Contract Default in a downward market

Real Estate Law
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Contract Default in a downward market

To Abate or not to Abate, that is the question

National Statistics released on April 14, 2023 shows 34.4% less real estate transactions in March 2023 than historically strong March 2022. There is no doubt about it, the real estate market is in the downward trend. But what happens to the buyers or the sellers who become victims of the downward market.

During the real estate hot market where multiple offers on any home were a given, the buyer had to put their best foot forward. Meaning that the buyer had to present the best possible offer to even be considered as a contender in the bidding war that often followed.  Best offer usually meant no condition on financing, no inspection, and thousands of dollars over asking price.  Once the offer was accepted, the buyers felt a sense of euphoria that their long search, after many rejected offers, to find their “perfect” home was finally over.  However, somewhere between signing the Agreement of Purchase and Sale and the closing date, the market conditions changed, and they changed quickly and for the worse.

Financial institutions changed their lending criteria, hiked interest rates and stress test requirements. Therefore, buyers whose offer was unconditional, had difficulties obtaining mortgage financing. Lower property values meant lower appraisals for the bank. Buyers were facing real possibility of defaulting.

Many buyers were under the impression that the only thing on the line was their deposit funds, paid at the time of offer acceptance. But this is simply not true. Assessment of damages is far greater than that.

The general rule at common law is that the innocent party should be placed on the same position as if the contact had been performed. That generally requires that the damages be assessed at the date of the breach, usually the closing date.

The seller who managed the sell their property at the peak of the market may be counting their blessings, but if the purchaser does not close the transaction, what are the sellers’ options?

Once the buyer defaults and unable to close, the seller would re-list the property for sale and continue to pay for their mortgage, insurance and property taxes until the new sale transaction closes.  If the seller sells the property for less than the initial failed contract, the buyer will be responsible for the difference between the two contact prices. The defaulting buyer would also be responsible for carrying cost, ie. mortgage payments, insurance costs, property taxes, real estate fees. All these costs could add up to hundreds of thousands of dollars.

However, there are instances where the defaulting buyers can come up with some but not all the funds to close the transaction. The buyers must provide a lower price appraisal, copy of a mortgage commitment, and show their additional down payment amount. The difference may not be hundreds of thousands of dollars but thousands.  The seller is faced with a real dilemma whether to abate or reduce the sale price and accept the lower purchase price for the house and close the deal or commence a lawsuit against the defaulting buyer to recoup their losses.

In cases where the buyers have tried to negotiate with the seller to accept the slightly lower purchase price and close the transaction, the courts may not look too favourably on the innocent seller. While the contract is binding and the seller is entitled to what he bargained for, the court may look at sellers’ unwillingness to negotiate as an act of bath faith. It is important to note that all cases are different and are decided on their individual merits, there is not a one mold fits all.

What happens to the buyer who purchased a property at the peak of the market without an inspection condition and after closing discovers that there are physical defects to the property?

Basic common law principle of “let the buyer beware “, the buyer is responsible for defects to the property that could have been discovered by conducting a reasonable inspection or making reasonable enquiries. In the absence of seller’s warranties in the agreement of purchase and sale, the buyer may still have recourse against the seller in four situations.

If the seller fraudulently misrepresented a fact about a property, meaning that the seller made a statement knowing that it was false with an intention that the statement would be acted/relied on and as a result, the buyer suffers damage.

Another situation where the buyer may have recourse against the seller is if the seller owes the buyer a duty of care or they parties have a special fiduciary relationship, a false statement is made and there is a negligence on the part of the seller about the truth of the statements. The buyer relies on the statement as a truth and suffers damages as a result.

Where the seller actively conceals the defect prior to closing by hiding or renovating over the issue without addressing the issue itself, courts have found that the buyers may be entitled to rescinding their contact or entitled to payment of damages.

The courts have found that the seller owes the buyer a duty to disclose issues that would not be discoverable through a reasonable inspection and the misrepresentation renders the property dangerous or uninhabitable. In a case there the seller failed to disclose to the buyer that the house was formerly used as a “grow op”, the court awarded damages to the buyer for a fraudulent misrepresentation by the seller.

While the innocent buyer may have some recourse against the seller they are faced with a major hurdle. The above remedies are only available if the buyer can prove that the seller had knowledge of the alleged defect. The seller cannot conceal an unknown defect and/or cannot misrepresent what he or she does not know. However, in some cases the court may impute knowledge to the seller of it can be shown that the seller ought to have known.

What happens to the innocent buyer where the seller refuses to close the transaction?

We are heading back into a spring market and seeing multiple offers on many properties in some neighborhoods. Sellers who sold the properties before the wave of multiple offers may feel sellers remorse and regret of not making as much of a profit on the property as possible. In rare cases, the sellers may even go as far as default on the agreement of purchase and sale and either remain in the property or re-list it for a higher price. Courts have awarded damages and sometimes specific performance to innocent buyer who are faced with sellers who default on their obligation to close the transaction.

In the downward market, the buyer may be able to find a similar property for the same or even lower price. As such the innocent buyer must decide if they will sue the defaulting seller for all the costs associated with finding another property. Such costs could include prolonged rent, possible mortgage rate change, moving and storage costs as well as legal fees. The same common law principle applies here; the innocent party must be put in the position it would have been, had the deal closed. The innocent buyer would have to go to court to seek the return of their deposit together with damages.

In the market where the properties are seeing multiple offers and are sold over asking price the damages awarded to the innocent buyer could be substantial. Where a buyer signed a contract to buy a property before the market started to heat up and the seller changed their mind for one reason or another and defaulted on their obligation of complete the contract, the damages will assessed at the time of the default. As such if the buyer purchased when the market was down and because of the sellers default is forced to purchase again only in the upward market, the seller will be responsible for the price difference between their home and the new home that the innocent buyer had to buy. The courts will look at the location of the property, the similarities between them and the inventory of available properties on the market when issuing the damages.

In the examples provided, we have seen that damages don’t necessarily mean just a loss of initial deposit, they go far beyond that. The defaulting party should be prepared to pay for breaching their obligation under the contract. The courts have been clear in their positions when it comes to awarding damages, the innocent party must be put in the same position it would have been had the obligation under the contract would have been fulfilled.

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The Content is current as of its original date of publication, but should not be relied upon as accurate, timely or fit for any particular purpose. Content is provided solely for informational purposes. It is not intended to be legal or other professional advice or an opinion of any kind. You are advised to seek specific legal advice by contacting members of MBLAW (or your own legal counsel) in relation to your specific legal issues.

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