Buyer Beware:  Is Your Purchase Agreement Enforceable?

California Court of Appeal strikes down
a “free look” contract

In a case that may have some scratching their heads, the California Court of Appeal refused to enforce a real estate purchase agreement because the buyer had the right to terminate the agreement at any time, without penalty. Steiner v. Thexton, 163 Cal. App. 4th 359 (2008). The purchase agreement was of a similar type that is often used by parties where entitlements or other closing conditions are at issue. Seller agreed to convey the property to buyer, and buyer was given a specific period of time to obtain land use approvals and entitlements. Buyer could also terminate at any time prior to the closing deadline. A $1,000 deposit was made, but it was fully refundable to buyer. Buyer proceeded to obtain land use entitlements and subdivision approvals. Before buyer could close the transaction, the seller terminated the contract and refused to convey the property. Buyer then sued for specific performance and monetary damages. The trial court found that the contract was not enforceable, and this ruling was appealed to the California Court of Appeal.

Even though the buyer spent about $50,000 obtaining land use entitlements over a period of several years, the Court of Appeal found that the contract was unenforceable for lack of consideration. The court’s holdings include:
• The contract to purchase was actually an option to purchase the property;
• Because buyer did not provide seller any separate consideration for the option, seller was not required to sell the property to buyer; and
• Buyer had no right to damages.
The court focused on the fact that buyer was not obligated to do anything with respect to seller, and that buyer could terminate the contract at any time, without penalty. Even though buyer did have some obligations (for example, buyer was obligated to assign any entitlement applications to seller, and provide seller with due diligence reports that buyer may have obtained), the court found that this did not constitute adequate consideration, because buyer could have terminated at any time, before these obligations were due. Therefore, the purchase agreement was actually an option to purchase, and because buyer did not pay consideration for the option, the agreement was not enforceable.

It is also interesting to note that the court would not enforce the doctrine of promissory estoppel – in other words, seller’s promise should be enforced as a matter of fairness. Even though buyer argued that it performed substantial work to its detriment, the court again found that buyer was without risk during the entire period of time prior to closing. So, according to the court, it would be unfair to enforce the contract against seller. As a result, buyer was out over $50,000, lost the property, and the court required buyer to pay seller’s attorneys fees – over $85,000.

The lesson to be taken from this case is two fold. First, the parties to a real estate contract need to be sure that there is adequate, legal consideration at the time the contract is signed. Second, a contract can provide too much protection. If a party has a “bullet proof” right to terminate, then it should also be aware that there may be a chance that the contract is not enforceable from its side.

Unfortunately, the case may raise more questions than it answers. For example, the court did not provide any guidance as to how much consideration buyer needed to provide in order to create an enforceable option or purchase contract. Parties to purchase agreements and option agreements should carefully consider these issues when making the decision to enter into an agreement.

If you have any questions about this article, or would like to talk to a Reuben & Junius attorney regarding transactional work , please call Kevin Rose at 415.567.9000. Reuben & Junius, LLP provides a wide range of transactional services, including leases, purchase and sale agreements, formation of limited liability companies and other entities, and lending/workout assistance, as well as subdivision and condominium work.