by David Hamerslough

A “gotcha” is an unexpected, usually disconcerting, challenge, revelation, or catch that results in an advantage on the part of one person over another. Unfortunately, “gotchas” are typically not positive experiences and often result in buyers and sellers having to adjust their expectations, which in turn can cause them to bring claims against each other and their real estate licensees.

This article briefly discusses the top “gotchas” that I have seen in the real estate market that we have been in for approximately the last six months (i.e., declining values, increasing interest rates, etc.). While every claim will turn on the specific facts and circumstances as well as the motivations of the parties, one of the “gotchas” in this article was the primary trigger for a claim.

1. Failing To Provide All Historical Documents

The Supplemental Seller’s Checklist (SSC) and/or the Seller Property Questionnaire (SPQ) require sellers to provide buyers with all the historical documents in their possession. What constitutes a historical document is set forth throughout the SSC and primarily in Paragraph 5 of the SPQ. Sellers continue to not understand the scope and extent of what constitutes a historical document. A common illustration of this misunderstanding is a seller’s response that identifies the inspection reports that the seller has obtained in conjunction with listing the property. Historical documents include far more than the current home, pest, and roof inspection reports.

Brokers and agents are also required to produce any historical documents that they have in their possession regarding the property. Brokers are required to keep transactional documents for a minimum of three years from the date of closing and, from the perspective of the DRE, are required to have a procedure in place that provides a way to retrieve the historical records and then provide them to a buyer regardless of the age of the historical document.

Failing to provide all historical documents has allowed buyers to cancel contracts, renegotiate the contract price and terms, or bring claims after close of escrow. In one recent transaction, the seller failed to provide the disclosures they had received when they purchased the property. Those disclosures contained material facts about additions to the property that were not part of the seller’s disclosures. The buyer cancelled when the seller was required to provide an amended set of disclosures. The impact to the seller was a loss of $400,000, the difference between the first buyer’s contract price and the resale price of the property.

2. Initialing The Liquidated Damages Clause

While agreeing to liquidated damages provides the seller with, among other things, some level of control over collecting the deposit, the issue for a seller in a declining market is whether to initial liquidated damages in the first place. Initialing liquidated damages caps the seller’s damages to the deposit actually paid. This is a “gotcha” that many sellers are experiencing in this declining market (e.g., buyer number one breaches, but the resale of the property generates a loss greater than the deposit actually paid).

In one recent deal, the contract price was $4.5 million with a deposit of $135,000. Liquidated damages was initialed. The buyer requested a price reduction of $200,000 because the market had declined. The seller refused to renegotiate on the grounds that it violated his principles. Unfortunately, when he attempted to resell the property, he did so at a price of only $4 million dollars. Even though the seller recovered the deposit of $135,000 from the first buyer, he still lost more money than he would have had he renegotiated with that buyer (with a sales price of $4.3 million offered by the first buyer vs. the resale price of $4 million paid by the second buyer, plus the $135,000 deposit from the first buyer, there was a net difference of $165,000).

While this seller had the option of renegotiating with the first buyer, when he refused to do so on the grounds of principle, he did not consider the potential impact of the true value of the property and the fact that his damages were capped due to the liquidated damages clause.

3. Failing To Include An Interest Rate (Or Other Loan Terms) In The Financing Clause

In the contracts I have reviewed in the last six months, I continue to see the absence of loan terms in the financing clause. While this may not have had as much of an impact when contracts were non-contingent and interest rates were low, it has resulted in “gotchas” for both buyers and sellers in the current market. The first issue is whether there is an enforceable contract. Assuming that there is, a buyer who does not have the protection of an interest rate cap may face a claim that they are required to perform at whatever rate they are approved for by the lender. If that rate is higher than the buyer expected or can afford, they may not be able to perform. If they can’t perform, they may ask to renegotiate. If the seller refuses to do so, then the buyer’s deposit is at risk. If liquidated damages has not been initialed, then the buyer may be liable for damages measured by the difference between the contract price and the fair market value of the property on the date of the breach (which is typically set by the resale price of the property). In a declining market, the resale price may result in a loss greater than the deposit.

I have been involved in many deposit disputes in the last six months over these issues. They all involve failed transactions, the delay to the seller associated with a failed transaction, and the loss of time and money as a result of the claims that were made. In most instances, liquidated damages was initialed, and the buyer ended up forfeiting their deposit. In those instances, the seller often ended up losing money because the resale price resulted in a loss in excess of the deposit. Unfortunately, this occurred in some instances even where the parties were willing to renegotiate but the buyer didn’t feel they could afford the property, given the monthly payment.

4. Failing To Review And/Or Question The Terms And Conditions Of A Buyer’s Prequalification Or Preapproval Letter And Verification Of Funds Documentation

This “gotcha” is related to the previous one. Prequalification and preapproval letters that contain outdated interest rates or don’t specify the interest rate of the loan are resulting in delayed or failed transactions for the reasons identified in number 3 above. Rate locks that may expire before the transaction closes can produce a similar result. Verification of funds letters that state “Buyer is a long-standing customer with sufficient funds to close this transaction” can also result in issues with the buyer’s ability to fund, because a letter of this nature doesn’t identify the amount of funds, whether they are cash, whether they are tied to a credit line, how liquid they are, etc. Buyers and sellers have been experiencing a “gotcha” when the funds are insufficient or the terms and conditions for using them require an extension of the close.

The claims that have been made as a result of these issues are similar to those described in the preceding section.

5. Failing To Appreciate That Contracts With Home Developers Are One-Sided

The contracts that most developers require a buyer to sign are not equally balanced between the buyer and seller. Many buyers are realizing this because of the market decline and/or rising interest rates. They experience a “gotcha” when there were delays in the completion of construction, the contracts contained delay clauses in favor of the developer, and the buyer’s rate lock (if they even had one) had long expired. Unfortunately, when many of these buyers could no longer afford to purchase the property, they learned that not all developers were willing to renegotiate the price and/or terms. Many of these buyers lost their deposits or were faced with an arbitration claim with the developer over these issues. Typically, developer contracts do not contain an attorneys’ fees clause, and the developer has in-house counsel and/or accountant to support their liquidated damages claims. Where that occurs, it is very hard for a buyer to justify spending money on an attorney and an accountant to arbitrate the return of the deposit because they can’t recover the cost of doing so. This is especially the case where that cost exceeds the amount of the deposit or is so disproportionate to the amount of the deposit that it will result in a very small net recovery for the buyer in the event they are successful.

Each real estate market/cycle results in different issues and claims for buyers, sellers, and real estate licensees. The market we have been in for approximately the last 6 months is no different. Managing the expectations of buyers and sellers in any market is always a challenge. Part of that challenge is managing expectations so that a buyer and seller do not experience a “gotcha” but only a minor adjustment to their expectations. This article highlighted some of the top “gotchas” that I have seen recently. Real estate licensees should provide it to their buyers and sellers, and if they have additional questions, refer them to either their manager and/or a qualified California real estate attorney.

About David Hamerslough

In his 35 years of practice, Dave Hamerslough has litigated and arbitrated residential and commercial real estate disputes on behalf of brokers and agents, buyers and sellers, and landlords and tenants. Dave also acts as a mediator and arbitrator of real estate disputes. He also teaches courses and writes articles on these subjects to brokers, agents, attorneys, and consumers.

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