Contract Requirements - There are 4 elements to any contract as well as in the formation of the various real estate contracts that you will be a part of during your real estate career. The legal profession tells us that there are 4 main requirements that are necessary in forming a VALID contract. These areas are as follows:
1. An offer and acceptance.
2. Consideration given by the involved parties.
3. Legal object (purpose).
4. Competent parties to the contract.
If any contract does not have ALL of these four requirements, it is NOT a valid contract.
The contract is known as a VOID contract. It never went into effect. This concept goes back a few centuries to English contract law.
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Offer and Acceptance - All parties to a contract have to agree . One party makes an offer and the other party makes the acceptance of the offer . Be careful on the test because the agent (you) does not make the offer. The agent/licensee simply presents the client's offer to the other party. The State considers the agent to represent the person making the offer.
Real Estate Offer 97% of the OFFERS in a real estate transaction are made by the buyers of real estate. The buyer fills out an Earnest Money Agreement/Purchase and
Sales Agreement with his/her agent. The agent will then present the offer to the seller of the property in question. When the agent for the buyer notifies the agent of the seller that an offer is coming in, the offer MUST BE presented to the seller. Even if the buyer's offer is ridiculously low, the offer must be presented to the seller of the property. Even if there are 8 offers on the table from 8 different buyers, all offers must be presented to the seller in an expedient manner.
Not An Offer - When a seller puts his/her real estate up for sale, this is not an offer. The seller is not negotiating with any specific party. This is basically a form of advertising and not an offer.
An Offer?
- If a person is admiring an owner's house and the owner says "I will sell it to you for $200,000". Is that an offer? Lawyers will say yes, but in real estate this is an
INVITATION for the person to make an offer. In short, the buyer always starts the real estate transaction rolling by filling out a Purchase and Sales or Earnest Money
Agreement.
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Offer Presented to Seller - When the agent for the buyer presents the offer on behalf of the buyer to the seller, the seller has three choices regarding the offer. The seller can:
1. Accept the buyer's offer by signing the Purchase and Sales or Earnest Money
Agreement. Now we have an offer and an acceptance. This would complete the offer and acceptance requirement in the formation of a valid contract.
2. Reject the Offer - The seller could say, "Forget it" and reject the buyer's offer completely. By refusing to sign the offer, the seller is rejecting the offer.
3. Make a Counteroffer - Usually when the seller rejects the buyer's offer (E/M agreement), the seller will make a counteroffer. Since the seller rejected the buyer's offer and is making a second proposal to the buyer, this is known as a counteroffer. If the buyer agrees to the seller's counteroffer, the buyer is accepting the offer.
Example: Mr. and Mrs. Z fill out and sign an Earnest Money agreement with $5,000 down. The Earnest Money agreement specifies an offer of $250,000 for
Ms. Y's house. Ms. Y could accept the Z's offer for $250,000 OR reject it outright for being too low OR she could say, "I will sell it to you for
$270,000". Ms. Y is making a counteroffer.
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Consideration Requirements - In forming a contact, all parties to a contract have to give consideration or value to each other. If only one party gives value it is void contract; never went into effect. In real estate the consideration is offered by the buyer (purchase price) and the seller (the real estate for sale).
Buyer's Consideration - The buyer provides the funds for the purchase of the real property in question. This can be in the form of cash, exchanging real estate, signing a land sales contract issued by the seller, et al. Normally, the consideration is a down payment (cash) and signing for the responsibility of a debt instrument with a mortgage broker. Usually signing responsibility for a loan backed by a mortgage or trust deed lien on the property.
Seller's Consideration - The seller provides the real estate being conveyed to the buyer through the escrow process of settling title. Good consideration on the part of the seller is to provide a fee simple estate without clouds on title. Conveying title with clouds is still consideration, BUT it would be bad consideration. The purchase price of the property would be reduced if the seller was providing bad consideration.
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Legal Object - A real estate contract must be drawn in a legal manner vs. an illegal manner. In order for any contract to be enforced, it must be legally drawn.
Example: A person in California sold the same parcel of land to 5 different people. He was an escrow agent and did not even own the land. All 5 of the contracts were void contacts; never went into effect. The buyers could not gain title to the land in question.
Void Contract - A contract must be used for legal purposes for it to be a valid contract.
The following are examples of an illegal contract and therefore, a void contract; never was enforceable.
Illegal Act - A contract hiring a person to kill another person would not be a valid contract in a court of law. If the person did carry out the contracted event, the party could not be sued for non-performance
.
Real Estate Purchase - Since the purchase of real property is a legal event, a real estate contract would meet the legal requirement.
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Competent Parties - All parties to a contract must be competent; they cannot be held to be legally incompetent. If a party is held incompetent, the contract they enter into becomes a unilateral contract. Only the competent party is responsible to carry out the contract.
An Incompetent - A party who is labeled an incompetent is not held accountable if the contract was entered into at the time of incompetence. The incompetent party can back out of the contract at any time.
Competent The competent party, on the other hand, is held accountable to the contract and cannot back out of the agreement with the incompetent party. The competent must live up to the responsibilities of the contract that they entered into.
Example: Jim enters into an agreement with the heir to the land next to his development.
He contracts to pay $10,000 a month for 12 months. The heir is a court determined incompetent. If they sign an agreement, the heir can back out at any time. Jim, on the other hand, is contracted to make the payments. Furthermore, 4 years later the legal representative for the heir could say that Jim took advantage of him and Jim has to pay another $120,000. The courts would tend to lean toward the incompetent in this situation.
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3.
Incompetent - People who could fall into the incompetent category would include:
Individuals under the age of 18. 1.
2. Those mentally incompetent as determined by the court.
Those under the influence of a substance as determined by the court.
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Valid Contract
All 4 requirements have been met:
Offer and an acceptance
Consideration exchanged between all parties to the contract
The contract was for a legal purpose
The parties to the contract where competent
Void Contact
If one of these four contract requirements is not met in a contract, the policy is known as a "void contract"; it was never in effect. If a buyer never paid money down or financed the purchase, there would be no "consideration" on the part of the buyer. The seller could back out of the agreement. Conversely, if the seller could not provide a fee simple estate/title, the buyer could back out of the agreement.
Voidable Contract
A lease is a voidable contract. It is a voidable contract because either party can void it as long as they meet the proper notification requirements of the State lease laws. Either would have to give proper WRITTEN notification to the other party as prescribed under
State law.
Transferring Ownership - This is when an individual sells their real property or gifts their interest to another. The person transferring ownership to another is known as the Grantor.
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Grantor - When selling or gifting property through conveying by alienation, the current owner (known as the grantor) is giving up his/her owner's rights to another by using a
Deed.
1. By Deed - This Deed is granting title of the land to another. The seller is the grantor, the giver of the Deed.
Grantee - The buyer is receiving title and is known as the grantee; receiver of the Deed.
* In legal contract terminology, the EE receives and OR gives or pays. Example:
With a mortgage, the bank is the mortgagee. The bank receives the mortgage payments.
The owner is the mortgagor. The owner makes the mortgage payments to the bank. The bank receives the payments (mortgagee).
The EE-OR Rule
The EE =Receiver (Buyer) Grantee
The OR = Giver (Seller) Grantor
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Statute of Frauds - Under real estate law, all real estate agreements are required to be a written contract for most real estate conveyances. A lease less than one year can be oral in nature.
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Contract law is based on FOUR forms of law in America: Common Law, Case Law,
Statutory Law, and Constitutional Law.
Definition of a Contract - A Voluntary and Lawful Agreement by Competent Parties for
Good Consideration to do a specific event. A legal contract needs a valid offer and an acceptance of the offer, legal object (vs. illegal), competent parties to the agreement, and consideration (value) exchanged between all contract parties.
1. Common Law - These are historical or precedent setting rulings that have been handed down through time. They go clear back to early England, France, and
Spain and were harsh in nature.
2. Case Law - Rulings here in America by the courts that update, modify, or clarify the old Common Law. We call these court rulings precedents. Court rulings in the
future would look to these precedent setting rulings.
3. Statutory Law - These are laws passed by State legislative action. These laws are passed to respond to the public needs.
4. Constitutional Law - These go back to the Constitution of the United States and the
Constitution of each State. The U. S. Constitution never gave power to the Federal
Government over real estate and so the States enjoy the regulatory power.
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Ad ministrative Rules and Regulations - Another aspect that affects contract law are the rules and regulations that a State passes into law.
Example: You will have to pass a real estate examination in order to obtain your real estate license. This is a State requirement; a State regulation.
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Voluntary Agreement - Manifestation of a Mutual Assent (Agreement), Meeting of the
Minds, or an Offer and Acceptance. The beginning factor in establishing a contract is to have two (2) people agree on the formation of a contract; a meeting of the minds . Usually one person makes an offer and the other party accepts; mutual assent .
1. Voluntary - For a contract to be binding, the contract must be voluntary.
2. No Threat of Duress - Each party to the contact must not be placed under duress or
menace or undue influence.
Example: Forcing a person to sign a contract at gunpoint would not be binding in the eyes of the court.
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Two parts of an agreement are the "offer" and the "acceptance of that offer."
A. "The Offer" - The requirements of a valid offer are important in real estate. The offer is made by the buyer. The buyer's offer is then delivered to the seller.
1. Clear and Definite - The offer that is drawn by the buyer must clearly specify what the buyer is willing to pay the seller. If there is anything left off the offer, the buyer can't come back with additions to the offer if the seller accepts the offer. In today's real estate market, there may be multiple offers from multiple buyers. The best offer will probably win out over the other offers. Let's discuss some of the problems associated with an offer.
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2. Unclear Offer - If the offer is vague or unclear, the agreement could cause a party to be injured financially. If an unclear offer is hauled into court three things could
occur and two of them are bad. The three possibilities are as follows:
The offer and acceptance is valid and the contract is binding.
The offer was unclear and the injured party has the right to escape the contract.
The contract would be voidable.
A party is injured financially and they sue for injuries.
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Deceit - If either the buyer or seller provides material misinformation by omission or commission it can lead to a Voidable contract by the injured party. Real Estate terminology:
"Material" - For a party to void an agreement due to misleading statements, they must be material information. Information "had I known the truth I would not have entered the contract". If an injured party can prove this is so, the contract is voidable.
Concealment and Misrepresentation - Concealment is hiding detrimental information from the other part.
Example: T he buyer not mentioning that he is in bankruptcy.
Misrepresentation is a party giving false information.
Example: The seller saying that the roof does not leak when it does.
Concealment is silence; hiding information. Misrepresentation is a false statement.
A Material Fact - To terminate an agreement for any of the above reasons, the information must be a material fact. It is something important. It would be something that would have caused the party to reject the agreement. Example: Bill says he is left handed and he is right-handed. This is a misrepresentation, but it is not material to the decision whether to buy the property or not .
Fraud - Fraud must be determined by statute definition. The courts, police, or real estate commission determines the actions of a party to a contract to be fraud; very serious accusation.
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A. "Puffing" - An obvious exaggeration of the characteristics of real property that is up for sale. Since it is considered an exaggeration, it is not a material misrepresentation.
Example: A real estate agent states that a two bedroom home would make a great bed and breakfast .
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Terminate an Offer - When a buyer makes an offer to buy, the offer is good until one of the following occurs:
A. Seller Rejects - The seller/offeree rejects the buyer/offeror's offer.
B. Counteroffer - The seller/offeree rejects the buyer/offeror by making a counteroffer.
Example: T he buyer offers $140,000 and seller offers $148,000.
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Totally Terminating an Offer - The following would cause a contract to be voidable:
1. Revoking Offer - The buyer revokes his/her offer prior to seller accepting the offer.
2. Incompetents - Death or insanity of either party prior to acceptance.
3. Illegal Acts - Subsequent illegality by either party at any time.
4. No Acceptance - The seller failing to accept the offer within a stated time period; a conditional contract.
Example: The seller offers $140,000 for the seller's house and says that the offer is good for
20 days. If the seller does not accept within 20 days the offer terminates.
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Acceptance of an Offer - When the seller agrees to the buyer's offer, this is an acceptance.
To be a valid acceptance, all of the following characteristics must occur:
No Counteroffer - The seller/offeree accepts the buyer's/offeror's offer with no changes to the offer. If the seller makes a counteroffer to the buyer, it is NOT an acceptance.
Example: The buyer offers $140,000 for the house. If the seller accepts $140,000 it is an
acceptance. If the seller says no and offers $141,000 it is a counteroffer.
Communicates the Acceptance To Buyer - If the seller makes an acceptance of the offer, it must be communicated to the offeror/buyer. The acceptance is not effective until communicated to the buyer.
Non-Response - After receiving the offer from the buyer, non-response by the seller is considered rejection; silence is a rejection.
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Lawful Agreement - The contracted act must have Legal Object. It must be legal actions versus illegal actions. Also the contract must be possible to perform.
Example: If the real estate agent is not properly licensed in a transaction, the contract is voidable because it was formed by an illegal party.
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Good Consideration - Something of value must be exchanged by all parties to the contract.
If only one person gives value (consideration) the contract is voidable.
What Is Consideration? - Value or Good Consideration can include "love and affection". If a father turns over a parcel of land to a daughter, he is giving the land and she is giving love and affection.
A. Value - Valuable Consideration would also include any of the following:
Cash - Money or something convertible to money.
Act - An act or a forbearance of an act.
Example: Bill tells Paula that he will give her an easement if she will paint the fence next to the easement.
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Legal Rights - Creation or destruction of a legal right. Example: Molly will drop her lawsuit against Vern if he will destroy the outhouse next to his house.
Real Estate - The Good or Valuable consideration in a real estate transaction consists of the buyer providing money to the seller and seller provides the real property to the buyer. Good title with no clouds.
Improper or No Consideration - A void contract. If the seller can't deliver a deed without clouds, the buyer can back out of the deal.
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Personal Aspect - Some contracts require "Personal Aspect" as part of the consideration.
Personal aspect means that the contracting parties only wish to work with each other and no one else. An example would be a listing agreement between the seller (the principal) and the real estate broker (the agent).
Exclusive Right - A listing agreement requires the parties to work with no one else for a specified period of time. The broker can't sell the listing agreement to another broker because of personal aspect. The seller wants to work with that broker and no one else. Anytime there is an agent-principal relationship present, personal aspect is part of the contract.
Personal Only - When a principal/agent agreement is formed between the seller and the real estate broker it cannot be assigned to another broker. Only death of either principal (seller) or broker (agent) can l terminate the contract once it is in force.
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The Purchase & Sale Agreement with Earnest Money Provisions - (a contract to buy or sell property) - The buyer makes an offer and puts down earnest money (consideration) as a good faith gesture. This is not based on personal aspect. It is formed on an offer and an acceptance with consideration put down on the agreement.
Bilateral vs. Unilateral contracts
A. Bilateral Contract ( Bi meaning 2 / lateral meaning 2-sided) - A bilateral contract is a two-sided contract; both parties to the contract are bound. If good consideration is given by the parties, one promise in exchange for another promise, both parties are legally bound to acts required by the agreement.
B. Unilateral Contract (Uni means 1 / lateral means 1-sided): a unilateral contract is a one-sided contract ; only one person to a contract is bound to act . A unilateral contract in real estate would include an option to buy. This is a promise for future action.
Example: Tom requests to pay $200 for an option to buy Nancy's home at $200,000 for 30 days while he finds the financing. Nancy can't sell to anyone except Tom for 30 days. Tom does not have to buy, but Nancy must sell to him if he exercises the option.
1. Unilateral - Options are used to induce the 2nd party to do something in the future, but 2nd party is not legally bound to act; unilateral contract. 1st party (Nancy) is bound to perform if 2nd party (Tom) does act.
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Competent Parties: Having equal status and understanding of their acts.
A. Identifiable Entity - A person must exist and be identifiable. This sounds ridiculous to some, but what if a person wanted to buy your house for cash and didn't want to divulge their name. You couldn't or shouldn't do this because you know nothing about this person. They could be an escaped convict or worst of all incompetent in the eyes of the court. Remember, all parties to a contract must be competent or the contract is a void contract.
B. Person" - A person under State law is any legal entity which includes individuals,
trusts, associations, partnerships, corporations, etc.
1. Identifiable - The person cannot be a fictitious entity or deceased.
2. Named - The person(s) must be named in the contract; often use "et. al.", "et. ux." or "et. vir." Example: The purchaser of the house is the Olsen Family
Trust, et al.
In other words, the trust and all of its beneficiaries.
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Incompetents - Individuals deemed to be incompetent have voidable rights to any contract that they enter into.
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Those Incompetent - This includes minors (those under 18), persons declared legally insane, those convicted of treason
(they can't own real property), and possibly someone who is under the influence of drugs and/or intoxicants at the time of signing a contract.
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Competent Party Is Bound - If an incompetent sold his house and received money for the transaction he could spend all the money and demand the house back . He was taken advantage of at the time of the contract by the competent parties. The competent buyer would have to let the incompetent buy the house back.
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Written Form - Some contracts such as real estate contracts are required to be in "Proper
Writing" in order to be valid. Remember, any real estate contract must be in writing except leases less than 1 year.
Express Contract - An oral or written agreement that expresses the requirements of all parties to the contract.
Implied Contract - A contract created by demonstration of acts and conduct. If a real estate person starts representing a buyer in a real estate transaction, an implied contract is formed because the buyer did not stop the agent's action.
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Statute of Frauds - The real estate laws known as the statute of frauds lists certain contracts that must be in writing and signed by all parties to be valid. If any of the following contracts are not in writing, they are void contracts.
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Land Contracts - Sales of land or interests in land including easements and long-term leases must be in writing. The exception to this rule includes leases of 1 year or less as well as a license of use granted to another person.
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Sales Agreements - Contracts must be in writing if they are used to sell land or interests in land such as listing agreements between the seller and broker, earnest money receipts for a buy/sell arrangement, as well as options to buy or to lease.
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Liens - Security devices (liens) on real property. All mortgage agreements between the buyer and the lender, trust deeds to purchase, as well as land sales contracts.
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Securities And Money agreements for stocks, bonds and money must be in writing.
- Sales
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$500 and Up Goods - Contracts for sale of "goods" that are worth $500 or more must be in writing. The term "goods" refers to movable, manufactured objects used in business.
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$5,000 Personal Property - The sale of any personal property that exceeds $5,000 in value must be in writing.
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Compliance - Complying with the Statute of Frauds
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Contracts - The in-writing requirement simply states that part of the agreement has to be at least in writing. It does not have to be a formal contract drawn up by lawyers. However, the agreement must be clear, have accurate description, and have no alterations unless mutually agreed to (initialed by all parties to the contract)
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Hand Written Power - If part of the agreement is handwritten, that portion of the contract will have better evidence than the typed portion in a court of law.
Finally, the person who has the original draft will be afforded better evidence than a photocopy.
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Deeds - When conveying real property a Deed is preferable over all other methods, but only the "elements of a deed is necessary to convey real property".
1. Named Grantor and Grantee - The Deed must have the grantor and grantee named. The Deed must specify the consideration provided by both parties and shown on the Deed. There must be some words of conveyance from the seller to the buyer. There must be an adequate legal description of the property being conveyed. The Deed must be signed by grantor and showing evidence of delivery to grantee (the buyer).
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Parole Evidence Rule - written documents take precedence over oral agreements. Hence the saying, "Get it in writing."
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Real Estate - In real estate the entire contract is in writing. The Statute of Frauds has determined it to be the best evidence of intentions by all parties to the contract.
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Exception: Material Mistake - The only time the courts would allow oral evidence is when there is a material mistake on the agreement or one of the parties committed a material misrepresentation on the contract. Oral would also be allowed if determined fraud can be proven by the courts or the Real Estate Division.
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Termination: Termination of a Real Estate Contracts. The following are ways that a real estate contract between the buyer and the seller can be terminated:
Performance (AKA Tendering Performance) - The best way to terminate a real estate contract is live up to the requirements under the agreement. The buyer pays for the real property and the seller delivers a Deed without clouds. The contract then becomes an:
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Executed contract - One that is completed in its entirety OR….
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Executory contract - One that has some additional requirements that have to be met by both or one of the parties to the agreement. A real estate contract is an executory contract. When the buyer and seller establish their contract, the agreement goes into escrow. Both the buyer and seller will have additional requirements that they will have to meet while the contract is in escrow. This usually takes around 30 days.
The contract is fully bound during this period, but is not completed. This is why it is called an
Executory contract. When escrow closes, the contract then becomes an Executed contract. It is terminated.
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Occurrence of a Condition Subsequent
- When the buyer makes an offer, he/she will usually put in a condition of sale. Something that the buyer wants done before the contract is finalized.
Example: The buyer makes an offer subject to an FHA inspection and loan approval . This is known as a condition subsequent. If the condition is not met, the contract is terminated.
Example: The FHA looks at the inspection of the house and turns done the loan.
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Assignment - A mortgage contract clause that permits or forbids assignment of the debt to a new buyer of the mortgaged property. This clause prevents the assignment of the mortgage to a new owner and is called the alienation clause (AKA Due on Sale Clause and the Call
Provision).
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Alienation clause - This clause specifically forbids the seller of mortgaged real property to have the buyer become the new mortgagor by assignment.
If the mortgagor/seller sells the home and it has a mortgage with this clause, the debt is due and payable immediately. This would terminate the mortgage contract.
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Mortgagor and Personal Aspect - The mortgage contracts are based on personal aspect and cannot be assigned. The mortgage company only wants to work with their chosen mortgagee. They do not want to be forced into working with an unknown buyer.
1. Assumption with Permission - Some mortgage contract clauses allow assumption, but there are conditions that have to be met. There are 3 types of assignment. The mortgage contract can have a:
2.
"Is subject to" clause - It states the seller will remain responsible for the mortgage debt. The old mortgagee (the seller) will be the person primarily responsible for the mortgage and the new mortgagee (the buyer) is secondarily liable.
3.
"Assumes and agrees to pay" - T he new mortgagee (the buyer) is primarily responsible but original mortgagee is secondarily liable if the new mortgagee defaults.
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Assignment and Release - This is the 3 rd
type of assignment. The new mortgagee is liable and the original mortgagee (the seller) is released ... "by novation."
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Novation - A new agreement replaces an old agreement. Nova means new. A completely new agreement is formed.
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Release and
Covenants not to Sue - This is when the buyer goes to the seller and asks to be released from the contract. The buyer also asks the seller to promise not to sue; the word covenant means promise. Example: The buyer's wife gets sick and now they can't afford the house. They ask the seller to be released by this "Release and Covenant" and not to sue arrangement.
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Mutual Rescission - This is when the buyer and the seller mutually agree to rescind the contract. The both want the contract rescinded.
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Operation of Law - The requirements in forming a contract were not met. One of the four contract requirements was not met properly.
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1. Incompetent Party - A minor exercising his/her right to void a voidable contract.
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Material Misrepresentation or Fraud - The buyer or seller misrepresented their position at the time the contract was drawn. Example: The seller failed to mention (concealment) that the property was under water 3 months of the year (material fact - important) . The buyer can terminate the contract.
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Material Alteration by One Party - If one of the parties to the contract alters the agreement, the other party does not have to abide by it.
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Subsequent Illegality or impossibility - If the buyer is purchasing the real property for a specific purpose and the purpose is eliminated before escrow closes, the buyer can terminate the agreement. Example: The buyer wants to build his dream home on the land. The City of Bellevue says there are cattails on the land and declares it a wetland that prevents construction . This would allow the buyer to terminate the contract.
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Bankruptcy of Either Party - If either party declares bankruptcy, the contract is rescinded.
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Default/Breach of Contract - If one of the parties to a real estate contract cannot perform, it is called a
Breach of Contract; a contract in Default.
Seller/Buyer Defaults - The following are rights of an injured party:
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Rescind contract and recover the costs and payments paid by the buyer. The buyer would also have to give back house.
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Sue for specific performance. The buyer tries to force the seller to sell as contracted. The courts rarely force the sale of home. The courts will force the buyer to purchase the home.
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Sue for compensatory and punitive damages - Compensatory damages are actual costs. Punitive damages are additional penalties.
W aiver and Estoppel - If a party to a real estate contract waives their right, they are stopped (estoppel) from demanding the right later.
Example: The buyer waives an inspection of the house. The buyer cannot demand one later.
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