts to provide the client with information that is within the scope of the agency relationship. To determine what information that might be, you have to know something about how real estate licensees are trained and what, as a group, they normally do. These two things, more than anything else, will determine the role an agent plays in aiding contract performance.
Real estate licensees are not lawyers, but they do have training in real estate contracts and real property law. Oregon courts have used this fact to hold that ” the ordinary layman dealing with a real estate or insurance agent may be justified in relying upon the latter to know enough in regard to real estate and insurance law to give reliable opinion on the simpler problems arising therein? Helping the client with the “simpler problems” regarding real estate law is within the scope of agency for real estate licensees.
The “simpler problems” in real estate law are those that come up all the time and do not require a law degree to understand. For instance, explaining the operation of the standard clauses in a pre-printed sale form provided by the agent is going to be within the scope of the agency created. An agent wouldn’t be expected to explain the legal ramifications of failure to fully satisfy the terms of a condition precedent, but would be expected to let the buyer know how many days they have to satisfy the condition and what the contract says with regard to satisfaction. Similarly, an agent doesn’t have to know the legal ramifications of a title exception, but could be expected to bring the existence of an unusual exception to their client’s attention.
One way to think about what is within the scope of agency when aiding in contract performance is to think in terms of real estate business, not law. Certainly, law underlies the business of buying and selling real property, but ordinary people make and perform real estate contracts everyday without being lawyers. They do that by reading what is said in the contract and bringing common sense experience to bear if there is a problem.
Agency is really just about the agent using their training and experience to augment the principal’s common sense and experience. In that regard, it is helpful as an agent to ask: what would I do given what I know about real estate if I were buying or selling this home for myself and my family to live in for the rest of our lives? Do that and you are likely to stay within the scope of your agency. You are also a lot more likely to provide quality professional services to your clients and customers.
Giving your client the benefit of what you know about real estate contracts and their performance based on your training and experience as a real estate licensee is but one part of aiding in contract performance. Another part is helping the client with the investigations necessary to fulfill the terms of the contract and satisfy themselves as to the wisdom of the purchase. In Oregon, by statute, real estate licensees have no “duty to investigate matters that are outside the scope of the real estate licensee’s expertise, including but not limited to investigation of the condition of property, the legal status of the title or the owner’s past conformance with law, unless the licensee or the licensee’s agent agrees in writing to investigate a matter.”
This statutory provision is essentially a limit on the scope of a real estate licensee’s agency. It defines what is and isn’t expected of a licensee when it comes to investigation of the condition of the property, the legal status of the title and the seller’s past (not present) conformance with law. That doesn’t mean that property inspection, title and conformance with law are not important or that an agent has no duty with regard to these subjects. Instead, it means that the agent doesn’t themselves have to investigate to find out if there are problems with the condition of the property, the title or the seller’s past conformance with law.
An agent cannot ignore problems in these areas that would be obvious to other agents in the same circumstances. That is, they cannot turn a blind eye to what a reasonable agent in the same circumstances would see or know. The law doesn’t require the agent to go looking for problems where none are apparent.
Take, for instance, the famous California case where a listing agent was held potentially liable for not disclosing to the buyer the risk that a landslide might destroy the house. Although widely believed in the industry to create some “duty to investigate,” the ruling actually turned on whether in the circumstances a reasonable real estate licensee in process of listing, marketing and showing the property would have become aware of the slide potential because there were a number of “red flags” that would be obvious to the ordinary, prudent agent without the need to investigate. It was the agent’s failure to respond to the red flags that created the potential liability, not a separate duty to “investigate.”
Identifying “red flags” during contract performance has always been within the scope of agency for a real estate licensee. That duty, like the duty to provide relevant information to the client, is limited to those things entrusted to the agent. What Oregon state law says is that investigation itself is not entrusted to the agent. That doesn’t mean the agent can ignore obvious problems and it doesn’t mean recommending that the client investigate is not within the scope of the agency. It obviously is. If it weren’t, commonly used sale agreement forms would not contain the warning that “Buyer’s election to waive the right of inspection is solely Buyer’s decision and at Buyer’s own risk.”
Other than not ignoring “red flags,” the key to handling investigation of property condition, title status and the seller’s conformance with law is advising the use of third-party experts. Advising agents to recommend to their clients consultation with third-party experts is common, and, in some regards, glib risk management advice. Such advice isn’t usually seen as helpful by agents because everyone knows that buyers and sellers do not want to spend money on third-party experts. Keep in mind, however, that while giving information and advice is often within the scope of agency for real estate licensees, making the client accept or follow that advice is not.
Take, for example, an addition or remodel done without a building permit. Such things can be real deal killers if discovered during contract performance. If not discovered until after closing, they are likely to lead to ugly lawsuits. We know that Oregon law says an agent doesn’t have to investigate whether the seller got the proper permits (past conformance with law). But, that doesn’t mean the listing agent can ignore an obvious addition or remodel or turn a blind eye to a discrepancy between what they see and the assessor’s data. It certainly doesn’t mean a buyer’s agent can ignore these things or fail to explain to their client the potential for problems if it turns out there were no permits.
An agent’s duty, according to Oregon courts, is to “give his principal information which is relevant to affairs entrusted to him and which, as the agent has notice, the principal would desire to have.” Give the advice you give based on training and experience as a real estate agent, not as a home inspector or surveyor or lawyer. Then, and this is critical if the client rejects the advice, follow up with a letter or email stating the advice given, the reason it was given, and the client’s decision with regard to the object of the advice. In other words: give the advice your training and experience tells you is relevant to the client’s performance of the contract and then document that advice.
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The Client’s Contract Performance
We have seen that for the most part the agent’s duty to the client during the client’s performance of the contract is one of using the agent’s training and experience to “give his principal information which is relevant to affairs entrusted to him and which, as the agent has notice, the principal would desire to have.” Click here for a more detailed discussion of the Scope of Agency. To fulfill that duty, it is necessary for the agent to understand something of the client’s legal duties when performing a contract.
The parties to a contract must perform the promises contained in their agreement or risk liability under the contract. Failure to perform as promised under contract is called “breach.” Click here for a detailed discussion of breach of contract. Whether some action or inaction is or isn’t a breach can be a complicated legal matter well beyond the scope of agency of a real estate licensee. It follows that advice on whether a contract has been breached or the consequences of that breach is not something real estate licensees would normally be involved in.
That is not to say real estate agents should know nothing of the law of breach or that they never base business advice to clients on that knowledge. Rather, it is to say that an agent should never presume to advise a client that some action or inaction is or isn’t a breach of the contract. Instead, the agent should limit advice to an explanation of what the contract actually says or a simple explanation of the duties the law imposes on the parties to a contract. In addition to performing the promises contained in the contract, that mostly means explaining the related duties of good faith performance and best efforts.
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Good Faith Performance of Contracts
In Oregon, all contracts include an implied covenant of good faith and fair dealing. The law imposes this duty of good faith and fair dealing to facilitate performance and enforcement of contracts. According to the courts, however, the duties of good faith and fair dealing must be consistent with, and in furtherance of, the agreed-upon terms of the contract or effectuate the parties’ objectively reasonable expectations under the contract. The implied covenant of good faith and fair dealing cannot be used to vary the substantive terms of the contract or impose obligations inconsistent with the terms of the contract.
According to Oregon courts, the duty of good faith and fair dealing does not “provide a remedy for an unpleasantly motivated act that is permitted expressly by contract.” Contrary to popular belief, Oregon courts will not examine the motives of a party who exercises rights under a contract in order to escape its legal obligations. This somewhat startling result is probably best illustrated by the famous Oregon real estate case of Zygar v. Johnson. Click here for a copy of the case.
Zygar listed his property for sale and soon attracted the attention of Johnson, a young man who was soon to be married. Johnson, looking for a home for himself and his bride-to-be, liked the Zygar property and made an offer which Zygar accepted. The young, and some would say foolish, Johnson did not consult his bride-to-be on the purchase.
One of the provisions of the contract was that Johnson had the right to approve of a pest and dry rot inspection. Johnson ordered the inspection which showed some dry rot under the house caused by an unknown source of water leakage. About the time Johnson received the inspection report, his would be bride viewed the house and informed him she hated it. Accordingly, Johnson disapproved of the dry rot inspection in order to get out of the deal and save (at least temporarily) his marriage.
Rather than let it go at “my client disapproves of the dry rot report,” Johnson’s agent evidently told the listing broker that Johnson’s real motive was his fianc?’s dissatisfaction with the house. When Zygar learned this he sued, claiming Johnson’s disapproval was a pretext and, therefore, Johnson breached the implied covenant of good faith and fair dealing.
The Oregon Court of Appeals disagreed with Zygar’s understanding of good faith and fair dealing holding that “a purchaser does not breach his contractual duty in refusing to proceed with a real estate purchase when the purchase was conditioned on the purchaser obtaining a satisfactory dry rot report and the purchaser was not satisfied with the dry rot report, even though he may have had other reasons for repudiating the agreement.” According to the court, “whatever reasons the purchaser may have had for wanting out of the transaction were immaterial to the question of whether he, in fact, was dissatisfied with the dry rot report.” Johnson, the court held, had a reasonable basis for disapproving of the inspection report and, therefore, the contractual right to do so as long as there was some reasonable basis for the disapproval.
Zygar, and its progeny, should not be taken to stand for the proposition that “weasel” clauses are ok in Oregon. Other than in circumstance where one party has a clear right to avoid the contract under a contingency, Oregon courts frown on bad faith performance of contracts. For instance, a buyer who enters several contracts with the intent to perform only one is acting in bad faith. That is the case because the intent not to perform precedes any contractual right not to perform. Motive isn’t always irrelevant to good faith, it is just irrelevant when a separate legitimate right exists under the contract.
What all this means to a real estate agent is that extreme care must be taken when clients start asking about “getting out of the contract.” What the law requires is good faith and fair dealing to facilitate performance. That means not misleading or trying to trap the other party into a breach or trying to trick them into foregoing a contractual right. It means, in short, applying the same willingness to perform as promised at the beginning of the contract as at the end.
The implied covenant of good faith and fair dealing is not the kind of thing a real estate agent discusses in depth with their client. Instead, it is the kind of thing that can cause a good agent to advise their client to be cautious and seek legal advice before taking some action implicating contract performance. The law favors performance of contracts. It does not favor technicalities or arbitrary performance. Do not get pushed into discussions about getting out of contracts and never, under any circumstance, make predictions about what is or isn’t allowed under a contract. Real estate agents have no duty whatever to assist clients in avoiding legal obligations. If someone wants out of a contract or advice on enforcing one, they need to talk to a lawyer.
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Breach of Contract
Breach of contract has specific legal meaning. That meaning is: “Failure, without legal excuse, to perform any promise which forms the whole or part of a contract.” This legal definition raises a number of issues important to real estate agents who aid their clients in performing contracts. Notice first that the definition applies to the failure to perform “any promise” whether that promise forms the “whole or part” of the contract. This manner of defining breach of contract is necessary because the law distinguishes among types of breaches when assessing remedies.
The failure, without legal excuse, to perform the whole of a contract is called a material breach. A failure to perform only a part of a contract may not be material to performance of the whole. That is the case because minor or easily corrected breaches do not defeat the purpose of the contract or deprive the other party of the substantial benefit of the bargain. Non-material breaches may result in an award in damages, but they do not excuse the other party from performing their side of the contract. Only a material breach can excuse performance. This issue of material breach is discussed in detail shortly.
No discussion of contract breach would be complete, because it happens all the time in real estate, without at least a mention of Anticipatory Breach. Anticipatory breach occurs when one party, without legal excuse, makes a positive statement to the other party that they will not perform. This can happen when one party believes, erroneously, they have a legal excuse not to perform. It can happen when one party finds they cannot or do not want to perform as promised. Whatever the situation, a real estate agent should know enough about material and anticipatory breach to advise their client to seek legal counsel when non-performance occurs or is anticipated.
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Under Oregon law, a material breach of contract is one that “goes to the very substance of the contract and defeats the object of the parties entering into the contract.” Material breaches are important because a material breach excuses the other party’s performance. Thus, if the buyer fails, without excuse, to perform a promise that “goes to the very substance of the contract and defeats the object of the parties entering into the contract,” the seller can refuse to sell. Similarly, a material breach by the seller would excuse the buyer’s obligation to purchase.
Whether a particular breach is material is a question of fact and depends on the circumstances in which the breach takes place. This makes predicting whether a breach is material or not complicated and difficult. It is for that reason that real estate agents should never offer an opinion on whether some failure to perform is or isn’t a material breach.
Unfortunately, agents offer such opinions all the time. Worse, they often do so without understanding the difference between material and non-material breaches. Evidently, somewhere in the distant past some lawyer taught real estate agents that the buyer’s failure to perform strictly as required by the contract meant the buyer was “out of contract.” According to the myth thus created, being “out of contract” excused the other party’s obligation to perform.
There is no such thing as “out of contract” as far as the law of contracts is concerned. There is just breach. Thinking in “out of contract” terms can cause great harm if you believe “out of contract” automatically means material breach. That is not the case.
Real estate sale contracts contain dozens of promises. Few are material. That is the case because a real estate contract is performed over weeks or even months. A simple missed deadline (in circumstance where performance is not due for weeks or months) will not usually defeat the purpose of the contract. Take, for instance, the buyer’s promise to make the loan application within three days of acceptance. No reasonable person would believe that a delay of a few days in making a loan application “defeats the object of the parties entering into the contract.” It follows that the buyer’s breach of the promise to make application within three days would not be considered material unless application was so delayed as to actually affect the closing date.
This result is often startling to real estate agents but it is the law. One of the consequences of the way the law treats breach is that form contracts often contain “time is of the essence” clauses. A “time is of the essence” clause is used to make a deadline material. As of January 2008, Oregon residential real estate forms make not only the closing date but all of the deadlines “of the essence.” Courts, however, are quick to find a “time is of the essence” clause waived if not enforced. Once waived, a deadline can be reinstated only by giving the other party notice and a reasonable time in which to perform.
All of this causes the more literal of agents to complain that deadlines don’t mean anything. That, however, is not the case. Courts are very interested in enforcing the intent of the parties as expressed in the contract. They are far less interested in technicalities or loopholes that one party might later try to use to “get out of the deal.” When parties enter into a contract for the sale and purchase of real property, their object is to transfer title, not assure every ancillary step required to accomplish that end. Courts will enforce the original intent to transfer unless something happens that defeats that purpose.
A real estate licensee should never counsel a client on how to get out of a contract or offer an opinion on whether a party has materially breached or the other party is entitled to terminate. Real estate licensees are employed to aid in performance, not to give advice on non-performance. When a client starts talking about non-performance of the contract in circumstances that raise issues of breach, it is time to advise the client to seek legal advice. Clients have to understand that there is no such thing as a weasel clause under Oregon law even if sometimes, like cheating on taxes, people do weasel out of contracts.
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An anticipatory breach of contract occurs when one party to a contract, without justification, makes a positive statement indicating they will not or cannot perform the contract. An anticipatory breach may excuse the other party’s performance. Anticipatory breach is important in real estate because when a buyer tells the seller they cannot or will not be able to close, the seller does not want to wait until closing to declare the contract terminated. Obviously, an anticipatory breach is a serious matter. For that reason, Oregon courts have ruled that “before a party to an executory contract may be said to have anticipatorily breached the same he must refuse by acts or deeds to perform his obligations under the contract positively, unconditionally, unequivocally, distinctly and absolutely.”
Suppose the buyer’s agent calls the seller’s agent three weeks before closing to say it looks like the buyer will not be able to come up with funds necessary to close. Is this an anticipatory breach? Probably it is not because the statement is not a positive, unconditional, unequivocal, distinct or absolute refusal to perform. How about if a few days later the buyer’s agent sends over a signed termination agreement stating that the earnest money is to be returned? Is that a refusal to perform? Again, probably it is not because most termination forms do not contain a refusal statement; they just ask if the other side will agree to mutual rescission of the contract.
If a buyer has not committed an anticipatory breach, and the seller is unwilling to agree to mutual rescission, the seller is stuck. Unless something more is done, the seller can end up having to wait until the closing date to declare the contract terminated. Sometimes waiting for the closing date is the best approach but it is also possible, once the buyer’s performance is reasonably in doubt, for the seller to force the buyer to declare their intentions. This is done by the seller seeking written assurance the buyer will perform.
Written assurance means a notice from the seller to the buyer stating clearly the reason the other party’s performance is in doubt and asking that the buyer give assurance that they will perform and how. For instance, in our example, the seller would send the buyer a notice stating that the seller has learned through the buyer’s agent that the buyer will not be able to come up with the funds necessary to close. The letter would then state the seller’s intent to enforce the contract according to it terms and ask the buyer to provide the seller with assurances that the buyer will perform as required by the contract. A short deadline (a day or two) for receipt of the buyer’s assurance is given.
If no assurances are forthcoming by the deadline, the seller is in a much better position to declare an anticipatory breach than they were. The trick when dealing with anticipatory breach (really any breach that comes before closing) is caution. A seller too quick to declare the buyer in breach can find that they, not the buyer, is the one who has breached. This is what makes the concept of “out of contract” so dangerous.
Take, for instance, a dispute over whether the buyer has applied for a loan on time or used best efforts to obtain the loan. If, based on their own assessment of the situation, the seller declares the buyer “out of contract,” the seller may themselves unwittingly commit an anticipatory breach. If it turns out the seller was wrong about the missed deadline being material, the seller’s attempt to terminate will turn out to be unjustified and risk being a material breach that excuses the buyer’s performance. Oh, what a tangled web!
Anticipated breach can trigger emotional responses. As the professional involved, resist the urge to respond emotionally and counsel your client against it. If the other side is talking about getting out of the contract and you don’t agree, stop and think about how to clarify the situation. Sending around a termination agreement that never gets signed by the other side doesn’t accomplish anything. What is needed is a document that states your position clearly and demands the other side do the same.
Stating your position clearly and demanding the same of the other side gives your client information they can use to make a rational decision. At a minimum, your efforts to clarify the situation will prevent the other side from later changing their story. More to the point, it will prevent them from claiming surprise or mistake when your client declares the contract terminated. Take, for instance, a situation in which a buyer sends over a termination agreement saying they haven’t been able to obtain a loan and demanding return of the earnest money. The seller believes the buyer has not used best efforts and refuses to sign the termination agreement because they want the earnest money. With no termination agreement and no positive refusal to perform, the deal goes into limbo.
This scenario is repeated every day in real estate, but there is no need for it. Refusing to sign a request from the other side asking for mutual rescission of the contract just keeps the existing contract in place. In other words, it does nothing. What is needed is for one side or the other to declare the contract terminated. Only once it is clear the buyer will not seek to perform the contact can the property safely go back on the market while the parties fight over the earnest money. Unsigned termination agreements are a prescription for disaster.
Rather than just refusing to sign, the seller should give the buyer notice that unless the seller hears otherwise within a very short time (24 or 48 hours) they will consider the buyer to have unilaterally terminated the contract. Then, at the end of the deadline, if the buyer’s response is anything other than we are going to perform, the seller can give final notice that they consider the buyer to have terminated due to buyer’s non-performance. At that point, it is much safer to move on to find a new buyer.
Terminating a contract is always a risky business if the parties cannot agree to the termination. Mutual rescission agreements (termination agreements in the parlance of the trade) are always the preferred means of terminating a contract because they leave no doubt. When, however, there is a dispute about terminating the contract, an unsigned termination agreement is simply too ambiguous to rely on. In such situations, it is wise to clarify the situation in writing and give the other side a short time to respond before unilaterally declaring the contract terminated by the non-performing party and moving on.
A real estate agent should, of course, always be careful about not practicing law. That means not making positive statements about legal consequences. An agent should always state facts, not consequences. It is not the practice of law to send a notice to the buyer saying the seller is in receipt of their termination agreement and has not signed it because the seller does not believe the buyer has used best efforts to obtain the loan. It is not the practice of law for the seller to give the buyer 24 hours in which to either assure the seller they will perform the contract or state clearly their grounds for refusing to perform. These are just facts. If a statement of consequences is needed, it should come from an attorney not a real estate agent.
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Handling Client Disputes
Disputes are unfortunately, and all too commonly a part of real estate transactions. It is worth keeping in mind, however, that in the overwhelming majority of transactions the disputes are minor and the parties do not resort to formal dispute resolution processes. That is not, however, to say that disputes are not important or can be ignored. Quite the contrary is true. A smart agent will be alert to the potential for disputes and strive to resolve them before they become serious enough to threaten the transaction or create liability.
Real estate transactions generate two kinds of disputes. The first is disputes between the parties. Such disputes are deal killers and lawsuit generators. They can also result in the second type of dispute: disputes that involve agents. A dispute between the parties means negotiating a business solution if possible. If not, it means advising your client to seek legal advice. A dispute involving agents means self-preservation.
Disputes involving agents are dangerous and stressful. Early principal broker involvement is absolutely critical at the first sign of a dispute that involves you as an agent. Because the broker is not personally involved with the client, they may be able to provide a more objective risk assessment. When clients stop fighting among themselves and start to point a finger at you, protecting your license needs to be foremost in your mind. That means getting your principal broker involved immediately.
Disputes between the parties to a real estate transaction come in two types: Those that arise before closing and those that arise after closing. Disputes that arise before closing generally fall into two categories. One is disputes involving unanticipated circumstances. The other is disputes involving the terms of the contract. These are, of course, not mutually exclusive categories. An unanticipated circumstance can lead to a dispute about the terms of the contract. For instance, finding a roof leak can lead to a dispute about the operation of the inspection clause.
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As a rule, the kinds of unanticipated circumstances that precipitate pre-closing disputes are matters for negotiation. For instance, suppose it comes to light during a transaction that a prior owner converted the garage to a family room without benefit of a building permit. If this were discovered on an inspection report, it would be grounds for the buyer’s disapproval of the condition of the property based on the report. If otherwise discovered and disclosed as a latent material defect, it would certainly be grounds for rescission of the contract based on a mutual mistake. Either way, the deal is going to die unless the parties can negotiate around the problem.
The seller may not see the problem as theirs alone if they did not do the remodel. That, however, is not relevant. As between this buyer and this seller, the problem is the seller’s because the buyer can walk away from the deal based on the discovery of the problem. Allowing this buyer to walk away does nothing for the seller because once the problem is known it must be remedied or disclosed to all potential buyers. The seller, therefore, is going to have to deal with the issue.
One potential solution is for the seller to obtain the necessary permits prior to close. Who pays the cost of obtaining the permits is a matter of negotiation, but the seller has little to bargain with given that the purchase price assumed a legal family room. Still, costs are always negotiable. However the negotiations come out, it is usually the agent’s job to reduce the agreement to writing. This is where real estate agents often come to grief.
The tendency once agreement has been reached regarding a dispute is to scribble out something like “Seller to obtain permits for family room” and let it go at that. This manner of resolving pre-closing disputes is a great disservice to clients. Agents are not lawyers, but they can learn to draft simple agreements that make clear the actual resolution of the dispute.
An agreement resolving a pre-closing dispute should start with a simple statement of the purpose of agreement. Second, the resolution of the dispute should be set out in clear terms of what each party has agreed to do and when they agree to do it. Finally, and this is where real estate agents almost always fall short, fail-safe mechanisms should be included so that if things do not go as planned future disputes are avoided.
Fail safe mechanisms are based on a close examination of the promises made in the agreement resolving the pre-closing dispute. For instance, if the seller has agreed to obtain the necessary building permits at their sole expense prior to the closing date, three potential problems are immediately apparent. The seller may find they cannot get the permit at all, they may find they can get them but at too great a cost, or they may find they can get them at an acceptable cost but not before the closing date. Each of these potential problems should be anticipated and the resolution for each potential problem included in the addendum resolving the problem.
An agreement to resolve a potential dispute over a family room having been built without a permit might look something like this:
“The parties to this agreement have discovered that unbeknownst to either party a prior owner converted the garage to a family room without obtaining building permits. To resolve this problem, the parties agree that the seller will use their best efforts to obtain the required permits prior to the closing date. The costs of obtaining the necessary permits, not to exceed $______ , will be paid by the seller. Should the regulatory authority refuse to issue the permits or it otherwise becomes impossible to establish the legality of the family room prior to the closing date, or any extension thereof agreeable to the parties, the transaction shall terminate and all earnest money be refunded to the buyers. If the cost of obtaining the necessary permits exceeds the amount specified above, the buyer, upon notice of the true cost, may elect to pay the difference and proceed to closing or terminate the transaction and have all earnest money refunded. If the permits are not obtained prior to the closing date, the closing date shall be automatically extended for _____ days. Thereafter, the closing date shall be extended only by mutual agreement of buyer and seller and if not so extended, the transaction shall automatically terminate and all earnest shall be refunded to the buyer.”
Certainly, it is easier to write “Seller to obtain permits for family room” than draft a whole paragraph. But scribbling a “seller to” sentence does not really define or handle the potential dispute. Some may object that so detailed an agreement is practicing law, but they miss the point. What is written above is a negotiated business solution to a known problem. All that is addressed are business problems raised by the lack of permits, not the legal consequences of not having the permits or the legal effect of closing without them.
Business expertise includes assessing a problem and helping the parties find a business solution. The actual terms of the solution, for instance, whether the buyer can elect to pay the difference if the permits cost more than expected, does not require legal analysis. It is simply the result of the business negotiations. The agent’s role is to help the parties by anticipating real world, not legal, problems. It is the parties who, with that help, find the solutions. Writing the document that memorializes the solution found by the parties is easy once the parties have decided how they want to handle the situation.
This manner of doing business traditionally is not taught, or even supported, in the industry. That is a consequence of the “sales” origin of the business. A modern professional services approach, however, demands more than simply filling in the blanks of a one-size-fits-all form. Professional service means bringing training, expertise and experience to bear on the client’s undertaking. When that undertaking is closing a real estate transaction, the ability to help the parties negotiate around problems is going to be critical.
A professional service approach means helping the parties understand the problem. For instance, understanding that an un-permitted addition can mean expenses and difficulty in the future if not corrected. That knowledge requires no legal training or analysis. It is something known to anyone familiar with real estate. It is the agent’s duty to share business knowledge. Once it is shared, it is the parties, with their agents’ help, who must decide on the solution.
It is real estate training, expertise and experience that are needed to help parties find potential solutions. This is done by helping them understand the business, not legal, ramifications of the various possible solutions. Dispute resolution is first a matter of negotiation, not the assertion of legal rights. As long as the parties are seeking business solutions by negotiation, the agents are within the scope of their agency and expertise.
Pre-closing disputes follow a predictable pattern. First, some problem arises prior to closing. The problem can be as simple as a misunderstanding over a document or as serious as an anticipatory breach by the other party. Whatever the problem, the first decision is always: do the parties want to continue? If they do not want to continue, it is time to advise legal consultation. If they do, it is time to negotiate a solution.
Once a pre-closing problem is defined and a solution is negotiated, it is time to memorialize the solutions. Real solutions require “fail-safe” provisions so that if the solution proves impossible or more burdensome than anticipated, the parties know what happens next. It is really quite simple if the real estate professionals involved approach the problem as a business problem amendable to rational deconstruction and resolution.
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Post – Closing Disputes
Disputes between clients that arise after closing can be difficult to resolve without legal help. Agreements resolving after-closing disputes, because they often involve giving up legal rights, almost always involve the practice of law and require legal advice. That is not to say, however, that real estate agents do not or should not play a role when disputes between the parties arise after closing.
It is first important to understand that as a general rule the agency relationship between a real estate licensee and a client ends with the closing of the sale. That is the case because the object of the agency has been completed. Click here for a detailed discussion of termination of agency relationships. This is important because it means an agent is not legally obligated to help a former client resolve a post-closing dispute and, if they do, their authority will be extremely limited.
Agents involve themselves in post-closing disputes as a matter of good business practices, not legal obligation. It is always good business to have satisfied and happy ex-clients out in the world singing your praises. It is perhaps even more important not to have disgruntled ex-clients out there making complaints to the Real Estate Agency and filing lawsuits. It is a short step from “the seller took advantage of me” to “his agent took advantage of me” to “why did my agent let these crooks take advantage of me.” A buyer’s agent who eggs his buyer client on by suggesting fraud and deceit may find themselves named in the lawsuit that results once their client hires a lawyer.
Although not every post-closing suit can or even should be resolved – frivolous claims and unreasonable people do exist – it is a foolish agent (whichever side they were on) who does not first explore business solutions to disputes that arise after closing. The most common post-closing dispute, of course, is one over the condition of the property. This simple fact makes agent or company provided home warranties among the most cost effective risk management tools available. Click here for a discussion of the commission sharing issue associated with agent provided home warranties.
When there is no insurance, a defect discovered after closing is very likely to mean the buyer calling their agent to call the seller’s agent to seek redress. The tendency at that point is for everyone to point fingers at everyone else. That is a foolish approach. There will be plenty of time for finger pointing later on. Rather than pointing fingers and assessing blame, the first step, just like with a pre-closing problem, is to carefully define the problem.
Suppose, for instance, the problem is that the buyer has no hot water when they move in. The first step is for someone to determine what exactly is wrong and what it will take to fix it. This sounds basic but it is all too often overlooked. Helping a former client get a problem correctly diagnosed by recommending repair people you know to be honest and competent is the kind of service that wins life-long clients, helps defuse potentially unpleasant situations and marks you as a true real estate professional. More importantly, to paraphrase a former U.S. Secretary of Defense, it is much easier to see solutions to known problems than unknown ones.
Once a post-closing problem is understood, it is time to talk to the client about solutions. This is basically beginning the same process as that used for finding resolution to pre-closing disputes. If the client feels no obligation and is unwilling to participate in any resolution, and the problem is one that could result in a significant claim, it is time to recommend they seek legal advice. If not, it is time to negotiate a resolution and to not forget about fail-safe provisions.
Agents, however, should not draft agreements to resolve disputes that arise after closing. Such an agreement will be considered a settlement agreement and as such can affect legal rights. Drafting such agreements is the work of attorneys. If a problem is big enough or complex enough to require a written agreement to resolve, it is time to get lawyers involved. Agents should, therefore, make it clear from the outset that their efforts to help former clients resolve post-closing disputes do not include legal advice or drafting settlement agreements.
If the former clients cannot or will not resolve a post-closing problem, it is time to assess the agent’s own potential exposure. Unhappy people are bad for business and can even be a threat to your license. Sure, that can seem, and maybe even is, unfair but it is reality. If someone is unhappy with your client because of a real estate transaction in which you represented that person, you need to assess the risk of that unhappiness extending to you. Their own agent should be doing the same thing.
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Disputes Involving the Agent
Early principal broker involvement is absolutely critical at the first signs of a dispute involving an agent. The first thing that must be done is an objective risk assessment. That means understanding that disputes aren’t just about who is right and who is wrong. Getting to right and wrong costs money whether you turn out to be right or wrong. Every post-closing dispute raises the issue of negotiating against transaction costs. Negotiating against transaction costs means a rational objective assessment of the difference between the cost of resolving the dispute through arbitration, court action or administrative investigation and the cost of settlement.
There is no pat answer to settlement questions. What is it worth in a particular case to maintain a good relationship with a former client or customer? What is it worth to protect your license even if you believe you have done nothing wrong? How much less will it cost to settle now before going to the expense in time, money and stress necessary to prove you did nothing wrong? These are questions that need to be answered in each individual case in close consultation between principal broker and agent.
Negotiating against the transaction costs associated with formal dispute resolution feels a lot like being blackmailed but that doesn’t change the costs associated with dispute resolution. Fighting about the cost of a used refrigerator, a hot water heater or new bedroom carpeting is probably going to be a fool’s errand if fighting means a Real Estate Agency investigation and dealing with judges or arbitrators. Other claims may be too expensive or too frivolous for there to be much choice. Being able to tell the difference between the two is what early principal broker involvement and negotiating against transaction cost is about.
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Formal Dispute Resolution
Formal dispute resolution in residential real estate in Oregon usually means being involved in a Mediation/Arbitration process. If, however, the dispute involves a claim for $10,000 or less, the dispute is heard in a small claims court. Disputes between buyer and seller are treated differently for dispute resolution purposes than disputes involving licensees and firms. This is the case because the vast majority of residential real estate transactions in Oregon are accomplished using the same REALTOR®-developed sale agreement forms.
The commonly used residential sale form contains five clauses that apply to dispute resolution involving seller and buyer only. A single additional clause is provided for dispute resolution involving licensees or firms. The first of the five clauses dealing with buyer/seller disputes defines the disputes subject to the dispute resolution provisions of the contract. This clause, in effect, contains the parties’ agreement to forego their existing legal rights in favor of those contained in the contract. With the exception of a few narrowly defined disputes involving mortgages and landlord/tenant actions, the parties agree that all disputes will be resolved using the procedures and processes set out in the contract.
The first of the procedures and processes dictated by the contract is that all disputes within the jurisdiction of the Small Claims Court “shall be brought and decided there, in lieu of mediation, arbitration or litigation in any other forum.” Essentially, the parties agree that any dispute involving a claim of damages of $10,000 or less will not be mediated or arbitration or litigated. Instead, it must be heard in a Small Claims Court. Small Claims Courts are state courts controlled by state statute.
Small Claims Courts are divisions of state Circuit Courts. They are authorized and controlled under chapter 46 of the Oregon Revised Statutes. Small Claims Courts are intended to be inexpensive and efficient. Not surprisingly, lawyers are banned from Small Claims Courts except by leave of the court. The cost of pursuing a small claims action is modest compared to filing suit in Circuit Court actions. Small Claims procures are specifically designed for use by ordinary citizens.
Buyer/Seller disputes beyond the jurisdiction of Small Claims Courts are subject to mediation as set out in the fourth clause of the dispute resolution provisions of the sale agreement. The mediation provision is a source of considerable confusion, especially among lawyers unfamiliar with its provisions. The mediation clause says that mediation must be in accordance with the procedure of a Home Seller/Home Buyer Mediation Program established by the National Association of REALTORS® or “other organization-adopted program” if the buyer or seller was represented by a REALTOR® and such a mediation program is available through the REALTOR’S® local board or association.
If the local board or association does not have a Home Seller/Home Buyer Mediation Program (and most don’t), the person filing for mediation can choose a state-wide real estate mediation program developed by Arbitration Services of Portland or “any other impartial private mediator(s) or program(s)” available in the county in which the property is located. Information on the Arbitration Services of Portland program can be found on their webpage at: www.arbserve.com. Just click on Real Estate Sales (in REALTOR® printed forms). The form for filing for mediation can be had by clicking on Request for Mediation.
Arbitration between buyer and seller is detailed in the fourth of the buyer/seller dispute resolution clauses found in the sale agreement. The clause requires that “[a]ll Claims between Seller and Buyer that have not been resolved by mediation, or otherwise, shall be submitted to final and binding private arbitration in accordance with Oregon Laws.” Oregon laws dealing with private arbitration are found in chapter 36 of the Oregon Revised Statements.
There are several boards or associations managing arbitration programs for buyers and sellers. If there is not a board-managed arbitration program, the parties are given the choice of either using the Arbitration Services of Portland or “any other professional arbitration service that has existing rules of arbitration, provided that the selected alternative service also uses arbitrators who are in good standing with the Oregon State Bar, with expertise in real estate law and who can conduct a hearing in the county where the property is located.” Information of the Arbitration Services of Portland program can be found on their webpage at: www.arbserve.com. Just click on Real Estate Sales (in the section REALTORS® printed forms).
Private arbitration is intended to be faster, less formal and less expensive than civil litigation. Arbitration advocates also point to the use of arbitrators with specific industry or legal expertise as a significant plus. In recent years, private arbitration detractors, have cast doubt on each of these claims. In addition to concerns about the speed, cost and efficacy of private arbitration some challenge the fairness of arbitration programs. They point to the difficulty of appealing arbitration decisions as evidence of the unfairness of the system.
Concerns with the efficacy and fairness of consumer contract mandated arbitration have lead to disclosure concerns. Many believe that existence of a private arbitration clause in a consumer contract must be disclosed to the consumer before they enter into the contract. As the consumer’s agent, disclosure falls to real estate licensees. To meet disclosure concerns, the arbitration clause in the sale form contains the following all caps disclosure:
“BY CONSENTING TO THE PROVISIONS HEREIN, BUYER AND SELLER ACKNOWLEDGE THAT THEY ARE GIVING UP THE CONSTITUTIONAL RIGHT TO HAVE THE CLAIM TRIED BY A JUDGE OR JURY IN STATE OR FEDERAL COURT.“
It is a good practice for agents to point out the dispute resolution clauses to their clients and have the client read the disclosure. Some companies go as far as having the client initial the arbitration disclosure clause in the margin of the contract.
The final clause in the buyer/seller dispute resolution provisions deals with attorney fees. Under Oregon law, attorney fees are available in a contract dispute only if the parties have agreed they will be available. It is in this fourth clause that the buyer and seller agree the prevailing party in any “suit, action or arbitration (excluding those Claims filed in Small Claims Court)” will be entitled to attorney fees and costs. There is, however, a catch. The catch is the prevailing party must prove to the satisfaction of the judge or arbitrator that they “offered or agreed in writing to participate in mediation prior to, or promptly upon, the filing in arbitration or court.” Thus, attorney fees are used to encourage the parties to engage in mediation.
Until recently, the buyer/seller dispute resolution procedures (Small Claims Court, mediation, arbitration and attorney fees only if the party agreed to mediation) applied to all disputes, including those involving the agents or their firms. Under the current version of the sale agreement form, disputes involving licensees or firms are subject to different procedures. Such disputes are still required to go to Small Claims if the dispute is within the jurisdiction of that Court; mediation is not, however, required.
Arbitration of disputes involving licensees or firms is required using the same arbitration procedures as buyer/seller disputes. Arbitration must be used in lieu of litigation in any other forum. This arbitration requirement does not apply to REALTOR®/REALTOR® disputes covered by the Code of Ethics. It also does not apply if the licensee or firm has agreed to some other process in a listing or buyer service agreement or the licensee is the buyer or seller.
The new licensee or firm dispute resolution clause expressly replaces and supercedes the alternative dispute resolution and attorney fee provisions that apply to buyer/seller disputes. What that means is that the prevailing party in a suit against a licensee or firm is not entitled to attorney fees or costs. The provision replacing and superceding the provisions of the buyer/seller dispute resolution procedures is in bold print. There is, however, no express disclosure or warning regarding the consequences of the clause.
Embedding dispute resolution clauses that concern licensees and firms in a contract between a buyer and seller raises difficult legal issues. First, there is the problem that ordinarily agents are not parties to their client’s contracts. Fortunately, arbitration laws are written broadly enough that a formal contractual relationship may not be needed to support an agreement to arbitrate. Nevertheless, agents should keep in mind that any provision defining their rights in a contract of which they are not party to, has the potential to create legal issues.
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In a broad sense, a “short sale” is any sale in which the proceeds are insufficient to cover the cost of closing the sale. This definition of short sale focuses attention on the problem with such sales: the seller’s lack of money at the closing table. In a short sale, the seller is said to be “upside down.”
In a short sale something has to give or the deal cannot close for want of clear title. The seller is going to have to put money into the sale, or transaction costs have to be reduced (e.g. commissions), or one or more creditors agree to reduce debt or some combination of these things has to happen. Debt reduction by the mortgage holder is what is usually meant when real estate agents talk about doing a “short sale.” Doing a “short sale” sounds simple. It is not.
What follows is an explanation of the process involved. It begins with Do the Numbers so you, your client and eventually the lender will understand the exact financial situation. Part of doing a short sale is having a serious Talk with the Client about their financial condition. Once you have the numbers and know your client’s financial condition, you can Contact the Lender, Market the Property, Write the Deal and, finally, Get Paid.
Short sales are driven by the threat of foreclosure. Most lenders will not consider a short sale until foreclosure has become a real possibility. That means missed payments and financial distress. Foreclosure also drives short sales because lenders, as a rule, will consider a short sale only when they will make more on the short sale than they would make in a foreclosure. Click here for an explanation of Oregon foreclosure laws.
Agents sometimes consider a short sale for the first time when the seller accepts an offer that will not generate enough money to clear title. This is an extremely poor practice. If the seller has not missed any payments, and is not otherwise in serious financial distress, the lender is probably not going to be interested in a short sale. Lenders are simply not interested in protecting the seller’s other assets or, for that matter, real estate commissions and other closing costs.
What lenders want to know in a short sale situation is what business people always want to know: what’s in it for me? Do not make the mistake of approaching a lender with what is in it for the seller, the buyer or for you. Instead, to be successful in a short sale situation, you must be prepared to show the lender that approving this sale at this time for this amount of money is in their best interests. To do that, you have to know the numbers.
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Do the Numbers
Short sales, like all real property sales, should start with a broker’s price opinion (BPO) backed by a Competitive Market Analysis (CMA). Click here for a detailed discussion of BPOs and CMAs. Lenders are not going to discount their loan so a buyer can acquire the property for less than its actual value. That means you have to know the actual value of the property. Market value is the number the lender will start with, not the loan payoff or even the offered price.
Your CMA and BPO will give you what the property should bring on the open market. Market value, unlike sales price, does not depend on the seller’s financial condition or need to sell. Such factors may motivate a seller to reduce their asking price below market, but that is initially of no interest to a lender. To the lender, it is simply a matter of figuring out what process is likely to result in the most money in their pocket. To get there, they have to start with the actual market value. Sure, they are going to have to discount that number, but first they need the number.
Once you have market value, you can do a preliminary net sheet for your seller. The net sheet will tell you, the seller (and eventually the lender) how much money an offer will actually make available. You have to figure the unpaid balance of the loan(s), any late fees, real estate commissions, necessary repairs, closing costs and the like. What you are looking for is cash to the seller at closing. That number will be negative in a short sale situation.
How negative the number you arrive at tells you how “short” the sale will be for a given purchase price. It is the amount you are going to ask the lender to eat. You can compare that number with the rule of thumb twenty-five percent of market value recovery in foreclosure to get an idea of whether a short sale is going to be attractive to the lender. If you are going to have to ask the lender to give up more than they can expect in foreclosure, they are going to say no. If your numbers says you are in the ball park, it is time for a serious conversation with your client.
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Talk to the Client
Sellers, quite naturally, see a short sale as a way to protect their income and assets. Lenders don’t see it that way at all. In fact, lenders see ALL the seller’s income and assets, not just the property, as a potential source of funds to pay them what is owed on the loan. This is true even though most lenders cannot take default judgments on most residential property in Oregon. Most lenders will want the seller to provide proof the seller lacks the income and assets to payoff the loan at closing before they will agree to reduce the payoff on their loan.
Your seller client should anticipate that the lender will ask for information about savings accounts, investments, other real estate, cash, money market accounts and the like. Tax returns are, of course, always something lenders like to see. Having this information available upfront will not only speed up the short sale process, but go a long way toward convincing the lender they are dealing with a competent professional. Having in hand a financial statement that shows the seller doesn’t have the ability to pay off the loan, makes a successful short sale a lot more likely.
You can also make a short sale more likely by talking to your client about a “hardship letter.” The letter will explain how the seller got into the financial situation they find themselves in. Job loss, illness and other “but of the grace of God” explanations of financial distress make a better impression than asset mismanagement, real estate speculation and so on. It’s not that a lender will never agree to a short sale where the hardship was self-imposed; it’s just that like all people lenders tend to be more sympathetic when people are caught up in circumstance beyond their control. The lender will also be able to use the hardship letter to assess the likelihood of the seller filing bankruptcy. If that is a possibility, they may be more open to working toward a short sale. Click here for a discussion of bankruptcy laws.
Talking to your client about finances and hardship may suggest that marketing the property as short sale is not really their best option. Ethical agents will at this point suggest the seller explore other options. A good source of reliable information about foreclosure can be found on the website of the Department of Housing and Urban Development at: www.hud.gov/local/or/homeownership/foreclosure.cfm. Once you have talked to your client and have a financial statement and hardship letter, it is time to contact the lender.
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Contact the Lender
Contacting a lender is not as easy as it once was. The bundling and selling of real estate loans on the securities markets has greatly complicated mortgage lending. It has also made finding the actual holder of a mortgage more complicated. It may take a number of phone calls to find the mortgage holder- or worse yet, mortgage holders.
Once you find the mortgage holder, you will need to find the person within that organization who has the authority to authorize a short sale. This can be a daunting and, depending on the number of lenders and their relationship, sometimes impossible task. Most lenders, however, will have a “short sale,” “workout” or “mitigation” department. In that department, once you find it, there will be one or more supervisors with real decision-making authority. These are the people you are trying to find.
The first step once you find the people you need to deal with is to provide them with a written Letter of Authorization. A Letter of Authorization is a letter from the property owner(s) authorizing the lender to disclose personal information about the seller and the property. Such letters contain the property address, loan number, owner’s name, agents name and contact information, the date and the authorization statement. Click here for sample Letter of Authorization. Offering the lender a Letter of Authorization early in the process will help you establish credibility.
Once you have found the people you need to deal with, given them your letter of authorization, and received from them any loan data you need, you can present your plan for marketing the property as a short sale. Remember, you represent the seller, not the lender. You probably won’t get any commitment from the lender at this point, but you can establish your credibility, explain the situation, set out your marketing plan and get the lender’s understanding and acquiescence. That way, when you get an offer and send it in for approval, the lender will know what is going on. Now all you have to do is market the property.
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Market the Property
Marketing a short sale is just like marketing any property with one serious exception. That exception is that at some point the seller is going to have to disclose the short sale requirement to the buyer. When and how that disclosure is made is a big part of marketing a short sale property.
When to make the “short sale” disclosure depends largely on the numbers you developed with your seller. If the asking price minus the seller’s closing costs is more than the loan payoff, a full price offer will not result in a short sale. In such a situation, the disclosure would not be necessary, or usually made, until the seller was considering an offer less than the asking price that would result in a short sale. When a full price offer will not result in short sale, the property can be marketed just like any other property. No short sale notice would be needed until the seller countered an offer that did not generate sufficient revenue to clear the title.
The general rule here is that a short sale disclosure is required prior to entering into any contract under which the seller will not be able to deliver clear title. If the seller is going to counter with a short sale contingency, the counter itself will disclose the short sale. When, however, the asking price itself is less than the loan payoff, and the seller will not or cannot make up the difference, every offer will trigger a short sale situation. That raises serious disclosure timing issues.
Disclosing a short sale situation signals seller distress. Seller distress can reduce offers to below market value. In addition, the uncertainty of the short sale process may discourage potential buyers and their agents before they even see the property. A short sale disclosure can also attract the attention of market predators, “low ball” offers and real estate scams of every stripe.
Your seller must be prepared for the marketing down-side of short sales before agreeing to market the property as a “short sale.” The bottom line with a short sale is that the seller cannot accept an offer without a lender approval contingency. That means either inviting an offer with such a contingency or countering with the contingency. Either is a form of short sale disclosure.
Unless you use a short sale form, or your company has a standard short sale addendum, someone will have to draft the short sale contingency. Drafting such contingencies is well beyond the expertise of a real estate licensee. Nevertheless, knowing how such a contingency works is a big part of writing a short sale deal.
Write the Deal
A short sale deal is special in several important ways. The first, of course, is the lender approval contingency. The second is altering standard deal procedures and deadlines to accommodate the lender approval contingency. A third is dealing with the potential for multiple offers created by the lender approval contingency. This section will deal with each of these issues in turn.
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Short Sale Contingencies
Short sale contingencies can be as simple as saying “subject to lender approval.” Such a shorthand contingency is, however, a very bad idea. Like any contingency, it is important to spell out both context and consequences. The context here is that the debt owing against the property is more than the purchase price. The consequence is that the lender must agree to take less than the loan payoff or there can be no sale.
Starting with context and consequences helps you see what the contingency must contain. The buyer and seller should acknowledge that the purchase price will not provide sufficient funds to payoff the loan and clear the title and that as result the transaction is contingent upon the lender approving of the sale. This is a third-party approval contingency because the lender is not a party to the real estate sale agreement.
As between buyer and seller, there is usually a binding enforceable contract upon acceptance. With a short sale, however, the contract is contingent on the seller’s creditors reaching approving of the sale. The time between buyer and seller acceptance of the sale contract and the lender’s agreement to take less than the loan payoff amount is a critical time.
In Oregon, during the short sale contingency, the most commonly used form for short sale addendums favors the buyer. OREF 027B allows for a buyer to terminate the contract with written notice, prior to the lender’s consent, for any reason. Absent such written notice, the contingency binds both seller and buyer until the lender approves the sale or the closing date occurs. Click here to view OREF 027B. If using another form, the nature of the contingency should be made clear: that the sale is contingent on the lender’s approval of the sale agreement on terms acceptable to both buyer and seller. Further, the form should include a deadline at which the buyer may withdraw if the bank is too slow in responding, so as to prevent being stuck in the contract at the lender’s mercy.
The short sale contingency will require some kind of written consent from the lender regarding the transaction and the seller’s obligation to the lender. Often lender consent will contain conditions that require the buyer and seller to modify their sale agreement. Lenders may demand as a condition of approval that the real estate commissions be reduced, that other creditors receive less than they are owed or that other transaction costs be reduced. Lender consent agreements are, therefore, key to a successful short sale. Click here to view a standard Lender Consent Agreement.
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Dealing With Deadlines
Standard sale agreement forms, and Oregon’s are no exception, contain time periods and deadlines that run from acceptance of the contract by the buyer and seller. In a short sale situation, the sale is uncertain until the lender approves. Buyers are therefore going to be very reluctant to do inspections, pay loan fees and so on until they know the creditors have approved. It is for that reason that short sale form and addendums usually suspend contract time and performance deadlines until creditor approval is obtained. However, the closing date is excluded from thi ssuspension.
A problem that can arise when suspending all contractual deadlines is what to do about the seller’s property disclosure statute? (ORS 105.465-490). The statute requires the seller to make the disclosure “to a buyer who makes a written offer.” That would, of course, normally be the date upon which the parties reach mutual agreement to the sale contract, not the date the short sale contingency is released.
Attempts to move the statutory seller’s disclosure deadline by contractual agreement raise serious statutory issues. Although a buyer can waive the disclosure, and their revocation rights under it, it is not clear that parties can by contract suspend the statutory deadlines themselves. If the buyer is considered to have waived rights under the statute by agreeing to deadlines other than those imposed by statute, they would have no statutory rights at all. On the other hand, if no waiver of statutory rights is intended, then the buyer can revoke anytime prior to actually receiving the disclosure.
It is far from clear that agreeing in a contract that the seller will not provide the disclosure until some date after the date offer automatically suspends the buyer’s rights under the statute. Fortunately, there is no real reason to delay the disclosure. The condition of the property does not depend on whether the sale is a short sale or not. As with any sale, it is wisest to give the seller’s property disclose and start the revocation clock.
Among the most important of contractual deadlines is the payment of earnest money and the closing date. Buyers may be reluctant to tie up earnest money on a deal that needs lender approval. At the same time, the seller will want to know the buyer is serious before getting into the short sale approval process. One solution is some earnest money upon acceptance and more upon lender approval. The closing date can be handled by simply agreeing to close a certain number of days after creditor agreement is obtained.
Common Oregon short sale addendums make clear that, although other time and performance deadlines are suspended while waiting for lender approval, the contract closing date is excluded from such suspension. The closing date now terminates the contingency, if not satisfied or waived by that time by the lender. If the seller and buyer want the contract to continue, they must agree to a new closing date in writing. This change in how short sales are handled in Oregon came about due to lenders delaying the short sale process. Prior to 2008, buyers could find themselves stuck in limbo waiting for lenderâ€™s approval since short sale forms favored the seller.
If not using the standard OREF form, it is critical to the seller that the contingency be written so the deal automatically fails if the lender doesn’t approve. Otherwise, the seller could find themselves bound to convey title they cannot clear. You will see short sale contingencies that make this mistake by having an approval period that expires without spelling out the consequences of not obtaining lender approval. As with any contingency, it is often more important to spell out what will happen if the contingency is not met than it is to spell what happens if it is met.
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Whatever the details of the short sale contingency itself, some thought should be given to how subsequent offers will be handled. Lender approval takes time. During that time, it is not unusual to get other offers. Indeed, it is often in both the lenders and the seller’s interest to try to get better offers. At the same time, short sales are uncertain enough for the buyer that introducing multiple offers into the mix can be very disconcerting.
A good short sale addendum will address the issue of subsequent offers. The old industry standby of taking “backup” offers doesn’t really work. A lender will not approve an offer in “first place” if there is a better offer in “backup.” Because a better offer will be more likely accepted, and result in less loss to lender and seller alike, it is often not in the seller’s interest to withhold subsequent offers from the lender. At the same time, passing on subsequent offers can cause hard feelings, contract disputes and increase marketing difficulties.
One way to handle the multiple-offer problem is to warn buyers right up front that the seller will continue to market the property and submit all offers obtained to the lender for approval. This will discourage low-ball offers. It may also, however, complicate the approval process and discourage some buyers. Another approach is to create contingent offers under which there is no contract at all until the lender approves. Such contingent contracts can be terminated by either party for any reason prior to approval. This solves some problems, like timing issues, at the expense of certainty.
Other approaches, for instance, having an open “offer period” designed to obtain the best offer prior to submitting an offer to the lender, are possible. Whatever the approach, it must be clearly understood by all the parties before offers are accepted. Multiple listing service rules about “pending” sales must be addressed. Short sales are not just deals with a “subject to lender approval” contingency. Careful preparation, including client counseling and proper disclosures, is key. So important is such counseling that Oregon form publishers attach a “Short Sale A Brief Summary” to their short sale addendum. Click here to find a sample Short Sale A Brief Summary form.
The contractual issue of continued marketing is separate from the MLS issue. Any seller is entitled to continue to market their property. Putting that fact in the contract is a matter of wise disclosure, not legal right. None of this has anything to do with the multiple listing services.
Multiple listing services typically have two categories of listings for member search purposes. One is “active” and the other is “pending.” Whether a property filed with the MLS is or should be carried as active or pending depends on the MLS rules. Parties cannot change these rules by contract. Brokers cannot change the rules either. It follows that whether a short sale is carried as “active” or “pending” is decided by the MLS, not the parties or individual brokers.
Some multiple listing services allow members to carry short sale listings as “active” until the short sale contingency is removed. Others simply enforce existing rules and carry short sales as “pending.” One way tends to favor sellers and lenders, the other buyers. Which is “best” is a political issue to be resolved by MLS rule.
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Short sales put pressure on commissions. It is just a fact of life. In short sales, there is not enough money to go around. The seller is in serious financial trouble. Foreclosure or bankruptcy may be on the horizon. The buyer is looking for a deal and the lender is losing money. Getting a fair commission in such circumstances can be an ordeal.
A seller in serious enough trouble to qualify for a short sale is not going to question the real estate commission. They don’t really care how much the lender has to discount the loan as long as they don’t have to pay. The lender, however, is going to care. And, if the seller is going to get a 1099 for the debt forgiven, they should too. So, real estate commissions are going to be an issue right off the bat.
Lenders are not opposed to paying real estate commissions. They are, however, much more business oriented than the average home owner. That means they will almost certainly negotiate the commissions paid. Agents can deal with this fact in two ways. One is to list the property at the commission rate typical for their area and expect to negotiate with the lender later. The other is to decide on a commission rate that is appropriate for the professional services provided to put together a successful sale and stick to it.
If the seller has hired, or is themselves, a foreclosure consultant or mitigation expert of some kind, you will want to carefully read the section on Dealing with Foreclosure Consultants.
Whatever the approach you choose with respect to listing side commission, thought needs to be given to the selling side. Multiple listing services have strict rules about offers of compensation. Basically, you must state the compensation as a dollar amount of a percentage of the sales price. This MLS policy can cause real problems in a short sale when the lender starts making approval contingent on commission reductions.
The MLS offer of compensation is an offer of a unilateral contract. A unilateral contract is one that is accepted by performance, not promise. The performance required to accept a unilateral offer of compensation in the form of a coop real estate commission is procuring a buyer ready, willing and able to purchase on terms acceptable to the seller. As a general rule, a buyer is procured when they write an offer that is accepted by the seller. That means a unilateral offer of compensation is accepted by the selling agent when they submit an offer that is accepted by the seller.
Once an offer is accepted, it can be changed only by mutual agreement. Put that in the context of a unilateral offer of compensation and you can see that once you have a deal the coop commission cannot be changed other than by agreement of the selling broker. This can be a real obstacle when the lender demands commission reductions as a condition of approving a short sale. If the selling brokerage is willing to risk the deal, they can refuse to reduce the selling side and thus place the entire reduction of the listing broker.
Multiple listing services as a rule will not allow listing agents to qualify their offer of compensation. You cannot offer “half of whatever I eventually agree to” in the MLS. Such an offer would not qualify as a unilateral offer of compensation because the payment term would be indefinite. You also cannot put “commissions subject to reduction by lender” or other qualifiers in the remarks section and use that to unilaterally reduce the commission split offered in the MLS. It is never a good idea to make real estate commissions a contingency of a sale as that can put the agents’ interests in conflict with their clients.
One way to deal with the coop commission issue is to put information in the remarks section that warns the coop broker that lender approval may be conditioned on renegotiating the commissions. Such a warning is not binding and does not change the unilateral offer of compensation, but it will at least put agents on notice. The only other way to deal with the problem is to reach an agreement with the coop broker before they have procured a buyer.
Residential real estate agents tend to favor blind offers. Often the first anyone knows of a buyer is when their offer shows up on the listing agent’s fax machine. It is difficult at that point to renegotiate the commission split. Renegotiation works much better if done before there is a written offer.
One way to get to the selling broker before there is an offer is to demand showings by appointment. When the agent makes the appointment, the listing agent can explain the situation and get their agreement to participate in any commission reduction that may be demanded by the lender. This agreement to participate can be memorialized with a simple email. That way, when the time comes, the agents will be on the same page and in agreement on how to proceed.
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Dealing With Foreclosure Consultants
Understanding Foreclosure Consultants
With the downturn of the real estate market in 2008, a rising tide of foreclosures created an entry opportunity for what are called foreclosure consultants or mitigation experts. Often, these consultants and experts team up with investors or equity purchasers. The stated purpose of individuals and organizations involved in foreclosure consulting or mitigation is to help distressed homeowners avoid foreclosure. It is the threat of foreclosure that drives short sale listings and brings real estate licensees into contact with foreclosure consultants, mitigation experts and the like. Click here for Frequently Asked Questions on foreclosure consultants and short sale negotiators.
Although there are honest and reputable people involved in foreclosure consulting and loss mitigation, these activities can involve very sharp business practices and even fraud. The federal Department of Housing and Urban Development (HUD) publishes a list of “HUD-approved Organizations” that provide foreclosure prevention related counseling. The list is available at: www.dfcs.oregon.gov/ml/foreclosure/counselors.html. The Oregon Department of Finance and Corporate Securities (DFCS) publishes extensive information about foreclosure scams. The information is available at: www.dfcs.oregon.gov/ml/foreclosure/foreclosure_fraud.html. General information about preventing and dealing with foreclosure is available from the Oregon State Bar on their Legal links Cable Television Show. The relevant episodes are available here.
Desperate homeowners facing foreclosure will often clutch at straws and are therefore easy prey for sharp operators. It is for that reason that the Federal Trade Commission (FTC) publishes a consumer information pamphlet called “Foreclosure Rescue Scams: Another Potential Stress for Homeowners in Distress.” The publication is available online from the FTC at: www.ftc.gov/bcp/edu/pubs/consumer/credit/cre42.shtm. The pamphlet warns consumers about foreclosure scams, explains how common scams work and offers a list of “red flags.” The FTC also publishes a list of lawsuits against, and settlements with, foreclosure “rescuers” here.
The FTC and multiple state attorney generals have been actively prosecuting foreclosure rescue companies that are conducting these types of scams on distressed homeowners. Some states, including Oregon, have enacted laws that specifically regulate these types of businesses. The FTC began its own rulemaking process in 2009 and has now issued a final rule impacting many real estate licensees in what is being called the MARS Rule (Mortgage Assistance Relief Services Rule) which became effective January 31, 2011.
The MARS rule covers short sale negotiations. The rule defines Mortgage Assistance Relief Services as a service, plan or program offered or provided to the consumer in exchange for consideration that provides services in relation to a consumer mortgage, including a possible loan modification which includes negotiating a short sale of a dwelling on behalf of a consumer. Additionally, the FTC defines Mortgage Relief Service Provider as someone who provides or offers to provide, or arrange to provide, any mortgage assistance relief service.
As you can see, these FTC definitions mean that, absent an exception, the MARS rule can have an impact on a real estate licensee who handles almost any type of short sale transaction.
While the rule is primarily aimed at companies that offer loan modification services to consumers, the rule falls squarely on real estate licensees as well and requires a disclosure be given by parties, including real estate licensees, who are involved in negotiating short sales. The FTC has defined negotiate to include contacting a lender about the possibility of short sale transaction involving a consumer loan. Therefore, it is recommended that the disclosure be given anytime you are dealing with a short sale where you represent the seller until and unless an exemption is granted to real estate licensees by the FTC. For a sample disclosure and more information on MARS please click here. However, due to response from real estate licensees, the FTC issued a statement that it would not enforce most provisions of its MARS Rule against real estate brokers and their agents who assist financially distressed consumers in obtaining short sales from their lenders or servicers. Read more about the FTC forbearance here.
Like the federal government, Oregon has moved to protect homeowners from foreclosure scams. In 2007, the Oregon legislature responded to growing concern about foreclosure scams when it passed the Oregon Mortgage Rescue Fraud Protection Act: House Bill 3630 (HB 3630). A copy of the entire bill is available from the Oregon Legislature at: www.leg.state.or.us/08ssorlaws/0019.html. The new law is codified at ORS 646A.700 through 646A.765. Click here for a copy of the statutes. The Act has a number of features real estate licensees should be familiar with.
The Oregon Mortgage Rescue Fraud Protection Act applies to a person who acts as a “foreclosure consultant.” The term is broadly defined to include anyone who, for compensation, offers to help a homeowner stop foreclosure or in some way renegotiate or otherwise modify a loan or rights under a trust deed or mortgage. Real estate licensees are exempt from the Act “if acting within the scope of that license.” To act within the scope of a real estate license means to act under a listing agreement or as the representative of a buyer.
The Fraud Protection Act creates contractual notice, rescission and cancellation rights for homeowners who contract with foreclosure consultants. Foreclosure consulting can be done only under a written contract. The written contract must be presented to the homeowner at least twenty-four hours before it is signed by the homeowner. It must be in the language spoken by the homeowner and used in discussion between the homeowner and the consultant. The terms of the service and payment must be plainly expressed. The contract must contain a statutory notice that begins with the following warning: “THIS IS AN IMPORTANT LEGAL CONTRACT AND CAN RESULT IN THE LOSS OF YOUR HOME. YOU SHOULD CONTACT A LAWYER OR OTHER PROFESSIONAL ADVISER BEFORE SIGNING.” If the consultant does not meet the requirements of the Act, they are in violation of the Unlawful Trade Practices Act.
Under the Act, foreclosure consulting contracts can be cancelled at anytime by the homeowner. The consultant must provide the homeowner with a statutory cancellation form. A copy of a form that meets the statutory requirements is available here. If the homeowner exercises their right to unilaterally cancel the contract, they must pay for any services actually delivered prior to cancellation and any money expended by the consultant on their behalf. Any consideration received by the consultant from a third party must be fully disclosed to the homeowner in writing. If the consultant is involved in facilitating or arranging for an equity conveyance (typically, to an “investor” or “equity purchaser”), the consultant cannot be paid by the equity purchaser.
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Listings Involving Foreclosure Consultants
Real estate licensees come into contact with foreclosure consultants and mitigation experts because most “rescues” involve trying to sell the property usually as a short sale. The involvement of foreclosure consultants or loss mitigation experts in real estate sales conducted through real estate licensees raises serious risk management and business issues for the licensees involved. Licensees must be aware of potential for involvement in fraud. Even if no fraud is involved, potentially difficult agency issues can arise when the seller has hired a foreclosure consultant. The viability of listings involving foreclosure consultants must always be assessed from a business as well as a legal and risk management point of view.
Most foreclosure consultants are not licensed to practice real estate. That means sharing any part of a commission, or even promising to share any part of a commission, is illegal. Foreclosure consultant will sometimes have schemes for evading the commission sharing rule. Some of these may, depending on how exactly they work, be legal if the payment comes from a party to the contract rather than the agent. Such arrangements, however, will tend to tie the agent to the consultant’s business and business practices. No agent should even agree to any arrangement regarding the commission when a foreclosure consultant is involved without first checking with their principal broker.
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Avoiding Involvement in Fraud
Real estate licensees who list property for owners involved with foreclosure consultants, loss mitigation experts, investors or equity purchasers must first make up their mind whether they should be involved at all. Often, the consultant will have some contractual arrangement with the seller before the property is listed for sale. That means a dispassionate investigation of the consultant or expert and the nature of their relationships with the seller is needed before agreeing to list the property. That kind of investigation starts with finding out whether the mitigation expert or consultant is licensed to do business in Oregon. That information is available from the state online at: www.filinginoregon.com.
A quick check of FTC enforcement actions at the national level is a good second step. That can be done on-line at the Federal Trade Commission’s website. Finally, a call to the Financial Fraud/Consumer Protection Section of the Oregon Attorney General’s office (503-947-4333) will tell the licensee if complaints against the particular individual or company have been filed in Oregon. Having this kind of information before taking the listing is essential because it is much easier to decline a listing than get out of one after-the-fact.
Being licensed to do business in Oregon and not appearing on any government listing related to foreclosure scams does not mean it is a good idea to be involved with a particular company. If possible, the licensee should review the mitigation company’s advertising. The FTC singles out the following advertising messages commonly used by what they call “scam artists”:
“Stop Foreclosure Now!”
“We guarantee to stop your foreclosure.”
“Keep Your Home. We know your home is scheduled to be sold. No Problem!”
“We have special relationships within many banks that can speed up case approvals.”
“We Can Save Your Home. Guaranteed. Free Consultation”
“We stop foreclosures everyday. Our team of professionals can stop yours this week!”
Ads like these are aimed at desperate homeowners and intended to convey that an easy fix is available. That kind of advertising should put the licensee on guard and cause him or her to look closely at how the consultant’s or expert’s program actually operates.
Although new scams, and variations on old scams, arise all the time, there are a number of common scams to watch out for. Phony foreclosure counseling or “help” is the simplest of the common foreclosure scams. Under this kind of scam, the “consultant” promises to negotiate some kind of deal with the lender, takes a fee up front and then simply disappears. A real estate licensee can diligently market the property while the consultant who is supposed to be negotiating with the lender is long gone.
A particularly sinister variation of the phony help scam involves having the homeowner make the mortgage payments to the consultant while the “negotiations” are taking place. No negotiations ever take place. The scam artist simply keeps the mortgage payments until the lender finally forecloses. Real estate licensees involved in marketing the property while the seller sends his payments to the scam artist can find themselves a target of the seller’s lawyers when the whole thing blows up. Licensees can also find themselves involved in the aftermath of a phony help scams when the now really desperate homeowner tries for a “quick sale” at the last minute. Usually, it is too late by the time the scam artist is done and therefore such listings are not practical from a business standpoint.
Along the lines of the phony help scam is the bankruptcy scam. In such scams, the “consultant” promises to stop a foreclosure at the eleventh hour for an upfront fee. Once they have the fee, they file bankruptcy on the homeowner’s behalf promising to work something out with the lender. The bankruptcy filing does stop the foreclosure, but only temporarily. Meanwhile, the scam artist has moved on, leaving the homeowner with ruined credit and a complicated bankruptcy action to deal with. As with the phony help scam, real estate licensees find themselves marketing something that can no longer be sold. Licensees may also get involved in the aftermath of bankruptcy scams when the desperate homeowner tries for a “quick sale” at the last minute through the bankruptcy process. Unless experienced in sales involving bankruptcies, taking such listings may not be a good business decision.
By far the most dangerous of scams for real estate licensees are those that involve equity transfers. An equity transfer involves a conveyance of some kind between homeowner and consultant or between the homeowner and an “investor” or “equity purchaser” found or recommended by the consultant. The scam may involve the homeowner signing documents represented to be a new loan that actually transfer title to the “investor” in exchange for a “rescue” loan. Real estate licensees get involved when the investor lists the property for way more than the “rescue” loan. Dealing with this kind of listing is covered later in this section.
A licensee who works with an investor who has obtained the property by fraud can easily be drawn into the resulting lawsuits especially if the licensee and “investor” establish an ongoing relationship that involves listing all of the investor’s properties. Even when the equity transfer does not involve blatant fraud like misrepresenting documents, it may involve very sharp business practices and heavy sale pressure. The wider the margin between what the “investor” paid and the listing price, the more potential there is for fraud or sharp practices to be involved. Careful assessment of the risk involved in representing such “investors” in the re-sale of the home is essential.
Another popular scam is the “rent to buy” scam. Rent to buy is an equity purchase scam in the sense that the homeowner conveys title to the consultant or investor. Instead of then selling the property for a huge profit, the scam artist lets the former owner rent the house until they can buy it back. Often, however, the terms of the buy back are so onerous the homeowner has no real chance of ever completing the deal. Or, the new owner may simply raise the rent until the homeowner starts missing payments and then evict the homeowner and sell the house. When they go to sell they house, they will usually want to list it with a licensee.
A variation on the “rent to buy” theme involves a homeowner who has stopped making payments and moved out of the property conveying the property to the scam artist who is supposed to have “special knowledge” that allows them to sell the property and split the profits with the homeowner. The mortgage remains with the homeowner. The scam artist then lists the property and either rents it out or seeks a lease/option buyer. They then collect the rent and wait for the lender to foreclosure on the original homeowner. Because the scam involves an equity transfer and subsequent lease, lease purchase or sale, real estate licensees can easily get caught up in such scams.
Avoiding being caught up in foreclosure scams is a matter of diligence. On the listing side, that diligence begins with a careful analysis of agency relationships. Deciding who your client is, or ought to be, is always the first step. That begins by focusing closely on who is asking you to do what. If the seller has approached you to market the property and has hired a foreclosure consultant to negotiate with the lender, you have one client (the seller) who has two agents (you and the consultant). In that case, your duty is to the seller alone.
Representing a seller who is using a foreclosure consultant is not a comfortable position to be in whether there is fraud involved or not. If there is fraud, and the agent says nothing, the seller is likely to conclude the agent was in on it. On the other hand, if the agent does say something and there is no fraud, they risk a business liable/contract interference claim by the consultant. That is why the first step should always be to check out the foreclosure consultant. If the company isn’t registered in Oregon, or their name appears on a government fraud list, the wise agent will avoid the listing.
If there is no obvious problem with the consultant or their company, try to get a look at the consultant’s contracts and advertising before taking the listing. If there is no written contract, the consultant is probably in violation of the Mortgage Rescue Fraud Protection Act. If there is a contract, make sure it contains the required warning language and statutory cancellation form. If all that is in order, look at how the consultant is being paid. This is where upfront fees, rent-backs, equity transfers and the like should come under careful scrutiny. The question here is not one of fraud, but of whether involvement with these practices is a wise business decision.
If the consultant and firm don’t check out, or you feel uncomfortable in anyway regarding the structure of the consulting fee, don’t take the listing. If you do take a listing where the seller has engaged a foreclosure consultant any foreclosure consultant, even the most reputable you should make certain the seller clearly understands the scope of your relationship. You want to make certain the seller understands that you are not responsible for the consultant, the consultant’s conduct, seller’s contract with the consultant, the wisdom of hiring the consultant, or the outcome the consultant achieves. That can be done with a disclaimer attached as an addendum to the listing agreement. Here is a sample of such a disclaimer:
Seller under this Listing Agreement has entered, or will enter, into a separate written agreement with a “foreclosure consultant” who has agreed to provide certain services to the seller under a separate agreement. Seller understands and acknowledges that the listing broker, listing company and the principal broker involved in this Listing Agreement are not responsible for the consultant, the consultant’s conduct, Seller’s contract with the consultant, the wisdom of hiring the consultant or the outcome the consultant achieves. The scope of the services provided Seller under this Listing Agreement are limited to marketing the property to find a buyer ready, willing and able to purchase on terms agreeable to Seller and assisting Seller in performance and closing of any resulting sale contract. Although the listing broker will cooperate with Seller’s consultants as directed by Seller, neither the listing broker or the broker’s principal broker will be responsible for advising Seller on any aspect of the consultant’s services, the terms of the consultant’s contract or the consultant’s conduct in performing services under the contract. Seller is advised to exercise extreme care in entering into any agreement with a foreclosure consultant, or an investor or equity purchaser found or endorsed by the consultant. Foreclosure consulting services are subject to the Oregon Mortgage Rescue Fraud Protection Act. Seller is advised to seek competent legal advice from an attorney regarding the terms, conditions, obligations and services provided by any foreclosure consultant as well as the consultant’s conformance with state laws and regulations. Seller acknowledges that such advice is beyond the scope of a real estate licensee’s training or expertise and Seller is therefore not relying on the listing broker, listing brokerage or the principal broker in any way with regard to the foreclosure consultant or the consultant’s services or conduct.
Another situation that can arise when working with foreclosure consultants or other mitigation experts is when the consultant, or an investor or equity purchaser of some kind working with the consultant, wants to list the property. Such situations can be fraught with peril for a real estate licensee and, therefore, must be very carefully and dispassionately reviewed. Principal brokers are well advised to have a policy that forbids brokers from entering into any listing agreement with anyone who is not the owner of record at the time the listing is taken unless the listing has been reviewed and pre-approved by the principal broker.
The reason for having such a policy is twofold. First, foreclosure consultants and their associated investors or equity purchasers are not usually the owner of the property they want to list. Instead, they usually have some sort of contingent interest such as an unexercised option, contingent sale contract or limited power of attorney. Whatever the vehicle used by the consultant, investor or equity purchaser, if they are not presently the owner of record (or have recorded power of attorney that specifically grants them the right to sell this piece of real property on the record owner’s behalf), the broker must have the true owner’s written permission to market and show the property. This is the case because of real estate advertising rules and civil laws like those for trespass. It is critical that any listing file for a listing with anyone other than the record owner contain a copy of the record owner’s written permission to market and show.
Demanding the written permission of the record owner to market and show does not make the record owner the listing broker’s client. It does, however, raise the second reason for extreme caution when listing property for a foreclosure consultant or their investor or equity purchaser the potential for unintended or misunderstood agency relationships and the resulting conflicts of interest. Simply put, the broker can find themselves caught between the interests of the record owner who is not their client, but has given the broker permission to market and show, and the consultant or investor who is their client because they signed the listing.
As with any potential conflict of interest, the solution (other than avoiding the situation altogether) is full disclosure. Here, the consultant or investor is the client, not the record owner. The broker needs something in the file that shows the record owner has not only given marketing and showing permission, but understands that the broker does not represent the record owner, does represent the consultant or investor but is not responsible to either for the relationship or transaction between the record owner and the consultant or investor. That means a disclosure to the client consultant or investor that, with their permission, is shared with the record owner. Here is sample of such a disclosure:
Seller under this Listing Agreement has entered, or will enter, into a separate written option, purchase or other binding agreement with record owner of the listed property. The record owner has agreed in writing that the listing brokerage may market and show the property on behalf of Seller. Seller agrees the listing broker may provide a copy of this disclosure to the record owner. Seller, and record owner, understand and acknowledge that neither the listing broker, listing brokerage or the principal broker involved in this Listing Agreement are responsible for the agreement between Seller and the record owner, it terms, provisions, fairness or consequences. The scope of the services provided under this Listing Agreement are limited to marketing the property to find a buyer ready, willing and able to purchase on the terms of this Listing Agreement and assisting Seller in performance and closing of any resulting sale contract between Seller and a subsequent purchaser. Although the listing broker will cooperate with the record owner as directed by Seller in showing the property, neither the listing broker nor the broker’s principal broker will be responsible for advising record owner or Seller on any aspect of the agreement between Seller and the record owner. Seller and record owner are advised to seek competent legal advice from an attorney regarding the terms, conditions, obligations and conformance with state laws and regulations of their agreement. Seller and record owner acknowledge that such advice is beyond the scope of a real estate licensee’s training or expertise. Seller is not relying on the listing broker, listing brokerage or the principal broker in any way with regard to the agreement between Seller and the record owner. The record owner is hereby specifically advised that the listing broker, the listing brokerage and the principal broker represent only the Seller under this Listing Agreement and do not represent the record owner and are not in anyway responsible to the record owner.
The final issue when it comes to dealing with foreclosure consultants is the business wisdom of the relationship. Certainly, no business relationship is wise if there is any hint that fraud may be involved. In that regard, it is worth keeping in mind the ten “red flags” published by the Federal Trade Commission (FTC). The FTC recommends that anyone looking for foreclosure prevention avoid any business that:
- Guarantees to stop the foreclosure process no matter what your circumstances
- Instructs you not to contact your lender, lawyer, or credit or housing counselor
- Collects a fee before providing you with any services
- Accepts payment only by cashier’s check or wire transfer
- Encourages you to lease your home so you can buy it back over time
- Tells you to make your mortgage payments directly to it, rather than your lender
- Tells you to transfer your property deed or title to it
- Offers to buy your house for cash at a fixed price that is not set by the housing market at the time of sale
- Offers to fill out paperwork for you
- Pressures you to sign paperwork you haven’t had a chance to read thoroughly or that you don’t understand.
If there is no indication that fraud may be involved, and all involved are willing to let the broker use the proper disclosures and disclaimers, there is still the matter of whether the listing is worth the cost. This is a very hard thing for real estate brokers, especially in a down market where listings are scarce. Private foreclosure consultants, investors and equity purchasers have learned that real estate licensees are often willing to absorb the cost of marketing real property without regard to the likelihood of a sale. This willingness is, in effect, a subsidy for down market investors.
Because they do not need to expend money on marketing the property, consultants and investors can focus their efforts and capital on finding and tying up distressed property. The more property they can find and tie up, the better their odds of making a profit. To the consultant or investor, it is strictly a numbers game. If they tie up a hundred properties and sell only one, they make money as long as the profit on the one exceeds the expense of tying up the hundred. Since they are not expending any money on marketing the property they tie up, they may not be, and generally are not, very concerned about market viability. The record owner and the real estate broker who pays for the marketing take the risk of no sale, not the consultant or investor.
In addition to the Fraud Protection Act, Oregon laws also regulate what are called “debt management services.” The 2009 Legislature substantially changed the laws regarding debt management services found in ORS chapter 697. In House Bill 2191, the legislature expanded the existing definition of “debt management service” to include, among other things, “obtaining or attempting to obtain as an intermediary on a consumer’s behalf a concession from a creditor including, but not limited to, a reduction in principal, interest, penalties or fees associated with a debt.” A person who “provides or performs, or represents that the person can or will provide or perform a debt management service in return for or in expectation of money or other valuable consideration” must register with the Director of the Department of Consumer and Business Services (DCBS) and comply with DCBS rules and regulations. Unlike the Fraud Protection Act, there is no express exemption in HB 2191 for real estate licensees.
The key to dealing with the debt management services laws is to avoid being paid for any activity that falls within the definition of “debt management services.” It is the “in return for” and “in expectation of” language in the law, instead of a specific exception, that protects ordinary real estate activity. As long as the real estate licensee is being paid, and expects to be paid, only a real estate commission pursuant to a listing, the incidental assistance offered the seller in obtaining creditor consent to the transaction in a short sale should not be considered debt management services. On the other hand, a real estate licensee who hires out to sellers listed with other agents, or FSBO’s, or operates on behalf of “investors” or “equity purchasers” or otherwise is involved in short sales other than under a listing agreement with the owner, needs to carefully consider debt management services regulations.
Real estate licensees involved in short sales under a listing agreement with the owner of the property, should carefully spell out their involvement in a written addendum to the listing. In this way, problems with both the Fraud Protection Act and Debt Management Service laws can be avoided by explaining in writing the exclusive real estate nature of the relationship. In this way, it can be made clear that the real estate licensee is being paid a real estate commission for providing brokerage services and not for obtaining agreements with the seller’s creditors regarding the seller’s debts. The real estate deal calls for the creditor’s consent sufficient to clear the title; it does not require the real estate agent to negotiate new terms for the note or mortgage agreement between seller and creditor regarding the underlying indebtedness. That remains the seller’s responsibility. Click here for a sample Addendum to Short Sale Listing Contract.
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Multiple Offers and Excalator Clauses in Short Sales
Understanding the Short Sale Market
In the last few years, short sales have become a growth industry. At the end of 2008 and especially in early Spring 2009, the federal government moved to make the market for toxic real estate assets more liquid through policy changes, asset purchase programs and capital infusion. Toxic assets are assets that are worth less than what has been invested in them. If a market contains too many toxic assets, the assets become hard to sell, even at a loss. Such assets are then said to be “illiquid.” Time on market is a measure of liquidity in the residential real estate market.
Short sales are a mechanism for marketing toxic assets in an illiquid market. Normally, and this was certainly the case when the residential housing market first turned sour, there is little incentive for lenders to participate in short sales. Unless a short sale will result in significantly less loss to the lender than foreclosing on the property, the lender has no incentive to discount their loan. Short sales, therefore, are traditionally about convincing the lender that taking the short sale deal will actually make them money. See the Do the Numbers section of this subject.
In economic terms, the government’s intervention in the distressed property market created a market entry opportunity. In a sense, this new distressed property entry opportunity is an echo of the residential real estate market entry opportunity created by the easy credit that caused the real estate market bubble in the first place. Indeed, many of the same mortgage brokers, property flippers and real estate speculators who drove the real estate bubble are back as foreclosure consultants and equity purchasers. Basically, the government is using its money and influence to encourage sales at well below what would otherwise be the market price in order to increase liquidity and, therefore, clear the market of distressed properties.
Encouraging sales at below market price does two things. First, it increases market activity, particularly market activity in distressed property. Today distressed properties in the guise of short sales and REOs make up about 20% of real estate listings in the average market but account for more than half of all sales. Secondly, encouraging below market sales creates a new market bubble. The distressed property bubble is intended to stop the deflation created by the end of the original bubble. In many markets it is generating the same kind of frenzied activity as was seen market-wide at the height of the original bubble.
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Dealing with Short Sales in the New Short Sale Market
How long the distressed property market will last is hard to say. It is clearly a market aberration and, therefore, one would not expect it to last very long. While it does last, real estate agents who deal with distressed property will have to adjust. Paradoxically, that means adjusting to a hot market in the worse real estate market in memory. Hot markets are driven by investors hoping to buy low and sell high. Ordinary homebuyers may also be attracted to the market. That means, as it did at the height of the bubble, more people chasing the same properties. That in turn, as during the original bubble, means dealing with escalator clauses, multiple offers, frenzied buyers and sharp business practices.
Multiple offers, including agency and license law implications of being involved in multiple offers, are covered in the Multiple Offers section of Writing the Deal. The mechanics of dealing with multiple offers in the short sale context are, however, very different. To understand why that is the case, one must focus on the dual contract nature of a short sale. Although rarely appreciated by agents, a short sale actually involves two agreements that is, two contracts. The first is a standard purchase and sale agreement between seller and buyer. The second is a loan satisfaction agreement between the seller and the seller’s lender(s).
What the industry calls a “short sale addendum” is really just a real property contract contingency. It is no different in that respect than a 72-hour contingency or other contingency that must be satisfied before a party is obligated to perform the contract. The industry has dealt with buyer-side contingencies for years. What is different about a short sale is that the contingency conditions the seller’s obligation to sell, not the buyer’s obligation to purchase. In a short sale, the seller’s obligation to transfer title is contingent on the seller obtaining their creditor’s consent to lower the payoff on the seller’s mortgage or note so the seller can deliver clear title. To do that, the seller must reach an agreement with their lender(s) about satisfaction of the debt the seller owes the lender.
It is common in the industry to think of the interaction between seller and lender as one of the lender “approving” of the sale, but that is not what is going on. The lender is not a party to the sale and their approval of the sale itself will have no affect whatever on the seller’s obligation to the lender under the mortgage or note. What the lender is approving is not the sale, but a modification to their mortgage or note. The fact that lenders will almost always demand changes in the underlying sale agreement as a condition to agreeing to modify their mortgage or note does not make the lender a party to the sale itself.
It is important to understand the two agreements nature of short sales before trying to understand the impact of multiple offers in short sale situations. The first impact of having two agreements is that because the lender will consent to only one deal, the short sale addendum itself effectively works as a backup offer contingency would in an ordinary real estate transaction. The short sale addendum by itself protects the seller from becoming obligated to transfer title in more than one deal. That means the seller can accept as many offers as they like as long as each uses a short sale addendum that makes the seller’s obligation to sell contingent on the seller and lender reaching an agreement on the mortgage or note.
In short sales, there is no need to have offers in backup position as is done in ordinary sales. Every offer is in backup position, regardless of the order accepted, because the seller’s obligation to convey title is contingent in every offer. The impact of this simple truth is spelled out in paragraph #5 of the short sale addendum most used in Oregon where the buyer is warned that the listing will remain “active” and the seller will continue to consider and submit to the lender(s) competing offers. This warning in the short sale addendum is a multiple offer warning.
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Handling Multiple Offers in Short Sales
In an ordinary multiple offer situation, the seller alone has control of the situation and can make up their own mind about the wisdom of pursuing better offers. In a short sale situation, however, the seller is also negotiating with the lender over modification of the mortgage or note. The seller, depending on the exact situation, may or may not be liable for any deficiency should the lender end up foreclosing. See the Foreclosure section of this topic for an explanation of deficiency judgments under Oregon foreclosure statutes. The seller may or may not suffer tax consequences based on the amount of debt forgiven. The size of the deficiency can also affect the seller’s credit rating. All of this suggests the lender’s and seller’s interests in obtaining the best possible offer coincide and sellers should accept and forward for consideration better offers if they are made. Paragraph #5 of the short sale addendum reflects this conventional view of short sales.
The problem is that in real life the interests of the lender, the seller and multiple buyers can, and do, conflict in ways that make deciding what to do about subsequent offers in a short sale situation very difficult. This difficulty can make it very hard for an agent to serve their client’s interests and avoid risk. Take, for example, something as simple as an escalator clause in a short sale.
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Escalator Clauses in Short Sales
Buyers will sometimes include in their offer a clause in which they agree to pay a sum (typically a thousand dollars or so) “over any other buyer’s offer.” Escalator clauses appeared at the height of the real estate bubble and are now reappearing in the short sale market. Escalator clauses were then, and are again now, a buyer gimmick designed to trick the seller into leaving money on the table. What the buyer with the clause hopes is that they will get the property without having to bid against other informed buyers.
Escalator clauses work only if the competing buyers do not know of the clause. Keeping the existence of an escalator clause a secret from other buyers means risking leaving money on the table because there is no way to know if one of the other buyers might have paid even more for the property than was paid under the escalator. In a short sale situation, leaving money on the table means the seller risking a larger deficiency, tax burden, or credit hit than would otherwise be the case.
As was the case during the earlier bubble, an escalator clause signals a buyer who is trying to purchase at less than their best offer price. Sometimes, escalator clause buyers will actually tell the seller what the buyer’s best offer price really is by placing a limit price on the escalator. A rational seller will always seek each buyer’s best offer. It follows that an offer with an escalator clause should always be rejected and the buyer asked to make their last best offer.
If there are multiple offers pending at the time the offer with the escalator is made, each offer can be rejected and each buyer informed there are multiple offers and they should make their last best offer by such and such a date. The best offer is then accepted and forwarded to the lender. If the escalator comes after another offer has already been accepted and forwarded to the lender, simply reject it and ask for the buyer’s last best offer. If the buyer is just fishing for a fool, they will go away. If not, they will make their best offer. Either way, the situation is resolved without bringing in the complication of an offer with an escalator clause into an already complicated situation.
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Understanding Multiple Offers in Short Sales
The idea of getting to the last best offer applies equally to all offers in short sale situations, not just those with escalator clauses. The big question in short sales is how much “better” does an offer need to be before it should be accepted by the seller and forwarded to the lender. Notice first, there are two steps: (1) accepted by the seller and (2) forwarded to the lender. If an offer is not accepted by the seller, there is nothing to forward to the lender. This is where the two-contract nature of short sales becomes important.
Short sales, we have already said, are about sellers reaching agreements with lenders about mortgages or notes. To get that agreement (the seller/lender agreement), the seller needs to show the lender a particular offer the seller has accepted and negotiate with the lender based on that accepted offer. There is nothing that says a seller must accept and forward every offer they receive. The seller does not lose control of their property just because they are seeking an accommodation on their mortgage or note. What happens instead when a seller seeks an accommodation agreement from a lender is that the seller takes on the duties of honesty, good faith and fair dealing with respect to the accommodation agreement. The intentional lack of honesty is called fraud.
Fraud is about deceit. It is about the intentional concealment of material fact. The material fact we are talking about in a short sale is the fact of another offer. That fact is material to the lender because the seller is asking the lender to reduce the payoff on the mortgage or note based on the price of an accepted offer. If I negotiate for the lender to take a $50,000 loss by hiding the existence of an offer that would substantially reduce their loss, I am not being honest, dealing fairly or performing the mortgage reduction agreement in good faith once I get it. Stated plainly, once a seller asks the lender to take a loss based on a specific offer, they cannot simply ignore subsequent better offers.
That the seller cannot ignore subsequent better offers does not mean they have to continue to market the property or take all subsequent offers. They may very well want to do those things, but we are talking about whether they have to do them. The seller’s obligation is honesty, good faith and fair dealing. Good faith, and fair dealing are, setting aside for the moment intent, basically the same thing as honesty. The simplest way to be honest is to make full timely disclosures of material facts.
In real estate, disclosures are often thought of as forms to be signed. Disclosure is actually just the act of imparting what is secret or not fully understood. The legal definition, when it comes to contracts and agreements, is: “obligation of parties to reveal fact which is material if its revelation is necessary because of the position of the parties to each other.” As soon as the seller starts negotiating with the lender to reduce the payoff on their note, a subsequent better offer becomes material because of the position of the parties to each other. Other than as the triggering event for the lender/seller negotiations on the mortgage or note, the underlying sale agreement has nothing to do with it.
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Developing Practices for Dealing with Multiple Offers
Now that we understand that subsequent offers in short sale situations are material facts in the negotiation between seller and lender, we can develop practices and strategies to meet the resulting obligation of honesty, good faith and fair dealing. Timely disclosure, we know is the key to meeting these obligations. That being the case, the time to resolve the subsequent offer dilemma is when negotiation is opened with the lender on the first accepted short sale offer. What are needed are sound business practices that anticipate and handle subsequent offers in short sales before the offers are made. In short, practices that get the seller and agents in front of the situation by anticipating the situation.
There are only a handful of possible ways in which subsequent offers can be handled in short sales. One is to not market and not accept subsequent offers. Another is to accept subsequent offers in a “backup” position and send them to the lender sequentially as the lender rejects them. Another way is to request offers for a specific period of time, then close the offer period, stop marketing and send the best offer to the lender. Another is to accept all offers on a short sale contingency and send them all to the lender. Yet another is to send only offers better than previous offers by a set amount and then only until a certain cutoff date. Which among these alternatives is best depends on the circumstances.
There may be situations where the size of the deficiency doesn’t concern the seller or where there simply isn’t time to mess with subsequent offers. In such cases, the agent would submit the first offer with a cover letter or email (or phone conversation with a follow-up letter or email) that says due to the circumstances the seller will not market or seek subsequent offers. If the lender says nothing, they have agreed to that approach. If they do say something, the seller can negotiate with the lender to resolve the issue. That may involve postponing a foreclosure, taking only backup offers or whatever is necessary. Meanwhile, the accepted offer is in the works and the seller’s and agent’s duty of honesty, good faith and fair dealing has been met by communicating their intent to the lender.
Communicating intent to the lender is the key to meeting the duties of honesty, good faith and fair dealing. For instance, another way to handle the multiple offer potential would be to advertise (MLS comments are advertisements) that the seller will entertain all offers for a specified time (three weeks, a month, six weeks, whatever) and then accept and forward the best offer to the lender. Buyers would then make offers with an expiration date longer than the specified period. A buyer could, of course, revoke their offer at any time prior to the seller’s acceptance at the end of the period, but so what? To make this work, all that is necessary is to work out the details with the seller and inform the lender of how the seller intends to proceed. Silence is again agreement for honesty, good faith and fair dealing purposes. If the lender objects, the seller and the lender can work out the lender’s problems.
If the situation is such that the seller intends to continue marketing and accepting better offers to forward to the lender, then the thing to do right at the beginning is to establish some criteria with the lender regarding subsequent offers. That can be done with a cover letter that accompanies submission of the first accepted offer. In the letter, the seller can tell the lender they will continue to market for a specific period of time and accept and forward better offers. This lets the seller decide how long he wants to continue looking for a better offer and to define “better.”
How long the seller wants to seek better offers depends on the situation. Certainly, the foreclosure date is going to be a factor. There may be other considerations for the seller based on lender plans. Since all that is happening here is that the seller is covering his honesty, good faith and fair dealing obligation, setting a marketing time or criteria for determining a better offer is just informational. The same is true of defining what will be considered a better offer. The idea, again, is to communicate to the lender the seller’s idea of what is reasonable in the circumstances. If nothing is said by the lender, the assumption is that whatever the seller decided is considered reasonable. If something is said by the lender, the matter is negotiated and resolved.
There is a final scenario that should be mentioned while we are talking about communication and resolving matters by negotiation. There is a movement in some areas of the country to have sellers accept subsequent offers in short sales in what is termed “backup position.” This means the seller will accept, but not forward to the lender, any subsequent offers in short sales by having buyers agree to a backup position before the seller will accept an offer. This approach confuses the sale agreement with the lender/seller agreement and raises a couple of serious issues.
The first issue arising when sellers take backup offers in short sale situations is whether the backup offer is better in the sense of reducing the lender’s potential loss. If it is for a higher offer, accepting it as backup and not forwarding it raises the same honesty, good faith and fair dealing problem as simply rejecting the offer. As far as the lender is concerned, an offer not forwarded is an offer that is hidden. As we have already discussed, hiding better offers while negotiating with a lender to reduce the payoff on a loan raises very serious liability problems. Calling the hidden offer a backup offer doesn’t change anything with respect to the relationship between the lender and the seller.
To use the backup offer approach safely when a subsequent offer has the potential to reduce the lender’s loss, the seller would need the lender’s approval to treat subsequent offers as backups. That can be done by communicating in a cover letter to the lender, with the first accepted offer just like with other processes, the intent to take backup offers. Don’t be too surprised if the lender disagrees on this one. We are talking here about subsequent offers that are better in the sense of reducing the lender’s potential loss. In reality, a seller would be free, without any further communications with the lender, to accept in backup position an offer for less money than the one already forwarded to the lender.
The key to a successful short sale lies in understanding that in negotiations with a lender over how much money the lender is willing to forgive, the seller cannot hide from the lender other offers that have the potential of reducing the lender’s loss. The way to deal with that obligation is to tell the lender what you are going to do with subsequent offers when you submit the first one. If the lender doesn’t object to the plan, the seller has met his obligation of honesty, good faith and fair dealing. If the lender does object, the seller negotiates a process the lender will agree to. That way, you never get into a situation where the seller is hiding material information from the lender.
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Dealing With REOs
Understanding the REO Market
REO is the acronym for “real estate owned.” It is the acronym banks use for real estate the bank forecloses upon, takes in lieu of foreclosure or otherwise owns. Such property is carried on the bank’s books as an asset. The value of the bank’s assets is critical to the operation of the bank because the bank’s balance sheet, and thus its solvency, is linked to the value of its assets. In a market downturn, like the downturn in the real estate market after 2007, real estate assets become less valuable and this can raise very serious solvency issues for banks.
The link between asset value and bank solvency makes the sale of real estate owned critical to bank operations. The link also makes it difficult to predict how a bank will go about selling the real estate it ends up owning. Typically, the sale of real estate owned is handled by the bank’s “loss mitigation” department. Loss mitigation means making losses less severe or painful to the bank. How the loss mitigation department tries to mitigate the loss associated with real estate owned depends on the direction of the market, the rate of market change, market liquidity, the bank’s ratio of liabilities to capital and assets, the number of properties owned and many other factors.
As complicated as the loss mitigation factors may be, the bottom line is that the bank wants to keep losses to a minimum. That means that, contrary to popular belief, REOs are not normally dirt cheap. Banks do discount their property to reduce time on the market and to account for the fact that bank property is typically not occupied, or staged or otherwise groomed to obtain top price. Historically, this discounting has put REO properties on the market at about 95% of true market value.
Beginning in the Spring of 2009, government intervention in financial markets and the glut of REOs resulting from historically high foreclosure rates began forcing banks to consider larger discounts to clear their books of real estate owned. In some markets this has led to REOs being sold at 75% or less of market value. As a result, pre-foreclosure, REO and other foreclosure-driven sales can make up as much as 50% of total sales in some markets. Although the market is “distressed,” sales can be “hot” with multiple offers, escalator clauses and all the other pushing and shoving associated with a hot market. Click here for detailed discussion on multiple offers in a distressed property market. It has, therefore, become increasingly important that real estate professionals understand the operation of the REO market.
Unfortunately, the REO market involves a very odd real estate commodity. Most of the real estate owned market is residential. What is being sold is homes, but not homes in the typical owner-occupied family home sense. To the bank, the home is just an asset with a market value no different than a piece of repossessed farm machinery or the inventory of a failed business or a corporate bond. To the REO buyer, the home may be a home or a rental investment or just real estate with a short-term flip value. Thus, the REO market consists of buyers with different goals competing in a market where sellers are detached business people trying to minimize a loss rather than maximize profit.
Most agents spend their careers helping homeowners and homebuyers get together. Real estate practices and forms are designed for this homeowner/homebuyer market. The vast majority of individual agents’ experience is in the homeowner/homebuyer market. Although the object of the transaction is the same residential property REO transactions have very little in common with homeowner/homebuyer transactions. Whether on the listing side or the selling side, expectations, practices and forms will all change in a REO transaction. That means a steep learning curve for agents who find themselves in the REO market.
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REOs on the Listing Side
On the listing side, REOs are mostly about having a tightfisted, unresponsive, disinterested seller with a strong desire to minimize transaction costs and avoid all potential liability for the sale. For a “day in the life” view of what REO listing agents do, see Sheryl Vogel’s REALTOR® ONLINE ARTICLE. Although some lenders will spread REO listings among local real estate companies, more will work through only one local company or a large national “servicing” company whose business is handling REO sales for lenders. Listing REOs, if possible at all, is about making a deal with a demanding seller who has its own way of doing things. REO listings are, therefore, not for everyone.
A real estate professional on the listing side of any real estate sale has three general responsibilities. They will market the property, negotiate the deal and assist the seller in closing the resulting transaction. Those general responsibilities don’t change with a REO listing, but the way each is accomplished almost certainly will. Most banks and REO servicing companies have their own listing forms. These forms bear no resemblance to the MLS-generated homeowner listing forms most real estate agents are familiar with. REO listing agreements typically impose significant additional duties on the listing agent.
Marketing owner occupied residential real estate is about working with the homeowner to get the listing, throwing the listing in the MLS, running some ads and waiting for the buyers. REOs don’t work that way because there is no owner occupant to deal with. There is often no one at the property to discuss the condition of the property, make disclosures regarding the condition of the property, arrange for pre-sale repairs or staging or do any of the myriad of other things sellers usually do when they want to sell their house. Banks typically look to the listing agent to assume the duties of the owner occupant.
Most REOs come from foreclosures that dispossessed the owner-occupant. That means the previous occupant was living there for a period of time, sometimes a significant period of time, under severe mental stress and with no money. The condition of the property at the time of listing can, therefore, vary anywhere from an empty, neat and broom-clean house to a squatter occupied dump that has been stripped of all wiring and plumbing. Listing agents often become the point person for the bank in dealing with these issues. Indeed, some banks expect the listing agent to not only evict squatters, but fund with their own money getting the property in condition to sell. A wise listing agent will work through exactly how occupancy and property condition issues will be resolved before taking on the listing. Most lender service companies that handle listing REO property have provisions in the master listing agreement about such things.
The up side of REO listings is that REOs actually attract buyers (and their agents) because “REO” signals discounted property and that can mean the listing agent will see a flurry of lowball and oddball offers as soon as the listing goes active. How to deal with lowball and oddball offers, and the distrust and distaste of some buyers and their agents, are things the listing agent should work out with the bank at the time the property is listed. Some banks will handle the “lowball/oddball” issue by instructing the listing agent not to take offers below a certain price or on certain terms. Some will require buyers who make offers with finance contingencies to pre-qualify for a loan through the selling bank even if they are seeking financing elsewhere. Both of these strategies for dealing with lowball/oddball offers can put listing agents in a tight spot.
Oregon statute requires the listing agent “To present all written offers, written notices and other written communications to and from the parties in a timely manner without regard to whether the property is subject to a contract for sale or the buyer is already a party to a contract to purchase.” ORS 696.805(2)(b). Oregon administrative rules go a step further and require that: “A real estate licensee must promptly deliver to the offeror or offeree every written offer or counter-offer the licensee receives.” OAR 863-015-0135(2). As if that were not enough, the REALTOR® Code of Ethics wades in with: “REALTORS® shall submit offers and counter offers objectively and as quickly as possible.” Standards of Practice 1-6.
The statute, rule and Code provisions regarding the submission of offers and the like are often taken to mean the listing agent must submit every offer they receive to the seller whether the seller wants to see it or not. That cannot, however, be the case. Real estate statutes and rules and, of course, the Code of Ethics, do not apply to sellers. An agent cannot make the seller consider offers the seller has told the agent they do not want to consider. You cannot have a rule that says the agent must obey the seller and one that says the agent must make the seller consider offers they have specifically told the agent they will not consider. Fortunately, real estate rules create no such a conflict.
There is no reason to interpret the “present written offers in a timely manner” requirement as requiring the agent disregard or disobey the seller’s instructions. The seller has every right to say what they will or won’t consider as an offer. A piece of paper with the buyer’s signature and terms is not an offer to the seller if the seller has specifically defined what they will consider an offer. The seller can define the manner in which offers, in the form they demand, will be presented to them. They can define what they consider “prompt” by defining the circumstances. (“Prompt” means as soon as is practical in the circumstances and the seller can control the circumstances). In short, the seller can tell their agent they will not consider any offer that does not meet certain criteria established by the seller to be an offer. Until and unless the offer becomes an offer the seller will consider, there is nothing to submit or present or to be prompt about.
What is needed as far as the listing agent is concerned are clearly written instructions from the seller establishing what will be considered an offer and how the agent is to handle submissions from buyers that do not meet the seller’s definition of offer. The agent needs clearly written instructions because the agent does not have the authority to unilaterally decide what is and isn’t an offer. Real presentation rules are designed to prohibit agents from deciding themselves what the seller should see, but that doesn’t mean the seller cannot decide for themselves what they want to see. If the seller doesn’t want to see all offers, get the seller’s limitations on offers in writing and disclose those limitations up front to other agents and buyers by making it clear they are the written instructions of the seller.
Written instructions from a seller are wonderful things, REO or not. Unfortunately, when the seller is a bank, written instructions can be hard to come by. Banks aren’t people. They employ people to act on their behalf. That means the interests of the bank and the interests of the people employed can be two very different things. That the bank doesn’t want to see certain offers may or may not be the bank’s idea. It could be the idea of a burned out ex-mortgage broker riding out the real estate bubble they helped create by hiding out in the bank’s loss mitigation department doing REOs until things blow over. Such people know they can say pretty much anything they want to as long as there is no written record of what was said. The trick for listings agents is to make sure there is a written record of what is said.
Email is the perfect tool for the control of bank employees. Confirm everything that could come back to bite you, or the bank, your client by email. If a bank employee tells you not to forward offers unless they are above a certain price or that the buyer must be pre-qualified by the bank before an offer will be considered, thank them for the instructions and immediately repeat them back to them in a nice email. For instance:
“This is to confirm your instructions regarding offers on our listing #____________. I understand that you will not consider any offer below $_______________________ and that I am to inform buyers of this requirement and that their offer will not be forwarded for consideration if it is below $____________________. I will place this limitation in the MLS remarks so that agents understand your requirements. I also understand that offers contingent on buyer financing will not be considered unless the buyer has applied for and received a pre-qualification letter from the bank. Again, I will inform all buyers that this requirement must be met before their offer can be submitted for your consideration. I will place the requirement in the MLS remarks. Until I hear otherwise, I will proceed based on your instructions not to forward offers that do not meet these requirements.”
If the bank employee who signed the listing is not the same as the one giving you instructions on the listing, copy the email to the person who signed the listing. If they tell you stop copying them, send them an email that says “per your instructions, I will no longer copy you on emails regarding our listing # _____________________.” If this sounds paranoid, it is. Banks are institutions that handle other people’s money. Many of them are in serious trouble. They employ lawyers. The people they owe money to employ lawyers. When something goes wrong, you don’t want to be the one left holding the bag. That doesn’t mean being obnoxious or obstructive, but it does mean practicing situational awareness and paying attention to details.
Situational awareness means keeping things in context and thinking through potential consequences. Here is a true story that illustrates the point: A broker with a REO listing that wasn’t moving at $235,000 received an email from the bank’s loss mitigation department telling the broker to reduce the price to $99,000. The broker phoned their contact at the bank questioning the instruction, but was told: “do what you’re told; we need to get some interest going on this property.” Concerned about the potential for an unlawful trade practices claim if the bank had no intention of selling at $99,000, the broker emailed her bank contact person explaining her concern and suggesting the bank ask their lawyer about it. The broker immediately received an email from the loss mitigation manager saying the reduction must have been a typo and the price was really $199,000.
There is little, if anything, a broker can do to change the business practices of their lender client. It is often impossible to know whether what you are being told is the position of the client or just the position of the client’s employee. About all a listing side real estate licensee can do is keep from getting stuck holding the bag if something goes really wrong. The only way to do that is to document the client’s instructions and make certain there are written records that show why things were done as they were. It is always a good idea to then make sure the buyers, agents, third-party service providers and others involved understand what the seller wants as well.
Arranging for repairs, utilities, staging and the like is a good example of documenting instruction and making sure others understand why things are being done as they are. REO property is absentee-owner property. That means that the seller doesn’t know much about the property, isn’t around to do things for themselves and generally isn’t very responsive to marketing needs. This tends to put pressure on the listing agent to make arrangements, sign documents and so on. There is nothing wrong with that as long as agents remember they are not the seller and act accordingly. For instance, if the agent is ordering repairs, or utilities or arranging for staging, the order or contract for any services should be, whenever possible, in the lender’s name, not the agent’s, even if the agent will sign the order.
If Big Bank is the owner, and Sammy Sale the agent, the service order or contract should be in the name of Big Bank and is signed: Sammy Sale for Big Bank. The agent should be sure Big Bank is aware of the service order or contract for services. Again, this can be done by discussing the matter with the client and confirming the discussion with an email. For instance:
“This is to confirm our conversation yesterday regarding repairs on the property we have listed. Pursuant to your instructions, I will act as your agent to arrange for the repairs we discussed to be done on your behalf.”
Make sure the contractor makes the contract out to the client and that you sign for the client. That way, if something goes wrong, you are clearly an agent acting under the instructions of the client.
Some REO listings contain provisions requiring utilities, repairs, and so on to be in the listing agent’s name. This creates risk for the agent. Whether the listing is worth the risk depends on a number of factors. First and foremost are the terms for reimbursement. For instance, many REO service companies demand that all expenses be accounted for at closing or they will not be paid. That can mean the agent bearing the costs of utilities, repairs and so on if there is no sale. Read the master listing agreement and resolve these issues up front with the client. Regardless of who is paying, the key on the listing side is the same: The agent is acting under the instructions of the client as an agent and must make sure the records reflect that arrangement.
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REOs on the Selling Side
On the selling side, REOs can be big trouble. The commissions can be discounted, the listing agent detached, the seller distant and disengaged and the deal a legal nightmare on unfamiliar forms. If ever there was a “no such thing as a free lunch” transaction, it’s a REO transaction from the selling side. Selling agents and their clients need to understand the REO market and adjust accordingly. Many buyer agents will not show REO property without having a buyer service agreement with the buyer that spells out duties and compensation.
Adjusting to the REO market means understanding that a lender is not an unsophisticated homeowner selling their property with the help of a real estate licensee. Until the rise of the distressed property market, most agents had been involved only in homeowner transactions done on standard agent supplied forms using traditional practices and procedures. The residential homeowner sale market was so much of the total real estate market for so long that the forms, practices and procedures used in that market were often misunderstood as somehow required by law. That is simply not the case.
Buyers and sellers are not regulated by the state as buyers and sellers in any serious way. Sure, there are laws about contracts, deeds, required disclosures and the like, but not about how buyers and sellers must conduct their negotiations. Real estate agents are licensed and subject to real estate licensing laws, but license laws do not apply to buyers or sellers. Much, if not most, of what real estate agents do, and how they go about doing it, is not law but custom custom developed in the homeowner/homebuyer market. These customs have little or no application in the REO market. This causes no end of angst on the selling side of REO sales.
Because REO sales involve an institutional seller who is liquidating assets for loss mitigation purposes, REO sales are done on seller-generated forms with provisions never seen in homeowner/homebuyer sales. The companies involved in selling bank assets have well paid lawyers who have no trouble at all understanding their client’s needs. Those needs are to retain full control of the transaction until closing, minimum transaction costs and no liability after closing. These seller needs are typically met by the seller demanding that all buyers use the seller’s forms typically one or more addendums that are added to the contract form used by the buyer.
The seller’s addendums in a REO transaction are made the controlling instruments in the sale by expressly superseding any conflicting provision of the sale agreement to which they are attached. The addendums are often as long as the sale agreement form used by the buyer’s agent. The terms added are complicated and contrary to most of the terms found in standard homeowner/homebuyer forms. The REO addendum, therefore, ends up controlling all the important terms and conditions of the sale. Although real estate licensees cannot practice law by giving clients advice about the legal meaning of REO clauses, they should be aware of the business consequences of common REO clauses.
Most REOs use “property condition” addendums or clauses that are true legal works of art when compared to the tepid “as is” clauses used in homeowner/homebuyer forms. Rather than simply disclaim warranties and representations, REO clauses often make buyer risk and responsibility for the condition of the property part of the consideration for the contract itself. Sometimes these property condition clauses are set out as a separate addendum. Sometimes they are just a clause in the general REO addendum. However they are presented, REO property condition clauses are specifically designed to make it difficult or impossible for the buyer to sue the seller after closing for after-discovered defects. In short, all risk of loss from the condition of the property is shifted to the buyer.
REO contract and addendum clauses can hold other risk shifting surprises for the buyer. For instance, the title conveyed may be a bargain and sale or special warranty deed that does contain the same title warranties as in a homeowner/homebuyer sale. If the buyer wants financing, the seller may demand prequalification by a specific lender at the buyer’s expense. That is perfectly legal as long as they do not make where the loan itself comes from a term or condition of the sale. Finally, many REO contracts contain “per diem” clauses that can cost the buyer as much as a hundred dollars a day for any delay in closing, regardless of the reason for the delay.
REO addendums are usually presented on a take it or leave it basis by adding provisions that expressly forbid buyer-initiated changes. Listing agents are often instructed not to submit offers that do not conform to the seller’s offer criteria. This practice is very distressing to buyer agents, but the seller is entitled to define what they will and will not consider as an offer to purchase their property. An unaccepted offer in the hands of the seller is the seller’s document to do with as they please. They can instruct their agent to line things out, add provisions, or do what they will and hand it back to the buyer. It has nothing to do with making changes above some line. It is just a way, albeit a poor one, to communicate the seller’s offer criteria to the buyer. In REO’s, the seller will end up making a contingent offer to sell instead of the buyer making an offer to purchase.
The exchange of offers and counter-offers process used in homeowner/homebuyer real estate sales is not required by any rule or law. It is just a convenient process used to form contracts. It creates mutually binding contracts that can protect the rights and expectations of both parties. But that’s not necessarily what an institutional seller wants. The institutional seller wants full control, minimum transaction costs, and no ongoing liability. As a result, they don’t use the standard real estate offer and acceptance process.
In REO transactions, the seller may not be very interested in whether a particular buyer closes on a particular property because they have lots of properties and lots of buyers. They are seeking aggregate benefit, not just a single transaction benefit. To the buyer, and their agent, the REO transaction is a single transaction, but that is not the way the seller sees it. A REO seller’s attitude often is: “Ok, we can work with you on this and, if at the end of the day we still think it’s good for us, we’ll go ahead and close it, otherwise all bets are off.” That is not really acceptance in the legal sense of the word. It is a contingent offer.
A contingent offer is one that says: I will enter into a contract with you on these terms in the future if I still want to. Look for clauses like: “final acceptance of the contract of sale is subject to seller’s approval” or “this contract is contingent upon final approval by seller or seller’s Agent” or “the seller reserves the right to terminate the contract for any reason in its sole discretion” or “not binding until accepted by seller” or variations and combinations of reservation and approvals. In Oregon, a contingent offer is treated much like a letter of intent and is not usually binding on either party. It is not “illegal” to do business in this wa; it’s just that it is not the way agents and buyers usually think about real estate contracts.
At this point, buyer agents have to be wondering what, if anything, they can do for their clients in a REO transaction done on REO addendums using REO procedures. The answer is, negotiate in good faith and keep the buyer informed. The fact that REOs often have their own forms and procedures and are usually unwilling to even talk about changing those forms or procedures does not mean there is nothing the buyer’s agent can do.
It is not the agent’s duty to interpret the legal consequences of using REO forms. It is not their duty to demand changes in REO procedures or rail against the inequity in bargaining positions. Rather, it is agent’s duty to help the buyer client understand the business and real estate consequences of what is going on. That means finding out what is going on and reporting it to the client. The agent needs to have some way to document both the finding out and the reporting.
Finding out what is going on is a matter of asking questions. It is true that listing agents in REO deals sometimes do not do a good job of making the seller’s requirements known. That does not, however, excuse a buyer agent from treating a REO listing as if it were a homeowner listing. When a buyer wants to look at a REO listing, it is time for the buyer’s agent to shift gears. That shift should begin with telling the buyer that the property is a REO and what they can expect as a result. This is best accomplished at this early stage with a standard Client Information Letter.
A client information letter is just a way to provide important information to a client (and to prove you did so). Client information letters are not transaction documents. They are not disclosures or disclaimers. They are records of communication between principal and agent. They go in the client’s file. What is recorded is evidence of the agent’s diligence in promoting and protecting the interests of their client while staying within the scope of their expertise. Such letters can be standardized for convenience and efficiency. For example, here is a sample of an information letter to a buyer client who is considering a REO property:
“Information Regarding Real Estate Owned (REO) Property”
You have expressed interest in looking at, and perhaps purchasing, property owned by a bank. Such property, called “real estate owned” or “REO” property, can represent a price bargain. There are, however, some things you should be aware of before getting involved in a REO transaction.
Although banks are often willing to take less money for a property than might a homeowner with similar property, they will typically do so only on terms that are beneficial to the bank. REO property, therefore, is often sold using addendums to standard real estate contracts that substantially change the terms to favor the seller. Most often, these REO contracts and addendums are presented on a “take it or leave it basis” much like a car dealer presents a dealer’s contract that cannot be changed by a car purchaser.
Among the terms found in REO contracts or addendums are those that substantially limit the buyer’s ability to sue the seller if a problem with the property is discovered after the purchase is completed. Such terms make the inspection and investigation of REO properties by the buyer absolutely critical. Inspections and investigations can increase the buyer’s transaction costs. Limiting the buyer’s legal remedies can create substantial risk for the buyer. These increased costs and risks must be weighed against any potential reduction in price of REO property.
REO contracts and addendums often contain provisions that postpone the seller’s acceptance or otherwise reserve to the seller the right to cancel the contract if they obtain a better offer or decide for other reasons not to proceed. Such terms create uncertainty for the buyer because there may be no binding contract until right before the closing. The buyer, therefore, may be expending money to determine the condition of the property, the state of its title, compliance with government regulations and so on without a binding contract. These matters must be carefully considered before becoming involved in a REO transaction.
A real estate licensee cannot give legal advice or offer opinions on the legal consequences of specific contract terms. For that reason, I must strongly recommend that you seek the counsel of a qualified real estate attorney before entering into a REO transaction using forms provided by the seller. Although I will work closely with the listing agent to obtain information about the seller’s forms and procedures, and pass that information on to you, I cannot be responsible for the legal consequences of entering into a transaction on forms developed by the seller and offered on a take-it-or-leave-it basis. You must judge for yourself whether the potential savings are worth the risk and uncertainty typically found in REO transactions.
The point when dealing with REOs on the selling side is that a buyer should understand the situation. That begins with defining the situation. Defining the situation is a matter of communication with the listing office. Discussing documents and procedures with the listing agent is the first step. The second step is a follow-up email to the listing agent clarifying what was discussed. The third step is communicating the resulting information to the buyer client.
This pattern of communicating with the listing office, following up the communication with a confirming email, and then communicating the result to the buyer is good service and good risk management. Take, for instance, the no acceptance problem. The fact that the seller is reserving acceptance is as big a problem for the listing side as for the selling side. That being the case, they will have some mechanism for communicating some kind of preliminary OK. When that preliminary OK comes in, whether by phone, email, fax or whatever, follow it up with a confirming email. For example “this is to follow up on our telephone conversation this morning in which you confirmed that the seller is moving forward on our offer and ï¿½ï¿½” Copy the buyer and follow up any conversations with the buyer with emails as well. What you are looking for is a chronological email record that shows a diligent agent and a well-informed buyer.
It is hard for some agents to settle for being a diligent agent and keeping the client well informed because they believe they have to protect the client’s interests. Although true, the agent does have to protect their client’s interests, that doesn’t mean the agent has to decide what is best for the client. It doesn’t mean the agent has to be a lawyer. A real estate agent protects the interests of their client by finding and communicating information about the property and the transaction and using their real estate training and experience to advise the client on the potential business or real estate consequences of the transaction. Look again at the sample client information letter with this in mind.
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Foreclosure is the means by which a creditor gains the right to sell real property that secures a due and unpaid debt. The debt can be in the form of a mortgage, a note and trust deed or a lien on the property. Whatever the instrument, foreclosure under Oregon law is the only way the creditor can force the sale of real property to pay the debt.
There are two kinds of foreclosures in Oregon. One is called judicial foreclosure. The other is called non-judicial foreclosure. Judicial foreclosure is typically used to foreclose mortgages and other liens on real property. Non-judicial foreclosure is typically used to foreclose interests under a trust deed by a process known as “advertisement and sale.”
All foreclosures are closely regulated by statute under Title 9 of Oregon Revised Statutes. The judicial foreclosure of mortgages is governed by the provisions of ORS Chapter 88. Liens are covered in ORS Chapter 87. The non-judicial foreclosure of trust deeds is governed by the provisions of ORS Chapter 86.
Generally, foreclosure laws and procedures are beyond the scope of a real estate licensee’s expertise. Extreme care should, therefore, be taken when marketing property that is in foreclosure or in danger of foreclosure. Click here for a discussion of Marketing Property in the Face of Foreclosure. Foreclosure is always a factor in a short sale. Click here for a detailed discussion of Short Sales.
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Statutory Provisions Involved
ORS Chapter 86 Mortgages; Trust Deeds
ORS Chapter 87 Statutory Liens
ORS Chapter 88 Foreclosure of Mortgages and Other Liens
Judicial foreclosure requires a lawsuit in circuit court brought under the provisions of ORS 88.010 et. seq. The mortgagee or lien holder sues to have the mortgage or lien foreclosed. If the suit is successful, the court will issue a decree and order the property sold by the local sheriff at a public auction.
In order to sue for judicial foreclosure, the owner of the property must be in “default.” “Default” means they have failed to meet the terms of a mortgage or otherwise failed to pay a debt when due which is secured by the property. Like any lawsuit, a foreclosure suit requires service of the filed complaint. Service will serve as notice to the property owner that the legal foreclosure process has begun.
Once the suit is filed, the owner can avoid the foreclosure only by satisfying the debt. This right to satisfy the debt ends when the property is sold. How long it will take for the court to order foreclosure is hard to predict because it depends on whether the default is contested as well as how full the court’s docket is with other cases. Typically, a judicial foreclosure will take six months or longer.
Foreclosure sales are conducted according to the public sale provisions of ORS 18.924. The provisions require notice and publication, including posting notice on the property (usually taped to the door) and serial publication in newspapers. Once sold, the former owner has a six-month statutory right of redemption. That means they can get the property back for up to half a year after the sale by paying the purchaser the purchase price, taxes, interest and other costs.
Oregon is a “non-recourse” state when it comes to most residential property. “Non-recourse” means the mortgage holder cannot collect a default judgment if the sale does not produce enough proceeds to pay off the entire secured debt. The mortgagee takes the loss if the property is not worth the loan value As a general rule in the judicial foreclosure of residential property in Oregon, the mortgagee will have no recourse because under ORS 88.070 most residential mortgages are what are called “purchase money mortgages.”
A purchase money mortgage is one in which money is borrowed to purchase the property to which the mortgage is attached. There is, however, no general non-recourse rule for all liens and mortgages on real property. Mortgages on residential property taken for reasons other than for purchase may be subject to default judgments. Real estate licensees should, therefore, never advise clients about default judgments and should instead always refer clients to a lawyer, accountant or other financial professional.
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A trust deed is a real property security instrument created by statute. The relevant statute is the Oregon Trust Deed Act, ORS 86.705-86.795. A trust deed is similar to a mortgage but usually gives the security holder a “right of sale.” This “right of sale” allows the security holder to foreclose on the property without having to file a lawsuit in court. This process is called “foreclosure by advertisement and sale” and is found in ORS 86.735.
Trust deeds are called trust deeds because the deed is held by a third-party trustee. When the grantor (the property owner) pays the debt owed to the beneficiary (the lender), the trustee re-conveys the property back to the grantor. If, however, the grantor defaults, the beneficiary can elect to have the trustee foreclose on the trust deed. When that happens, the foreclosure is accomplished by the non-judicial procedures set out in the Oregon Trust Deed Act.
As with judicial foreclosure of mortgages, foreclosure of a trust deed by advertisement and sale requires a default. Unlike mortgages where the security holder can accelerate the entire debt, the property owner on a trust deed can cure the default by paying the amount delinquent under the trust deed. This right to cure by paying the delinquency instead of the entire debt is a powerful right. The right to cure is, however, cut off on the fifth day before the date set for the sale.
Non-judicial foreclosure is commenced by the recording and service of a Notice of Default. The contents of the Notice are set out in ORS 86.745. Among other things, the Notice will state the names of the parties involved, the sum owing on the obligation and the date, time and place of the sale. The notice starts the foreclosure clock running.
A non-judicial sale cannot be set for less than 120 days after the Notice is given. To this time must be added the time necessary to process the paper work and complete service — generally two or three weeks. The Notice must also be published in a newspaper of general circulation in the county for four consecutive weeks. The last publication must be at least twenty days prior to the sale. Taken together, these notice and publication procedures make it difficult to complete a non-judicial foreclosure in less than six months. Five months from the date of notice is pretty much the minimum time required for a non-judicial foreclosure.
According to ORS 86.770, “[a] guarantor of an obligation secured by a residential trust deed may not recover a deficiency from the grantor or a successor in interest of the grantor” “Residential trust deed” is defined in ORS 86.705(3) as â€œa trust deed on property upon which are situated four or fewer residential units, one of which the grantor, the grantorâ€™s spouse or the grantorâ€™s minor or dependent child occupies as a principal residence at the time a trust deed foreclosure is commenced” There is no right of redemption following a non-judicial sale.
Whether a trust deed is a “residential trust deed” is determined at the time of foreclosure and, therefore, may change depending on who is occupying the property. Thus, what started out as a residential trust deed may become a non-residential trust deed. This can expose the grantor to a deficiency judgment. It is for this reason that real estate licensees should never make statements about whether a particular owner will or won’t be exposed to a deficiency judgment in a particular non-judicial foreclosure.
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Marketing Property in the Face of Foreclosure
Marketing property in the face of foreclosure is different from marketing property generally in several important ways. First, foreclosures are public. Judicial and non-judicial foreclosures are public events in the sense that the details, including the owner’s name, the property address, the amount due on the loan and so on, are public information. There are companies and individuals who make their living churning the distressed property market. Dealing with these people, usually representing themselves as “investors,” is something to consider before taking on the marketing of property in the face of foreclosure.
The distressed property crowd creates issues for real estate agents in a number of related ways. People trying to make money on distressed property can be pushy low-ballers who upset sellers, complicate your marketing and generally take up time. Not all of them are ethical. A few are crooks. On the listing side, having a good relationship with your seller will help you keep yourself and your seller out of the worst that the distressed property market has to offer.
Forewarned is very much forearmed when it comes to marketing distressed property. The first step is to gather information. The Internet can be a source of information on foreclosure problems. For instance, a good deal of information on mortgage foreclosure rescue scams can be found here. The Oregon Department of Consumer and Business Services publishes a booklet entitled: “Foreclosure You Can Avoid It.” Further, the Oregon Department of Justice has helpful information here. Finally, agents should make themselves aware of what is going on in the local foreclosure market. The foreclosure market fluctuates and varies from area to area. Local knowledge is a huge advantage when marketing property in the face of foreclosure.
Knowledge is the key to marketing property in the face of foreclosure because it can be used to control expectations. Expectations (whether those of the seller or the buyer) are controlled by timely disclosure. There are two types of disclosures involved. The first is the disclosures the agent makes to their own client for risk management purposes. The second is the disclosures made to the other side as a matter of legal duty. These two different disclosures are not well understood.
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Risk Management Disclosures to Clients
Marketing property in the face of foreclosure means marketing on a short timeline that ends with the client losing control of the property. Since the property is in foreclosure, the seller’s distress is public. These factors argue in favor of below market pricing. Such pricing should be carefully documented so that it is clear the decision was an informed one made by the seller. That means a good CMA/BPO and written documentation of how the listing price was established. Written documentation, whether in the form of emails or client letters or more formal pre-printed documents, showing how pricing was determined is the first step in disclosure for risk management purposes.
Pricing documentation may raise the issue of a “short sale” if the listing price is near or below the seller’s payoff. If a short sale is a possibility, short sale disclosures should be made as soon as the listing is taken. Click here for a detailed discussion of short sales and short sale disclosures. Property priced to move quickly to avoid foreclosure can also raise multiple offer issues, even in a down market. Therefore, it is a good idea to have talked to the seller about multiple offers and have a plan for how they will be handled already agreed upon. It is absolutely critical that the buyer’s agent explain multiple offer issues to their client, and document having done so, as soon as multiple offers become likely. Click here for a detailed discussion of multiple offers.
Risk management disclosures are really just the documents an agent uses to show the client was fully informed about the situation and the agent’s actions. A client faced with foreclosure is looking for someone to save them. If that proves impossible, they may turn on the savior. Residential buyers in the pre-foreclosure market are looking for a deal. Getting that deal may prove a lot more difficult than expected. The potential for dashed expectations is high on both sides. The wise agent will control expectations by disclosing early and disclosing often.
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Disclosures to the Other Party
Oregon law imposes the obligation of good faith and fair dealing on all parties to a contract. Oregon real estate law demands disclosure of material facts known by an agent and not apparent or readily ascertainable to a party. Click here for a detailed discussion of Agency Duties. Together, these obligations can create a duty to disclose the existence of a foreclosure or, in some circumstances, problems on the selling side. These disclosures are mandatory in the sense that they are demanded by law. Click here for a detailed discussion of the Disclosure Duties.
Mandatory disclosure on the selling side is rare. The pre-foreclosure market being what it is, however, there may be situations when an agent learns the buyer is being dishonest to the seller — for instance, a buyer who is running a foreclosure scam. An agent who discovers their buyer is involved in a scam and has no intention of performing as required by the sale contract, can find themselves stuck between their duty of loyalty and confidentiality to the client and duty of honesty to the other party. At the first hint that such a situation may develop, the agent should take the matter to their principal broker. There may be time to end the agency relationship. If not, the duty of honesty must always take precedent after, of course, full disclosure to the client.
Far more common than questions of honesty on the selling side are questions of disclosure of material facts on the listing side. Here, the disclosure question is when and if the foreclosure itself must be disclosed to potential buyers. Such disclosures are serious matters because disclosing a pending foreclosure will tend to drive down offers both in number and price. Fortunately, the mere fact that the seller is in default and facing potential foreclosure is not material and, therefore, need not be disclosed.
Although not well understood by agents, foreclosure itself is not material. That is the case because, until the sale takes place, the owner retains full ownership in the property and can sell it with clear title at anytime by simply paying off the loan. Thus, a foreclosure becomes material only if and when an offer is accepted with a closing date that is beyond the foreclosure sale date (or involves a short sale or other third-party approval e.g., a bankruptcy trustee). That is the case as long as the seller can stop foreclosure and deliver clear title at closing.
Disclosure of a pending foreclosure in the MLS, or in ads or simply by word of mouth from the listing agent raises serious loyalty and confidentiality issues. It may be that the seller wants to signal distress in order to attract bargain hunters and “investors,” but that is a decision for the seller after full disclosure of the potential consequences. Such decisions should never be made unilaterally by the agent. As long as the seller can deliver clear title without approval of a third-party, there is nothing that requires disclosure of pre-foreclosure sales. Click here to review similar disclosure timing issues in short sales.
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Homebuyer Protection Act
The Homebuyer Protection Act applies to all new residential construction. It also applies to any residential property where $50,000 in remodeling or renovation has been done within 90 days of a sale. If the property falls into one of these two categories, the Act applies to the property and a CCB “Notice of Compliance with the Homebuyer Protection Act” form must be given to the buyer.
The form has two sections: “A” and “B.” Section “A” informs the buyer that the provisions of 87.007 do not apply to the particular sale. The Act applies to the sale if any work for which a lien might attach was completed within 75 days of the date of sale. The date of sale is the date the buyer becomes bound on the contract. If the seller knows no person may file a lien against the property, they may check the box in section A. Section “B” informs the buyer that the Act does apply to the particular sale. Section “B” also gives the buyer notice of how the seller will comply with the Act. There are five ways listed on the form for the seller to comply. The seller is free to choose any of the five. Click here to see a flow chart of timelines and choices involved.
The process just described can be confusing to real estate licensees if not addressed one step at a time. The first question, asked at the time of listing, is: does the Act apply to the property? That is, is this property new residential construction or has it had $50,000 or more worth of improvements within the last 90 days? If the answer is yes, the Act applies to the property and the seller will need to get the CCB “Notice of Compliance with the Homebuyer Protection Act” form. The seller can get the form by clicking here.
If the Act applies to a sale, which of the allowed protections listed in Section “B” of the form might best suit the seller’s circumstances is a business question for the seller. To the extent that answering that business question requires legal knowledge, it is beyond the expertise of a real estate licensee. Do not let your client involve you in the unauthorized practice of law. That said, you should know enough about the Act to advise your client on its basic operation so they can make informed choices.
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