If you have ever bought or sold real estate, you may be familiar with the contingency clauses contained in these agreements. These clauses offer the option to back out of a sale if certain events occur. The meaning and consequences of these contingencies can be confusing for first-time buyers or sellers. Even those with experience in the field sometimes struggle to grasp the implications of contingency clauses.
To understand real estate contingencies, it is necessary to have a basic understanding of the process in which real estate transactions are completed. When a potential buyer wishes to purchase a residential property, they will present the seller with a signed “Offer to Purchase.” In Wisconsin, the WB-11 form is the standardized contract used for residential real estate sales and serves as a base from which options are chosen. This Offer will contain all of the terms of the transaction and becomes a binding legal contract when signed by the seller. The Offer does not actually transfer the property but rather begins the process, which will culminate in a closing. At the closing, the documents are signed and the legal title to the property is transferred. Between acceptance of the Offer and the closing, the parties can agree to change the terms using an amendment, but unless both sides agree on a change, the terms in the original signed Offer will control.
The Offer lays out a series of responsibilities and deadlines for each party. These responsibilities generally consist of providing documents, making inspections and coordinating mortgage financing and title insurance. If a party does not timely complete their duties under the Offer, they are in breach of the contract. Depending on the situation, this may allow the other party to retain earnest money, which is the deposit to the seller that represents the buyer’s good faith to purchase, sue for monetary damages, or sue for “specific performance,” meaning they will request a judge to order the breaching party to fulfill their obligations. Often, the legal costs of pursuing these remedies deter the non-breaching party from pursuing them, but the potential for such legal action makes it inadvisable to assume that if something goes wrong, or if you change your mind, you can just walk away from an accepted Offer.
Because key information is sometimes not known when an Offer is accepted, most contracts contain contingencies which state that if specific events occur, then a party has the option to walk away without being in breach. If a contingency is triggered, the party backing out of the deal is not breaking the contract because the contract itself states they would not have to go forward if that event occurred.
Although some types of contingencies benefit the Seller, generally, Sellers prefer Offers with fewer contingencies because contingencies create more opportunities for the deal to fall through, leaving them with the unsold property. Buyers typically want more contingencies as it gives them flexibility if, after the Offer is accepted, something happens that makes them no longer interested in purchasing the property. What contingencies are included can be an important part of negotiations prior to the acceptance of an Offer.
The WB-11 form contains many options for contingencies. Most are preceded by a box which is checked if that contingency is to apply. If the box is not checked, that contingency is not part of the Offer. Outside of the contingencies included as options in the WB-11, additional terms may be added which make the Offer contingent upon other circumstances. With proper drafting, an Offer can be made contingent upon almost anything.
There are too many possible contingencies to describe them all here, but some of the more common contingencies are described below:
Financing Contingency. This contingency is common when the Buyer requires a mortgage to be able to purchase the property. If the Buyer is unable to obtain a mortgage for a set amount and at a set interest rate, and the Seller is not willing to offer them financing on the same terms, then the Buyer can walk away from the deal without being in breach.
Closing of Buyer’s Other Property Contingency: This contingency allows a Buyer who is in the process of selling another property, usually their existing home, to back-out of a deal if the sale of their old property does not close by a certain date. This can be very important to a Buyer; without it they may end up being forced to either breach the contract or own two homes. Be sure to carefully think through the dates and deadlines between the two transactions when using this contingency. Even if you already have a binding Offer on your old home, consider this contingency in case the deal falls through.
Inspection Contingency: This contingency allows the Buyer to have an inspector examine the property. If they discover a “defect,” as defined by the WB-11, the Buyer may be able to back out of the deal. The seller is typically given the right to “cure” the defect to prevent the sale from falling through. For example, if this contingency is included and an inspector identifies issues with the electrical wiring, the Buyer would have the right to walk away unless the Seller is willing to pay for the issue to be corrected.
Appraisal Contingency: Under this contingency, the Buyer may hire an appraiser to determine the value of the property. If the appraisal is less than the purchase price, the buyer can back out of the Offer. Appraisals are expensive and take time, so consider whether it is worth the expense and whether there is enough time between acceptance and closing to receive the appraiser’s report.
If you have questions about what contingencies are appropriate for your real estate transaction, how contingencies in an existing sale may interact, or how to draft custom contingency clauses, you should consult with a real estate attorney.