Legal traps in changing real estate markets
We sign or enter into contracts regularly. We all have cell phone contracts, and while many don’t sign one, all employees have an employment contract with their employer. However, we don’t really experience these contracts in a legal way. We sign the papers (for the phone contract) or show up for work. We spend very little time thinking about our contractual obligations.
When buying or selling a home, however, we should be spending time considering the legal implications of doing so. The value of the contract is significantly more than that of our phone contracts. While most of us use realtors who must use specific offer forms, problems can still occur. For example, I’ve discussed the issues involving property disclosure forms in the past here.
Today I want to discuss the topic of buyer’s remorse in changing markets. Winnipeg has experienced a healthy real estate market for the past 16 years. I don’t have statistics, but we all know friends or family who have done very well by selling their home. In an increasing market, like the one we lived through buyers feel the pressure. In many cases, a good listing attracts several offers. Purchasers who lose out on one, two or several homes, become braver and braver in their offers, fearing that they won’t find a suitable home.
In a market that continues to grow, the purchasers can rely on an increase in value over time that will negate any premium paid at the time of purchase. For example, if a purchaser really wanted a home in a certain competitive area, they could justify paying a higher price than the market would otherwise indicate. The “premium” paid to get the house, would soon be overtaken by the increase in property values in the area. No real harm done.
However, what happens when the market changes direction? Now, all of a sudden, that premium is no longer easy to absorb. Purchasers may feel like they bought too high. This becomes exaggerated when the possession date is several months after the date the offer was negotiated. What do purchasers do?
Their first impulse may be to walk away or back out of the deal. But what are the consequences of doing that? Do purchasers just lose their deposit?
A contract is a contract
Unfortunately, it is much riskier than that. In a case where a valid contract to buy and sell was negotiated and accepted by all parties, the purchaser is under a legal obligation to acquire the home for the agreed upon price. If a purchaser walks away or tries to back out, the vendor can keep the deposit. But that is just the start.
The vendor must then attempt to sell the property to another buyer. In a changing market, the new purchase price may be lower than the one first accepted. If it is lower, the original purchaser would be responsible to pay the difference between the new price and the original price.
This is exactly what happened to a young couple in Toronto. The purchasers got caught up in a hot market and offered $2.25 million on a townhouse listed for $2 million. Unfortunately for them, because they did not want to loose the purchase, they made the offer without any conditions. However, they had over-extended themselves and the bank wouldn’t finance the mortgage. The townhouse ended up being sold for $1.75 million. The original purchasers lost their $30,000 deposit and were ordered to pay an additional $470,000 to the vendor as damages.
On the other side of the transaction, the vendor has obligations as well. A vendor cannot simply sue a buyer who attempts to back out. Vendors must mitigate their damages. This means, they must attempt to sell the home again. If vendors fail to do so, they may be limited only to the deposit. The law wants vendors to try.
The vendor (and purchaser for that matter) may try to negotiate with the other party and settle rather than sue. Settlements bring finality which often lets people move on with their lives, but they can be expensive (although less expensive and risky than litigation). If negotiations are done, you should involve a lawyer. The lawyer will draft an appropriate release protecting the liable party from future lawsuits for the same transaction.
While Winnipeg prices aren’t in the millions (for the most part), one could easily see this happening here with amounts in the $50,000 to $100,000 range in losses. These amounts are not trivial and would likely lead to litigation.
Buyers and sellers should pay particular attention to the offer to purchase and understand the consequences of making them. Once accepted and the deposit paid, these create legally binding obligations. Make sure you understand what happens if you fail to live up to the commitment. Lawyers can help you understand your obligations, and even assist in crafting conditions for your protection prior to making an offer but we can’t change agreements when they are made.
If you have concerns, you can make your offer subject to your lawyer’s approval. This way, your lawyer can review and advise. If you must back out, the lawyer can make that happen.
Philippe Richer is President of TLR Law Group. TLR has been located in the St. Boniface neighbourhood, in Winnipeg, since 1996. The office serves the middle class and small business within the province. With a focus on estates, wills, real estate, and corporate law, he leads his team in providing accessible legal services. Philippe also authored the business law course for the Knowledge Bureau and instructed the français juridique class at the faculty of Law at the University of Manitoba.