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 20-13. 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-license holders 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 a broker, agent, or real estate attorney. 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 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. All contracts are negotiable and that negotiability extends beyond the confines of the TREC and TR forms. Experienced negotiators, however, know that it is better not to demand changes that you yourself would not be willing to grant if you were on the other side of the transaction.
The Value of a Special Provisions Addendum
Let’s assume that you find the existing text and format of the TREC 1-4 contract to be inadequate for an upcoming transaction. The parties have multiple side agreements that are not addressed by any of the promulgated addenda. 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 method is legally valid although it can get messy if there are lots of alterations. It is also less common in the age of electronic contracts since many of these are never printed out in physical form—although using a marked-up hard copy remains a perfectly viable option if the situation requires. There are times when “old school” may be the best course of action under the circumstances.
A cleaner and clearer method of amending a contract is to attach a special provisions addendum that supersedes conflicting provisions of the promulgated contract form. Only items to be altered are mentioned and specifically described in the addendum. This has an obvious advantage in negotiations: it is immediately apparent, on a single page or two, which contract terms are being changed and which are not. Another advantage is that brokers and agents may be more comfortable with this method, since the actual body of their familiar TREC or Texas Realtors (TR) 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 residential agents and brokers out of their comfort zone. Custom contracts are much more common in larger 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 informational items (factual statements and business details) applicable to the sale—not modification of the contract text or addition of provisions that are primarily legal in nature.
The special provisions section of the TREC contract is therefore not the appropriate place for license holders to insert provisions that have legal implications or materially amend the contract terms. A custom special provisions addendum (drafted by an attorney) is nearly always the better way to go. Of course this requires that at least one of the parties be willing to involve an attorney in the transaction. Rather than resisting this, the participating license holders should embrace it as an opportunity to keep the transaction on course while offloading liability for drafting non-standard provisions onto the attorney.
Caution on the part of real estate license holders is called for since substantive contract changes or addition of legal terms is likely to constitute the practice of law. While it is unlawful for anyone to practice law without a license, doing so is particularly problematic for license holders, who may as a result incur both TREC sanctions and considerable liability for doing this. License holders should always refer their clients to a real estate attorney if non-standard provisions or creative changes to the contract are contemplated. The attorney can provide a customized special provisions addendum that covers these modifications and correctly sets forth the intent and agreement of the parties.
Typical Concerns of the Seller
The seller usually has the simpler side of the transaction, at least when it comes to modifying the contract. 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 show that the buyer will be making a substantial down payment. Other concerns of the seller include:
(1) “As Is.” The seller should want 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 TREC contract includes a fairly good explanation of what it means to convey property “as is:” it “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.” This TREC clause is minimally adequate, but there are much higher-quality “as is” clauses out there.
If the seller wants to maximize the “as is” nature of the transaction (and sellers should) then inclusion of a more extensive “as is” clause should be accomplished by means of a special provisions addendum prepared by an attorney. Additionally, care should then be taken to assure that the warranty deed presented to the seller at closing also includes adequate “as is” language. It is not sufficient to rely on the “as is” language in the contract alone, since pursuant to the doctrine of merger the final closing documents (the deed, note, and deed of trust) usually supersede the contract going forward.
Bottom line: a seller is always on firmer ground if the deed includes a serious “as is” clause. Relying solely on the “as is” clause in the contract without also getting such a clause in the deed can leave the seller in a shaky legal position if the buyer challenges the transaction in court. This author takes the additional step of requiring that the buyer sign and acknowledge the deed in order to confirm that the buyer is accepting the property entirely “as is.” Taking this extra step eliminates all doubt or ambiguity.
Note: if the seller performs any repairs and treatments prior to closing, as paragraph 7.D.(2) may require, then the “as is” clause should specifically include these within its scope, thereby preventing the buyer from later claiming that such repairs were warrantied by the seller. The promulgated form offers no easy way to do this, so (again) we must rely on a special provisions addendum.
Lastly, as to existing defects: if there are adverse conditions or defects known to the seller, the seller will want to use the contract and the Seller’s Disclosure Notice as a means of fully disclosing these conditions, up front and in detail. In other words, the seller never wants to be in the position of being accused of withholding such information, or minimizing it, or glossing over it. Get it out there now in full.
(2) Buyer Due Diligence. The seller should make it clear that due diligence duties are the sole obligation of the buyer (including obtaining and evaluating 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 be required to 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) Curing Objections. The TREC contract allows the buyer to submit objections to the survey or the title commitment which the seller “shall cure” so long as the seller does not have to incur any expense in doing so. The seller should want to make it clear that seller may but shall not have the obligation to cure any objections; further, in the course of attempting to do so, seller will not be bound to expend undue effort or expense. The seller probably does not, for instance, want to have to cure heirship objections to title and do so “within 15 days” as called for by the contract. Basically, the seller wants cure efforts to be entirely at its discretion. And the seller certainly does not want the failure to cure objections (or failure to even try) to be construed as a default that could result in a lawsuit from the buyer.
(5) Specific Performance. “Specific performance” is an equitable remedy available to a buyer who pleads and proves that he was ready, willing, and able to perform according to the contract—although actual tender of the purchase price is excused if it would be a useless exercise given the obvious default of the seller. DiGiuseppe v. Lawler, 269 S.W.3d 588, 593-594 (Tex. 2008). It is in the seller’s interest to avoid the possibility of being sued for specific performance since this might result in a lis pendens (public notice of the suit) that could cloud the title and prevent sale of the property to anyone else. Accordingly, 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 agree to strike specific performance all around.
(6) Content of Warranty Deed. The seller should exercise at least some control over the content of the warranty deed that conveys title to the buyer instead of merely accepting a basic assembly-line version supplied by title company attorneys. As previously noted, the seller may want to require inclusion of comprehensive “as is” language along with the buyer’s signature indicating the buyer’s clear 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.” The seller generally pays for the warranty deed, so there is no reason why the seller should not have input into what it contains. This will require obtaining a copy of the proposed deed prior to closing.
(7) 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 a separate assumption agreement that specifies when and to whom the buyer will make payments, how casualty insurance will be handled, and other oft-overlooked but important details. 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 lender.
(8) 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 from the buyer for all seller-financing documents. By early, we mean well before closing since last-minute disputes about the form and content of seller-financing documents have ended more than one transaction. Many attorneys like to attach the form of these documents to the contract as approved exhibits—a great practice, although this more commonly occurs in commercial transactions.
(9) Wraparounds. If the transaction is a wrap, there should be a wrap addendum that addresses pertinent details. Since there is no TREC or Texas Realtors addendum specifically for this, a custom addendum drafted by an attorney is needed. As is the case with assumptions and seller financing, early review and approval of legal documents is preferred. Again, the best way to do this is to attach the pre-approved 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. It is still the best practice to do this whenever creative closing documents will be presented for signature at closing. Get ahead of this potential issue. Prepare these documents in advance.
(10) “Sub2” 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 Texas Realtors addendum specifically for a sub2. As is the case with a special provisions addendum and a custom wrap addendum, drafting a custom sub2 addendum constitutes the practice of law and will require the assistance of an attorney.
(11) Seller Representations. These are generically referred to by lawyers as “representations and warranties” (or “reps and warranties” for short) and they occur in nearly every contract pertaining to the sale of real estate. Paragraph 19 of the TREC 1-4 contract states “All covenants, representations, and warranties survive closing.” Really? Forever? This is clearly not in the seller’s interest and should be struck and the change initialed. Just as the seller wants to convey the property “as is,” at least to the maximum extent possible, a seller should also prefer to put a period on any ongoing liability. Liability should most definitely not be indefinite. Note that the last sentence of this paragraph (allowing for back-up offers) should remain.
The foregoing is a partial list of seller concerns. Problem is, not all of these can be addressed within the standard TREC contract framework, and there may well be other items to consider based on the unique nature of a particular transaction. This is where a special provisions addendum prepared by an attorney can be critical in protecting the seller’s interests.
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 the extensive requirements of Property Code Section 5.061 et seq. relating to executory contracts, this practice (always dubious) is now out of the question.
If a condition or circumstance could reasonably affect the decision by an ordinary buyer to buy or not buy, then it should be fully disclosed, even if the conveyance is to be made “as is.” That may mean going beyond the Seller’s Disclosure 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 Bus. & Com. Code Sec. 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 property or read documents because they were rushed or pressured by the seller. Such a claim is usually doomed in court.
Specific items of concern to the buyer:
(1) Financing Contingency. A buyer should want the third-party financing contingency to be a true contingency governed by specific parameters. The TREC Third Party Financing Addendum states: “Buyer shall apply promptly for all financing described below and make every reasonable effort to obtain credit approval for the financing, including but not limited to furnishing all information and documents required by Buyer’s lender.” 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 TREC text is silent on these specifics. Moreover, nowhere in the contract or in the TREC Financing 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) Legal Documents for 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? What happens if the seller dies?
Wrap issues should be addressed in a lawyer-prepared 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 legal documents early on. Ideally, no buyer should be ambushed at closing with documents that the buyer has neither seen nor agreed to.
(3) Property Condition and Disclosure of Defects. Sellers (and many buyers) choose to check paragraph 7D(1) which calls for the property to be sold “as is.” From the buyer’s point of view, it may be better to check 7D(2) which allows for the “as is” provision but also provides a space for required repairs and treatments. Here, insert “Seller shall deliver all home systems (including electrical, mechanical, plumbing, and HVAC) in good condition and working order.” The effect is to substantially upgrade the buyer’s legal position. If 7.D.(1) is checked, the contract merely provides that this “does not preclude Buyer from inspecting the Property under Paragraph 7A, from negotiating repairs or treatments in a subsequent amendment, or from terminating this contract during the Option Period, if any,” thus placing the burden on the buyer to either start a negotiation regarding repairs or opt out of the contract—an inherently weak position.
On the other hand, checking 7.D.(2) and including the above language in the available blank creates an affirmative covenant on the part of the seller, meaning that if the seller does not substantially perform, he will be in breach. If the seller or his broker resists, then the seller may be hiding something (It happens all the time). In such a case, the buyer should look carefully at the results of the inspections before choosing to proceed, or even consider withdrawing from the transaction altogether. A seller who is reluctant to agree in writing to full disclosure is a flashing red light and a giant alarm bell combined.
As part of the buyer’s investigation into property condition, it is clear that the buyer has an interest in full disclosure of all defects and material adverse conditions. A Seller’s Disclosure (TREC form OP-H or TR 1406) 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 is completed and signed by the seller.” There are exceptions, notably as to previously unoccupied new homes.
The Seller’s Disclosure Notice 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, whether or not proper permits were obtained, and whether or not there is a transferable warranty. Ideally, what a careful buyer wants is something stronger than what is offered by the Seller’s Disclosure, namely an express representation and warranty by the seller that certain defects and 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 it. 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 warranty deed should not be simply a seller-dictated document. The buyer also has an interest in its wording. 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. Accordingly, if it is the desire of the buyer to use the deed to do some basic estate planning (an entirely reasonable goal) then the grantee may 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 et seq. and not as tenants-in-common,” and both grantees should sign the deed—which will then constitute a written agreement in compliance with the statute. This adds value for the buyer at no cost to the seller.
(5) Sub2 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 new owner makes monthly payments.
(6) Legal Description and Survey. The earnest money contract should describe the property with reasonable certainty using lot-block-subdivision information or metes and bounds. It is not enforceable otherwise. Note that the weight of Texas case law suggests that a mere street address may not be enough.
The survey should be studied carefully to assure that it matches the legal description provided. Major variations are a problem. To the extent that there may be minor variations, use of a recent survey description is preferred over the legal description contained in the prior deed to the seller.
It is usually in the buyer’s best interest to delete the “survey exception” to title insurance coverage by requiring that the standard printed exception as to discrepancies, conflicts, shortages in area or boundary lines, encroachments or protrusions, or overlapping improvements be amended to read “shortages in area.” The TREC 1-4 contract offers offer a box at 6.A.(8) to be checked for this purpose. Although negotiable, the buyer usually pays for this.
While a new survey is almost always a good thing, a cash buyer may want 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 pursuant to paragraph C(1). The alternative offered in C(2) states that the buyer shall order a new survey; but this mandatory language may not be necessary, and the buyer should not be compelled by contract to order a new survey if there is no lender involved that requires one.
(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 known item that could reasonably affect the buyer’s decision to buy or not buy? Or what about openly declaring that the Seller’s Disclosure 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: Seller represents and warrants that: (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) the Property is not with an area designated by H.U.D., the Army Corps of Engineers, or any governmental agency as having an increased likelihood of flooding; and (iv) there is not, nor was there ever, any evidence of mold in any of the improvements. And where do these additional representations and warranties go? In a special provisions addendum.
(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.
(10) Seller Default. Just as the seller would prefer to eliminate specific performance (paragraph 15(a)), the buyer should want to retain the option to pursue this remedy if the seller decides not to close. Additionally, a buyer who invests a substantial amount in the due diligence process—reasonable and customary expenses such as inspection fees, appraisal fees, the cost of a survey, attorney’s fees, travel expenses, and the like—may not be satisfied with simple a return of earnest money. A prudent buyer will want the contract to provide for reimbursement of these pursuit costs. Lastly, it is usually in the interest of the buyer to strike out paragraph 16 (requiring mediation) in its entirety. A mediation (which can take months to arrange) often provides time and cover for a seller to convey the property to someone else. It is far more effective for a buyer to go directly to court and obtain a TRO against the sale.
(11) Earnest Money Installments. Brokers and agents typically encourage the buyer to put down substantial earnest money to demonstrate that he or she is serious. This is of course self-serving from the broker’s point of view, because if the buyer is financially committed in a significant way it is more likely that there will be a closing and a commission. However, rather than depositing say $10,000 with the title company, a careful buyer may want to consider dividing the earnest money into two $5,000 installments, with the second installment being due at the title company upon expiration of the option period. The earnest money paragraph (paragraph 5) easily provides for this.
(12) Assignability. It is entirely possible that an investor buyer will want to assign the contract, so the language of the “parties” paragraph should clearly state that the contract is assignable without seller consent.
(13) Income Stream. If the property is rented and the buyer is an investor, he or she will likely be seeking to ensure an income stream that produces an acceptable rate of return. Accordingly, the form and content of the lease as well as the tenant’s payment history should be examined in the due diligence process. Also, if there have been recent substantial improvements to the property, it is worthwhile to check with the appraisal district to see if the property has been fully assessed in its present condition; otherwise, a tax increase may occur that could alter the investor’s anticipated rate of return.
Negotiation of Representations and Warranties
Lawyers talk about certain issues being “heavily negotiated.” For some reason, lawyers just love that term, probably because it sounds so invigoratingly physical for persons who generally spend their days sitting behind a computer. Still, the term has real meaning when using a special provisions addendum to the TREC 1-4 contract (or, in the case of commercial transactions, the Texas Realtors 1801). It is possible that the parties’ representations and warranties will become the subject of intense back-and-forth between the lawyer for the seller and the lawyer for the buyer. This wrangle over reps and warranties should be expected and can be quite useful in revealing both the seriousness and candor of the parties.
There is a conceptual difference between representations and warranties versus covenants and agreements. If you think about it for a moment the distinction is apparent. A rep or warranty basically says “such and such is true about the property and/or me.” A covenant or agreement is subtly different. It states an affirmative promise by the seller or buyer to actually do an act or thing—such as the seller agreeing to deliver good, indefeasible, and undisputed title at closing. There is also a difference in how these two categories of obligation are enforced in the event of default. Competent counsel should address both in the course of negotiations.
Disclosure by Investors and License Holders
Whether in the capacity of buyer or seller, investors and real estate license holders should always disclose their status in the contract. They should also disclose if they are acting on behalf of a relative, a personal company, or a trust in which they have an interest. An 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 license holder] 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 or deception.
Do you have a contract? What about electronic communications?
Since negotiations can become fast-paced and complex when utilizing multiple media, it is useful to know when you actually have a contract. Generally speaking, the Statute of Frauds set out in Business & Commerce Code Section 26.01 and 26.02(b) requires a signed writing in order to have a valid contract for the conveyance of real property. Beyond that, however, there must be offer and acceptance that is clearly communicated—i.e., a meeting of the minds on material terms. For instance, if an offer is made containing specific terms and conditions, and the other party counters with a slightly different set of terms and conditions, then as a matter of law the original offer has been rejected. Why? No meeting of the minds on material terms so the original offer is effectively irrelevant. A counter-offer is now on the table awaiting action. G.D. Holdings, Inc. v. H.D.H. Land & Timber, L.P., 407 S.W.3d 856 (Tex.App.—Tyler 2013, no pet.).
“A contract is established when proven by a preponderance of the evidence that an offer is accepted, accompanied by consideration. Parties form a binding contract when the following elements are present: (1) an offer, (2) an acceptance in struct compliance with the terms of the offer, (3) [a] meeting of the minds, (4) each party’s consent to the terms, and (5) execution and delivery of the contract with the intent that it be mutual and binding.” McGehee v. Endeavor Acquisitions, LLC, 603 S.W.3d 515 (Tex.App.—El Paso 2020, no pet.).
A binding agreement may be made up of several different documents or writings so long as all essential material terms can be determined without resorting to oral testimony. Copano Energy, LLC v. Bujnoch, No. 18-0044 (Tex. January 31, 2020).
The Texas Supreme Court has stated that in interpreting conveyances (and presumably contracts as well) one should take a “holistic approach aimed at ascertaining intent from all words and all parts” of the subject document. Hysaw v. Dawkins, 483 S.W.3d 1, 13 (Tex. 2016).
Can emails or a sequence of emails taken together constitute a binding contract? Yes, if by reading all the emails together the intent of the parties to enter into a contract is clear. Dittman v. Cerone, No. 13—11—00196—CV, Court of Appeals of Texas, Corpus Christi—Edinburg, March 7, 2013. The principal statute affecting electronic communications is the Uniform Electronic Transactions Act (“UETA”) which clearly states that a contract may be valid and enforceable even though it is in electronic form.
Electronic signatures are a related issue. Is a sender’s name in the “from” line of an email the same as a signature? Can a person’s standardized signature block at the end of an email have the same effect as a custom signature on a written contract? Yes to both according to the 1st Court of Appeals in Houston: “A signature block from an email performs the same authenticity function as a ‘from’ field. Accordingly, it satisfies the requirement of a signature under the UETA” as well as the Statute of Frauds. Khoury v. Prentis Tomlinson Jr., No. 01-16-00006-CV (Tex.App.—Houston [1st Dist.] March 30, 2017). Although the 2nd Court of Appeals in Fort Worth reached a contrary result in a similar case, it is likely that Khoury charts the future direction of Texas law in this area.
Needless to say, an electronic contract that is intended to be signed and binding—such as one transmitted by DocuSign—is in fact no different in its legal effect than one that is on paper and executed by hand.
Online electronic notarization is now permitted in Texas. Chapter 406 of the Government Code discusses “regular notaries” (Subchapter A) and “online notaries” (Subchapter C) who have the same authority as traditional notaries. The online notarization process involves two-way video and audio conferencing and still requires that a signer produce valid, government-issued identification. The Secretary of State is tasked with developing rules and standards for this process.
Electronic signatures on real estate contracts and lender disclosures are common now, and electronic closing documents (including promissory notes) are next. Property owners may appear at appraisal board hearings and offer evidence electronically (Tax Code Sec. 41.45). Clearly, future business transactions and agreements will dispense with the required presence of your biological organism—which is as it should be. A legal agreement is nothing more than information, consent to which is verifiable.
Amendments and Extensions
TREC form number 39-8 is customarily used to amend or extend contracts. Filling out the form is straightforward enough. But what about consideration? Say, for instance, the parties want to extend the closing date for 30 days. Does the buyer have to pay an extension fee for this to be legal? The answer is no, not unless the parties clearly intend that payment and receipt of a fee is required as a condition precedent. “The words the parties [choose] are the best indicators of an intent to create a condition precedent. To make performance specifically conditional, a term such as ‘if,’ ‘provided that,’ ‘on condition that,’ or some similar phrase of conditional language normally must be used.” KIT Projects, LLC v. PLT Partnership, 479 S.W. 3d 519 (Tex.App.—Houston [14th Dist.] 2015, no pet.). In the KIT case, the court ruled that an extension agreement was valid even though the buyer’s check for the extension fee bounced! Why? The required magic words were not used in the contract amendment.
Interpretation of Contracts
Texas law generally favors enforcement of express contract terms if they are clear and unambiguous, disallowing any “parol evidence” (oral comments by the parties) that would purport to change these express terms. However, contracts are occasionally ambiguous. Terms and conditions may even contradict one another. In such cases, the court may look to extrinsic evidence (including oral statements) to clarify an ambiguity. There are also certain rules of construction that apply: for example, typewritten (or word-processed) terms prevail over any items that are handwritten, and words prevail over numbers. In one case a promissory note stated in words that the amount of the debt was “one million seven thousand.” The printed numbers, however, were “$1,700, 000.” The lender lost the case since words prevail over numbers. Charles R. Tips Family Trust v. PB Commercial LLC, 459 S.W.3d 147 (Tex.App.—Houston [1st Dist.] 2015, no pet.).
Generally, a court will not allow extrinsic evidence (found outside the four corners of the written document) in the interpretation of otherwise clearly-written contracts. This extends to evidence about prevailing practices in any given industry such as real estate. “The parol evidence rule bars consideration of evidence that contradicts, varies, or adds to the terms of an unambiguous written agreement . . . evidence of surrounding facts and circumstances, including evidence of industry custom and usage, cannot be used to add, alter, or change the contract’s agreed-to terms.” Barrow-Shaver Resources Company v. Carrizo Oil & Gas, Inc., 590 S.W.3d 471 (Tex. 2019).
Closing Documents and the Doctrine of Merger
Prospective changes in an earnest money contract should be considered in light of the doctrine of merger, which provides that the closing documents (most especially the deed) supersede the provisions of the contract. “After delivery and acceptance, deeds are generally regarded as the final expression of the agreement of the parties and the sole repository of the terms on which they have agreed.” Smith v. Harrison County, 824 S.W.2d 788, 793 (Tex.App.—Texarkana 1992, no writ). This is the reason, for instance, that (from the seller’s point of view) an “as is” clause should be included in the deed as well as in the earnest money contract. It also impacts the survival of any representations and warranties made by the parties.
Paragraph 19 of the TREC contract provides that “All covenants, representations and warranties in this contract survive closing.” This is known as a survival clause and it is fine as far as it goes. But there are good and cautious reasons not to rely on this clause as a guarantee that all clauses will actually survive.
First, the TREC form does not include an extensive set of seller representations and warranties. Even the Seller’s Disclosure states that is not a warranty of any kind by the seller . . . so it cannot really (legally speaking) be relied upon by the buyer. This strange admonition persists in successive versions of the disclosure form even though everyone in the business know that Texas buyers do exactly that.
And what if you want to add a custom warranty to the effect that the lot (not just the structure) remained above water during Hurricane Harvey? There is very little opportunity or space to do so. Conceivably, one could insert by hand a brief item #12 in the small space above the signature lines, but this would likely constitute practicing law and be beyond that authority of an agent or broker.
Second, when it comes to covenants (the promise by a party to take some action), the available space is similarly confined. Paragraph 7D(2) offers only a line and a half for specific repairs and treatments to be performed by the seller; and paragraph 11 (special provisions) intentionally limits custom covenants by providing a blank that is much smaller than that contained in earlier versions of the TREC contract. A result of restricting space for non-standard covenants can be to force the parties to condense them to the point that that became overly vague, even useless.
The fact is that special provisions and custom covenants happen. Often. Here’s a real-world example: suppose the special provisions paragraph requires that the “Seller shall completely renovate the condominium,” a very substantial covenant. Will it survive closing? Probably, according to paragraph 19. But how enforceable is such a covenant, given that it is so brief and ambiguous? What does “completely renovate” specifically mean? It could mean that the parties will find themselves in litigation, at least if sufficient money is at stake, with no assurance that the buyer will prevail. Why? Texas courts are loathe to re-write the parties’ contract or impose a specific affirmative covenant where none unambiguously exists.
This situation is a perfect example why custom special provisions addenda should be used more often. Since these are (by definition) not promulgated forms, the involvement of an attorney is a must. But in the foregoing example, “renovate” could have been fully defined and expanded to specifically list items to be renovated and to address such issues as cost and warranty. Additionally, a more comprehensive set of seller representations and warranties than are contained in the TREC contract could have been added.
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. License holders 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, add legal provisions, 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 to negotiate and draft a contract that is in one’s best interest.
The example provided in the last section (vaguely calling for a “complete renovation” of the property) is a good example of how a real estate lawyer can make a difference by creating a special provisions addendum that clarifies the specific intent and agreement of the parties.
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.
From Our Case Files
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 $25,000 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) and shouts “Honey, I’m home!”
Information in this article is provided 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 since we do not offer tax advice. This firm does not represent you unless and until it is retained and expressly retained in writing to do so.
Copyright © 2022 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, www.LoneStarLandLaw.com.