Unit 10 Real Estate Contracts

Validity of Contracts

A contract can be described as valid, void, voidable, or unenforceable, depending on the circumstances. A valid contract meets all the essential requirements of a contract that make it legally sufficient, or enforceable, and is binding in a court of law. A void contract 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 legal contract. For example, the use of a forged name in a listing contract would make the contract void. A voidable contract appears on the surface to be valid but may be rescinded or disaffirmed by one or both parties based on some legal principle.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 valid by the courts if the party who has the option to disaffirm the agreement does not do so within a time prescribed by law. A contract with a minor (under the age of 18 in Pennsylvania) is usually voidable. A contract entered into by a person with a mental illness is usually voidable during the mental illness and for a reasonable period after the person is cured. A contract made under duress, with misrepresentation, under the influence, or with intent to defraud is also voidable. An unenforceable contract may also appear on the surface to be valid; however, neither party can sue the other to force performance. Because the statute of frauds requires contracts for the conveyance of real estate to be in writing, oral real estate contracts are generally unenforceable. This means that if either party does not comply with the contract, 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. The defaulting party could be sued for damages the other party suffered because of the default. 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.

Executed Contract

A contract in which all parties have fulfilled their promises and thus performed the contract.

Contract Law

A contract is a voluntary, legally enforceable promise between two competent parties to perform (or not perform) some legal act in exchange for consideration. The definition may be easier to understand if its various parts are examined separately. A contract must be voluntary—no one may be forced into a contract; an agreement or a promise—a contract is essentially a promise or set of promises; 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 for a legal act—no one may enter a legal contract for something illegal. Licensees use many types of contracts and agreements to carry out their responsibilities to sellers, buyers, and the general public. The area of law that governs such agreements is known as contract law. In Practice Real estate licensees are advised to use preprinted and pre-approved forms provided by their associations or employing brokers. Remember that licensees cannot practice law without a license. Both the buyer and the seller have the option of selecting their own attorney.

Discharge of Contracts

A contract is discharged when the agreement is terminated. The most desirable case is when a contract terminates because it was completely performed, with all its terms fulfilled. Contracts may be terminated for other reasons, such as a party's breach or default.

Contract Law (cont.) Executed and Executory Contracts

A contract may be classified as either executed or executory, depending on whether the obligation is completely performed. An executed contract is one in which all parties have fulfilled their promises and thus the contract has been performed. This usage is not to be confused with the verb, execute, which means the contract is signed. An executory contract exists when one or both parties still have some act to perform. An agreement of sale 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 full sales price. At closing, these obligations are satisfied and the contract is fully executed.

Quiz

A contract may be express or implied, depending on how it is created. An express con-tract exists when the parties state the terms and show their intentions in words. An express contract may be either oral or written.2.The statement is false. A voidable contract is one that 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 prescribed by law.

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 without legal reason. A seller who fails to deliver title to the buyer breaches the contract. The breaching or defaulting party assumes certain burdens, and the nondefaulting party has certain remedies. If the seller breaches a real estate agreement of sale, 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, in which case the seller is asked to 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 in a real estate purchase contract specifies the amount of money to which the seller is entitled if the buyer breaches the contract. Statute of limitations State law limits the time within which parties to a contract may bring legal suit to enforce their rights. In Pennsylvania, the statute of limitations is four years from the date the contract is breached. Any rights that are not enforced within the applicable time period are lost.

Legal Purpose

A contract must be for a legal purpose, even with all the other elements (consent, competent parties, consideration, and offer and acceptance). A contract for an illegal purpose or an act against public policies is not a valid contract.

Essentials of a Valid Contract

A contract must meet certain minimum requirements to be considered legally valid. The following are essential requirements for a valid contract.

Consent

A contract that complies with all the basic requirements may still be either void or voidable. A contract must be entered into by consent as a 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 a lack of reality of consent as a defense.

Valid Contract

A contract that complies with all the essentials of a contract and is binding and enforceable on all parties to it.

Unenforceable Contract

A contract that has all the elements of a valid contract, yet neither party can sue the other to force performance of it. For example, an unsigned contract is generally unenforceable.

Void Contract

A contract that has no legal force or effect because it does not meet the essential elements of a contract.

Voidable Contract

A contract that seems to be valid on the surface but may be rejected or disaffirmed by one or both of the parties.

Executory Contract

A contract under which something remains to be done by one or more of the parties.

Implied Contract

A contract under which the agreement of the parties is demonstrated by their acts and conduct (also called an implied agreement).

Suit For Specific Performance

A court suit initiated by a buyer when the seller breaches a real estate sales contract, asking the court to force the seller to go through with the sale and convey the property as previously agreed.

Contract

A legally enforceable promise or set of promises that must be performed and for which, if a breach of the promise occurs, the law provides a remedy. A contract may be either unilateral, by which only one party is bound to act, or bilateral, by which all parties to the instrument are legally bound to act as prescribed.

Counteroffer

A new offer made as a reply to an offer received. It has the effect of rejecting the original offer, which cannot be accepted thereafter unless revived by the offeror.

Unilateral Contract

A one-sided contract wherein one party makes a promise to induce a second party to do something. The second party is not legally bound to perform; however, if the second party does comply, the first party is obligated to keep the promise.

Time Is Of The Essence

A phrase in a contract that requires the performance of a certain act within a stated period.

Acceptance

A promise by the offeree to be bound by the exact terms proposed by the offeror.

Offer

A promise made by one party requesting something in exchange for that promise with the intention that the offeror will be bound to the terms if the offer is accepted.

Addenda

Additional material attached to and made part of a document, as in a supplement added to an agreement of sale.

Legally Competent Parties

All parties to the contract must have legal capacity or contractual ability; that is, they must be of legal age and have sufficient mental capacity to understand the nature or consequences of their actions in the contract. As in most states, persons in Pennsylvania who are age 18 or older have contractual capacity. A contract entered into by a person who has a mental illness is usually voidable during the episode of illness and for a reasonable period after the person recovers. On the other hand, a contract made by a person who has been judged insane is void; it may be voidable once the individual is judged capable to contract. Mental capacity is not the same as medical sanity. In Practice Mental capacity to enter into a contract is not the same as medical sanity. The test is whether the individuals in question are capable of understanding their actions. Persons may suffer from mental illness but clearly understand the significance of their actions. Such psychological questions require consultation with experts.

Liquidated Damages

An amount predetermined by the parties to a contract as the total compensation to an injured party should the other party breach the contract.

Express Contract

An oral or written contract in which the parties state the contract's terms and express their intentions in words.

Contract Forms

Because many real estate transactions are very similar in nature, preprinted forms are available for most kinds of contracts. The use of pre-printed 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. In Pennsylvania Licensees are permitted to fill in the blanks on certain preprinted documents, such as agreements of sale and leases, as long as they do not charge a separate fee for completing the forms. In Practice It is essential that all parties to a contract understand exactly what they are agreeing to, especially when the contract contains complicated legal language. 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 them 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.

Bilateral and Unilateral Contracts

Contracts are 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 real estate sales contract is a bilateral contract because the seller promises to sell a parcel of real estate and deliver title to the buyer, who promises to pay a certain sum of money for the property. 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. An option to purchase real estate is another example of a unilateral contract. For instance, a law enforcement agency might offer a monetary payment to anyone who can aid in the capture of a criminal. The reward is only paid if someone actually aids in the capture of said criminal. Example A homeowner offers to pay a commission to a broker to find a buyer for a property. The broker is not obligated to find a buyer. The property owner is only obligated to pay a commission to the broker who finds a buyer. This is a unilateral contract.

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 whom acts have not been done or to whom money is owed. For instance, if the parties agree that performance is close enough to completion, 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 did 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 example, 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 the contract. Operation of law, such as in the voiding of a contract by a minor, or as a result of fraud, due to the expiration of the statute of limitations, or because the contract was altered without the written consent of all parties concerned. Rescission—one party may cancel or terminate the contract as though 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 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.

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-upon acts must be completely performed. Furthermore, many contracts provide that time is of the essence, which means that the contract must be performed within a specific time. A party who fails to perform on time is liable for breach of contract. In Practice When a time is of the essence clause is used in a contract, the parties should consult an attorney. The ramifications of a breach of a contract in which time is of the essence is used can be significant. For example, a buyer might lose escrow funds, or the seller might lose the right to enforce the 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. Courts have sometimes declared contracts to be invalid because they did not contain a time or date for performance.

Contracts Used in the Real

Estate Business The written agreements most commonly used by licensees are listing agreements and buyer agency agreements, real estate sales contracts, options agreements, escrow agreements, leases, and land contracts or contracts for deed. Many states have specific guidelines for when and how real estate licensees may prepare contracts for their consumers. These guidelines are created by state real estate officials, court decisions, or statutes. A licensee may be permitted to fill in the blanks on certain approved preprinted documents, such as sales contracts, as directed by the client. No separate fee may be charged for completing the forms. The practice of law includes preparing legal documents, such as deeds and mortgages, and offering advice on legal matters; a real licensee who is not a licensed attorney cannot practice law. In Pennsylvania In law, real estate licensees are prohibited from providing legal advice unless properly licensed to do so. The consequences of the unauthorized practice of law are far reaching. The unauthorized practice of law is a criminal offense, punishable by up to a one-year imprisonment and a $2,500 fine. Also, the State Real Estate Commission can take disciplinary action against licensees who provide legal advice, resulting in a fine or the suspension or revocation of a license. Finally, a party who is injured by the advice can file a lawsuit, which can result in an award of monetary damages against the individual who provided that advice.

Contract Law (cont.)

Express and Implied Contracts Depending on how a contract is created, it is either express or implied. In an express contract, the parties state the terms and show their intentions in words, either oral or written. Most real estate contracts are express contracts; they have been committed to writing. Under the statute of frauds, certain types of contracts must be in writing to be enforceable in a court of law. In an implied contract, the agreement of the parties is demonstrated by their acts and conduct.

The statement is false.

In Pennsylvania, licensees are permitted to fill in the blanks on certain preprinted documents, such as an agreement of sale, as long as they do not charge a separate fee for completing the forms.

Electronic Contracting

Technology and the internet have significantly changed the way in which real estate transactions are performed. As a result, electronic contracting is a growing field in real estate practice because it quickly and efficiently integrates information in a real estate transaction between clients, lenders, and title and closing agents. The transactions are conducted through email or fax and can save a lot of time and money. Two federal acts govern electronic contracting: the Uniform Electronic Transactions Act (UETA) and the Electronic Signatures in Global and National Commerce Act (E-Sign). UETA sets forth basic rules for entering an enforceable contract using electronic means and has been enacted in most states. The primary purpose of UETA is to remove barriers in electronic commerce that would otherwise prevent enforceability of contracts. UETA validates and effectuates electronic records and signatures in a procedural manner. It is intended to complement any state's digital signature statute. UETA does not in any way require parties to use electronic means. UETA's four key provisions are as follows: A contract cannot be denied its legal effect just because an electronic record was used. A record or signature cannot be denied its legal effect just because it is in an electronic format. If a state's law requires a signature on a contract, an electronic signature is sufficient. If a state's law requires a written record, an electronic record is sufficient. E-Sign functions as the electronic transactions law in states that have not enacted UETA, and some sections of E-Sign apply to states that have enacted UETA. The purpose of E-Sign is to make contracts (including signatures) and records legally enforceable, regardless of the medium in which they are created. For example, contracts formed using email have the same legal significance as those formed on paper. In Practice When entering into a residential purchase sales agreement, it is important for the parties to feel comfortable with and clearly communicate the method chosen for transacting the agreement, whether by paper and ink or by email. In Pennsylvania Pennsylvania's Electronic Transaction Act was enacted in January 2000 to facilitate e-commerce and protect the rights of consumers in electronic transactions. The law generally provides that, with the consumer's consent, electronic records or signatures meet the requirement for a record to be in writing, and that an electronic signature is recognized as valid. Acknowledgment or notarization is permitted electronically.

Statute Of Frauds

That part of a state law that requires certain instruments, such as deeds, real estate sales contracts, and certain leases to be in writing to be legally enforceable.

Plain Language

The Plain Language Consumer Contract Act in Pennsylvania promotes the use of plain language to protect consumers from making contracts they do not understand. Agreements that must be written in plain language include contracts in which a consumer borrows money; buys, leases, or rents personal property or real property; and engages services for cash or on credit for personal, family, or household purposes. Exempt documents include deeds, mortgages, certificates of title and title insurance contracts, documents used by state or federal financial institutions, contracts to buy securities, insurance policies, and commercial leases. Contracts should use short words, sentences, and paragraphs. They should also use active verbs and not contain technical legal terms (other than those that are commonly understood), Latin or foreign words, double negatives, and exceptions to exceptions. Definitions for words should use commonly understood language. The law suggests guidelines for type size, spacing, headings, and page layout. Any creditor, lessor, or seller not complying with the tests of readability (as defined by the law) is liable to the consumer for any loss caused by the violation, statutory damages of up to $100, court costs, and attorney fees. Anyone drafting consumer contracts should refer to the law for the specific guidelines. Contracts may be submitted to the attorney general for approval before being used to avoid problems that could arise in the future.

Consideration

The contract must be based on consideration. Consideration is something of legal value offered by one party and accepted by another as an inducement to act or to refrain from some act. A definite statement of consideration must be included in a contract as evidence that something of value was given in exchange for the promise made. 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 or kind of consideration. Adequate consideration ranges from as little as a promise of "love and affection" to a substantial sum of money. However, consideration does not have to be 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.

Rescission

The practice of one party canceling or terminating a contract, which has the effect of returning the parties to their original positions before the contract was made.

Overview

The real estate market is driven by contracts. Both listing and buyer representation agreements are contracts. Options are contracts—and an offer in 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. It is important for a licensee to know how a contract is created, what it means, what is required for the parties, and what kinds of actions can end it.

Quiz

The statement is true. Pennsylvania's Plain Language Consumer Contract Act intends to protect consumers from making contracts they do not understand by promoting the use of plain language. Agreements that must be written in plain language include contracts in which a consumer borrows money; buys, leases, or rents personal property or real property; and engages services for cash or on credit for personal, family, or household purposes.

Statute of Frauds

The statute of frauds requires that contracts for the sale of real estate be in writing and signed by the seller to be enforceable in a court of law. This statute also applies to certain lease agreements. Under the parol evidence rule, a written contract takes precedence over oral agreements or promises. In Pennsylvania The Pennsylvania State Real Estate Commission's Rules and Regulations require that a real estate broker representing a party to a transaction ensure that all contracts be in writing. As a practical matter, the printed word, as long as it is sufficiently complete and specific, provides written evidence of each party's rights and responsibilities and minimizes the likelihood of controversies.

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 to whom the offer is made 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. Most states require that the offer and acceptance be in writing. The wording of the contract must express all the agreed-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 the offer must be communicated to the offeree. An acceptance is the promise by the offeree to be bound to the exact terms proposed by the 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 definite and communicated to the offeree. 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 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. Example If a buyer gives a seller three days to accept an offer and on the third day the buyer's broker calls the seller's broker and cancels the offer, the offer is now void.

Breach Of Contract

Violation of any terms or conditions in a contract without legal excuse; for example, failure to make a payment when it is due.

Learning Objectives

When you have completed this unit, you will be able to accomplish the following. Describe different types of contracts. Explain the requirements for creating a valid contract. Summarize how contracts may be discharged. Identify contracts used in the real estate business and the need for plain language.

Novation

is the substitution of a new contract in place of the original one. 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.

Assignment

refers to a transfer of rights or duties under a contract. Generally, rights and obligations may be assigned to a third party (called the assignee) unless the contract forbids it. Obligations may be delegated, but the original party remains primarily liable unless specifically released. Most contracts have a clause to either permit or forbid assignment.