DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
RESIDENTIAL SALES CONTRACTS IN TEXAS
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) promulgated by the Texas Real Estate Commission as form number 20-11. The blank form is available at www.trec.state.tx.us. 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.
Real estate investors will find that they are almost always better off using the TREC 1-4 with the appropriate addenda rather than anything simpler that is supposedly designed exclusively for investor use. This is true even though TREC forms are generally designed to be neutral "one-size-fits-all" documents. Accordingly, a seasoned investor will become familiar with the various options and boxes to be checked in the TREC form and learn how to tailor the contract to his or her advantage.
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 immediately 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 sales contract when the TREC form is available online without charge, and it is often completed by agents and brokers who are trained and licensed to do the job? Because lawyers can modify the actual language of the form to favor their clients and brokers cannot. Brokers are limited to checking the appropriate boxes, filling in the blanks, and attaching required addenda. They are not permitted to materially alter the text of the contract. That is considered the practice of law and is a task for lawyers only.
Another logical question: why alter these contracts at all? After all, they were prepared by a state-appointed 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. Circumstances vary. The goals of sellers and buyers vary. Every home sale is unique. While some may say, "It´s just the standard form, it´s OK to sign it," no attorney worth his or her salt is ever satisfied with any standard form. Most importantly, no buyer or seller should be satisfied unless the contract is negotiated and drafted with his or her best interests in mind. Consulting a real estate attorney is a form of inexpensive but valuable insurance.
Unfortunately, many realtors attempt to steer their clients away from attorneys, fearing that the attorney will "kill the deal." This is almost never the case when an experienced real estate lawyer is involved. The attorney knows the difference between what changes are "reasonable" and what is not – and could not stay in business with a reputation for killing deals. Likewise, meticulous and ethical realtors should see the wisdom of suggesting that a client obtain legal advice, particularly when a transaction has non-standard aspects. This benefits the client and also shifts potential liability away from the realtor or the investor.
It is particularly important for persons who are using an "intermediary" realtor (i.e., there is only one realtor in the transaction) to get independent advice and opinion. Who else is going to exclusively represent one´s interests, without any other stake in the transaction?
The Use of an Addendum
How should revision of the standard 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. It is often more convenient to attach an addendum to the standard form that supersedes any printed provisions that may conflict. Only items to be altered are mentioned in the addendum. Other provisions are left intact. This method of modifying the contract has an obvious advantage in negotiations: it is immediately apparent to everyone 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. By looking at the addendum, they can plainly see what the proposed changes are.
When adding an addendum of this nature, the wording "See Special Provisions Addendum attached hereto and incorporated herein" should be inserted in paragraph 11 (Special Provisions) of the 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 that is available for inserting extra comments, but its permitted use for 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, nor is it an acceptable substitute for the lawyer-produced addendum just discussed.
Typical Concerns of the Seller
Usually, 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 a contract. Also, the contract should arrive with a sufficient earnest money check 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) that survive closing. The goal should be a transaction that is "as is," with "no reps and warranties," and "no survival" of contract terms.
(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 accuracy, he should be advised to buy a new one. And there should be no automatic extension of the closing date for survey-related issues.
(4) Specific Performance. The seller should avoid the possibility of being sued for specific performance of the contract, which could possibly 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 be struck.
(5) Content of Legal Documents. The seller has an interest in exercising control over the content of the warranty deed that conveys title to the buyer (and for which the seller pays) instead of accepting the assembly-line version supplied by title company attorneys who prepare "one-size-fits-all" documents. For example, the seller should require inclusion of comprehensive "as is" language. 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 the case of assumptions, the seller should assure that there is or will be a mutually acceptable assumption agreement as well as a deed to secure assumption that will be signed by the buyer at closing. Such an agreement should include disclosure of the potential future impact of any "due on sale" clause upon buyer. See our articles entitled Assumptions in Texas and Due-on-Sale in Texas.
(7) Seller Financing. In the event of a seller-financed transaction, it is in the seller´s interest to exercise control over 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 the form and content of the deed, note, and deed of trust. See the article entitled Owner Financing in Texas.
(8) Wraparounds. In the event of a wrap transaction, there should be a wrap addendum that addresses the details of the wrap (note: there is no TREC or TAR promulgated addendum for this) and then, ideally, obtain early approval for the form and content of the deed, note, deed of trust, and wraparound agreement. See Wraparound Transactions in Texas.
(9) "Sub 2" Transactions. In the case of "subject to" transaction, precise language to this effect should be included. See "Subject to" Transactions in Texas.
This is a partial list of seller concerns. There may be other items to consider based on the unique nature of the particular transaction. Each item can be effectively addressed by a customized addendum to the contract.
As an aside, it should also be noted that the TREC Contract should never be used as a substitute for a contract for deed or other executory device. Given changes to Sec. 5.061 et seq. of the Property Code, this practice, always dubious, is now out of the question for residential transactions. See Executory Contracts in Texas.
If a condition could reasonably affect the decision by an ordinary buyer to buy or not buy, then it must be disclosed, even if the conveyance is to be made "as is." The prudent rule is "disclose, disclose, disclose" – and that means going beyond the Seller´s Disclosure of Property Condition if that form does not provide sufficient detail. Failure to do so could violate the DTPA (the Deceptive Trade Practices-Consumer Protection Act – see Sec. 17.41 et seq. of the Texas Business and Commerce Code). However tempting it may be for a seller to avoid disclosure of a material fact, it is not worth risking a lawsuit that ends with treble damages plus attorney´s fees. See Seller Disclosure in Texas.
The Buyer´s Side of the Transaction
The 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 the buyer´s own due diligence efforts, from a title commitment, from a survey, from disclosure by the seller, from information provided by a broker, or even from neighbors. The phrase "buyer beware" still has considerable meaning as it relates to the purchase of real estate.
There is no excuse for a buyer failing to do his or her homework on the property or failing to read documents before signing them. We live in an information-oriented society. Not putting forth a minimum effort to obtain information about the house one is buying (not having it 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 that they were absolved from their duty to inspect property or read documents because they were "pressured" by the seller or broker.
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, not a vague notion subject to dispute by a seller who may argue that the buyer failed to "apply promptly" or make "every reasonable effort" to get a loan. Does the TREC language require application to one lender or four? In its attempt to be neutral, the text is silent. 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? Does failure of the property to adequately appraise constitute denial of the buyer´s loan application? It should. Failure to appraise should be considered a failure to "satisfy the lenders´ underwriting requirements" and therefore permit the buyer to cancel the contract and obtain the return of 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 – not uncommon in sales of higher-end homes? 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 a wrap, there is always the issue of the specific content of legal documents the buyer will be asked to sign at closing. The TREC Loan Assumption Addendum and the TREC Seller Financing Addendum are reasonably detailed, but what if the seller´s attorney unexpectedly includes 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.
There is no promulgated addendum for a wrap, and yet many details need to be addressed. Is the buyer fully informed about the particulars of the wrapped indebtedness? Has the buyer seen a copy of the existing note? 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 periodically receive written evidence that payments are current? What happens if the lender exercises the "due on sale" clause and accelerates the wrapped note? What about casualty insurance? Wrap issues should be addressed in an addendum to the contract, followed by a detailed wraparound agreement that should be signed at closing. Additionally, wrap deals may include seller-financing in the form of a second or third lien. What will the seller-financed note and deed of trust look like? The buyer´s attorney should see all this coming and insist on seeing draft documents early on. Ideally, no buyer should be ambushed at closing with legal documents that the buyer has neither seen nor agreed to.
(3) Disclosure of Material Conditions and Defects. Disclosure is usually the biggest concern of the buyer. A "Seller´s Notice of Property Condition" is required by Section 5.008 of the Property Code which states "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." Note that there are exceptions to Sec. 5.008, notably as to previously unoccupied new homes.
The Seller´s Disclosure form has several problems from a lawyer´s point of view. Firstly, the form states 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 seek to convert the contents of the Seller´s Disclosure into a set of express representations and warranties.
Secondly, disclosure of defects and conditions is limited by the form 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 discerned by inspections and other due diligence, sometimes not. Often, the truth is discovered only after subsequent conversations with neighbors who report 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. A buyer doing thorough due diligence will also want to see the contractor paperwork in order to determine the exact nature and extent of the work as well as whether or not there is a transferable warranty. Therefore, what a buyer wants is something stronger than what is offered by the Seller´s Disclosure – an actual representation and warranty by the seller that certain negative conditions do not exist.
Finally, at no point does the seller state, swear, or affirm that the Seller´s Disclosure is true and correct. Most everyone assumes that this is so since the seller signs it. But look closely – the form does not say that. 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 recourse against the seller that survives closing.
What about previous inspection reports? Neither the contract nor the Seller´s Disclosure obligate the seller to provide them. The buyer should therefore always request copies of these.
(4) JTWROS. 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 and wife, Mary," 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 (see Texas Probate Code Sec. 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 and wife, Mary, as joint tenants with rights of survivorship, and not as tenants in common." This adds value for the buyer at no cost to the seller. See Co-Ownership of Property in Texas.
(5) "Sub 2" Transactions. Often investor buyers will want to take title to the property "subject to" the existing indebtedness. Express language (both in the buyer´s addendum and in the deed) to the effect that buyer will not be assuming the obligation to pay the existing debt – and therefore seller will not be released from the debt until it is paid – is useful in forestalling subsequent claims by remorseful sellers who suddenly realize that they are still on the hook for a loan with no control over whether or not the current owner makes the monthly payments.
(6) Survey. The survey deserves consideration from the perspective of the buyer. 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." Unfortunately, the TREC contract does not offer a box to be checked for this purpose, so this item will need to be included in an addendum.
The buyer also wants flexibility as to whether or not to order a new survey if the seller fails to deliver the existing one. The contract says the buyer "shall" order a new survey; but this may not be necessary and the buyer should not be compelled by the contract to do so. Alternatively, the buyer may want to specify that failure by the seller to supply the existing survey shall, at buyer´s election, be an occasion for termination of the contract and return of the earnest money. It may be advantageous to have an "out" for the buyer rather than a mere seller default. The difference? The first supplies a clean exit from the contract by the buyer (along with a return of the earnest money), and the second only gives the buyer grounds for a lawsuit
(7) Seller´s Representations. Because of the buyer´s 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 against the seller; it does not provide an expedient remedy for the buyer – e.g., termination of the contract and return of the earnest money plus expenses.
What about adding additional seller "reps and warranties?" For instance, that seller has made full disclosure of any item that could materially affect 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?
(8) Restrictions. Applicable restrictions and covenants ("CC&R´s") 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 is too late for the buyer to back out. If a specific use of the property is vital to the buyer, 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.
(9) Final Walk-Through. The buyer should have the unconditional right to do a final walk-through when the property is vacant and all furnishing removed. It is best to do this in the hours immediately prior to closing. If there is a material change, the buyer should have the right to terminate the Contract 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 paragraph 11 (Special Provisions), and the language used should approximate the following: "Buyer is a real estate investor [and/or licensee, as the case may be] engaging in this transaction for a profit. Seller should obtain professional advice." Such a disclosure will mitigate any subsequent claim by lay persons that their relative innocence was exploited by a predatory professional. Juries do not tend to favor investors if the transaction contains any hint of unfairness.
A Buyer´s Nightmare
A buyer goes to closing without doing a last minute "walkthrough." 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 positioned his artwork and oriental rugs strategically so as 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 re-paper 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, 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!"
Merely because standard contracts are available does not mean that significant improvements cannot be made to them. Making such improvements, whether on behalf of buyer or seller, is the proper role and function of the real estate attorney who can create an addendum that makes the contract more favorable to his or her client.
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 © 2013 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.