Types of Real Estate Contracts - protrain.hs.llnwd.net (Req Read) P1.pdf · Types of Real Estate Contracts In addition to understanding the basic principles of contract law, real

LP-10 Required Reading Part One

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Types of Real Estate Contracts

In addit ion to understanding the basic pr inciples of contract law, real

estate agents must be famil iar with the specif ic types of real estate

contracts. This chapter descr ibes several types of contracts related to real

estate, including l ist ing agreements, purchase agreements, land contracts,

leases, and opt ions.

Listing Agreements

A l isting agreement is a wr it ten employment contract between a property

sel ler and a real estate broker. (A copy of the Pennsylvania Associat ion of

REALTORS residential l ist ing agreement form is shown in Figure 8.1.) The

sel ler hires the broker to f ind a buyer who is ready, wil l ing, and able to buy

the property on the sel ler ’s terms. A l ist ing agreement does not give the

broker the author ity to accept of fers on behalf of the seller, or to transfer

t i t le to the sel ler’s property.

Even though the l ist ing agreement form is f requently f i l led out and signed

by a salesperson working for the l ist ing broker, the contract is between the

sel ler and the broker (not the salesperson). Some states require the broker

to sign the contract as wel l.

Typically, a real estate broker is paid by commission, also cal led a

brokerage fee . The commission is usual ly computed as a percentage

of the sales pr ice (the price that the property is sold for), as opposed to the

l ist ing price.

In most states, a broker cannot sue a sel ler to col lect a commission

unless there was a writ ten l ist ing agreement. There wi l l be condit ions set

forth in the l ist ing agreement that also must be met before the sel ler is

obl igated to pay the broker a commission.

Some states have a specif ic rule that l ist ing agreements must always be

in wr it ing. In other states, an oral l ist ing agreement can exist in theory, but

i t won’t be enforceable in court because of the statute of f rauds. A few


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states recognize oral l ist ing agreements i f they are for a period of less than

one year. Note that an oral agreement between brokers to split a

commission may be enforceable, even when an oral l ist ing agreement is no t.

Earning a Commission

A l ist ing agreement can make payment of the broker’s commission

dependent on any lawful condit ions that are mutual ly acceptable to the

broker and the sel ler . For example, the sel ler might ask to include a “no

sale, no commission” p rovis ion in the agreement. This would make the

broker’s commission payable only if the transact ion actually c loses and the

sel ler receives full payment f rom the buyer. If this condit ion is not met due

to circumstances beyond the sel ler ’s control ( for examp le, because the

buyer couldn’t obtain f inancing), the commission need not be paid. On the

other hand, if the condit ion is not met because of the sel ler ’s bad faith or

f raud, the broker is st i l l ent it led to the commission.

Unless otherwise agreed, however, certain standard rules are followed

regarding payment of the broker’s commission. These include the rules

concerning a ready, wi l l ing, and able buyer; and those concerning the three

types of l ist ings.

Ready, Will ing, and Able Buyer . As a general rule, a l ist ing agreement

obl igates the sel ler to pay the l ist ing broker a commission only if a ready,

will ing, and able buyer is found dur ing the l ist ing period.

Acceptable Offer. A buyer is considered “ready and wil l ing” if he makes

an offer that meets the selle r ’s stated terms. In the l ist ing agreement, the

sel ler sets forth the terms on which she wants to sell the property: pr ice,

closing date, f inancing arrangements, etc. If a buyer makes an offer that

matches those terms, the broker is usual ly entit led to the commission—even

if the seller decides not to accept that offer af ter all.


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When a buyer makes an offer on terms other than those set forth in the

l ist ing agreement, the sel ler can turn down the offer without becoming l iable

for the broker’s commission. But if the sel ler accepts an offer, he general ly

is required to pay the broker’s commission even if the offer did not match

the terms set forth in the l ist ing agreement.

Able to Buy. A ready and wil l ing buyer is considered “able” i f s he has the

capacity to contract and the f inancial abi l i ty to complete the purchase. The

buyer must have enough cash to buy the prop erty on the agreed terms, or

else be eligible for the necessary f inancing.

Commission Without Closing. In most states, once a ready, wi l l ing, and

able buyer has been found, the broker has earned the commission, whether

or not the sale is ever completed. When failure to close is the sel ler ’s fault ,

the broker is st i l l ent it led to the commission (although the broker might

decide not to demand payment). For example, once the sel ler accepts an

offer, he st i l l owes the broker a commission if the sale fai ls to close for any

of these reasons:

the sel ler has a change of heart and decides not to sel l;

the sel ler does not have marketable t it le;

the sel ler is unable to del iver possession of the property to the

buyer; or

the sel ler and the buyer mutual ly agree to terminate their contract.

Unless specif ical ly required by the l ist ing agreement, it may not even be

necessary for the buyer and sel ler to execute a wr it ten purchase agreement

in order for the broker to be entit led to a commission. I t can be enough if the

buyer and seller have reached an agreement as to the essential terms of the

sale: the price, downpayment, loan term, interest rate, and amort izat ion. I f

the sel ler backs out before the agreement is put into wr it ing, the broker

could st i l l claim the commission.

Sometimes the seller and the broker disagree as to whether the buyer

located by the broker was in fact ready, wi l l ing, and able. A court wi l l


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normally presume that the buyer was ready, wi l l ing, and able if a wr it ten

purchase agreement was signed. On the other hand, if no contract has been

signed and the agreement between the buyer and the seller is st i l l at the

unwrit ten stage when it falls through, the broker is not ent it led to a

commission unless he can prove that the buyer was f inancial ly able to

perform the contract.

A few states fol low a rule that the sale of the property must actual ly c lose

before the broker is entit led to a commission.

Types of Listing Agreements. The circumstances under which a sel ler is

required to pay a broker’s commission also depend on the type of l ist ing

agreement they have. The three basic types of l ist ing agreements currently

used are:

the open l ist ing,

the exclusive agency l ist ing, and

the exclusive r ight to sel l l ist ing.

Open Listing. Under an open l ist ing agreement, the seller is obl igated to

pay the broker a commission only if the broker was the procuring cause of

the sale. The procur ing cause is the person who was primar ily responsible

for bringing about the agreement between the part ies. To be the procur ing

cause, a broker (or one of his salespersons) must have personal ly

negotiated the of fer f rom the ready, wil l ing, and able buyer and

communicated the offer to the seller.

An open l ist ing is also cal led a nonexclusive l ist ing, because a sel ler is

f ree to give open l ist ings to any number of brokers. If a seller signs two

open l ist ing agreements with two dif ferent brokers, and one of the brok ers

sel ls the property, only the broker who made the sale is entit led to a

commission. The other broker is not compensated for his efforts. Or if the

sel ler sel ls the property direct ly, without the help of either broker, then the

sel ler does not have to pay any commission at al l. The sale of the property

terminates al l outstanding l ist ings.


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The open l ist ing arrangement has obvious disadvantages. I f two

competing brokers both negotiate with the person who ends up buying the

property, there may be a dispute over which broker was the procuring cause

of the sale. Also, because a broker with an open l ist ing agreement is not

assured of a commission when the property sel ls, he may not put as much

effort into marketing the property, so it may take longer to sel l. For the most

part, open l ist ing agreements are used only when a sel ler is unwil l ing to

execute an exclusive l ist ing agreement. Mult iple l ist ing services generally do

not accept open l ist ings.

Exclusive Agency Listing. In an exclusive agency l ist ing, the se l ler

agrees to l ist with only one broker, but retains the r ight to sel l the property

himself without being obligated to pay the broker a commission. The broker

is ent it led to a commission if anyone other than the seller f inds a buyer for

the property, but not if the seller f inds the buyer without the help of

an agent.

Exclusive Right to Sell Listing. Under an exclusive r ight to sel l l ist ing,

the sel ler agrees to l ist with only one broker, and that broker is ent it led to a

commission if the property sells dur ing the l ist ing term, regardless of who

f inds the buyer. Even if the sel ler makes the sale direct ly, the broker is st i l l

ent it led to the commission.

In spite of the designation “exclusive r ight to sel l,” remember that this

type of l ist ing agreement does not actual ly authorize the broker to sel l the

property. As with the other types of l ist ings, the broker is authorized only to

submit of fers to purchase to the sel ler.

The exclusive r ight to sel l l ist ing is preferred by most brokers, because it

provides the most protect ion for the broker. I t ’s the type of l ist ing that is

most commonly used.

Exclusive vs. Open Listings. Exclusive l ist ings have some important

dif ferences f rom open l ist ings. Because an exclusive l ist ing agreement

prevents the seller f rom working with other brokers, it is important to know

how long the agreement wi l l last. Many states require l ist ing agreements to


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include a specif ic terminat ion date. In states that do not require this, if the

l ist ing agreement does not have a termination dat e, the law may al low the

sel ler to terminate the agreement at any t ime, or the agreement may expire

af ter a reasonable t ime has passed. To avoid this uncertainty, an exclusive

l ist ing should always include a date on which the l ist ing agreement

wi l l terminate.

There is also a dist inct ion between open and exclusive l ist ings

concerning the broker’s contractual obligat ions. An open l ist ing is

considered a uni lateral contract: the sel ler promises to pay the broker a

commission if the broker f inds a buyer, but the broker does not promise to

make any ef fort to do so. I f the broker does nothing at al l, i t is not a breach

of contract.

On the other hand, an exclusive l ist ing is considered a bilateral contract.

In most exclusive l ist ings, in exchange for the sel ler ’s promise to pay a

commission no matter who f inds a buyer (or if any agent f inds a buyer), the

broker promises to exercise due di l igence and make a reasonable effort to

f ind a buyer.

Buyer Representation Agreements. On the other side of a real estate

transaction, buyers are of ten represented by their own real estate agents. A

buyer representat ion agreement between a broker and a prospective buyer

is essential ly the counterpart to a l ist ing agreement between the seller and

the sel ler ’s broker. Unlike a l ist ing agreement with the sel ler , however, the

contract usual ly does not relate to a specif ic piece of property. The

important elements of a buyer representat ion agreement primarily involve

general agency law and wil l be discussed in Chapter 9.

Elements of a Listing Agreement

A l ist ing agreement must have all of the essent ial elements of a val id

contract that were discussed in the previous chapter, including competent

part ies, of fer and acceptance, considerat ion, and a lawful purpose. Also, a

l ist ing agreement usual ly must be in wr it ing and must be signed by the


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sel ler. The broker may also sign the l ist ing agreement (although her

signature is not required in many states). The broker gives implied consent

to the terms of the agreement by start ing to market th e property.

I f there is no wr it ten l ist ing agreement, the broker wi l l have dif f iculty

suing the sel ler for a commission, even though an oral agreement may have

established an agency relat ionship between the broker and the seller (see

Chapter 9).

At a minimum, a l ist ing agreement should include provisions that:

identify the property,

set acceptable terms of sale,

grant the broker authority, and

determine the broker ’s compensat ion.

As mentioned ear lier, some states also require the l ist ing agreement to

include a termination date. In general, i t is always a good idea to indicate

when the l ist ing wi l l terminate.

Property Description. A l ist ing agreement must ident ify the sel ler ’s

property. The street address is useful, but it may not be enough to ident ify

the property with certainty. I t ’s a good idea to attach a legal descr ipt ion of

the property to the l ist ing agreement as an exhibit . Any pages attached to a

contract should be dated and init ia led by the part ies, to show that the

attachments are intended to be part of the agreement.

Terms of Sale. A l ist ing agreement should specify what the sel ler wants in

the way of an offer. This includes how much money the seller wants for the

property (the l ist ing price) and any other terms of sale that matter to the

sel ler. Any items that the sel ler wants to exclude from or include in the sale

that would not otherwise be excluded or included should also be noted in the

l ist ing agreement.

As we explained ear l ier, the sel ler can reject any of fer that doesn’t meet

the terms of sale described in the l ist ing agreement, without becoming l iable


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for a commission. However, if an offer is made that does meet those terms,

and the sel ler rejects the offer, the broker may be ent it led to a commission.

Thus, it is very important for all of the essential terms of sale to be set forth

clearly and fully in the l ist ing agreement.

Broker’s Authority . The list ing agreement sets forth the broker’s authority

to f ind a buyer for the property. The broker is usual ly also given the

author ity to accept and hold good faith deposits on the sel ler’s behalf . In the

rare case where a broke is not given authority to accept deposits for the

sel ler and the prospective buyer gives the broker a deposit , then the broker

is act ing as an agent for the buyer in regard to the deposit . In this case, the

sel ler would not be l iable to the buyer if the broker were to lose or

misappropr iate the deposit .

Commission. A provision stat ing the rate or amount of the broker’s

commission is another key part of every l ist ing agreement. The commission

is usually computed as a percentage of the sales pr ice. The commission rate

or amount must be negotiable between the sel ler and the broker. In fact, i t is

a violat ion of state and federal antitrust laws for brokers to set uniform

commission rates. Any discussion of commission rates among members of

competing f irms could give r ise to a charge of price f ixing (see Chapter 10).

Some states have addit ional regulat ions to prevent pr ice f ixing. For

example, they may require that the l ist ing agreement contain a statement

informing the sel ler that commission rates must be negotiable. In general,

the commission rate or amount should never be pre-pr inted on the l ist ing

agreement form. Instead, the commission should be f i l led in separately for

each transaction.

Sometimes the amount of the broker’s commission is not based on a

percentage of the sales pr ice. Instead, the sel ler st ipulates the net amount

of money she requires f rom the sale of the property. The broker then tr ies to

sel l the property for more than that net amount. When the property is sold,

the sel ler receives the required net and the broker keeps any money in


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excess of that amount as the commission. This is referred to as a

net l isting .

Example: The sel ler insists on gett ing $345,000 from the sale of

her property. The broker sells the property for $378,000. $378,000

less the required $345,000 net equals $33,000. Thus, the broker’s

commission is $33,000. I f the broker had sold the property for

more, his commission would have been more. Likewise, if the

broker had sold the property for less, his commission would have

been less.

Net l ist ings are i l legal in many states. Even in those states where net

l ist ings are legal, they are generally f rowned upon; an unscrupulous broker

could easi ly use a net l ist ing to take advantage of a seller. States that al low

net l ist ings may have addit ional restr ict ions on them to guard against the

potent ial for abuse.

Payment. A broker’s commission is typical ly paid with a check (usually

f rom the proceeds of the sale at closing), but if the seller and the broker

agree, the commission payment can take other forms. For instance, it may

be in the form of a promissory note, an assignment of an exist ing promissory

note, or an assignment of funds f rom the buyer to the sel ler.

Ordinar ily, the commission is the only compensat ion the broker receives.

The broker does not present the sel ler with a bi l l for expens es incurred in

sel l ing the property, unless the sel ler specif ically agreed to this arrangement

in the l ist ing agreement.

Safety Clauses. A safety clause (also called an extender clause,

protect ion clause, or protect ion per iod clause) is found in most l ist ing

agreements. Under this type of provision, the broker is ent it led to a

commission if the seller sells the property af ter the l ist ing term expires to

any person the broker negotiated with during the l ist ing term. This protects

the broker f rom part ies who conspire to deprive the broker of a

commission by wait ing unti l the l ist ing has expired before they sign a

purchase agreement.


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The broker usual ly has to provide the sel ler with a l ist of the part ies she

negotiated with. That way, the seller wil l know to whom he can sel l the

property without becoming l iable for a commission. Some states require the

broker to provide this l ist to the seller within a certain t imeframe. For

example, the broker might be required to provide the l ist before the l ist ing

terminates, or within 72 hours af ter the terminat ion date. This deadl ine

should be included in the safety clause.

Termination Date. A l ist ing agreement should include a termination date —

the date on which the l ist ing wi l l expire and the broker’s authority to act on

the sel ler ’s behalf will end. This is especial ly important for an exclusive

l ist ing, because the sel ler is not f ree to work with a dif ferent broker unti l

af ter the l ist ing expires. As was mentioned earl ier, the law in many states

requires l ist ing agreements to have a def inite termination date. This may

apply to all l ist ing agreements, or specif ical ly to excl usive l ist ings. Some

states also impose a maximum l imit on the length of the l ist ing period, such

as 90 days.

Distressed Property Listings. As a result of the recent mortgage

foreclosure cr is is, a number of states have passed distressed property laws

that are intended to protect homeowners f rom foreclosure scams. Under

these laws, someone who part ic ipates in a transact ion with a distressed

property owner (the owner of a home in foreclosure or in imminent danger of

foreclosure) may be required to use specia l forms, make certain disclosures,

and follow other rules. In some states that have distressed property laws,

real estate l icensees are subject to these addit ional requirements.

Purchase Agreements

When a sel ler accepts a buyer ’s of fer to purchase the pr operty, they

enter into a purchase agreement. This agreement is a wr it ten contract

between the buyer and seller that establ ishes al l of the terms of the sale.

The contract between the buyer and the sel ler is known by dif ferent

names in var ious parts of the country. I t may be called a purchase


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agreement, a contract of purchase and sale, an earnest money agreement, a

deposit receipt, or an offer to purchase.

In most transactions, the buyer presents a writ ten, s igned of fer to the

sel ler along with a good fa ith deposit . I f the seller chooses to accept the

offer, he signs the form, and the form then becomes the binding contract

of sale.

The statute of f rauds requires an agreement to buy and sell real property

to be in

wr it ing. A copy of the Arizona Associa t ion of REALTORS residential

purchase agreement form is shown in Figure 8.2.

The basic provisions of a purchase agreement are fair ly s imple.

The purchase agreement:

identif ies the part ies,

descr ibes the property,

sets forth the price and method of payme nt, and

sets the date for closing the transaction (when t it le and possession

are transferred).

However, most purchase agreements are quite detai led. I t ’s important for

the purchase agreement to state al l of the terms of the transaction clear ly

and accurately. Who is required to do what and when depends on the terms

of the purchase agreement.

Typical Provisions

A purchase agreement form typically includes the fol lowing types of

provisions.

Identification of the Parties. The buyer(s) and seller(s) must be proper ly

identif ied in the agreement. Everyone who has an ownership interest in the

property must sign the contract, and each party must have the capacity to

enter into a contract. Note that if the sel ler is married, laws regarding


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marital property may require that the seller’s spouse sign the purchase

agreement for it to be enforceable. I t is always best to have both spouses

sign the contract, to secure the buyer ’s t i t le to the property.

Description of the Property. The purchase agreement must descr ibe the

property with certainty. As with the l ist ing agreement, a full legal descr ipt ion

of the property is not always required. Even so, it is st i l l a good pract ice to

include the legal descript ion. I f i t is too long to f it in the blanks on the form,

a copy of the legal descript ion should be init ialed by the part ies and

attached to the purchase agreement as an exhibit .

Terms of Sale. The purchase agreement should set forth as clearly as

possible al l of the terms of the sale, such as the total sales pr ice, the

amount of the downpayment, the method of payment, and what items are

included in or excluded from the sale.

The method of payment should be set forth in detai l; the purchase

agreement form may include a pre-pr inted checkl ist of the most common

types of f inancing arrangements. But regardless of the form used, al l of the

f inancing arrangements should be fully described, including the type of loan,

the principal amount, the interest rate, how the loan is amort ized, the term

of the loan, and the monthly payments. (Types of f inancing programs are

discussed in Chapter 12.)

Conditions of Sale. Most purchase agreements are condit ional. For

example, it is common to condit ion a sale on the buyer’s abi l i ty to obtain the

necessary f inancing. If the buyer is unable to obtain the f inancing af ter

making a good faith effort to do so, she does not have to go through with the

purchase, and does not have to forfeit the deposit .

Any and all condit ions must be clearly stated in the purchase agreement.

A provision that sets forth a condit ion is cal led a contingency clause . A

contingency clause should state exactly what must occur to fulf i l l the

condit ion, and it should explain how one party is to notify the other when the

condit ion has been fulf i l led or waived. There should also be a t ime l imit

placed on the condit ion (for example, if the condit ion is not ful f i l led by


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January 15, the contract is void). Final ly, the contingency clause should

explain the part ies’ r ights if the condit ion is not met or waived.

Condition of the Property. A purchase agreement may include a var iety of

provisions concerning the condit ion of the property. The sel ler may warrant

the condit ion of certain elements (such as the roof , plumbing, or appl iances)

or else may sel l the property “as is.” Note that in most states, even if the

property is sold “as is,” the sel ler is st i l l subject to state laws that require

disclosure of material facts concerning the condit ion of the property. Some

of these disclosures may be included in the purchase agreement, or they

may be part of a separate document.

Conveyance and Tit le. The purchase agreement should specify the type of

deed that wi l l be used to convey t it le to the buyer. Furthermore, t it le is

required to be marketable, meaning that the property is f ree f rom

undisclosed l iens and encumbrances. In addit ion to the sel ler ’s assurances,

most buyers wi l l want the addit ional protect ion of a t it le insurance pol icy.

Which party pays for t it le insurance normally depends on local custom, and

this should also be specif ied in the purchase agreement.

Escrow and Closing. I t ’s a good idea for a purchase agreement to include

the arrangements for escrow and closing. At the very least, the agreement

should set the closing date for the transaction. Both part ies must agree to

the ident ity of the escrow agent; one party can’t choose the escrow agent

without the other’s consent.

Date of Possession. Possession of the property is usual ly transferred to the

buyer on the closing date, but other arrangements can be made in the

purchase agreement. If possession wi l l be transferred either before or af ter

closing, the part ies should execute a separate rental agreement, sometimes

cal led an interim occupancy agreement .

The Uniform Vendor and Purchaser Risk Act, a law that has been adopted

in many states, determines who suf fers the loss when property subject to a

sales contract is damaged or destroyed. This law provides that unti l

possession of the property is transferred to the buyer, the r isk of loss is the


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sel ler ’s. For instance, if a house is destroyed by an earthquake the day

before possession is transferred to the buyer, the seller bears the loss.

Once possession is t ransferred to the buyer, however, the r isk of loss is the

buyer ’s. The part ies may choose to apport ion the r isk of loss dif ferent ly by

including a risk clause in the purchase agreement.

Time is of the Essence. Many purchase agreements contain a clause

stat ing that “t ime is of the essence” (see Chapter 7). This clause indicates

that failure to meet any of the deadl ines set in the agreement constitutes a

breach of contract.

Good Faith Deposit . A purchase agreement normally requires the buyer to

make a good faith deposit (sometimes cal led an earnest money deposit) at

the t ime of the agreement, to show that the buyer is ser ious about goi ng

through with the transaction. Although the deposit is not required for a val id

contract (the sel ler’s promise to sel l and the buyer ’s promise to buy are

suff icient considerat ion), a good faith deposit is almost always part of a real

estate transaction. I f the agent holds the good faith deposit on the seller’s

behalf instead of passing the deposit direct ly to an escrow agent, the

purchase agreement serves as the buyer ’s receipt for the good faith deposit ;

this is why you may hear the purchase agreement a lso referred to as a

deposit receipt.

The appropr iate amount for a good faith deposit var ies according to local

custom; it can be any amount that both part ies agree on. I f the buyer goes

through with the transaction, the deposit is ordinari ly applied to t he

purchase price.

The purchase agreement should explain the circumstances in which the

deposit wi l l be refunded to the buyer or forfeited to the seller. In many

cases, the deposit is treated as l iquidated damages (see Chapter 7). Some

states have laws establ ishing addit ional condit ions that must be met before

the deposit can serve as l iquidated damages. For example, the part ies may

need to init ial a l iquidated damages provision in the contract, and the


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amount of the deposit that can be treated as l iquida ted damages may be

l imited to a certain percentage of the purchase pr ice.

The form of the deposit should be stated in the contract. A personal

check is the most common, but another form of payment—such as a

promissory note—may be used. The form of the deposit should be disclosed

to the sel ler before he accepts the offer.

Broker’s Compensation . Many purchase agreements also provide for the

payment of the broker’s commission. In most cases, this provision is merely

a reaff irmation of the commission agreement set forth in the l ist ing

agreement. But if the broker has r isked working under an oral or impl ied

l ist ing agreement, such a provision in the purchase agreement wi l l qualify as

a “writ ten agreement,” in case the broker needs to sue the sel ler for

the commission.

Binder

In some areas of the United States, the agent or broker does not prepare

the purchase agreement. Instead, a shorter document known as a binder is

used as the basis for the offer and acceptance. A binder states the essential

terms of the agreement, such as the purchase pr ice and the amount of the

down payment. Binders are common in the northeastern United States.

The binder is designed to function as a contract between the part ies for

only a short t ime. The full purchase agreement is normally draf ted by an

attorney af ter the binder has been signed. This agreement replaces the

binder as the contract for the sale of the property.

Amendments

Af ter the buyer and sel ler have signed the purchase agreement, the terms

of the contract can be modif ied only in wr it ing. Oral changes are not legally

binding. Sometimes, changes are just wr it ten into the original contract and

signed by the part ies. However, i t ’s much safer to use an amendment form to


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make changes. Al l the part ies who signed the original agreement must also

sign the amendment, or it wi l l be unenforceable.

Don’t confuse an amendment with an addendum. An amendment is a

wr it ten modif icat ion that occurs af ter the part ies have signed the purchase

agreement. An addendum, on the other hand, is an attachment added to the

agreement prior to signature. The addendum contains terms that are not

contained in the basic purchase agreement; the agreement wi l l refer to and

incorporate the contents of the addendum at some point.

A rider is another term for a document that is added to a contract.

Depending on how it is used, a r ider may be either an amendment or an

addendum. It is important to be clear as to whether the or iginal agreement

incorporates the addit ional document by reference, or whether the document

is supposed to modify an already exist ing agreement.

Escrow Agreements

Af ter the buyer and sel ler have agreed on the sale of a property, the

transaction needs to close. This wil l usual ly involve an addit ional contract

known as an escrow agreement or escrow instruct ions. The escrow agent

may have separate contracts with the buyer and the sel ler or a single

contract with both of them, depending on local custom. The escrow

agreement is based on the purchase agreement; the purpose of the escrow

agreement is to provide instruct ions so that the terms of the purchase

agreement are properly carr ied out. Escrow and the closing process are

discussed in Chapter 14.


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Land Contracts

What we’l l refer to as a land contract is also known by a number of other

names: real estate contract, real property sales contract, condit ional sales

contract, instal lment sales contract, or contract for deed. Under a land

contract, a buyer purchases property on an instal lment basis, rather than

paying the sel ler the full purchase pr ice al l at once. The buyer takes

possession of the property immediately, but the seller does not convey t it le

to the buyer unti l the full pr ice has been paid.

The part ies to a land contract are usually referred to as the vendor

(sel ler) and the vendee (buyer). The following example i l lustrates how a

land contract works.

Example: Bender agrees to buy Jones’s farm for $500,000, to be

paid at the rate of $50,000 per year, plus 9% interest, for ten

years. Jones (the vendor) allows Bender (the vendee) to take

possession of the farm, and she promises to convey t it le to Bender

when he has paid the full purchase pr ice. Bender and Jones have

entered into a land contract.

During the period in which the vendee is making payments on the

contract, the vendor retains legal tit le to the property. The vendor does not

del iver the deed to the vendee unti l the ful l purchase pr ice has been paid. In

the meantime, the vendee is said to have equitable title to the property.

Equitable t it le is essential ly the r ight to possess and enjoy the property

while paying off the purchase price.

Rights and Responsibilities of the Parties

Both the vendor and the vendee have var ious r ights and responsibi l i t ies

under a land contract. The vendor retains legal t i t le to the property and has

the r ight to t ransfer or encumber the property without the vendee’s consent.

I f legal t i t le is transferred, the new owner takes t it le subject to the r ights of

the vendee under the land contract.


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I f the vendor allows l iens to be placed on the property, the vendee may

end up paying the full contract pr ice only to f ind that the property is totally

encumbered. Usual ly, the vendee avoids this problem by having the

contract recorded, which places prospective l ienholders on notice of the land

contract. In many states, this wi l l protect the vendee’s interest in the

property against future encumbrances. The vendee could also insist on a

provision in the contract that requires the vendor to maintain marketable t it le

to the property.

The vendee is entit led to possession and use of the property; his main

responsibi l i ty is to make the required instal lment payments to the vendor.

The vendee is general ly also responsible for keeping the property insured

and paying the property taxes.

Like the vendor, the vendee has the abil i ty to encum ber the property, but

few lenders are wi l l ing to make loans with a vendee’s equitable interest as

the only security. The vendee may sel l her interest in the property by

assigning the r ight to receive the deed when the contract price has been

paid in ful l . (However, the vendee wil l remain responsible for making the

contract payments unless the vendor releases the vendee from liabi l i ty.) The

vendee also has the r ight to devise (wil l) her interest.

Historical ly, land contracts tended to favor the vendor, a nd of ten had

provisions restr ict ing the vendee’s r ights. For example, the contract might

prohibit the vendee from recording the contract, or assigning his interest in

the property. These provisions are usual ly discouraged today; many states

do not allow the contract to prohibit recording , and some actual ly require

that land contracts be recorded. State laws may also impose other

restr ict ions on land contracts for the protect ion of the vendee.

Remedies for Default

I f the vendee pays the purchase pr ice in full, but the vendor fai ls to

transfer legal t i t le to the property, the vendee can sue for specif ic

performance of the contract (see Chapter 7).


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I f the vendee defaults (for example, by fail ing to make the instal lment

payments), the vendor can terminate the contract. The consequences of

terminat ion depend on the terms of the contract, as wel l as on state laws.

Tradit ionally, land contracts contained a forfeiture clause that allowed the

vendor to retake possession of the property. The vendor was also al lowed

to keep any money the vendee had already paid on the contract. Today,

however, most states have imposed restr ict ions on forfeiture as a remedy for

default . For example, the vendor may be al lowed to retake possession of the

property, but would be required to reimburse the vendee for the amount paid

to the vendor under the contract. The vendee’s reimbursement could be

reduced by any damages that the vendor incurred, and by the fair market

rental value of the property for the period the vendee was in possession.

Example: Under a land contract, Porter paid Roll ins $12,800 over a

ten-month per iod. The rental value of the property for that period

was $1,100 per month, or $11,000. Porter stops making installment

payments af ter the tenth month, and Rol l ins reclaims the property

under a forfeiture clause. State law requires Rol l ins to reimburse

the amount paid under the contract, minus the rental value of the

property. Porter would be ent it led to a reimbursement of only

$1,800. ($12,800 – $11,000 = $1,800).

Some states do not al low the vendor to demand forfeiture immediately

upon the vendee’s default . Instead, the vendor is required to give notice of

default to the vendee. The vendee then has a specif ied per iod of t ime in

which to cure the default and reinstate the contract. Furthermore, courts in

some jurisdict ions have held that once the vendee has paid a substantial

port ion of the contract price, she gains a r ight of redemption (the r ight to

keep the property by paying off the entire amount of the debt). The r ight of

redemption is a concept normally applied to mortgages, and wil l be

explained in more detai l in that context (see Chapter 11).

I f the vendee does not cure the default or redeem the property, then the

vendor is ent it led to retake possession. However, a recorded land contract is

a cloud on the property’s t it le; the vendor may need to obtain a quitclaim


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deed from the vendee or f i le a quiet t i t le act ion to make the t it le

marketable again.

A few states do not al low forfeiture as a remedy for default on a la nd

contract at all. Instead, the vendor is required to foreclose on the property

l ike any other l ienholder.

Reasons for Using a Land Contract

A land contract is a secur ity instrument that is somet imes used in

conjunct ion with seller f inancing. The sel ler extends credit to the buyer and

holds t it le to the property as security for the repayment of the debt. (See

Chapter 11 for a detai led discussion of security instruments.) However,

because of the vendee’s r ights of reinstatement, reimbursement, and

redemption under a land contract, most people prefer to use mortgages or

deeds of trust in sel ler -f inanced transact ions (see Chapter 11).

(Rockwell, 168-196)

Cited Material:

Real Estate Principles . Bellevue, WA: Rockwell Publishing, 2014. . Pr int.

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Types of Real Estate Contracts - protrain.hs.llnwd.net (Req Read) P1.pdf · Types of Real Estate Contracts In addition to understanding the basic principles of contract law, real