Sunday, May 22, 2011

Caution -- what you say in a proposal may make it binding.


Two sides seeking to negotiate a lease option contract sign a document explicitly entitled “Final Proposal” which states clearly that its terms “are hereby accepted by the parties subject only to approval of the terms and conditions of a formal agreement.”   Where a formal agreement is never approved by the parties, can this be a binding contract?

Yes.  In First National Mortgage Company, v.  Federal Realty Investment Trust, 631 F.3d 1058, 1065 (9th Cir. 2011) the Ninth Circuit applying California law affirmed a $15 million breach of lease jury verdict finding the existence of a binding contract in precisely the above situation.  The Court distinguished another case holding no binding contract where the document was entitled “letter of intent” and specifically provided that “this letter of intent is of no binding effect.”

The lesson is that it is not enough to state that a contract is conditioned upon the approval of the terms and conditions by way of a formal agreement.  An informal agreement, but an agreement nonetheless, may be found to exist.  If a party wishes to make plain that contractual language is not meant to be binding, the party should state that plainly in the document. 

The Court observed “calling something a ‘proposal,’ instead of a ‘contract’ or a ‘lease,’ does not necessarily mean it was not meant to be binding, especially where the circumstances suggest otherwise.”   In other words, the language of an ambiguous document together with the circumstances surrounding its creation may allow the finder of fact to determine a contract has been formed.

Saturday, February 19, 2011

Seller's Broker Beware

Caveat Seller’s Broker. Holmes v. Summer, 188 Cal. App. 4th 1510, 116 Cal. Rptr. 3d 419 (4th Dist. 2010).

In a shocking decision which should cause selling agents concern, a California Court of Appeal has held that a selling agent owes a duty to disclose to a buyer, even before escrow, that there is a substantial risk that the seller could not transfer title free and clear of monetary liens and encumbrances.

The decision is surprising on several levels. First, a selling agent does not normally owe a fiduciary duty to the buyer, but only to his client, the seller. The Holmes Court glided over this point stating that “although the seller's agent does not generally owe a fiduciary duty to the buyer, he or she nonetheless owes the buyer the affirmative duties of care, honesty, good faith, fair dealing and disclosure. . . as well as such other nonfiduciary duties as are otherwise imposed by law.”

The Holmes Court found that the broker should have disclosed to the buyer what the broker knew: that the property was so over-encumbered that it could not be sold unless the lenders agreed to a short-sale or the seller deposited close to $400,000 in cash into escrow to cover the shortfall. Holmes seems to create a new quasi-fiduciary duty for a selling agent, maybe not of the highest good faith, honesty and fair dealing, but still a duty disclose known conditions or risks with the property directly to the buyer, who is not the selling agent’s client. The Court held: “At a minimum, the brokers did not act fairly towards these residential buyers when signing them up for a real estate deal the brokers had reason to know was a highly risky proposition.”

The new non-fiduciary duty to disclose in Holmes arose before the buyer and seller even entered into a contract. One might wonder if a selling agent is now required before escrow to disclose possible matters about a house such as: problems with the neighborhood; a history of roof leaks; defective construction; earthquake damage; or other facts that could be material to a purchase decision. The current convention is that such disclosures are made after the purchase contract is signed and during escrow. Selling agents would be wise to consider how and when they make disclosures, and now to consult counsel.

The buyers in Holmes could have discovered quite easily on their own that the house they were buying was underwater simply by checking title or having their own broker pull a preliminary title report. The recorded deeds of trust were a matter of public record. The California Association of Realtors form used in Holmes required disclosures about title within seven days of opening escrow. And so what if the buyer learns a week into escrow about the precariousness of the seller’s ability to convey title at the agreed purchase price? The seller presumably can cure this condition. The buyer retains the right to cancel escrow if good title could not be conveyed by closing.

Holmes fails to consider the implications of a rule that requires pre-escrow and pre-contract disclosure of matters known to the seller that a reasonable investigation would identify. Holmes means that sellers and their agents must disclose matters that buyers could discover on their own, if the information is sufficiently material that, but for the nondisclosure, the buyer might not have made the offer.