By Rob Hofmann
On May 28, 2008, the Third Appellate District for the Court of Appeal hammered home that technical form over substance rules in real property purchase transactions, irrespective of the parties’ original intent. At issue was a run of the mill purchase and sale transaction, overseen by attorneys on both sides, which granted the buyer a due diligence period to inspect the property and the ability to cancel the transaction if the buyer concluded the property ultimately did not meet its specifications. In this instance, however, the seller chose to cancel the deal during the due diligence period despite the jilted buyer having already spent some $60,000 obtaining a parcel split and related entitlements. The court not only rejected the buyer’s request to enforce the contract but also required the out-of-luck buyer to pay the seller’s $80,000-plus in attorneys’ fees incurred in defense of the buyer’s challenge of the deal cancelation. Steiner v. Thexton (2008) 163 Cal. App.4th 359.
Option Agreement to Enter Into Agreement to Purchase
The Court of Appeal upheld the trial court’s conclusion that the agreement between the parties was not a purchase contract, but instead an option agreement (unilateral contract) to enter into a purchase contract. The agreement empowered the buyer to purchase the property at a set price for a set period of time but did not require the buyer to perform. The option agreement was void, however, because the buyer did not tender any consideration for the option.
Interestingly, the distinction between a unilateral contract and a bilateral contract is one of the first concepts aspiring lawyers learn in law school. Specifically, a unilateral contract only requires the promise to perform by one of the parties to a transaction. A bilateral contract, on the other hand, is a promise for a promise that requires performance by both parties. Since the language of the contract at issue gave the buyer ‘absolute and sole discretion’ to cancel the agreement at any time during the due diligence period, with no affirmative obligation to do anything, the court concluded that the contract was in fact an (unilateral) option agreement. Nevertheless, “(t)o be enforceable, an option, like any contract, must have consideration.” The Court of Appeal agreed with the trial court that, here, no consideration was tendered. Therefore, no enforceable option existed and the seller, like the buyer, was free to walk away at any time.
The REAL ESTATE PURCHASE CONTRACT
The document executed by the parties on September 4, 2003, entitled “REAL ESTATE PURCHASE CONTRACT”, provided, in relevant part:
“Martin A . Steiner and/or Assignee, hereinafter called ‘Buyer,’ offers to pay to FAS Family Trust, Paul Thexton, hereinafter called ‘Seller’, the purchase price of Five Hundred Thousand Dollars ($500,000.00) for 10 acres of a 12.29 acre property situated in the County of Sacramento … hereinafter … the ‘Property’ …
TERMS OF SALE:
1. Upon Seller’s acceptance escrow shall be opened and $1,000.00 … shall be deposited by Buyer, applicable toward the purchase price.
2. During the escrow term, Seller shall allow Buyer an investigation period to determine the financial feasibility of obtaining a parcel split for development of the Property. Buyer shall have no direct financial obligation to Seller during this investigation period as Buyer will be expending sums on various professional services needed to reach the financial feasibility determination …
10. If any condition herein stated has not been eliminated or satisfied within the time limits and pursuant to the provisions herein, or if, prior to close of escrow, Seller is unable or unwilling to remove any exceptions to title objected to … then this Contract shall … become null and void …
7. It is the intent of Buyer that the time period from execution of this contract until the closing of escrow is the time that will be needed in order to be successful in developing this project. It is expressly understand that Buyer may, at its absolute and sole discretion during this period, elect not to continue in this transaction and this purchase contract will become null and void.
CLOSE OF ESCROW:
Upon successful completion of subdividing the 10 acres from the existing parcel, Buyer will pay Seller the balance of the purchase price to escrow and close immediately.”
The seller notified the title company to cancel the escrow in October 2004.
Consideration Arguments Not Persuasive
The buyer argued that the seller incurred a benefit from the buyer’s work done and expenses incurred to obtain the parcel split which, therefore, constituted sufficient consideration to support an option. However, the court did not deem any of this effort or cost to confer actual benefit on the seller. Further, the court concluded that consideration “must be measured as of the time the contract is entered into” – a time at which the contract imposed no affirmative obligations on the buyer and the buyer could unilaterally cancel. Thus, the court concluded no consideration was tendered.
The buyer also argued that the $1,000 deposit constituted the consideration necessary to support an option. Again, however, the Court was not persuaded because these funds were to either be applied to the purchase price or, if the deal was not consummated, returned to the buyer. The funds were not tendered in exchange for the option to purchase.
How Does a Buyer Avoid this Result?:
A majority of those commenting on the Steiner decision have appropriately looked to the buyer’s lack of affirmative obligations and unilateral ability to cancel as key drafting areas to address so as to avoid a similar result. Unfortunately, there are a large number of form agreements in circulation that have analogous due diligence inspection periods, including an optional provision of the California Association of Realtors (CAR) form, that are potentially subject to being deemed void (lacking consideration) option agreements. This is understandable because Buyers frequently desire exactly these types of provisions to limit what is expected of them and to give them the greatest flexibility to get out of the deal. Like anything else, however, the only sure way to get what you want is to pay for it. In Steiner, the buyer’s misfortune could likely have avoided by simply requiring forfeiture of the $1,000 initial deposit in the event the buyer canceled the escrow during the due diligence period.
The stakes are too high in most real estate transactions to rely on a one size fits all approach with the corresponding documentation. Relying on form real estate contracts, or cut and paste compilations from the documents used in prior transactions, is tantamount to playing Russian roulette. All it takes is one deal to go awry to more than wipe out any time or expense benefits gained by using old forms. The best protection against a devastating result like Steiner is to involve experienced attorneys that takes the time and effort to thoroughly understand the transaction at hand and that properly prepare the appropriate documentation. This will ensure the transaction comes to fruition in the manner the parties originally intended.
Rob Hofmann is an associate with Abbott & Kindermann, LLP, and is a member of the City of Davis Planning Commission, and a member of the San Joaquin Valley Air Pollution Control District Hearing Board. For questions relating to this article or any other California land use, environmental and planning issues contact Abbott & Kindermann, LLP at (916) 456-9595.
The information presented in this article should not be construed to be formal legal advice by Abbott & Kindermann, LLP, nor the formation of a lawyer/client relationship. Because of the changing nature of this area of the law and the importance of individual facts, readers are encouraged to seek independent counsel for advice regarding their individual legal issues.