LEARNING OBJECTIVES
 When you've finished reading this Chapter, you should be able to: 
     ► identify the requirements for a valid contract.
     ► describe the various types of contracts used in the real estate business.
     ► explain how contracts may be discharged.
    ► distinguish among bilateral and unilateral, executed and executory, and valid, void, and voidable contracts.
    ► define the following key terms: addendum; amendment; assignment; bilateral contract; breach of contract; consideration; contingencies; contract; counteroffer; disclosure; earnest money; equitable title; escrow contract; executed contract; executory contract; express contract; implied contract; land contract; liquidated damages; novation; offer and acceptance; option; rescission; statute of frauds; suit for specific performance; time is of the essence; unenforceable contract; unilateral contract; valid contract; void contract; voidable contract

REAL ESTATE PRACTICE & PRINCIPLES KEY WORD MATCH QUIZ --- CLICK HERE ---
I would encourage you to take this “Match quiz” now as a pre-chapter challenge to see how many of these key words or phrases you are familiar with. At the end of each chapter I recommend that you take the quiz again to reinforce these important keywords. Each page contains four words or phrases and you need to drag and drop the correct definition into the puzzle key. Each page is considered as a question, but there is no scoring and you can return to each chapter quiz as many times as needed to reinforce your memory. 

WHY LEARN ABOUT... REAL ESTATE CONTRACTS?
The real estate market is driven by contracts. Both listing and buyer representation agreements are contracts. Options are contracts, and an offer is the first half of a sales contract. Leases and escrows are contracts. Wherever you go as a real estate professional, whatever aspect of the real estate business you find yourself in, you will be dealing with contracts. And like any other tool of your profession, it is important that you know how a contract is created, what it means, what is required of the parties, and what kinds of actions can end it.

 CONTRACT LAW
A contract is a voluntary agreement or promise between legally competent parties, supported by legal consideration, to perform (or refrain from performing) some legal act. That definition may be easier to understand if we consider its` various parts separately. A contract must be:
    ► voluntary—no one may be forced into a contract;
    ► an agreement or a promise—a contract is essentially a legally enforceable promise;
    ► made by legally competent parties—the parties must be viewed by the law as capable of making a legally binding promise;
    ► supported by legal consideration—a contract must be supported by some valuable thing that induces a party to enter into the contract and that must be legally sufficient to support a contract; and
    ► about a legal act—no one may make a legal contract to do something illegal.

Essentially, a contract is an enforceable promise—a promise that someone may be compelled by a court to keep. Brokers and salespersons use many types of contracts and agreements to carry out their responsibilities to sellers, buyers, and the general public. The general body of law that governs such agreements is known as contract law.
A contract may be express or implied, depending on how it is created. An express contract exists when the parties state the terms and show their intentions in words. An express contract may be either oral or written. The majority of real estate contracts are express contracts; they have been reduced to writing. Under the statute of frauds, certain types of contracts must be in writing to be enforceable in a court of law. (Enforceable means that the parties may be forced to comply with the contract's terms and conditions.) In an implied contract, the agreement of the parties is demonstrated by their acts and conduct.

 FOR EXAMPLE  Harold approaches his neighbor, Bill, and says, "I will paint your house today for $50." Bill replies, "If you paint my house today, I will pay you $50." Harold and Bill have entered into an express contract.

Karen goes into a restaurant and orders a meal. Karen has entered into an implied contract with the restaurant to pay for the meal, even though payment was not mentioned before the meal was ordered.

Contracts may be classified as either bilateral or unilateral.  
In a bilateral contract, both parties promise to do something; one promise is given in exchange for another. A listing agreement is a bilateral contract in which the broker promises to use his or her skills to produce a buyer and the seller promises to pay a commission or brokerage fee. A real estate sales contract is a bilateral contract because the seller promises to sell a parcel of real estate and convey title to the /property to the buyer, who promises to pay a certain sum of money for the property. An exclusive right to sell listing contract is a bilateral contract.

A unilateral contract, on the other hand, is a one-sided agreement. One party makes a promise to induce a second party to do something. The second party is not legally obligated to act. However, if the second party does comply, the first party is obligated to keep the promise. For instance, a law enforcement agency might offer a monetary payment to anyone who can aid in the capture of a criminal. Only if someone does aid in the capture is the reward paid. An option contract, which will be discussed later, is another example of a unilateral contract.

 FOR EXAMPLE  Bill puts up a sign that says, "If you paint my house today, I will pay you $500." If Harold paints Bill's house, Bill will be legally obligated to pay Harold. Bill and Harold have a unilateral contract. On the other hand, if Harold says to Bill, "I will paint your house for $500," and Harold replies, "I will pay you $500 for painting my house," they have a bilateral contract, a promise exchanged for a promise.

Executed or Executory?
A contract may be classified as either executed or executory, depending on whether the agreement is performed. An executed contract is one in which all parties have fulfilled their promises: The contract has been performed. This should not be confused with the word execute, which refers to the signing of a contract. An executory contract exists when one or both parties still have an act to perform. A sales contract is an executory contract from the time it is signed until closing: Ownership has not yet changed hands, and the seller has not received the sales price. At closing, the sales contract is executed.

Essential Elements of a Valid Contract
A contract must meet certain minimum requirements to be considered legally valid. The following are the basic essential elements of a contract.
    
Offer and acceptance.
There must be an offer by one party that is accepted by the other. The person who makes the offer is the offeror. The person who accepts the offer is the offeree. This requirement is also called mutual assent. It means that there must be a meeting of the minds," that is, there must be complete agreement between the parties about the purpose and terms of the contract. Courts look to the objective intent of the parties to determine whether they intended to enter into a binding agreement. In cases where the statute of frauds applies, the offer and acceptance must be in writing. The wording of the contract must express all the agree-on terms and must be clearly understood by the parties.

An offer is a promise made by one party, requesting something in exchange for that promise. The offer is made with the intention that the offeror will be bound to the terms if the offer is accepted. The terms of the offer must be definite and specific and must be communicated to the offeree.

An acceptance is a promise by the offeree to be bound by the exact terms proposed offeror. The acceptance must be communicated to the offeror. Proposing any deviation from the terms of the offer constitutes a rejection of the original offer and becomes a new offer. This is known as a counteroffer. The counteroffer must be accepted by the original offering party for a contract to exist.

Besides being terminated by a counteroffer, an offer may be terminated by the offeree's outright rejection of it. Alternatively, an offeree may fail to accept the offer before it expires. The offeror may revoke the offer at any time before receiving the acceptance. This revocation must be communicated to the offeree by the offeror, either directly or through the parties' agents. The offer is also revoked if the offeree learns of the revocation and observes the offeror acting in a manner that indicates that the offer no longer exists.

Consideration.
The contract must be based on consideration. Consideration r is something of legal value offered by one party and accepted by another as an inducement to perform or to refrain from some act. There must be a definite statement of consideration in a contract to show that something of value was given in exchange for the promise. Consideration is some interest or benefit accruing to one party, or some loss or responsibility by the other party.

Consideration must be "good and valuable" between the parties. The courts do not inquire into the adequacy of consideration. Adequate consideration ranges from as little as a promise of "love and affection" to a substantial sum of money. Anything that has been bargained for and exchanged is legally sufficient to satisfy the requirement for consideration. The only requirements are that the parties agree and that no undue influence or fraud has occurred.

Reality of consent.
A contract that complies with all of the basic requirements may still be either void or voidable. This is because of the doctrine of reality of consent. A contract must be entered into as the free and voluntary act of each party. Each party must be able to make a prudent and knowledgeable decision without undue influence. A mistake, misrepresentation, fraud, undue influence, or duress would deprive a person of that ability. If any of these circumstances is present, the contract is voidable by the injured party. If the other party were to sue for breach, the injured party could use lack of voluntary assent as a defense.

Legal purpose.
A contract must be for a legal purpose, that is, even with all the other elements (consent, competent parties, consideration, and offer and acceptance), if the contract is to do something illegal, it is not a valid contract. So when movie gangsters talk about "taking out a contract" to do something unpleasant to some unfortunate person, remember that it is not a valid, enforceable contract.

Legally competent parties.
All parties to the contract must have legal capacity, that is, they must be of legal age and have enough mental capacity to understand the nature or consequences of their actions in the contract. In most states, 18 is the age of contractual capacity. Under state law, an imprisoned felon or certain mentally ill persons may be legally incompetent to enter into a contract.

Validity of Contracts.
    ► A contract can be described as valid, void, voidable, or unenforceable, depending on the circumstances.
    ► A contract is valid when it meets all the essential elements that make it legally sufficient, or enforceable.
    ► A contract is void when it has no legal force or effect because it lacks some or all of the essential elements of a contract. A contract that is void was never a contract in the eyes of the law.

A contract that is voidable appears on the surface to be valid but may be rescinded or disaffirmed by one or both parties based on some legal principle. A voidable contract is considered by the courts to be valid if the party who has the option to disaffirm the agreement does not do so within a period of time prescribed by state law. A contract with a minor, for instance, is usually voidable. This is because minors are generally permitted to disaffirm real estate contracts at any time while under age and for a certain period of time after reaching majority age. By the same token, a minor may affirm a contract entered into when he or she was underage, in effect validating the contract after the fact. A contract entered into by a mentally ill person is usually voidable during the mental illness and for a reasonable period after the person is cured. On the other hand, a contract made by a person who has been adjudicated insane (that is, found to be insane by a court) is void on the theory that the judgment is a matter of public record.

IN PRACTICE  Mental capacity to enter into a contract is not the same as medical sanity. The test is whether the individual in question is capable of understanding what he or she is doing. A party may suffer from a mental illness but have a clear understanding of the significance of his or her actions. This is a thorny legal and psychological question that requires consultation with experts.

Unenforceable Contract
An unenforceable contract also seems on the surface to be valid; however, neither party can sue the other to force performance For example, an oral agreement for the sale of parcel of real estate would be unenforceable. Because the statute of frauds requires that real estate contracts be in writing, the defaulting party could not be taken to court and forced to perform. There is, however, a distinction between a suit to force performance and a suit for damages, which is permissible in an oral agreement. An unenforceable contract is said to be "valid as between the parties." This means that once the agreement is fully executed and both parties are satisfied, neither has reason to initiate a lawsuit to force performance.

 DISCHARGE OF CONTRACTS
A contract is discharged when the agreement is terminated. Obviously, the most desirable case is when a contract terminates because it has been completely performed, with all its terms carried out. However, a contract may be terminated for other reasons, such as a party's breach or default.

Performance of a Contract
Each party has certain rights and duties to fulfill. The question of when a contract must be performed is an important factor. Many contracts call for a specific time by which the agreed-on acts must be completely performed. In addition, many contracts provide that "time is of the essence:" This means that the contract must be performed within the time limit specified. A party who fails to perform on time is liable for breach of contract.

When a contract does not specify a date for performance, the acts it requires should be performed within a reasonable time. The interpretation of what constitutes a reasonable time depends on the situation. Generally, unless the parties agree otherwise, if the act can be done immediately, it should be performed immediately. Courts have sometimes declared contracts to be invalid because they did not contain a time or date for performance.

Assignment
Assignment is a transfer of rights or duties under a contract. Normally, rights may be assigned to a third party (called the assignee} unless the contract forbids it. Obligations may also be assigned (or delegated), but the original party remains primarily liable unless specifically released. An assignment may be made without the consent of the other party unless the contract includes a clause that permits or forbids assignment.

 FOR EXAMPLE   John enters into a contract to paint Tim's toolshed. Under the terms of the contract, John will be paid $1,000 when the job is finished. John owes $1,000 to Rob, and so John assigns to Rob the right to receive the payment. When the job is done, Tim will pay $1,000 to Rob.

On the other hand, suppose that the day after John contracts to paint Tim's toolshed for $1,000, Ken offers John $3,000 to paint a gazebo. John wants to take the better-paying job but doesn't want to breach the contract with Tim. If the contract with Tim permits it, John may assign both the right to be paid and the duty to paint the toolshed to Peter, another painter. If Peter fails to paint the toolshed, however, John will be liable to Tim for breach of contract.

Novation
A contract may be performed by novation, that is, the substitution of a new contract in place of the original. The new agreement may be between the same parties, or a new party may be substituted for either (this is novation of the parties). The parties' intent must be to discharge the old obligation. For instance, when a real estate purchaser assumes the seller's existing mortgage loan, the lender may choose to release the seller and substitute the buyer as the party primarily liable for the mortgage debt. When a contract is performed by novation, both parties must consent to novation.

Breach of Contract
A contract may be terminated if it is breached by one of the parties. A breach of contract is a violation of any of the terms or conditions of a contract without legal excuse. For instance, a seller who fails to deliver title to the buyer breaches a sales contract. The breaching or defaulting party assumes certain burdens, and the nondefaulting party has certain remedies.

If the seller breaches a real estate sales contract, the buyer may sue for specific performance unless the contract specifically states otherwise. In a suit for specific performance, the buyer asks the court to force the seller to go through with the sale and convey the property as previously agreed. The buyer may choose to sue for damages, however, in which case he or she asks that the seller pay for any costs and hardships suffered by the buyer as a result of the seller's breach.

If the buyer defaults, the seller can sue for damages or sue for the purchase price. A suit for the purchase price is essentially a suit for specific performance: The seller tenders the deed and asks that the buyer be compelled to pay the agreed price.

The contract may limit the remedies available to the parties, however. A liquidated damages clause permits the seller to keep the earnest money deposit and any other payments received from the buyer as the seller's sole remedy. The clause may limit the buyer's remedy to a return of the earnest money and other payments should the seller default.

Statute of limitations.
The law of every state limits the time within which parties to a contract may bring legal suit to enforce their rights. The statute of limitations varies for different legal actions, and any rights not enforced within the applicable time period are lost.

Other reasons for termination.
Contracts may also be discharged or terminated when any of the following occurs:
 ► Partial performance of the terms, along with a written acceptance by the other party. For instance, if the parties agree that the work performed is "close enough" to complete, they can agree that the contract is discharged even if some minor elements remain unperformed.
► Substantial performance, in which one party has substantially performed on the contract but does not complete all the details exactly as the contract requires. (Such performance may be enough to force payment, with certain adjustments for any damages suffered by the other party.) For instance, where a newly constructed addition to a home is finished except for polishing the brass doorknobs, the contractor is entitled to the final payment.
► Impossibility of performance, in which an act required by the contract cannot be legally accomplished.
► Mutual agreement of the parties to cancel.
► Operation of law—such as in the voiding of a contract by a minor—as a result of fraud, due to the expiration of the statute of limitations, or because a contract was altered without the written consent of all parties involved.
► Rescission—one party may cancel or terminate the contract as if it had never been made. Cancellation terminates a contract without a return to the original position. Rescission, however, returns the parties to their original positions before the contract, so any monies that have been exchanged must be returned. Rescission is normally a contractual remedy for a breach, but a contract may also be rescinded by the mutual agreement of the parties.

 CONTRACTS USED IN THE REAL ESTATE BUSINESS
The written agreements most commonly used by brokers and salespersons are
► listing agreements and buyer agency agreements,
► real estate sales contracts,
► options,
► land contracts or contracts for deed, and
► leases and escrow agreements.

Many states have specific guidelines for when and how real estate licensees may prepare contracts for their clients and customers. These guidelines are created by state real estate officials, court decisions, or statutes. A real estate licensee who is not a licensed attorney may not practice law. The practice of law includes preparing legal documents, such as deeds and mortgages, and offering advice on legal matters. A broker or salesperson may, however, be permitted to fill in the blanks on certain approved preprinted documents, such as sales contracts and leases, as directed by the client. No separate fee may be charged for completing the forms.

Contract forms.
Because so many real estate transactions are very similar in nature, preprinted forms are available for most kinds of contracts. The use of preprinted forms raises three problems: (1) what to write in the blanks, (2) what words and phrases should be ruled out by drawing lines through them because they don't apply, and (3) what additional clauses or agreements (called riders or addenda) should be added. All changes and additions are usually initialed in the margin or on the rider by both parties when a contract is signed.
 
It is essential that both parties to a contract understand exactly what they are agreeing to. Poorly drafted documents, especially those containing extensive legal language, may be subject to various interpretations and lead to litigation. The parties to a real estate transaction should be advised to have sales contracts and other legal documents examined by their lawyers before they sign to ensure that the agreements accurately reflect their intentions. When preprinted forms do not sufficiently cover special provisions in a transaction, the parties should have an attorney draft an appropriate contract.

Listing and Buyer Agency Agreements
A listing agreement is an employment contract. It establishes the rights and obligations of the broker as agent and the seller as principal. A buyer agency contract establishes the relationship between a buyer and his or her agent. Refer to Chapter 6 for a complete discussion of the various types of listing agreements and buyer agency agreements and to Figure 6.2 and Figure 6.3 for sample contracts.

Some states suggest or require the use of specific forms of listing contracts. Oral listing contracts for a period of less than one year are recognized in some states, while in other states only written listing contracts are recognized.

IN PRACTICE  If a contract contains any ambiguity, the courts generally interpret the agreement against the party who prepared it.

Sales Contracts
A real estate sales contract contains the complete agreement between a buyer of a parcel of real estate and the seller. Depending on the area, this agreement may be known as an offer to purchase, a contract of purchase and sale, a purchase agreement, an earnest money agreement, or a deposit receipt.

Whatever the contract is called, it is an offer to purchase real estate as soon as it has been prepared and signed by the purchaser. If the document is accepted and signed by the seller, it becomes a contract of sale. This transformation is referred to as ripening.

The contract of sale is the most important document in the sale of real estate. It establishes the legal rights and obligations of the buyer and seller. In effect, it dictates the contents of the deed.

Several details frequently appear in a sales contract in addition to the essential elements of a contract. These include
     ► the sales price and terms;
     ► a legal description of the land;
     ► a statement of the kind and condition of the title, and the form of deed to be delivered by the seller;
     ► the kind of title evidence required, who will provide it, and how many defects in the title will be eliminated; and
     ► a statement of all the terms and conditions of the agreement between the parties, and any contingencies (discussed later in this Chapter).

The following paragraphs discuss some of the issues that often arise as an offer to purchase ripens into a contract of sale.
 
Offer.
A broker lists an owner's real estate for sale at whatever price and conditions the owner sets. When a prospective buyer is found, the broker helps him or her prepare an offer to purchase. The offer is signed by the prospective buyer and presented by the licensee to the seller. This is an offer.

Counteroffer.
As discussed earlier in this Chapter, any change to the terms proposed by the buyer creates a counteroffer. Note, however, that a counteroffer is not created when the offer's language is simply clarified in an amendment to an offer. The original offer ceases to exist because the seller has rejected it. The buyer may accept or reject the seller's counteroffer. If the buyer wishes, he or she may continue the process by making another counteroffer. Any change in the last offer may result in a counteroffer until either the parties reach agreement or one of them walks away.

An offer or counteroffer may be revoked at any time before it has been accepted, even if the person making the offer or counteroffer agreed to keep the offer open for a set period of time.

Acceptance.
If the seller agrees to the original offer or a later counteroffer exactly as it was made and signs the document, the offer has been accepted. Acceptance of the offer means that a contract is formed. The licensee must advise the buyer of the seller's acceptance and obtain the approval of the parties' attorneys if the contract calls for it. A duplicate original of the contract must be provided to each party.

An offer is not considered accepted until the person making the offer has been notified of the other party's acceptance. When the parties communicate through an agent or at a distance, questions may arise regarding whether an acceptance, a rejection, or a counteroffer has occurred. Current technologies make communication faster; a signed agreement that is faxed, for instance, would constitute adequate communication. The licensee must transmit all offers, acceptances, or other responses as soon as possible to avoid questions of proper communication.

Binder.
In some states, brokers may prepare a shorter document, known as a binder, instead of a complete sales contract. The binder states the essential terms of the offer and acknowledges that the broker has received the purchaser's deposit. The parties have a more formal and complete contract of sale drawn up by an attorney once the seller accepts and signs the binder. A binder might also be used where the details of the transaction are too complex for the standard sales contract form.

Earnest money deposits.
It is customary (although not essential) for a purchaser to provide a deposit when making an offer to purchase real estate. This deposit, usually in the form of a check, is referred to as earnest money. The earnest money deposit is evidence of the buyer's intention to carry out the terms of the contract in good faith. The check is given to the broker, who usually holds it for the parties in a special account. In some areas, it is common practice for deposits to be held in escrow by the seller's attorney. If the offer is not accepted, the earnest money deposit is immediately returned to the would-be buyer.
 
The amount of the deposit is a matter to be agreed on by the parties. Under the terms of most listing agreements, a real estate broker is required to accept a "reasonable amount" as earnest money. As a rule, the deposit should be an amount sufficient to
     ► discourage the buyer from defaulting,
     ► compensate the seller for taking the property off the market, and
     ► cover any expenses the seller might incur if the buyer defaults.

Most contracts provide that the deposit becomes the seller's property as liquidated damages if the buyer defaults. The seller might also claim further damages, however, unless the contract limits recovery to the deposit alone.

Earnest money held by a broker must be held in a special trust, or escrow, account. This money cannot be mixed with a broker's own personal funds (called commingling). A broker may not use earnest money funds for his or her personal use (called conversion). A separate escrow account does not have to be opened for each earnest money deposit received; all deposits may be kept in one account. A broker must maintain full, complete, and accurate records of all earnest money deposits.

The special account may or may not pay interest, depending on state law. If the account bears interest, there must be some provision in the contract for how the interest earned will be distributed. The broker must provide the parties with an accounting of the amount and dates of interest payments. Often, a check for the interest amount is given to the buyer at closing. On the other hand, the contract may provide for the interest to be paid to the seller as part of the purchase price.

Equitable title.
When a buyer signs a contract to purchase real estate, he or she does not receive title to the land. Title transfers only upon delivery and acceptance of a deed. However, after both buyer and seller have executed a sales contract, the buyer acquires an interest in the land. This interest is known as equitable title. A person who holds equitable title has rights that vary from state to state. Equitable title may give the buyer an insurable interest in the property. If the parties decide not to go through with the purchase and sale, the buyer may be required to give the seller a quitclaim deed to release the equitable interest in the land.

Destruction of premises.
In many states, once the sales contract is signed by both parties, the buyer bears the risk of any damage to the property that may occur before closing. Of course, the contract may provide otherwise. Furthermore, the laws and court decisions of a growing number of states have placed the risk of loss on the seller. Many of these states have adopted the Uniform Vendor and Purchaser Risk Act, which specifically provides that the seller bear any loss that occurs before the title passes or the buyer takes possession.

Liquidated damages.
To avoid a lawsuit if one party breaches the contract, the parties may agree on a certain amount of money that will compensate the nonbreaching party. That money is called liquidated damages. If a sales contract specifies that the earnest money deposit is to serve as liquidated damages in case the buyer defaults, the seller will be entitled to keep the deposit if the buyer refuses to perform without good reason. The seller who keeps the deposit as liquidated damages may not sue for any further damages if the contract provides that the deposit is the seller's sole remedy.

Parts of a sales contract.
All real estate sales contracts can be divided into a number of separate parts. Although each form of contract contains these divisions, their location within a particular contract may vary. Most sales contracts include the following information:
► The purchaser's name and a statement of the purchaser's obligation to purchase the property, including how the purchaser intends to take title.
► An adequate description of the property, such as the street address. (Note that while a street address may be adequate for a sales contract, it is not legally sufficient as a description of the real property being conveyed, as discussed in Chapter 9.)
► The seller's name and a statement of the type of deed a seller agrees to give, including any covenants, conditions, and restrictions that apply to the deed.
► The purchase price and how the purchaser intends to pay for the property, including earnest money deposits, additional cash from the purchaser, and the conditions of any mortgage financing the purchaser intends to obtain or assume.
► The amount and form of the down payment or earnest money deposit and whether it will be in the form of a check or promissory note.
► A provision for the closing of the transaction and the transfer of possession of the property to the purchaser by a specific date.
► A provision for title evidence (abstract and legal opinion, certificate of title, Torrens certificate, or title insurance policy).
► The method by which real estate taxes, rents, fuel costs, and other expenses are to be prorated.
► A provision for the completion of the contract should the property be
damaged or destroyed between the time of signing and the closing date.
► A liquidated damages clause, a right-to-sue provision, or another statement
of remedies available in the event of default.
► Contingency clauses (such as the buyer's obtaining financing or selling a currently owned property or the seller's acquisition of another desired property or clearing of the title; attorney approval and home inspection are other commonly included contingencies).
► The dated signatures of all parties (the signature of a witness is not essential to a valid contract). In some states, the seller's nonowning spouse may be required to release potential marital or homestead rights. An agent may sign for a principal if the agent has been expressly authorized to do so. When sellers are co-owners, all must sign if the entire ownership is being transferred.
► In most states, an agency disclosure statement.

Additional provisions. Many sales contracts provide for the following:
► Any personal property to be left with the premises for the purchaser (such as major appliances or lawn and garden equipment)
► Any real property to be removed by the seller before the closing (such as a storage shed)
► The transfer of any applicable warranties on items such as heating and cooling systems or built-in appliances
► The identification of any leased equipment that must be transferred to the purchaser or returned to the lessor (such as security systems, cable television boxes, and water softeners)
► The appointment of a closing or settlement agent
► Closing or settlement instructions
► The transfer of any impound or escrow account funds
► The transfer or payment of any outstanding special assessments
► The purchaser's right to inspect the property shortly before the closing or settlement (often called the walk-through)
► The agreement as to what documents will be provided by each party and when and where they will be delivered

Contingencies.  Additional conditions that must be satisfied before a sales contract is fully enforceable are called contingencies. A contingency includes the following three elements:
     1. The actions necessary to satisfy the contingency
     2. The time frame within which the actions must be performed
     3. Who is responsible for paying any costs involved

The most common contingencies include the
     ► mortgage contingency. A mortgage contingency protects the buyer's earnest money until a lender commits the mortgage loan funds.
     ► inspection contingency. A sales contract may be contingent on the buyer's obtaining certain inspections of the property. Inspections may include those for wood-boring insects, lead-based paint, structural and mechanical systems, sewage facilities, and radon or other toxic materials.
     ► property sale contingency. A purchaser may make the sales contract contingent on the sale of his or her current home. This protects the buyer from owning two homes at the same time and also helps ensure the availability of cash for the purchase.

The seller may insist on an escape clause.  An escape clause permits the seller to continue to market the property until all the buyer's contingencies have been satisfied or removed. The buyer may retain the right to eliminate the contingencies if the seller receives a more favorable offer. (Note that contingencies create a voidable contract: If the contingencies are rejected or not satisfied, the contract is void.)

Amendments and addendums.
An amendment is a change to the existing content of a contract. Any time words or provisions are added to or deleted from the body of the contract, the contract has been amended. For instance, a form contract's provision requiring closing in 90 days might be crossed out and replaced with a 60-day period. Amendments must be initialed by all parties.

On the other hand, an addendum is any provision added to an existing contract without altering the content of the original. An addendum is essentially a new contract between the parties that includes the original contract's provisions "by reference," that is, the addendum mentions the original contract. An addendum must be signed by the parties. For example, an addendum might be an agreement to split the cost of repairing certain flaws discovered in a home inspection.

Disclosures.
As discussed in previous Chapters, many states have enacted mandatory disclosure laws. The purpose of these laws is to help consumers make informed decisions. Many brokers have instituted procedures for making disclosures and recommending technical experts to ensure that purchasers have accurate information about real estate. Disclosure of property conditions may be included as part of a sales contract, or it may be a separate form. As discussed in Chapter 4, disclosure of the broker's agency relationship may also be required by state law.

Options
An option is a contract by which an optionor (generally an owner) gives an optionee (a prospective purchaser or lessee) the right to buy or lease the owner's property at a fixed price within a certain period of time. The optionee pays a fee (the agreed actual consideration) for this option right. The optionee has no other obligation until he or she decides to either exercise the option right or allow the option to expire. An option is enforceable by only one party—the optionee.

An option contract is not a sales contract. At the time the option is signed by the parties, the owner does not sell, and the optionee does not buy. The parties merely agree that the optionee has the right to buy and the owner is obligated to sell if the optionee decides to exercise his or her right of option. Options must contain all the terms and provisions required for a valid contract.

The option agreement (which is a unilateral contract) requires that the optionor act only after the optionee gives notice that he or she elects to execute the option. If the option is not exercised within the time specified in the contract, both the optionor's obligation and the optionee's right expire. An option contract may provide for renewal, which often requires additional consideration. The optionee cannot recover the consideration paid for the option right. The contract may state whether the money paid for the option is to be applied to the purchase price of the real estate if the option is exercised.

A common application of an option is a lease that includes an option for the tenant to purchase the property. Options on commercial real estate frequently depend on some specific conditions being fulfilled, such as obtaining a zoning change or a building permit. The optionee may be obligated to exercise the option if the conditions are met. Similar terms could also be included in a sales contract.

Land Contracts
A real estate sale can be made under a land contract. A land contract is some times called a contract for deed, a bond for title, an installment contract, a land sales contract or articles of agreement for warranty deed. Under a typical land contract, the seller (also known as the vendor retains legal title. The buyer (called the vendee takes possession and. gets equitable title to the property. The buyer agrees to give the seller a down payment and pay regular monthly installments of principal and interest over a number of years. The buyer also agrees to pay real
estate taxes, insurance premiums, repairs, and upkeep on the property. Although the buyer obtains possession under the contract, the seller is not obligated to execute and deliver a deed to the buyer until the terms of the contract have been satisfied. This frequently occurs when the buyer has made enough payments to obtain a mortgage loan and pay off the balance due on the contract. Although a land contract is usually assumable by subsequent purchasers, it generally must be approved by the seller.

IN PRACTICE   Legislatures and courts have not looked favorably on the harsh provisions of some real estate installment contracts. A seller and buyer contemplating such a sale should first consult an attorney to make sure that the agreement meets all legal requirements. The individual concerns of the parties must be addressed.

Leases and Escrow Agreements.
A lease is any agreement which gives rise to the relationship of landlord and tenant or lessor and lessee. A lease is a contract for exclusive possession of land, for a term of time, at will, usually for a specified rent or compensation. An escrow contract is an agreement between a buyer, seller, and escrow holder setting forth rights and responsibilities of each. An escrow contract is entered into when earnest money is deposited in a broker's escrow account.

 SUMMARY
A contract is a legally enforceable promise or set of promises that must be performed; if a breach occurs, the law provides a remedy.

Contracts may be classified according to whether the parties' intentions are express or merely implied by their actions. They may also be classified as bilateral (when both parties have obligated themselves to act) or unilateral (when one party is obligated to perform only if the other party acts). In addition, contracts may be classified according to their legal enforceability as valid, void, voidable, or unenforceable.

Many contracts specify a time for performance. In any case, all contracts must be performed within a reasonable time. An executed contract is one that has been fully performed. An executory contract is one in which some act remains to be performed.

The essentials of a valid contract are legally competent parties, offer and acceptance, legality of object, and consideration. A valid real estate contract must include a description of the property. It should be in writing and signed by all parties to be enforceable in court.

In many types of contracts, either of the parties may transfer his or her rights and obligations under the agreement by assignment or novation (substitution of a new contract).

Contracts usually provide that the seller has the right to declare a sale canceled if the buyer defaults. If either party suffers a loss because of the other's default, he or she may sue for damages to cover the loss. If one party insists on completing the transaction, he or she may sue the defaulter for specific performance of the terms of the contract; a court can order the other party to comply with the agreement.

Contracts frequently used in the real estate business include listing agreements, sales contracts, options, land contracts (installment contracts), and leases.

A real estate sales contract binds a buyer and a seller to a definite transaction as described in detail in the contract. The buyer is bound to purchase the property for the amount stated in the agreement. The seller is bound to deliver title, free from liens and encumbrances (except those identified in the contract).

Under an option agreement, the optionee purchases from the optionor, for a limited time period, the exclusive right to purchase or lease the optionor's property. A land contract, or installment contract, is a sales/financing agreement under which a buyer purchases a seller's real estate on time. The buyer takes possession of and responsibility for the property but does not receive the deed immediately.

 RELATED STATE OF TENNESSEE LAWS, RULES, and REGULATIONS
When preparing to make and accept offers for the sale or rental of real property, buyers and sellers want to make decisions based on full knowledge of the property and title. Additionally, in today’s marketplace, the real estate industry has seen a movement from caveat emptor (buyer beware) to seller discloser. Today, sellers are asked to disclose information material to a buyer’s making an informed decision.

FAQ’s about Contract Issues

What is a contract?
A contract is a set of legally binding promises between two informed parties that must be performed and for which, if a breach occurs, the law provides a remedy. Any contract that transfers an interest in real estate must be written and signed by the parties to be charged to be enforceable. Lease agreements however, are a little different. Leases need not be written and signed unless the term of the lease is greater than a year or the lease will be effective for more than 1 year from the date of inception until the end of the relationship. However, good business practices should dictate that all leases be written and signed.

In Tennessee, on execution of any instrument in connection with a real estate transaction, licensees are required to immediately deliver legible copies of the original document to each party. It is the responsibility of the licensee to prepare sufficient copies of such instruments to satisfy this requirement.

What is the age of legal competence in Tennessee, with no exceptions, to enter a contract?
In Tennessee the age of majority is 18. Thus, a person is a minor until he or she reaches that age. Any contract entered into by that person would be voidable by the minor. Also, if a person who is mentally impaired or is under the influence of alcohol or drugs enters into a contract, the contract is voidable by that person

What does informed parties mean?
Before entering into a legally binding contract to buy or sell real estate, what the parties offer and accept must be the same. Hence, it is important that sellers disclose every important issue about the property. Otherwise, the buyer is buying less than agreed on. It is an act of fraud to withhold disclosure of adverse facts. Sometimes, a seller or agent does not know, or negligently withholds information. In these situations, the buyer may be able to void the contract.

Define adverse fact
 In Tennessee, adverse facts are conditions or occurrences that are generally recognized as being of such significance that they would affect either party’s decision to enter into a contract. Included in this definition are situations that would significantly, adversely, and negatively affect the value of a property and situations that would significantly reduce the structural integrity of a property. Also, any situation that presents a significant health risk to the occupants of the property would he considered an adverse fact

Define fraud.
Fraudulent acts require intentional deception in such a way as to harm another person. Included in the definition is fraudulent advertising, making false statements about a property’s condition, and intentionally concealing known facts. Such fraudulent acts are subject to license suspension or revocation.

What is negligence?
Misrepresentation or omission of pertinent 'acts does not have to be intentional to bring liability exposure. Negligence occurs when licensees should have known that incorrect statements were being relied upon as material fact.

Who is permitted to draw up real estate contracts?
Tennessee allows brokers to prepare listing and sales agreements and buyer representation agreements without this preparation being considered the practice of law. Licensees should caution against actions that could lead to charges of the unauthorized practice of law.

Legal advice, however, should certainly be sought.  In practice, most real estate practitioners in Tennessee use sales agreements, listing agreements, and buyer representation agreements prepared by the Association of REALTORS ®

Regarding those contractual documents over which the broker has control, failure to obtain all signatures or initials of the required parties is subject to disciplinary action and a civil penalty. The licensee must deliver signed copies to all parties as soon as possible.

What specifically may a broker NOT prepare?
In Tennessee, real estate brokers should be cautious to avoid the charge of practicing law without a license. Brokers are not allowed to prepare deeds, to prepare affidavits of child support or spousal support, or to complete installment sales contracts, mortgages or deeds of trust, or documents necessary to correct title defects. Licensed attorneys must be used for these documents.

How is property described in Tennessee legal documents?
Tennessee did not become a state until 1796. Before that, it was the western territory of North Carolina and, as such, continued with the type of legal description used there. Metes-and-bounds and lot and block number descriptions are in common usage. The rectangular survey system is not used in Tennessee except for a few of the southeastern counties, referred to as the Ocoee Land District.

Is a legal description required in a listing agreement?
There must be a meeting of the minds to make a contract, and the street address must be definitive enough to clarify what is being purchased. Street addresses are not considered legal descriptions because of their temporary nature A street address may be sufficient in a listing agreement, but it is best that the legal description appear in a deed and deed of trust.

What forms must be completed during a real estate transaction?
The TREC does not require the use of specific forms. It does require an agency disclosure in addition to the purchase agreement. Additionally, for the sale of residential properties, another form or two are required: the Residential Property Condition Disclosure and, if the residence was built prior to 1978, a lead-based paint disclosure form. The broker must retain copies of these statements for three years after the date of closing, along with a copy of the listing, any offers to purchase, and all pertinent correspondence.

FAQ’s about Residential Property Condition Disclosure

What is the purpose of the Residential Property Condition Disclosure?
The purpose of the disclosure is to provide the buyer of residential property with written information about the condition of the seller's property. The buyer can then make an informed offer. The seller is required to make this disclosure because it is assumed that he or she knows the property the best.

TREC has establishes the form to be used to comply with the law. The form may not be completed nor sign by a broker or affiliate broker.

When must the property disclosure be made?
The disclosure of property conditions could affect the buyer's often TREC requires that the seller provide the buyer, before the offer to purchase is accepted, a written Residential Property Condition Disclosure.

To what properties does the Seller Property Disclosure apply?
It applies only to one- to four-family residential properties, and the law lists several exemptions to these

What transactions are exempt from the disclosure statement requirement?
Disclosure is not required in certain situations. The following property transfers are exempt from the disclosure statement requirement:
• Court-ordered transfers such as estates, writs of execution, foreclosure sales, bankruptcy trustee sales, eminent domain transfers, and decrees of specific performance
• Foreclosures under a deed of trust or a deed in lieu of foreclosure
• Transfer by a fiduciary in the administration of a decedent's estate, guardianship, conservatorship, or trust
• Transfers from one or more co-owners to another co-owner where ownership was in the form of tenancy in common, joint tenancy, and/or tenancy by the entirety
• Transfers made between a spouse and a person or persons in the lineal line of consanguinity
• Transfers between spouses resulting from a decree of divorce or a property settlement stipulation
• Transfers from a tax sale (state, federal, or local)
• Transfers to or from any government entity or public or quasi-public housing authority or agency
• Transfers involving the first sale of a dwelling, provided that the builder offers a written warranty
• Any property sold at public auction
• Any transfer of property where the owner has not resided on the property at any time within three years prior to the date of transfer
• Any transfer from a debtor in a Chapter 7 or a Chapter 13 bankruptcy to a creditor or third party by a deed in lieu of foreclosure or by a quitclaim deed

Who must make the property disclosure?
The disclosure statement applies to any owner interested in transferring residential real property of one to four units. The owner is required to deliver a written disclosure statement to any person interested in being transferred the real property.

After the seller filled out the property disclosure form, some items changed. How should these changes be handled?
Once delivered, any new discoveries (like previous termite infestation) require an amended statement. Once the owner or owner's agent has knowledge of any previously unknown defects, that information must be communicated to the buyer. Unless otherwise amended, any inaccurate or misleading information on the original disclosure is assumed accurate and complete. Failure to disclose any subsequently known defects is considered fraud.

What are the licensees responsibilities to ensure that the seller makes the disclosure and that the buyer receives it in a timely fashion?
A real estate licensee representing the seller has the duty to inform the seller of the seller's rights and obligations under this act. Likewise, the buyer's agent or licensee working with the buyer must inform the buyer of the buyer's rights and obligations.

Once this has been done, the licensee has no further duties and will not be liable to any party for any violation of this law. The licensee, however, will be liable for misrepresentation or for defrauding the buyer or for failing to disclose adverse facts of which the licensee had knowledge.

What if the property transfers without a seller disclosure statement?
A transfer is not invalidated solely because of the failure of a person to comply with the written disclosure requirement.

Whose signatures must be on the seller property disclosure form?
The sellers must sign the form, certifying that it is true and correct to the best of the seller's knowledge. The buyer(s) must also sign the form, acknowledging receipt of it.

In other words, sellers disclose that the provided information regarding the property's condition is based on information known or reasonably available to them and certifies that the information is true and accurate to the best of their knowledge. Buyers acknowledge receipt of the document; however, note that the document is not intended to be a warranty or a substitute for any inspection deemed necessary by the buyers. If there is more than one buyer, any one buyer may accept delivery of the executed statement.

What if the buyer feels that the disclosure was incorrect?
If the owner misrepresented the property on the disclosure form, the buyer may terminate the contract prior to closing. If the property has already transferred, the buyer may bring an action for damages within one year from the date the buyer received the disclosure form.

FAQ’s about Offers and Acceptances

Do I have to let the buyers agent present the offer to my seller client?
Listing agents are not required to permit a buyer's agent to be present when presenting offers or discussing confidential matters with their seller clients. However, in some Tennessee brokerage communities, it is customary to give buyers' agents the privilege of presenting their buyers' offers.

In what order are multiple offers presented to the seller for consideration?
TREC rules state that any and all offers received by a listing agent must be promptly presented to the seller for consideration, or the listing broker can face disciplinary action. The seller must be permitted to view all offers to determine which offer is best for him or her. The formal acceptance or rejection must then be promptly communicated to the potential buyer or the buyer's agent.

All offers must be submitted to the sellers by licensees either by hand delivery; by fax, if communication by fax is agreed to by the parties in the contract form; or by the U.S. Postal Service. Likewise, acceptances or rejections may be communicated by the same methods.

Licensees need to help the buyer understand that another offer may be presented while the seller is considering the first offer. No particular courtesies are extended to the person writing the first offer. There is no particular advantage to writing the first offer.

Should subsequent offers received after the seller accepts an offer be presented to the seller?
The seller has the right to see offers that arrive, even if the seller has accepted an offer. The seller is still bound to the accepted offer, but may wish to view a later offer as a possible backup or secondary offer.

Once the offer is accepted, what rights does the buyer have in the property?
The purchaser acquires equitable title when an offer has been accepted by the offeree and acceptance communicated to the offeror. After a purchase agreement is signed and the buyer or buyer's agent is in receipt of the signed document, equitable title passes to the purchaser. At this point, the buyer has an insurable interest in the property and is allowed the opportunity to purchase additional insurance. The seller cannot arbitrarily withdraw acceptance and sell to another party.

What is meant by dual contracts, and why are they illegal in Tennessee?
While backup contracts are commonly used in Tennessee, dual contracts are fraudulent. The term dual contracts refers to two contracts from the same buyer on the same property. One of the offers is used to purchase the property, while the other is used to finance the property. The offer to purchase can be either written or just an oral arrangement, while the offer to finance is generally written.

The true purchase price is known only between the contracting parties. The purpose of dual contracts is to enable the buyer to obtain a larger loan than the true sale price or to enable the buyer to qualify for a loan that the buyer otherwise could not obtain. Thus, the lender is deceived.

FAQ’s about Closings

Who is responsible for closings?
If a broker acts as a closing agent, he or she must provide copies of the closing documents to all parties. That is the only requirement brokers have regarding closings under Tennessee rules. After closing, the broker is required to keep copies of all executed documents for three years.

The buyer has requested that some funds be withheld from the seller until all of the repairs are completed. Under what conditions can this be done?
In the event all repairs are not completed by closing, the closing agent can be instructed to hold funds aside, generally equal to one and a half times the cost of repairs not yet completed.

Can brokers charge to prepare some documents?
Real estate brokers cannot charge a fee for the preparation of purchase agreements.


FAQ’s about Stigmatized Properties

What is a stigmatized property?
A stigmatized property is one that has acquired an undesirable reputation. Stigmatized properties include homes with recorded paranormal activities, those psychologically impacted by newsworthy incidents such as murder or murder/suicide, or those suspected of being a front for illegal drug sales or the site of a forcible felony.

Is there any responsibility for failure to disclose information about stigmatized property?
There is no duty for the seller to disclose such information. Federal fair housing laws prohibit an agent from disclosing that an occupant of the subject property has or had AIDS or HIV.

No cause of action is warranted against a seller's agent for failure to disclose that the purchased property was psychologically impacted, i.e., that the property was the site of a homicide, felony, or suicide. Also, an act or occurrence that had no effect on the physical structure, its physical environment, or the improvements thereon need not be disclosed.

There is no duty for the licensee to discover. If the buyer's agent had prior knowledge, then, under agency responsibilities, the buyer's agent may have a duty to disclose such information. Under no circumstances, though, may an agent discuss AIDS or HIV of a previous occupant.

FAQ’s about Environmental Concerns

Who implements CERCLA in Tennessee?
There is no Tennessee law that implements CERCLA. Part 2 of the Hazardous Waste Management Act of 1983 is a similar but separate law.

What is the purpose of the Hazardous Waste Management Act of 1983?
The primary purpose of this legislation is to control hazardous substance spills or disposals that represent problems. Inactive sites are identified and promulgated under state regulations notification to the state is required prior to the commencement of target housing abatement projects.

Under the federal law, the seller is required to notify the buyer of any known lead-based hazards and provide the buyer with any information on lead-based hazards from risk assessments or inspections in the seller's possession. The seller must also provide a booklet to the buyer or tenant. Buyers (but not tenants) have the right to have the property inspected within ten days or any time period agreed on or to waive this right. Failure to disclose any known presence is subject to a $10,000 fine per violation. Copies of these disclosures must be retained for three years.

Has Tennessee addressed the issue of asbestos removal?
Tennessee does require notification to remove regulated asbestos-containing material (ACM) where quantities exceed a certain amount. The person or firm planning such a removal must notify the Tennessee Division of Air Pollution Control at least ten days before the stripping or removal work begins. The state has the right to conduct site inspections when deemed necessary. If any violations of the standards and procedures are found, civil penalties may be imposed up to a maximum of $25,000 per day.

Some properties and situations are exempt. Exemptions from notification include nonfriable-asbestos-containing materials, packings, gaskets, resilient floor coverings, and asphalt roofing products that, when dry, cannot be crumbled, pulverized, or reduced to powder by hand pressure. Residential properties of one to four units are exempt unless the improvements are being demolished for commercial development or road widening.

Has Tennessee any requirements for radon testing or disclosure of UFFI?
There are no requirements for radon testing or mitigation. Tennessee has no specific regulations regarding the installation, use, and disposal of urea formaldehyde foam insulation (UFFI).

FAQ’s about Other Closing Issues

Is Tennessee a lien theory or title theory state?
Tennessee uses deeds of trust to secure debt. In a deed of trust, the borrower. known as the grantor or trustor, conveys legal title to a trustee, who holds the title on behalf of the lender, known as the beneficiary.

Tennessee law provides the right of statutory redemption, but this right is usually waived in the deed of trust. The trustee has the "power of sale," which eliminates the judicial process of foreclosure. The trustee, or substitute trustee, must advertise the sale of the property once a week for three weeks and may hold the sale on the courthouse steps the fourth week.

How does a buyer know that title to the property is good and marketable ?
There is no legal requirement in Tennessee that a title search or title opinion be done. Most lenders, as a condition to making the loan, will require a lender's title insurance policy or, at the very least, an attorney's opinion based on a title search.

Often, this is all that is done, because the buyer may not know how to protect himself or herself. Licensees are encouraged to recommend owner's title insurance policies or attorney's opinions.

Is a survey required?
Generally, a survey is performed only if required by the lender. Even this is becoming less and less a condition to making the loan, except for FHA insured and VA-guaranteed loans. Licensees should recommend a survey to all buyer clients as well as buyer customers.

What are transfer taxes?
For increased revenue, Tennessee charges property owners a transfer tax when they transfer legal title to their properties. Transfer taxes are based on the entire purchase price (or value, whichever is higher). The current transfer tax rate is 37¢ per $100.

How are transfer taxes computed and who pays them?
Example: $180,000 sale. $180,000 ÷ 100 x .37 = $666.00.

There is another tax if there is a deed of trust. See below.

The state does not care who pays the tax as long as it is paid. Typically, at closing, this amount is paid by the buyer to the state of Tennessee. However, the seller could pay the tax instead.

Does Tennessee use mortgages or deeds of trust?
Tennessee is one of the few states that use deeds of trust instead of mortgages.

Is there a tax on the deed of trust?
Yes; the Tennessee tax on the deed of trust is 11½¢ per $100 of loan amount, excluding the first $2,000. This is in addition to the transfer taxes.

How is the tax on the deed of trust calculated?
Example: Property sells for $180,000, $144,000 loan.
$144,000 minus $2,000 = $142,000 ÷ 100 = 1,420 x .115 = $163.30.
The entire tax due on the sale of a $180,000 property with a $144,000 deed of trust is $666 plus $163.30 = $829.30.

Of course, this does not include the recording fees, probate fees, and imaging fees, if any.