Real property purchase agreements in California are often drafted with broad due diligence or feasibility provisions that allow the buyer to terminate the agreement, and get the deposit back, for any reason in the buyer’s sole discretion. These “free look” provisions are valuable to prevent disputes over whether a buyer is entitled to terminate the agreement. The buyer simply has the right to terminate for any reason or no reason, as long as notice of termination is given within a specified period.
As made clear in the Steiner case, under California law such agreements are not purchase agreements at all, despite what they are often called. Instead, these are actually option agreements, with the seller obligated to hold open its offer to sell on the stated terms of the agreement, and the buyer holding the power to accept or reject the offer. And for an option agreement to be irrevocable, so that the seller cannot retract his offer, the buyer needs to have given the seller legal consideration for the option to purchase the property. If there is no option consideration given by the buyer, then the option can be revoked by the seller at any time until it is unconditionally accepted by the buyer. This is where the court of appeals and the Supreme Court parted ways in the Steiner case. Even though Steiner had expended substantial sums of money in reliance upon his “contract” to buy the property, the appellate court held that Steiner had given no consideration for his option, and so therefore the seller, Thexton, could unilaterally terminate the agreement. The Supreme Court disagreed, and held that Steiner’s actions in seeking a parcel split that was required before the property could be sold was sufficient to render his option irrevocable, particularly since that was an important component of the deal to Thexton.
The Supreme Court’s decision, while good for developers and other buyers, raises many issues that will need to be resolved in subsequent cases. In the meantime, however, buyers should be sure that their purchase agreements are drafted to avoid inadvertently creating a revocable option. To do so, buyers need to either (i) pay actual consideration for the option, or (ii) undertake a clear affirmative obligation to do something that confers a benefit on the seller or imposes a burden on the buyer. Since one of the underlying advantages to a broad due diligence clause is avoiding disputes, buyers may want to avoid committing to affirmative legal obligations. Our advice is to use a clause similar to the following, which provides for a portion of the deposit to be retained by the seller if the buyer decides not to go forward with the transaction:
“In the event the sale of the Property as contemplated hereunder is consummated, the Deposit shall be credited towards the Purchase Price. In the event the sale of the Property is not consummated because of the failure of any condition or any other reason other than a default under this Agreement on the part of Buyer, the Deposit (less the amount of $__________ (the “Contract Consideration”)) shall be returned to Buyer and, notwithstanding anything to the contrary contained in this Agreement, the Contract Consideration shall be paid to and retained by Seller for and in consideration of Seller’s entering into this Agreement. Buyer and Seller agree that the Contract Consideration together with the mutual covenants and agreements herein set forth are adequate to prevent this agreement from constituting a revocable option to purchase the Property.”
The amount of the "Contract Consideration" need not be large, but should be more than nominal.
Thomas B. Jacob, Real Estate Group