No "Free Look" For Buyers: California Supreme Court Addresses Consideration and Enforceability Issues in Real Estate Purchase Contracts
On March 18, 2010, the California Supreme Court decided the much anticipated case of Steiner v. Thexton and addressed the issue of the enforceability of real estate purchase contracts containing unilateral "sole and absolute discretion" buyer termination rights. The Court's decision had been eagerly awaited by developers and real estate professionals because the lower court's ruling had created uncertainty regarding the enforceability of common real estate purchase contracts, which typically include unilateral "sole and absolute discretion" buyer termination rights and the right of a full deposit refund in connection with the due diligence process and the satisfaction of contingencies.
In Steiner, the Supreme Court agreed with the lower court that the subject agreement, although entitled "Real Estate Purchase Contract," was in effect an option because it bound the seller for three years to sell the property while reserving to the buyer the right to terminate the agreement at any time for any reason in his "sole and absolute discretion."
However, unlike the lower court, the Supreme Court held that, because the buyer pursued approvals for a parcel split and development permits, there was sufficient bargained-for consideration to make the option irrevocable and the agreement enforceable.
FOUR MAJOR TAKEAWAYS FROM THE COURT'S DECISION
(1) Agreements Containing Unilateral "Sole and Absolute Discretion" Buyer Termination Rights Are Enforceable If There Is Part Performance Of A Bargained-For Obligation
From Steiner, we learn that, even though a real estate purchase contract contains a unilateral "sole and absolute discretion" termination clause in favor of the buyer, the resulting option can be irrevocable and the agreement enforceable if consideration of benefit to the seller (and to the detriment of the buyer) is bargained for at the time the contract is entered into and subsequently there is at least partial performance.
The Court found bargained-for consideration in the part performance by the buyer based on the buyer's efforts to obtain county approvals for a parcel split and development permits – matters the seller desired and the buyer agreed to pursue if the buyer decided to eventually purchase the property.
According to the Court, the elements of consideration were present due to the benefit conferred on the seller (to the detriment of the buyer) by the buyer's efforts to obtain the seller's desired parcel split and by virtue of the fact that
the promise by the buyer to pursue the parcel split was bargained for and induced the seller to grant the option.
As a consequence of this ruling, contract negotiations and language should clearly cover bargained-for consideration and anticipate the issue of part performance.
(2) Refundable Deposits May Be Sufficient Consideration
Although the Court based its decision regarding consideration sufficiency on the buyer's part performance, the Court raised the issue that the buyer's posting of a deposit, even though refundable, might constitute valid consideration. The Court noted that by placing the deposit in escrow, the buyer gave up use of the money to his prejudice, thus potentially constituting sufficient consideration. However, because the Court did not specifically rule on this issue, there may be a risk in relying solely on refundable deposit provisions to ensure the enforceability of purchase contracts containing "sole and absolute discretion" unilateral buyer termination provisions. At the very least, some thought should be given to making a portion of the deposit (or maybe the interest thereon) nonrefundable.
(3) Bilateral Contracts Allowing Withdrawal Due To Contingency Failure Are Valid
In Steiner, the agreement allowed the buyer to terminate at any time for any reason. The Court distinguished the agreement from the "common form of real estate contract that binds both parties at the outset" and that includes contingencies allowing withdrawal only if the contingencies fail. The Court concluded that "bilateral contracts subject to a contingency, which are widely used in real estate transactions, are not affected by our holding." Thus, real estate purchase agreements that allow termination by the buyer in the event of failure of contingencies should not be subject to enforceability issues. However, the Court only mentioned loan or inspection contingencies in its decision, so enforceability issues could still arise if a specific contingency is so ambiguous or subjective as to be, in effect, a substitute for a "sole and absolute discretion" unilateral termination right or if the determination of contingency failure is subject to a buyer's "sole and absolute discretion."
(4) Unilateral Agreements Without Consideration Are Revocable
Steiner reaffirms that agreements that do not contain bargained-for consideration and give a buyer the unilateral right to terminate at any time are revocable options that may be terminated by the seller.
In drafting real estate purchase contracts, especially with unilateral buyer termination clauses including "sole and absolute discretion" language, buyers should consult with their attorneys to ensure that consideration and enforceability issues are adequately addressed. In addition, caution should be taken in relying on standard form contracts that may have enforceability issues in view of the holding in Steiner.