Avoid Legal Snafus Around Canceled Contracts

Home buyers or sellers may back out of a home sale for any number of reasons, but lawsuits are a real risk. Know how to protect yourself.

Most real estate professionals have had a client with cold feet back out of a deal at the last minute. Maybe the client got psyched out over finances or is dealing with a life-changing circumstance that prevents him or her from following through on a sales contract. Whatever the case, you need to make sure that when you cancel a contract, you’re not breaking your fiduciary responsibilities.

While only 5% of sales contracts nationwide were terminated in January, according to the most recent REALTORS® Confidence Index, that figure was at 16% last July—the highest rate in the previous two years. The midsummer spike was attributed to a sharp rise in mortgage rates, which scared off many buyers at the closing table. The latest Window to the Law video from the National Association of REALTORS® addresses the legal considerations you should keep in mind in case you’re involved in a canceled contract.

Even though signed purchase contracts are legally binding, they often include an exit plan if one party wants to back out. A home buyer, for example, may be able to cancel a contract because of a contingency or during an attorney review period. Canceling a contract can become trickier when the reason falls outside of the agreed-upon contingencies. But unfortunate circumstances, such as a job loss or change in household status, may result in the need to cancel.

In every transaction, real estate professionals can help their clients understand the acceptable “outs” to avoid the risks of losing escrow money or even facing a lawsuit, NAR staff attorney Mike Rohde says in the Window to the Law video. “Every contract has an implied duty of good faith and fair dealing, which means parties must act honestly, cooperate with the other party and not discourage or hinder the agreement’s completion,” he adds. Breaching this duty could jeopardize a buyer or seller’s legal rights and lead to litigation. “And as a fiduciary, an involved broker’s actions or inaction may be scrutinized when a contract is terminated.”

For example, if a home seller backs out, a buyer could try to pursue any number of avenues if they think there was a breach of contract. A buyer could try to receive liquidated damages specified in the contract or compensatory damages calculated by actual economic losses. The buyer also could cite specific performance by asking a court to require the parties to complete the originally agreed-upon transfer of property. 

To avoid these risks, Rohde urges real estate professionals to advise their clients about the importance of contingencies and meeting deadlines as well as the risks of waiving contingencies. Also, “avoid casual communications with other parties via text or email, and assure amendments are in writing and signed by all parties to avoid doubts about enforceability,” Rohde adds.

And be careful not to overstep your duties. “While you may understand the terms of the agreement, your state law and Article 13 of the Code of Ethics prohibit the unauthorized practice of law,” Rohde says. “Filling in state-approved forms with factual data is generally permitted. However, use caution when interpreting or amending contract provisions. Your state may have statutes governing specific procedures for effectuating a notice of termination or the disbursement of disputed escrow funds.”