DAVID J. WILLIS ATTORNEY
Copyright © 2014. All rights reserved worldwide.
RESIDENTIAL SALES CONTRACTS
With Comments on the Use of Assumed Names in Asset Protection
by David J. Willis, J.D., LL.M.
The most commonly used residential sales contract in Texas is the One to Four Family Residential Contract (Resale) most recently promulgated by the Texas Real Estate Commission on 4-28-2014 as form number 20-11. The blank form is available at www.trec.state.tx.us. I will refer to it as the "TREC 1-4 contract." All licensed brokers and agents are required to use this contract and other TREC promulgated forms when representing clients in the purchase and sale of real property. Non-licensees and attorneys may use any format they wish. Note that our comments in this article are not intended as comprehensive instructions on how to complete the TREC 1-4 contract or as a substitute for using the services of real estate broker or agent. We merely touch upon the highlights.
Real estate investors will find that they are almost always better off using the TREC 1-4 contract with appropriate addenda rather than anything simpler that is supposedly designed or streamlined for investor use – and that includes the modified contracts that emerge from the multitude of real estate "guru" seminars. Accordingly, an experienced investor will become familiar with the various options and boxes to be checked in TREC forms and learn how to tailor a contract to his or her advantage.
The truth is, even when amicably conducted, the sale and purchase of real estate is by definition an adversarial transaction. From a lawyer’s perspective, producing a contract and closing documents that advance the client’s best interests is the whole point of the exercise.
Strike-Outs versus an Addendum
How should revision of the TREC 1-4 contract be accomplished? One way is to make changes on the form itself–strike, insert, and initial with pen. This is legally valid although it can get messy if there are lots of alterations. It is often cleaner to attach a special provisions addendum that supersedes any printed form provisions that may conflict. Only items to be altered are mentioned in the addendum. This method of modifying the contract has an obvious advantage in negotiations: It is immediately apparent, on a single page or two, which terms are being changed and which are not. Another advantage to the addendum method is that brokers and agents are more comfortable with it, since the actual body of their familiar TREC contract has not been changed.
Another possibility is to design an entirely custom contract suited to the specific circumstances, but this seldom happens since non-standard contracts tend to push licensees out of their comfort zone, at least in the residential arena. Custom contracts are much more common in commercial transactions.
If your choice is to add a special provisions addendum, the wording "See Special Provisions Addendum attached hereto and incorporated herein" should be inserted in paragraph 11 (Special Provisions) of the TREC 1-4 contract. Also, in paragraph 22 (Agreement of Parties), the box "other" should be checked and "Special Provisions Addendum" inserted in the line that follows.
A further note as to paragraph 11 (Special Provisions): it is a blank space available for inserting extra comments, but its permitted use by brokers and agents is limited to "factual statements and business details applicable to the sale"–i.e., not modification of text or addition of provisions that are primarily legal in nature. It is therefore not the appropriate place to insert provisions that have legal implications (unless this insertion is suggested by an attorney for one of the parties) nor is it usually an acceptable substitute for a special provisions addendum when dealing with a creative or complex transaction. For one thing, the blank space offered by the form is too small to include much additional text.
Typical Concerns of the Seller
The seller usually has the simpler side of the transaction. First and foremost, the seller wants to make sure that a buyer is serious and capable of following through. For this reason, the seller may want to require that the buyer submit a pre-approval letter with the contract. Also, a contract should arrive with sufficient earnest money and should show that the buyer will be making a substantial down payment. Other concerns of the seller include:
(1) "As Is." The seller usually wants to convey the property to the greatest extent possible "as is" without responsibility for repairs or any representations or warranties (other than warranties of title), particularly those that survive closing. This means checking the box at 7.D.(1). The latest TREC 1-4 contract includes a fairly good explanation of what it means to convey property "as is" – "As Is" means the present condition of the Property with any and all defects and without warranty except for the warranties of title and the warranties in this contract. Not bad, but there are much better "as is" clauses available, for example: AS A MATERIAL PART OF THE CONSIDERATION FOR THIS TRANSACTION, SELLER AGREES TO SELL AND BUYER AGREES TO PURCHASE THE PROPERTY IN ITS PRESENT CONDITION, "AS IS," WITH ALL DEFECTS, KNOWN OR UNKNOWN, PATENT OR LATENT, AND WITHOUT REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED, EXCEPT FOR WARRANTIES OF TITLE THAT MAY BE MADE IN THE DEED TO BUYER. ANY PRIOR ORAL OR WRITTEN STATEMENTS CONCERNING CONDITION OF THE PROPERTY, WHETHER MADE BY SELLER, SELLER'S AGENTS, OR THIRD PARTIES, ARE EXPRESSLY DISCLAIMED. BUYER ACKNOWLEDGES THAT BUYER IS NOT RELYING UPON ANY REPRESENTATIONS, STATEMENTS, ASSERTIONS, OR NON-ASSERTIONS BY SELLER. BUYER CONFIRMS THAT BUYER HAS PERSONALLY INSPECTED THE PROPERTY AND BEEN ADVISED TO OBTAIN THOROUGH PROFESSIONAL INSPECTIONS. BUYER RELIES SOLELY ON THESE INSPECTIONS AND OTHER DUE DILIGENCE, ALL OF WHICH IS BUYER'S SOLE AND EXCLUSIVE RESPONSIBILITY, IN EVALUATING PROPERTY CONDITION AND SUITABILITY. BUYER IS SATISFIED WITH THE CONDITION OF THE PROPERTY AND REQUIRES NO ACTION ON THE PART OF THE SELLER. NO REPAIRS, REMEDIATION, OR TREATMENT WHATSOEVER ARE REQUIRED TO BE PERFORMED BY SELLER. DO NOT SIGN THIS CONTRACT IF YOU ARE NOT WILLING TO ACCEPT THE PROPERTY "AS IS." IF BUYER IS UNCERTAIN ABOUT THE MEANING AND EFFECT OF THIS "AS IS" CLAUSE, THEN BUYER SHOULD CONSULT AN ATTORNEY. AN "AS IS" CLAUSE ACCEPTABLE TO SELLER WILL BE INCLUDED IN THE WARRANTY DEED TO BUYER AND BUYER WILL BE REQUIRED TO ASSET TO THE "AS IS" CLAUSE BY SIGNING THE WARRANTY DEED.
(2) Buyer Due Diligence. The seller should make it clear that due diligence duties are the sole obligation of the buyer (including obtaining inspections, determination of square footage, an appraisal, a title commitment or policy, legal advice, and the like). Reliance on any statements by seller or seller’s agents should be expressly disclaimed.
(3) Existing Survey. If an existing survey is supplied by seller to buyer, the survey should be supplied "as is" without warranties. If the buyer wants someone to hold liable for survey currency or accuracy, then the buyer should obtain a new one at the buyer’s own expense. And there should be no automatic extension of the closing date for survey-related issues.
(4) Specific Performance. It is in the seller’s interest to avoid the possibility of being sued for specific performance of the contract, which might result in a lis pendens being filed that could prevent sale of the property to anyone else–so specific performance as a buyer remedy should usually be struck. And since specific performance is generally an ineffective remedy for the seller, there is no reason (from the seller’s point of view) not to strike specific performance all around.
(5) Content of Legal Documents. The seller should exercise at least some control over the content of the warranty deed that conveys title to the buyer (and for which the seller pays) instead of merely accepting an assembly-line version supplied by title company attorneys. For example, the seller may require inclusion of comprehensive "as is" language along with the buyer’s signature indicating the buyer’s assent to this provision. The seller may also want to expand that section of the deed entitled "Exceptions to Conveyance and Warranty" to include "all matters of which Grantee has actual or constructive notice and all matters excepted from coverage in any owner’s title insurance policy issued to Grantee in connection with this conveyance."
(6) Assumptions. In assumptions, the seller should assure that there will be a mutually acceptable deed of trust to secure assumption (with a due-on-sale clause) as well as an assumption agreement that specifies when and to whom the buyer will make payments, how casualty insurance will be handled, and so forth. The assumption agreement should also include disclosure of the potential future impact of any existing due-on-sale clause and provide a course of action in the event due-on-sale is invoked by the current lender.
(7) Seller Financing. If there is seller-financing, it is in the seller’s interest to control the terms and conditions of the note and deed of trust beyond what is provided in the TREC Seller Financing Addendum–and then, ideally, obtain early approval for all seller-financing documents. By early, we mean well before closing since last-minute disputes about the form and content of legal documents have ended more than one transaction. Many attorneys like to attach the form of these documents to the contract as approved exhibits.
(8) Wraparounds. In the event the transaction is a wrap, there should be a wrap addendum that addresses pertinent details. Since there is no TREC or Texas Association of Realtors promulgated addendum for this, a custom addendum is needed. As is the case with assumptions and seller financing, early approval of legal documents is preferred. Again, the best way to do this is to attach the preapproved legal documents to the sales contract itself, although this seldom occurs because the parties are usually in a rush and reluctant to pay an attorney to create documents at this early stage. Attaching preapproved docs happens more frequently in commercial transactions.
(9) "Sub 2" Transactions. In the case of a "subject to" transaction, precise language to this effect should be included in a custom addendum to the contract since there is no TREC or TAR addendum for a sub 2.
This is a partial list of seller concerns. There may be other items to consider based on the unique nature of a particular transaction. Each item can be effectively addressed by a customized special provisions addendum that is brief and to the point. It need not ramble on, page after page, with unnecessary legalese.
As an aside, be cautioned that the TREC 1-4 contract should never be used as a substitute for a contract for deed or other executory device. Given changes to section 5.061 et seq. of the Property Code, this practice, always dubious, is now out of the question.
If a condition could reasonably affect the decision by an ordinary buyer to buy or not buy, then it should be disclosed, even if the conveyance is to be made "as is." That may mean going beyond the Seller’s Disclosure of Property Condition if that form does not provide sufficient scope or detail. Failure to do so could violate the Deceptive Trade Practices-Consumer Protection Act ("DTPA"). See Tex. Bus. & Com. Code §§ 17.41 et seq. However tempting it may be for a seller to avoid disclosure of a material fact or condition, it is not worth risking a lawsuit that ends with a judgment for treble damages plus attorney's fees.
The Buyer´s Side of the Transaction
A buyer’s concerns are more complex. Generally, the buyer should want to know everything there is to know about the property, whether that information is derived from due diligence, a title commitment, a survey, disclosure by the seller, information provided by a broker, or even gossip from neighbors. "Buyer beware" still has considerable meaning in the purchase and sale of real estate.
There is no excuse for a buyer (particularly an investor) failing to do his or her homework on a property or failing to read documents before signing them. We live in an information society. Not putting forth a minimum effort to obtain information about a property one is buying (not having it professionally inspected, for instance) looks more and more . . . well, stupid–and judges and jurors are likely to see it that way. Yet there continue to be suits by buyers who claim they were absolved from their duty to inspect or read documents because they were rushed or pressured by the seller.
Specific items of concern to the buyer:
(1) The Financing Contingency. A buyer should want the third-party financing contingency to be a true contingency governed by specific parameters. The Third Party Financing Addendum for Credit Approval (2-10-2014) states: "Buyer shall apply promptly for all financing described below and make every reasonable effort to obtain credit approval for the financing." Is this sufficiently specific to protect a buyer from accusations by a seller who argues that the buyer failed to "apply promptly" or make "every reasonable effort" to get a loan? Does "promptly" mean two days or twenty? Does "every reasonable effort" require application to one lender or four? The text is silent on these specifics. Moreover, nowhere in the contract or in the TREC Financing Condition Addendum is it spelled out what constitutes adequate evidence of failure to get financing. Can the buyer be sure that the seller will take the buyer’s word and agree to return the earnest money? These issues may not be so compelling if the earnest money is only $500 . . . but what if it is $5,000 or $15,000, amounts that are not uncommon in sales of higher-end properties? It is also to the buyer’s benefit to specify that providing a "turn-down letter" shall be conclusive, indisputable evidence that financing was denied.
(2) Assumptions, Seller-Financing, and Wraps. If the transaction involves an assumption, seller-financing, or wrap, there is always the issue of the specific content of legal documents that the buyer will be asked to sign at closing. We have discussed this from the seller’s side, but in many cases it is just as important to the buyer. The TREC Loan Assumption Addendum and the TREC Seller Financing Addendum are reasonably detailed, but what if the seller's attorney includes unexpected or oppressive clauses in the note or deed of trust? Does the closing fail? Is there a breach? It is wise to anticipate and prepare for these issues well before closing. Again, a special provisions addendum may be useful. Even better, a careful buyer may want to see and approve the form of the warranty deed that the seller will deliver at closing.
As noted, there is no promulgated addendum for a wrap, yet many pesky details need to be addressed. Is the buyer fully informed about the particulars of the wrapped debt? Has the buyer seen copies of the existing note and deed of trust? How can the buyer be sure the seller will pass monthly payments along to the first-lien lender? Will the buyer have the right to contact the lender or receive written evidence from the seller that payments are current? What happens if the lender exercises due-on-sale and accelerates the wrapped note? What about casualty insurance? Wrap issues should be addressed in a custom wrap addendum to the TREC 1-4 contract, followed by a detailed wraparound agreement signed at closing. Additionally, wrap deals may include extra seller financing in the form of a second or third lien. The down payment on a wrap may even be financed by means of a down payment note. What will the seller-financed note and deed of trust look like? The buyer’s attorney should see all this coming and insist on reading and approving draft legal documents early on. Ideally, no buyer should be ambushed at closing with documents that the buyer has neither seen nor agreed to.
(3) Disclosure of Material Conditions and Defects. Disclosure is often the buyer’s biggest concern. A "Seller’s Notice of Property Condition" (TREC form OP-H dated 10-23-2103) is required by Property Code section 5.008, which states that "[a] seller of residential real property comprising not more than one dwelling unit located in this state shall give to the purchaser of the property a written notice as prescribed by this section or a written notice substantially similar to the notice prescribed by this section which contains, at a minimum, all of the items in the notice prescribed by this section." Section 5.008(d) goes on to say that the "notice shall be completed to the best of seller’s belief and knowledge as of the date the notice completed and signed by the seller." There are exceptions, notably as to previously unoccupied new homes.
The Seller’s Disclosure has several problems from a buyer’s point of view. First, the form states, right at the top, that "IT IS NOT A WARRANTY OF ANY KIND BY SELLER OR SELLER’S AGENTS." Why not? The form’s utility as a disclosure tool is diminished by this statement. The buyer’s attorney should consider using a special provisions addendum to convert the Seller’s Disclosure into a set of express representations and warranties.
Second, disclosure of defects and conditions is limited to the seller’s knowledge and awareness–not the highest standard. What the buyer is concerned with is not what the seller knows or says he knows, but with what is actually true about the property. It is just too easy for an unethical seller to later say, "Oh, I didn’t know about that." Sometimes problems can be detected by inspections and other due diligence, sometimes not. Often, the truth is discovered only after subsequent conversations with neighbors–who may take perverse delight in reporting that not only did the seller know about water penetration behind that faux stucco, he personally patched and painted it to conceal the damage. The buyer should want to know about any such repairs and ask to see contractor paperwork to determine the extent of the work done as well as whether or not there is a transferable warranty. Broadly speaking, what a careful buyer wants is something stronger than what is offered by the Seller’s Disclosure, namely an actual representation and warranty by the seller that certain negative conditions do not exist.
Finally, at no point does the seller expressly state, swear, or affirm that the Seller’s Disclosure is true and correct. Most everyone assumes that this is so since the seller signs the disclosure. But look closely–the form does not say that, merely stating that "This Notice is a disclosure of seller’s knowledge. . . ." This is another disappointment for the buyer. From the buyer’s point of view, there is no substitute for maximum, unconditional disclosure backed up by meaningful recourse against the seller that survives closing.
What about previous inspection reports? Neither the contract nor the Seller’s Disclosure obligates the seller to provide them. The buyer should therefore always request copies of these.
(4) Joint Tenancy with Right of Survivorship. The buyer also has an interest in the wording of the warranty deed. For example, unless otherwise instructed, title company attorneys will list the grantee as "John Jones and wife, Mary Jones," creating tenancy in common. This form of co-ownership does not provide for the surviving spouse to automatically inherit the entire property when the other dies. Title to the property vests in the surviving spouse only if the property is community property and the deceased had no children or, if there are children, all of them are the result of the marriage between John and Mary. Tex. Prob. Code § 45. Accordingly, if it is the desire of the buyer to use the deed to do some basic estate planning, the grantee should be listed as "John Jones and wife, Mary Jones as joint tenants with rights of survivorship as provided by Texas Estates Code sec. 112.051 and not as tenants-in-common." This adds value for the buyer at no cost to the seller.
(5) "Sub 2" Transactions. Investor buyers will often want to take title "subject to" existing indebtedness. Express language (both in the buyer's addendum and in the deed) to the effect that the buyer will not be assuming the obligation to pay the existing debt–and therefore the seller will not be released from the loan until it is paid-is essential in forestalling subsequent claims by remorseful sellers who suddenly realize that they remain on the hook for their old loan with no control over whether or not the current owner makes monthly payments.
(6) Survey. It is usually in the buyer’s best interest to delete the "survey exception" to title insurance coverage (and ask the seller to pay the fee for this service) by requiring that the "standard printed exception as to discrepancies, conflicts, shortages in area or boundary lines, encroachments or protrusions, or overlapping improvements shall be amended, at seller’s expense, to read, "shortages in area." The latest TREC 1-4 contract offers offer a box at 6.A.(8) to be checked for this purpose.
The buyer also wants flexibility as to whether or not to order a new survey if the seller does not have an existing survey or fails to deliver it to the buyer pursuant to paragraph C(1). The alternative offered in C(2) says the buyer "shall" order a new survey; but this may not be necessary and the buyer should not be compelled by contract to do so.
The buyer may want to specify that failure by the seller to supply the existing survey will, at buyer’s election, be a default and cause for termination and return of the earnest money. It may be advantageous to have a clean "out" for the buyer rather than a mere seller default. The difference? The first supplies the buyer with an exit from the contract (along with return of earnest money), but the second only gives the buyer grounds for a lawsuit–an expensive and time-consuming remedy.
(7) Seller´s Representations. Because of concern with full disclosure, the buyer may not be satisfied with the language of paragraph 19 (Representations). This paragraph states that "If any representation of Seller in this contract is untrue on the Closing Date, Seller will be in default." Again, this merely provides grounds for a lawsuit; it does not facilitate the buyer’s expedient termination of the contract and return of the earnest money plus out-of-pocket expenses, so a Special Provisions Addendum should address this and other representations and warranties that may be desirable from the buyer’s point of view.
For instance, what about asking the seller to declare that he or she has made full disclosure of any item that could materially affect the buyer’s decision to buy or not buy? Or what about openly declaring that the Seller’s Disclosure of Property Condition is true and correct? Any deal where a seller refuses to agree to such terms should be avoided as if the property were radioactive (it just might be). There are many such "reps and warranties" a buyer may want from a seller that are not on the TREC forms. Here is one of my favorites: As to the effects of moisture and mold: (i) The improvements on the Property have never been flooded or penetrated by water from any source, including roof leaks, wall leaks, or slab seepage. (ii) The lot or tract drains properly; no part of it experiences standing water after a rain. (iii) There is, nor was there ever, any evidence of mold in any of the improvements.
(8) Restrictions. Applicable covenants and restrictions should not be overlooked as part of the buyer’s due diligence. Title companies like to provide these at closing, if at all, but by then it may be too late for the buyer to back out. If a specific use of the property is vital to the buyer (for instance, a day-care center in a neighborhood that is transitioning out of exclusively residential use) then a request for a copy of the restrictions should be made during the option period. The specific use should also be expressly described in the blank at paragraph 6.D of the TREC 1-4 contract.
(9) Final Walk-Through. The buyer should have the unconditional right to do a final walk-through when the property is vacant and all furnishings removed. It is best to do this in the hours immediately prior to closing. If there is a material adverse change, the buyer should have the right to terminate and receive the earnest money as well as compensation for expenses.
Whether in the capacity of buyer or seller, investors and real estate licensees should always disclose their status in the contract. The appropriate place to do this is the Special Provisions paragraph (or in a special provisions addendum) by using language similar to the following: "Buyer is a real estate investor [and/or licensee] engaging in this transaction for a profit. Buyer has not given Seller real estate advice. Seller should obtain professional advice." This disclosure mitigates any subsequent claim by lay persons that their relative innocence was exploited by a predatory professional. As discussed later, judges and juries do not favor investors if the transaction contains any hint of unfairness.
The Role of the Real Estate Attorney
Negotiating a real estate transaction presents multiple opportunities to favor one side or another, and not just on price. This is where it may be advantageous to consult a real estate lawyer. A real estate investor should always have (at least) three professionals on call: a CPA, an insurance agent, and a real estate attorney.
Why, might one ask, involve an attorney in preparing or advising on a TREC form that is available online and which is often completed by agents and brokers who are trained and licensed to do the job? Because lawyers can (1) modify the actual language of the form and, if needed, (2) customize a Special Provisions Addendum to favor a client. Brokers and agents cannot do either one. Licensees are limited to checking appropriate boxes, filling in blanks, and attaching required promulgated addenda. They are not permitted to materially alter or supplement the contract text, or write custom addenda, which is considered the practice of law.
Another logical question: Why alter these contracts at all, since they were prepared by a broker-lawyer committee composed of experienced, practicing professionals? The answer is that no standard form can anticipate every condition or circumstance; and while many transactions are similar, no two are ever identical. Goals of sellers and buyers vary. Every transaction is unique. While some may say, "It’s just a standard form, it’s OK to sign it," no investor, and certainly no attorney, should ever be satisfied with any standard form. Neutrality is not good enough. The goal is negotiate and draft a contract that is in the investor’s best interest.
Unfortunately, there is a common fear that bringing in an attorney will kill the deal. This is almost never the case with an experienced real estate lawyer, since lawyers know the difference between changes that are reasonable and those that are not–and they could not stay in business with a reputation for killing deals. Likewise, meticulous and ethical investors and realtors should see the wisdom of suggesting that an inexperienced person obtain legal advice, particularly when a transaction has non-standard aspects. This not only benefits the individual involved but shifts liability away.
A Buyer´s Nightmare
A buyer goes to closing without doing a last minute walk-through. When the buyer arrives at her new home, she finds that the seller removed all the shrubbery and rose bushes-that very morning-and took them with him.
Moreover, the buyer discovers that the seller had, when showing the house, strategically positioned his artwork and oriental rugs to conceal sheetrock and slab cracks. The foundation will cost $15,000 to repair. The seller has moved to Missouri. The inspector has no E&O insurance.
Although the seller indicated on the Seller’s Disclosure that the house itself had never been flooded, he neglected to mention that during heavy rains the entire lot is 18 inches underwater, all the way up to the weepholes. And weep the buyer does.
The buyer decides to repaper the bathroom and discovers black mold under the old wallpaper. Astonishingly, the Seller’s Disclosure did not ask specifically about mold–only about "water penetration" or "any condition that materially affects the physical health or safety of an individual." When confronted by phone, the seller replies, "That mold never bothered my health."
Even after all these challenges, the buyer settles in. Suddenly, the front door opens and in walks the seller´s estranged common-law wife (whose existence was not disclosed by the seller) – who shouts "Honey, I´m home!"
Information in this article is proved for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is retained and expressly retained in writing to do so.
Copyright © 2014 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his web site, http://www.LoneStarLandLaw.com.