CE DIGEST 1 Chapter Index Chapter 2 Chapter 3 Chapter 4 Chapter 5 CHAPTER 1 CONTRACTS IN GENERAL The single most important application of law to the field of real estate is in the area of contracts. Virtually every real estate transaction involves a contract. These contracts are very important to the parties involved in the transaction. A well drafted contract protects both sellers and buyers of real estate. Well designed agreements also protect a broker's right to a commission. Contracts must be interpreted and understood by others involved in the real estate transaction. The written agreements reached between the sellers and buyers of real estate provide the foundation for the instructions that guide the escrow holder. Should a legal dispute arise, the contracts drafted in the transaction will be read and translated by the courts and the attorneys of the parties who are involved in the transaction. Lenders, title insurers, and real estate licensees could all be affected by the interpretation of these drafted real estate contracts. For this reason, all real estate licensees should strive to know the rules governing the creation and operation of contracts. More specifically, real estate licensees need to know how to apply the law of contracts to real estate transactions. CONTRACTS DEFINED A contract is an agreement to do or not to do a certain thing. It may be written or oral. In order to create a contract that is legally valid, the agreement must contain certain essential elements. The four essential elements that must be present to create a valid contract are: Parties who are capable of contracting Mutual consent A lawful object Consideration Contracts that contain these elements are binding and enforceable. This means that if the contract is breached, the injured party can seek the help of the courts to enforce the contract or award money damages for nonperformance.
2 CE DIGEST PARTIES CAPABLE OF CONTRACTING To create a valid contract, there must be two or more persons who have the legal capacity to enter into a binding contract. Most people are considered to be legally capable. There are, of course, exceptions. In California, parties who are considered to lack the capacity to enter into contracts would include: Minors Incompetents Aliens Convicts Both parties to a contract must have the legal capacity to contract. If one of the parties lacks capacity, the contract is voidable by the person who lacks the capacity. Or, the contract may be void from its inception. Corporations are considered to be legally competent parties. The individual who enters into the contract for the corporation must have been given the authority to do so by the Board of Directors of the corporation. This authority is usually given in the form of a corporate resolution. MINORS One of the conditions required to qualify a person as having legal capacity is that of age. A person who is 18 years of age or older is considered to be an adult. An adult person can enter into a legally binding contract. A person who is under the age of 18 is considered to be a minor. A minor cannot enter into a legally binding contract. A minor cannot give a delegation of power or make a contract relating to real property. Any contract that a minor would enter into may be disavowed and made void by the minor. A minor is incapable of appointing an agent. Any such delegation of power such as giving another person a power of attorney to buy or sell real property for the minor is void. For this reason, a broker could not act as an agent for the minor to buy or sell real property. A contract entered into by an adult and a minor may only be disaffirmed and made void by the minor. Therefore, an adult who enters into a contract with a minor does so at his own risk. Although a minor has the legal right to disaffirm a contract with an adult, the minor is liable under the contract until steps are taken to void the contract. Any consideration received by the minor must be returned to the other party.
CE DIGEST 3 RATIFICATION Ratify means to give formal sanction to; approve and so make valid. A person, who approves a voidable contract that he or she has a right to disaffirm, ratifies the contract. Ratification applies to a voidable contract. Take the case of a minor who enters into a contract with an adult. Later, after the minor has reached the legal age of eighteen, the person s conduct continues to indicate that he or she approves of and is satisfied with the contract. The party s acts and conduct would ratify the contract and eliminate the right to disaffirm. EMANCIPATED MINORS The Emancipation of Minors Act is contained in the Civil Code. Based on this act, an emancipated minor is a person under 18 years of age who: Is married; Has been married even though the marriage has been dissolved; Is on active duty with the armed forces of the United States; Has received a declaration of emancipation by petitioning the Superior Court in the county where he or she resides. Persons, who fall into one of these categories, are considered as being over the age of majority and do have certain powers to deal with real property. Emancipated minors may enter into legally binding contracts to: 1) Sell 2) Buy 3) Lease 4) Encumber 5) Exchange or, 6) Transfer any interest in real or personal property. INCOMPETENTS Under California law, a person, who has been judged in a court of law to have an unsound mind, would be classified as being mentally incompetent. Should this happen, the incompetent person would not have the legal capacity to enter into a contract until such time as the person s capacity is restored. Similarly, a person who is entirely without understanding has no power to contract. This is true even if the person has not been judicially determined to be incompetent. The best procedure is for the incompetent person to be represented by a court appointed guardian or conservator. Any acts of the guardian or conservator on matters concerning real property would be subject to court approval. If someone makes a contract while drugged or intoxicated, the contract is voidable by that person. A mentally incompetent person cannot legally contract. Any such contract would be void. Minors or incompetents may convey, mortgage, lease or acquire real
4 CE DIGEST property through the acts of their guardians or conservators subject to court approval. Both minors and incompetents may acquire title to real property through a gift or an inheritance. ALIENS In California, resident or nonresident aliens have essentially the same property rights as citizens. Section 671 of the Civil Code provides that any person whether citizen or alien may take, hold, and dispose of property, real or personal, within this state. Under federal law, however, there are certain restrictions upon the property rights of aliens. CONVICTS Persons sentenced to imprisonment in state prisons are deprived of their civil rights as may be necessary for the security of the institution in which they are confined and for the reasonable protection of the public. Convicts do not, however, forfeit their property. They may acquire property by gift, inheritance, or by will under certain conditions. They may also convey their property or acquire property through a conveyance. MUTUAL CONSENT The second element of a valid contract is that the parties, who have the legal capacity to contract, must mutually consent to be bound by the contract. To have mutual consent, we need: A definite offer made by one of the parties to the contract, and A genuine acceptance made of the offer by the other party to the contract. These two components of offer and acceptance form the essential element of mutual consent needed to form a valid contract. To satisfy the requirement of mutual consent, there must be a meeting of the minds by the parties as to the terms and conditions of the agreement. The assent of both parties must be genuine and freely made. The party who makes the offer is known as the offeror; and, the party who accepts the offer is the offeree. A DEFINITE OFFER Advertisements placed in newspapers, magazines, or other mass media do not constitute definite offers. These kinds of advertising can be characterized as an invitation to enter into preliminary negotiations to make an offer. These mass media serve to announce that certain items or properties are for sale. Similarly, other communication forms such as proposals, preliminary negotiations, and, listings are not definite offers. An agreement to agree is not a contract. It is an illusory contract. The term illusory is used to describe that which has a false appearance. An offer from an offeror
CE DIGEST 5 who promises to buy your property if I can find acceptable financing is an example of an illusory offer. The offeror is not making a real promise since there is no standard on which to base a determination of what is acceptable financing. It is left to the offeror to determine what is acceptable financing and does not effectively bind the offeror to the contract. A true offer must: Demonstrate a present intent on the part of the offeror to enter into a contract with the offeree in exchange for the offeree s promise to: a) Perform some act; or, b) Refrain from doing something. Be definite and certain as to its terms and the acts that are to be performed. The preciseness of the wording in a contract becomes very important if the contract has to be interpreted later in a court of law. The contract must set forth the conditions of performance with enough certainty so that the court can determine the validity of the contract, whether or not it has been breached, and the rights of the parties to the agreement. Be communicated to the person who can accept the offer. To be effective, the offer may only be communicated voluntarily by the offeror or through his or her duly authorized agent. ************************************************************* CASE HISTORY GOODYEAR v. MUNOZ (1985) 170 C.A. 3d 919 Goodyear Rubber Corp. held a lease with an option to purchase certain real property for fair market value from Munoz. When Goodyear attempted to exercise their option, Munoz refused their tender offer of $80,000. Munoz claimed the term fair market value was too uncertain to support performance of the contract and that the option was therefore unenforceable. Goodyear filed a complaint for specific performance. The trial court entered a summary judgment in favor of Munoz. The Court of Appeal reversed this decision. The court held that the term fair market value was a generally accepted and well-established means of property valuation requiring neither greater specificity nor future agreement of the parties to be specifically enforceable. ******************************************************************** ACCEPTANCE OF OFFER When an offeree accepts and communicates his or her acceptance of a definite and certain offer from an offeror, a binding contract is formed. An offer must be accepted in the manner specified in the contract. However, if an exact method of accepting the contract is not stated, any reasonable manner is deemed to be legally sufficient. The acceptance of an offer must be absolute and unqualified. If the terms of the offer are modified in any kind of a material way by the offeree, it becomes a counteroffer. The
6 CE DIGEST acceptance of the offer must be within the time limit specified in the contract. If no time is specified, then acceptance must be within a reasonable time. Once accepted, the death or insanity of either party will not terminate the contract. An offeree, who receives an offer that he would like to accept after making certain changes to its terms or conditions, is making a counteroffer. The original offer is legally rejected. The offeree now becomes the offeror of the counteroffer; the original offeror becomes the offeree. Each change made in an offer or counteroffer should be dated and initialed by all parties to the transaction. Additionally, if it is a real estate contract, the broker must give copies of the contract or changes to the parties signing or initialing at the time the contract is signed or the changes are made. A contract is made when the acceptance is mailed or put in the course of transmission by any prescribed or reasonable mode such as deposit of a telegram for transmission. This is so even though the letter of acceptance is lost and never reaches the party making the offer since the acceptance has been placed in the course of transmission by the offeree. TERMINATION OF AN OFFER The hope of a person who makes an offer is that the other party will accept the offer and that a contract will be formed. However, the offeror usually does not want to wait indefinitely to find out if the offer is accepted. An offer may be terminated in a number of ways. Lapse of Time - An offer is revoked if the offeree fails to accept the offer within the time period specified in the contract. The offeror generally specifies that the offeree s acceptance must be communicated to the offeror by a certain date. If the offeree s acceptance is not received by that date, the offer is considered to have been revoked. Revocation of Offer - An offer may be withdrawn at any time before the offeror receives communication of the offeree s acceptance in writing. This is true even if the offeror said the offer would be kept open for a stated period of time which has not yet elapsed. If the offeree pays to keep the offer open for a prescribed period of time, it becomes an option contract and the offeror must abide by its terms. Failure of Offeree to Fulfill a Condition - If the offeree fails to fulfill a condition prescribed by the offeror or to accept the offer in a prescribed manner, the offer may be terminated. If the offeree makes a qualified acceptance such as by changing the price, the offer becomes a counteroffer and the original offer is dead. It cannot later be accepted unless revived by the offeror making the same offer over again.
CE DIGEST 7 Rejection by the Offeree - An unequivocal rejection ends the offer. However, requests for clarification or preliminary bargaining do not have the same effect if they involve no more than inquiries or suggestions for different terms. Death or Insanity of the Offeror or Offeree - Revokes the offer. However, should one or both of the parties to the contract die or become incapacitated after acceptance of the offer, the contract becomes binding upon the heirs or guardians. An Illegal Purpose - If the conditions or the purpose of the contract are illegal, then the contract is terminated. *****************************************************8 CASE HISTORY GIBBS v. AMERICAN SAVINGS & LOAN 217 C.A. 3rd 1372 James and Barbara Gibbs submitted an offer for $180,000 to American Savings and Loan to purchase a house in Woodland Hills that American had taken back in foreclosure. A short while later the Gibbs received a counteroffer from American Savings. The counteroffer contained several additional terms and conditions but made no mention of the purchase price. Mrs. Gibbs received the counteroffer on June 6, 1985 at approximately 8:45 a.m. She then drove to her husband's worksite to get his signature on the counteroffer, signed it herself, and drove to her office where she prepared an envelope and certified mail receipt and gave the ready-to-mail envelope to the mail clerk at her office to mail at approximately 10:00 a.m on the morning of June 6, 1985. At approximately 11:00 a.m. on the same morning (June 6th), Barbara Gibbs had a telephone conversation with an employee from American Savings during which the thrift's employee informed Mrs. Gibbs that the counteroffer contained an error since American Savings had intended to increase the purchase price to $198,000 and that because of this error the counteroffer was revoked. American Savings then took the position that no contract had been formed since they had withdrawn their counteroffer prior to receipt of the Gibbs's offer. The Gibbs insisted that they had accepted the counteroffer before it was revoked by placing it in the hands of the mail clerk for mailing prior to being informed that American Savings was withdrawing their counteroffer. The trial court found for American Savings and Loan. The Gibbs appealed the decision. It is a basic principle of contract law that an offeror may withdraw an offer to enter into a contract at any time prior to receiving the offeree's acceptance of the offer. In the trial court's proceedings, evidence had been presented that indicated that giving their acceptance to the mail clerk on June 6th did not meet the standard of putting their acceptance "in the course of transmission" to the other party. This was based on the fact that although the
8 CE DIGEST Gibbs' acceptance of the counteroffer had been given to the mail clerk on June 6th, their acceptance was not postmarked until the following day June 7, 1985. Therefore, American Saving's revocation occurred prior to the Gibbs' acceptance. Civil Code Section 1583 provides "consent is deemed to be fully communicated between the parties as soon as the party accepting an offer has put his or her acceptance in the course of transmission to the offeror. This means that the acceptance must be placed out of control of the accepting party in order to be considered "in the course of transmission." In California, an acceptance is deemed to be communicated upon deposit in the mail. In this case, however, the acceptance was given to the mail clerk on June 6th. The postmark of June 7 on the envelope was clearly after the June 6th withdrawal of the American Savings' counteroffer and prior to the Gibbs' acceptance. Based on these facts, the trial court's verdict was upheld by the appeals court. **************************************** GENUINE ASSENT The element of mutual consent is clouded if it is induced by: Fraud Mistake Duress Menace Undue influence If any one of these obstacles is present, the contract is voidable at the option of the injured party. The injured party may seek to have the contract rescinded in which case both parties would be restored to their original positions. Or, the party, who has the option to make the contract void, may sue for dollar damages. FRAUD Fraud exists when a person misrepresents a material fact. A material fact means an important fact which significantly affects the party s decision to enter into the contract. Fraud is either actual or constructive. Actual Fraud: Exists when a person intentionally misrepresents a material fact knowing that it is not true in order to induce the other party to enter into a contract. The Civil Code lists five acts which could be construed as actual fraud. 1. The suggestion, as a fact, of that which is not true, by one who does not believe it to be true; 2. The positive assertion, in a manner not warranted by the information of the person making it, of that which is not true though the person believes it to be true;
CE DIGEST 9 MISTAKES 3. The suppression of that which is true, by one having knowledge or belief of the fact; 4. A promise made without any promise of performing it; or, 5. Any other fact designed to deceive. Another possible obstacle to genuine assent between parties occurs when either one or both of the parties is mistaken as to the subject matter of the contract. A contract in which a mistake is made is void or voidable. Where both parties are mistaken as to the subject matter of the contract, there is no contract. Where the subject matter of the contract has ceased to exist and this fact is not known to either party, there is no contract. DURESS, MENACE, & UNDUE INFLUENCE Sometimes a contract may be rendered voidable because it was entered into under the pressure of duress, menace, or undue influence. All three could cause a person to enter a contract against his or her will. The law allows the person on whom the unlawful pressure has been applied to void the contract at a later date. LAWFUL OBJECT A contract must be legal in its formation and operation. Both its consideration and its object must be lawful. The object refers to what the contract requires the parties to do or not to do. If a contract has a single object and that object is unlawful or is impossible to perform, the contract is void. If there are several distinct objects, the contract is normally valid as to those parts that are lawful. An object is not lawful that is contrary to an express provision of the law or to good morals. In general, the law does not lend its support to either party involved in an unlawful contract. SUFFICIENT CONSIDERATION Every contract requires a sufficient consideration. Consideration is anything of value which induces a person to enter into a contract. Consideration may be: 1) A promise 2) An act, or 3) Money. All consideration is considered to be valuable consideration which means it is something that the parties consider to be of value. The exception to this statement is love and affection which is termed good consideration.
10 CE DIGEST In summary, contracts require certain essential elements to be classified as valid and binding contracts. These elements are: 1) Capable parties; 2) Mutual consent; 3) A lawful object; and, 4) Consideration. Real estate contracts, however, usually require a fifth essential. Real estate contracts generally must be in writing in order to be enforceable. INTERPRETATION OF CONTRACTS The majority of all contracts are properly performed and discharged or executed without legal complications. If contractual disputes occur, the parties themselves, or with the aid of legal counsel, will typically work out an amicable settlement. But the courts remain available for the resolution of conflicts between contracting parties that cannot be settled by the parties. It is helpful, therefore, to understand the rules which guide the courts in their interpretation of contracts. In general, contracts are interpreted to give effect to the mutual intent of the parties at the time the contract was formed. A contract may be explained by reference to the circumstances under which it was made and the subject matter of the contract. However, if the language of the contract is clear and explicit, the language of the contract will govern its interpretation. Under the Statute of Frauds, virtually all real estate contracts must be in writing to be enforceable. Real estate licensees can perform the ultimate in consumer protection service by seeing to it that what is written in a sales contract clearly sets forth the intentions of all parties to the contract. However, when a written contract fails to express the real intention of the parties because of fraud, mistake, or accident the courts will seek to regard such real intention and disregard the written parts of the contract that are in error. A written contract will take precedence over all negotiation either oral or written that took place prior to the forming of the contract. When a contract is partly written and partly printed, written parts control the printed parts. In addition, the parts which are purely original control those which were copies from a form. The modification or alteration of a contract creates a change in the terms and conditions of the contract and requires the mutual assent of the parties to the contract. PAROL EVIDENCE RULE Courts are often asked to interpret the meaning of a contract. This gives rise to the question of whether the courts can consider other evidence that is not set forth in the written contract. The general rule is that oral statements or representations made prior to the forming of a contract which modify the subject matter of a written contract are inadmissible in a court of law.
CE DIGEST 11 This is known as the parol evidence rule. This rule prevents the introduction of prior oral or written agreements which would modify or contradict the written contract drawn up between the parties. Parol evidence may be used, however, to show a later verbal modification of a written contract or to clarify an ambiguity. **************************************************** CASE HISTORY WILSON v. GENTILE (1992) 8 C.A. 4th 759 In this case, a dispute arose as to the proper exercise of a lease option to purchase. The lessor brought an unlawful detainer action and the lessee, in turn, filed an action for declaratory relief and specific performance. The lease option agreement provided that the lessee must exercise the option right personally in writing within thirty (30) days prior to the expiration of this option. The trial court granted summary judgment for the lessee, determining that the lessee properly exercised his option to purchase the leased property seven days before the option period expired. The lessor appealed. However, the Court of Appeals upheld the trial court s decision determining that the lessee exercised the option within the period allowed by the agreement. The court held that in the context of an option to buy, as opposed to an option to renew a lease, the language within 30 days prior to is properly interpreted to allow exercise of the option during the 30-day period immediately preceding the expiration of the option. ********************************************** CLASSIFICATION OF CONTRACTS There are certain terms that are used to classify contracts. A listing of these terms would include: MANNER OF CREATION There are two terms generally used to describe the manner in which a contract is created. A contract may be an express contract. Or, a contract is an implied contract. An express contract is created in words. These words may be placed into writing which sets forth the terms of the agreement between the parties. Or, they may be conveyed in an oral agreement. An implied agreement is one created by the acts and conduct of the parties rather than in words. EXAMPLE: You have a credit account at the local drugstore. You go into the drugstore and select an article that you wish to purchase from the shelf. The
12 CE DIGEST clerk is talking to another customer but you catch her eye and show her the article that you wish to buy. She nods affirmatively. You turn around and exit the store. Was a contract created? Yes! It would be an implied contract even though not one word passed between you and the clerk. CONTENT OF THE CONTRACT The content of the agreement may be bilateral or unilateral. A bilateral contract is one in which the promise of one of the parties is given in exchange for the promise of the other party. EXAMPLE: Able tells Baker, I ll pay you $7,000 if you will promise to remodel both my bathrooms. Baker responds, I promise that I will remodel both your bathrooms for the $7,000 you will pay. In a bilateral contract, both parties promise to do something or refrain from doing something. A unilateral contract, on the other hand, is an agreement between the parties whereby one party promises to do something in exchange for the act of the other party. EXAMPLE: Able s pet dog is lost. Able puts up reward posters saying, I promise to pay a $200 reward to anyone who finds my lost dog. At this point, nobody has actually promised to find the dog and no agreement exists between the parties. However, if someone finds and returns the dog to Abel, has a contract been made? Yes! It is based on the exchange of a promise by one of the parties to do something in exchange for the performance of some act by the other party. It is a unilateral contract. PERFORMANCE In reference to the extent of the performance of a contract, you will find the use of the terms executory and executed to describe a contract. In an executory contract, certain terms and conditions contained in the contract have yet to be performed. In a contract described as executed, all the terms and conditions have been met by both of the parties to the contract. LEGAL EFFECT Contracts may be classified in four ways in terms of the legal effect of the contract: Valid Void Voidable Unenforceable
CE DIGEST 13 A valid contract is one that contains all the legal essentials required to create a legally binding contract. It is a good contract and is binding on both parties to the agreement. It is enforceable by both parties to the agreement. If the conditions required to create a valid contract have been met, any party to the contract may seek help in a court of law should there be a breach in the contract. The injured party may ask the courts to help enforce the contract as created or award money damages as compensation for the breach of the contract. A void contract is a contract that is lacking in one or more of the legal essentials required. A void contract has no legal effect. It is not binding on or enforceable by any of the parties to the contract. A voidable contract is a contract that is valid and enforceable on its face but may be made void by one or all of the parties because of some defect. A contract induced by fraud would be voidable by the injured party. It is however, valid until made void. An unenforceable contract is one in which one or both of the parties cannot be compelled to perform under the terms of the contract. An example would be the lapse of the time limitation required under the Statute of Limitations. Another example would be an oral contract that under the Statute of Frauds is required to be in writing. All void contracts are unenforceable. STATUTE OF FRAUDS The Statute of Frauds is a law that requires certain contracts to be in writing to be enforceable in a court of law. The parties to a contract, which under the Statute of Frauds is required to be in writing, are barred from enforcing their rights if the contract is not in writing. The injured parties may not seek the help of the courts in finding a legal remedy. The Statute of Frauds was first adopted in England in 1677 and became part of the English common law. Subsequently, it was introduced into this country and has been codified in California. The purpose of this law is to prevent perjury, forgery, and dishonest conduct on the part of unscrupulous people in proving the existence and terms of certain important types of contracts. WRITING REQUIRED The statute provides that certain contracts are invalid unless they are in writing and signed by the parties or their agents. Under Section 1624 of the California Civil Code, the contracts that are required to be in writing that pertain to real estate are: An agreement that by its terms is not to be performed within a year of its creation.
14 CE DIGEST An agreement for the leasing for a longer period than one year, or for the sale of real property, or of an interest in real property. An agreement authorizing or employing an agent, broker, or any other person, to purchase or sell real estate, or to lease real estate for a longer period than one year. Or, to procure, introduce, or find a purchaser or seller of real estate or a lessee or lessor of real estate where such lease is for a longer period than one year for compensation or a commission. An agreement which by its terms is not to be performed during the lifetime of the promisor or an agreement to devise or bequeath any property, or to make any provisions for any reason by will. An agreement by a purchaser of real property to pay an indebtedness secured by a mortgage or deed of trust upon the property purchased, unless assumption of the indebtedness by the purchaser is specifically provided for in the conveyance of such property. REMEDIES The Stature of Frauds relates to the remedy only and not to the validity of the contract. A contract, which is required by this statute to be in writing but is not, is not void. It is merely unenforceable. It is an effective contract for all purposes except in the case where the contract is breached. The injured party cannot pursue the help of the courts in seeking a legal remedy. When a contract has been fully performed, the Statute of Frauds no longer applies and may not be called upon by the parties for any reason. The writing required by the law may be in any form. Its main purpose is to provide evidence that a contract exists and that the parties have entered into an agreement. The writing must contain, however, all the material terms of the contract so that a court can determine what the parties agreed. It must provide evidence that the party being charged signed the agreement. REAL ESTATE APPLICATIONS Several of the sections contained in the Statute of Frauds have an important impact on persons dealing in real estate. Practically all contracts of sale or purchase giving any right, title, or interest in real property must be in writing. The words transfer of real estate or of an interest therein include such transactions as: Assignment of a percentage of the proceeds of oil produced from designated lands All instruments creating liens such as trust deeds
CE DIGEST 15 Leases for periods of time of more than one year Rights to rights-of-way through property and any and all encumbrances incurred or suffered by the owners To sum up, the easiest way to remember which real estate contracts fall under the Statute of Frauds is to take the approach that all real estate contracts must be in writing in order to be enforceable. The exception is, of course, a lease for 1 year or less which may be oral and still be enforceable. STATUTE OF LIMITATIONS The Statute of Limitations is a law which establishes certain time limitations in which to bring a legal action for breach of contract. The injured party must start legal proceedings within a certain period of time or the courts will not help the party. This California law sets forth a number of important time frames for real estate. Some of the time periods that real estate licensees should be familiar with are: An oral contract or title insurance claim - 2 years An action for trespass upon real estate - 3 years All rights arising out of a real estate contract - 4 years An action to recover real property such as a quiet title action, adverse possession, or tax sale - 5 years Recovery under a judgment lien - 10 years after it has been recorded PERFORMANCE AND DISCHARGE OF CONTRACTS In the majority of contracts, the contracting parties perform properly according to the terms and conditions of the agreement without legal complications. However, sometimes a transaction can break down despite the best efforts of the principals and their agents. If difficulties do arise, the parties, sometimes with the aid of legal counsel, will attempt to work out an amicable settlement. However, if this fails, the courts are available to resolve the differences between the parties. There are three ways, generally, that a contract may be discharged. They are: Performance Agreement By law
16 CE DIGEST PERFORMANCE Most contracts are discharged by the full performance of the parties. However, a person may wish to withdraw from a contract without terminating it. Under the proper conditions, this may be accomplished through either an assignment or a novation. ASSIGNMENT An assignment is the transfer of a person s rights under a contract to another person. The new party literally steps into the shoes of the original contracting party and assumes that person s rights and responsibilities contained in the provisions of the contract. The effect is that the person making the assignment (assignor) drops out of the contract. The person receiving the assignment (assignee) continues on in meeting the terms and conditions of the agreement. A contract may be assignable depending upon the nature of the terms of the contract. Most unilateral and bilateral contracts are assignable unless the terms of the contract expressly prohibit an assignment. The assignee becomes primarily liable under the contract. The assignor still retains a secondary liability. The following types of contracts may not be assigned: An option in which the consideration is an unsecured promissory note A contract that expressly prohibits an assignment. If this type of contract is assigned, it is voidable by the injured party Personal service contracts such as a listing may not be assigned A deed cannot be assigned NOVATION A party may withdraw from a contract through a novation. A novation is the substitution by agreement of a new obligation for an existing one with the intent of extinguishing the existing contract. The substitution may be a new contract between the same parties or a new party may be involved. A novation requires the intent to discharge the old contract. The new contract must have all the legal essentials required to create a contract including a sufficient consideration. DISCHARGE BY AGREEMENT In the event there is a breach of contract, the injured party may look to the courts for help. The court s remedies include court actions for specific performance, money damages, or liquidated damages.
CE DIGEST 17 However, as a practical matter, the time and cost of pursuing a remedy in a court of law may exceed the benefits to be gained. In addition, the possibility exists that the judge may not agree with the person initiating the lawsuit. In this event, the party suing could end up losing the case in court. For this reason, the injured party may find it more practical and prudent to agree with the other party and simply mutually rescind the contract. When both parties agree to mutually rescind the contract, it has the effect of releasing each other from the contract and restoring each party to their original positions. For the protection of everyone, the agreement to cancel should be in writing and signed by the parties to the original contract. DISCHARGE BY LAW If one of the parties to the contract fails or refuses to perform his or her obligations without legal justification, the contract is breached. A breach of contract by one of the parties gives the other party or parties several potential causes of action. The injured party may make a legal claim in court for one of three possible legal solutions. They are: UNILATERAL RESCISSION - If a breach occurs, the wronged party may seek to unilaterally rescind the contract. However, the suing party must use reasonable diligence to rescind promptly upon discovering the facts that would entitle the party to rescind. In addition, the party seeking to rescind must restore to the other party everything of value received from the other party under the contract. Or, offer to restore same if the other party will do the same. SUE FOR DAMAGES - The victim of a breach of contract has, obviously, been wronged. The courts take the approach that the aggrieved party may be awarded compensation in the form of money for being wronged. This type of compensation is known as damages. SPECIFIC PERFORMANCE - If dollar damages would not provide an adequate remedy, the courts may order the performance of the original contract on its terms and conditions. This type of action may be sought by either party when the non-breaching party still wishes to proceed with the sale or purchase. Specific performance is especially important in the real estate business in connection with contracts for the transfer of interests in land. Since every piece of land is unique, the law presumes that the breach of an agreement to transfer real property cannot be compensated adequately by the payment of money damages. For specific performance to be available as a remedy, however, certain other requirements must be met before the court will order a person to perform a contract. These requirements are: The consideration in the contract must be adequate. The contract must be just and reasonable as to the party against whom it is being enforced.
18 CE DIGEST The contract must be sufficiently certain or definite. The legal remedy must be inadequate The performance ordered by the court must be substantially the same as that called for in the contract. FORFEITURES Contracts often contain a provision "liquidating" or setting the damages a nonbreaching party will receive in the event of a contract breach by the other party. The purpose of these provisions is to provide a fixed or, at least, easily determined amount of damages if a default occurs. In this day of expensive and time-consuming litigation, this is important because it presets the amount of damages to be awarded in the case of a forfeiture. The provision in the contract that achieves this objective is known as a "Liquidated Damages" clause. If the contract is for the purchase and sale of residential real property, of not more than four units and the buyer/owner intends to occupy one of the units, the following rules apply: These special rules apply only to amounts actually prepaid, in the form of deposit, down payment or otherwise. If the amount paid in accordance to the liquidated damages clause does not exceed three (3) percent of the purchase price, the clause is valid unless the buyer proves that the amount paid is unreasonable. If the amount actually paid in accordance with the liquidated damages clause exceeds three (3) percent of the purchase price, the clause is invalid unless the party seeking to enforce it proves that the amount paid is reasonable. The provision must be separately signed or initialed by each party to the contract, and if it is a printed contract, the provision must be set off in ten (10) point bold-type or contrasting red print in eight (8) point type. CONTRACT PREPARATION REAL ESTATE CONTRACTS Real estate contracts provide the foundation for the agreements reached by the parties in a real estate transaction. The two major contracts that all licensees need to be thoroughly familiar with are the listing agreement and the purchase agreement. It is imperative in reducing the risks involved in a typical real estate transaction that real estate licensees fully understand these forms and be well trained in their usage.
CE DIGEST 19 Real estate contracts adhere to the same essentials as contract law in general. They follow the same requirements for contract formation, enforceability, and rules applicable to contract interpretation. These essentials include: 1) Parties capable of contracting 2) Mutual consent 3) A lawful object and 4) Sufficient consideration. In the case of real estate contracts, however, a fifth requirement is that they be in writing in order to be enforceable in a court of law. A real estate agent should make it a practice to use the approved preprinted standard listing contracts and purchase agreements fill-in forms offered through state boards and associations. The use of this type of form acts as a risk reducer to avoid the possibility of a misunderstanding by one or both of the parties in the transaction. The preprinted forms have been prepared by legal experts and state the items that need to be in a contract to fully "legally package" the transaction. **************************************************** CASE HISTORY FRANKLIN v. HANSEN 1963 59 C. 2d 570 Hansen owned residential property in Newport Beach. Franklin had acted as an agent for Hansen in the rental of Hansen s property and had informed Hansen that he would like to represent Hansen as his agent in the sale of Hansen s property. A sale price of $115,000 was agreed upon. Over the period of the next few months, several offers were received. However, all the offers were for less than $115,000. Hansen eventually agreed that he would accept an offer of $100,000. At this point, no written agreement existed between Hansen and Franklin on the sale of the property. Hansen had assured Franklin that a signed listing was unnecessary as his word was good. A short while later Franklin received an offer for $100,000. Franklin telephoned the seller and requested Hansen to send him a telegram authorizing him to sell the property. Hansen complied and sent a telegram confirming he would sell the property for $100,000. Franklin proceeded with the sale and then called Hansen again to tell him that the property had been sold and that he had accepted a check for $5,000 as a down payment. Hansen stated he was pleasantly surprised and consented to the suggested escrow agent. However, when a standard form deposit receipt providing for payment of a 5% commission to Franklin was presented, Hansen refused to sign it and indicated he wished to get out of the deal. At a meeting between Franklin, Hansen, and the buyers of the property, the buyers refused to waive their rights under the agreement. Hansen admitted he was stuck with the deal and that Franklin would receive his commission. Subsequently, however, Hansen refused to sign any of the documents necessary to complete the sale of the property and also refused to pay the agreed upon commission. Franklin sued for his $5,000 commission citing Hansen s promise to abide by the verbal listing of the property and the telegram in confirmation thereof. Hansen relied on the statute of frauds as his main defense. However, the trial court, after taking into account all the transactions between the parties, awarded a judgment to Franklin.
20 CE DIGEST Hansen appealed contending that neither the telegram nor any other writing constituted a sufficient memorandum or ratification of a contract of employment to satisfy the statute of frauds. The appeals court ruled in favor of the appellant, Hansen, and reversed the trial court s decision. The appeals court based its decision on its finding that a written agreement must specify that it is a contract of employment. Hansen s telegram to Franklin confirming that he would sell the property contained no reference to the fact that Hansen was employing Franklin or to any representation that he would pay a commission. If Hansen s telegram had stated that Hansen was employing Franklin to sell the property, a payment of a commission would have been inferred. The court held that a listing agreement must unequivocally show the fact of employment of the broker seeking to recover a real estate commission. The appeals court concluded that in Franklin v. Hansen, the telegram failed to use any words in recognition of a contractual obligation and, therefore, was insufficient under the statute of frauds to support Franklin s claim for a commission. ********************************************************** INSURING MARKETABLE TITLE It is especially important in the transfer of real property that a marketable title is conveyed. Lenders and buyers would be very reluctant to commit their funds to real estate transaction unless they have assurances that the title to the subject property was merchantable. Buyers want to know that there are no hidden interests in the real property they are proposing to buy. A title is merchantable if there are reasonable assurances as to the rights of the parties involved in the transaction. A grant deed conveys two implicit promises with the transfer of title. When the word "grant" is used in a deed, the seller is warranting that: (1) He or she has not already conveyed the title to somebody else, and (2) That the title is free and clear of any encumbrances such as taxes, assessments, and any other liens other than the ones that are being disclosed to the buyer. These warranties usually do not appear on the face of the deed. The word "grant" carries with it these two implied warranties. COMMON AREAS OF RISK IN REAL ESTATE CONTRACTS The preponderance of lawsuits filed in real estate transactions stem from misrepresentations, negligence, and non-disclosures. The best proactive risk control steps that can be taken to reduce the potential for this type of lawsuit is to do the right thing, in the right way, and at the right time. The best way to accomplish this feat is to make sure you fully document your activities, conversations, and recommendations and disclose what you know or discover about a property that your client is interested in buying or selling. Simply said, this means "When in doubt, disclose it - and put it in writing"!
CE DIGEST 21 SCOPE OF AGENT'S DUTIES AND LIABILITIES The listing contract is generally the written agreement between the seller and real estate broker that creates an agency relationship. It is an express agency. The agent holding the listing is bound by the rules of law applying to the agency relationship and owes certain obligations to the principal. A real estate licensee, who is performing his or her services under a written listing contract, has two sets of responsibilities. There are the responsibilities and legal obligations set forth in the terms and provisions of the listing contract. And, there are the fiduciary responsibilities created by the agency relationship established as a result of the written listing agreement. If the listing contract is unenforceable, the broker cannot be held liable for failing to fulfill the broker s contractual obligations. However, even if the contract is unenforceable, the broker may be held liable for a failure to meet his or her fiduciary duties imposed by the agency relationship. The listing agreement clearly spells out the scope and the limits of the agent's duties and responsibilities in the handling of the transaction. A sure way to reduce the risks in any transaction is to make sure that all licensees are thoroughly familiar with what is written on the listing agreement. And, that they clearly understand what duties they are required to do as well as what is beyond the scope of their agency and, therefore, that they are not legally required to do. No liability is incurred by the principal for acts of an agent that are beyond the scope of the agent s actual or ostensible authority. A third party, who deals with an agent and knows of the agency, is under a duty to determine its scope. If the agent acts beyond the agent s actual authority and the conduct of the principal has not been such as to give the agent ostensible authority to do the act, the third party cannot hold the principal liable. It is a good idea to remember that the listing agreement must be in writing if the agent expects to receive a commission. An oral agreement to buy or sell real estate can be valid, but it is not enforceable in a court of law. All licensee's should be aware of California Civil Code Section 1624 (a) (4). SECTION 1624 (a) The following contracts are invalid, unless they, or some sort of memorandum thereof, are in writing and subscribed by the party to be charged or by the party's agent. (4) An agreement authorizing or employing an agent, broker, or any other person to purchase or sell real estate or to lease real estate for a longer period than one year, or to procure, introduce, or find a purchaser or seller of real estate or a lessee or lessor of real estate where the lease is for a longer period than one year, for compensation or commission. Most real estate licensees operate as "special agents" in pursuing their real estate activities. A special agent is one who has been employed to do a specific thing such as finding a buyer for a particular property that a seller is interested in selling. Therefore, his