What Is A Default in a Real Estate Transaction or Contract?
Default is a dirty word, but how many Silicon Valley home buyers and sellers understand what a it is? Consumers often confuse the term default with cancelling the sale at any time – even backing out of a contract during the contingency period for a legitimate reason. Buyers cancelling during the contingency period is very easy to do in most cases and is very seldom a default.
Default is a strong word which refers to a failure to do something promised in contract or not doing it on time; we sometimes call it “non-performance”. In the purchase agreement, buyers and sellers both make promises to do certain things within a certain time frame, so either one could potentially default.
Defaults don’t always cause the sale to not go through, but they can cause a delay and it may harm the other party – at the very least, not fulfilling the promises of the contract adds unnecessary stress and drama to real estate transactions, which are already, in & of themselves, stressful.
Home buyer defaults
For instance, the following items are areas where a buyer could default (not an exhaustive list):
- not putting the initial deposit (good faith deposit) into escrow on time
- cancelling the sale after removing all contingencies or without cause allowed by the contract
- not removing contingencies on time (or possibly ignoring other deadlines)
- not completing loan papers on time
- not returning the signed disclosures on time
- not bringing “good funds” to escrow in time for closing
Missing contingency removal deadlines may be a default. For instance, the PRDS contract states on page 1 of that agreement:
BUYER’S FUNDS: Buyer represents that all funds, including deposits, cash balance, and closing costs, will be readily available as “good funds” (as determined by Escrow Holder) at the time of payment. Obtaining these funds is not a contingency of this Contract.
The loan approval, though, may be indirectly tied to whether or not the buyer liquidates stocks or other accounts to provide the down payment. What happens if the loan is fully approved except for the verification of this down payment? The buyer’s job is to have the funds available so that obtaining them later does not cause a delay. If a delay is caused because the buyer didn’t get the funds ready on time, that is a buyer default.
Not every default is an equally grave problem, of course. In the case above, the buyer can go ahead and remove the loan contingency and continue to liquidate the down payment assets (which should have been done much earlier in the escrow). BUT, if the buyer does not complete the sale due to a problem with getting those funds, his or her good faith deposit will be at risk via the liquidated damages clause because getting those funds is not a contingency.
Home seller defaults
Sellers, too, can be guilty of defaulting on contractual promises. Here are some areas in which a seller could default:
- not moving out on time
- not providing completed disclosures or reports on time
- not having work done which was contractually required (such as pest work or repairs)
- not keeping the power & water on for inspections and final walk through
- not providing the loan payoff information, or any other required information, in a timely manner to the title company (escrow)
- causing a delay in closing due to not signing off on time
- refusing to schedule or attend a sign off to sign the closing papers
In Silicon Valley, there are two purchase agreement forms in use: the California Association of Realtors (CAR) contract and the Peninsula Regional Data Service (PRDS) contract. Generally speaking, the PRDS & CAR contracts are similar on many points. They are not so similar in the treatment of defaults, though.
What does the contract say about defaults?
Oddly, the CAR contract only mentions the word default twice, and in both cases the topic is a buyer’s default, first in the liquidated damages paragraph (25) and next in the other terms & conditions paragraph (27).
Paragraph 25: “If Buyer fails to complete this purchase because of Buyer’s default, Seller shall retain, as liquidated damages, the deposit actually paid.”
Paragraph 27: “If this offer is accepted and Buyer subsequently defaults, Buyer may be responsible for Brokers’ compensation.”
In fairness to the CAR form, the concept of failing to perform is also used in regard to the seller for not providing disclosures on time (paragraph 14B3) but the seller’s non-performance is not called a default. There are forms which may be used for buyers or sellers to demand that the other party perform – that is, a demand that the other side do what is supposed to be done (Paragraph 14A and 14C1). This contract is an “As Is” form – between the language of default applying only to the buyer and the lack of repairs demanded of the seller, this form would seem to lean in the seller’s favor.
What about the PRDS contract?
One of the pluses to the PRDS purchase agreement, in my opinion, is that it has a fairly comprehensive discussion on the concept of default in the realty transaction (paragraph 22). (The PRDS contract is used on much of the Peninsula and in the west valley areas of Santa Clara County, including Los Gatos, Saratoga, Monte Sereno, Cupertino, Los Altos and many other parts of Silicon Valley.)
[The first part of this paragraph (mentioning paragraph 5) is referencing the liquidated damages clause.]
This PRDS discussion of default lays out very clearly that if one party defaults, he or she may be liable for damages. Seller doesn’t move out on time? Perhaps he or she will be footing the bill for the buyer’s storage and hotel costs. Buyer default causes escrow to not close? Deposit is at risk. “Other Non-Performance” puts everyone involved on notice that a default may cause the one responsible to pay damages.
When is it not a default?
Buyers usually have some time to investigate the property and anything which materially impacts the home’s value or desirability. Let’s say they have 10 days to remove their property condition contingency, and during that time they have a foundation inspection which turns up a lot of work which needs to be done. The buyers could ask the sellers to fix it, and if the sellers refuse, the buyers may be able to get out of the contract and have their deposit returned (less any costs not yet paid for inspection, appraisal, etc.). This contingency period gives the buyers the right to back out if they learn something about the property that they cannot or do not accept.
So too with an appraisal contingency – if the home does not appraise to purchase price, they don’t have to buy it. Also with loan or other contingencies.
Sellers sometimes have contingencies, too. If the sale of the house, condo or townhouse is subject to (contingent upon) a bank approval of the sale because it’s a short sale, the seller does not have to sell if the lender either does not approve the sale or if the lender will only approve it if the seller will put money into the transaction. The seller can elect to not complete the sale if she or he does not like the bank’s terms.
If the home is significantly damaged prior to close of escrow due to something like an earthquake or fire, the buyers can usually get out of contract even if their contingencies have been removed due to the changed condition of the property. This would not be a default. It’s a “no fault” situation.
In closing, if you are in transaction to purchase or sell property, it is imperative to remember that time is of the essence and all changes must be agreed to in writing. There are things which need to be done quickly and without delay, especially here in the San Jose area, where escrows are normally just 30 days long. (A good friend of mine, a Realtor in Buffalo, NY, tells me that there a normal length of escrow is 60 days.) If there’s a problem with some part of what you need to do, see if you can fix it with a little more time and if so, consider writing an addendum and asking the other side to agree to the new terms. Staying out of default will make the transaction infinitely easier and happier for all.
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