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Part II – Review of your Form Purchase Agreement

In this Part II, we continue our review of some important items to review in your form purchase and sale agreements.

Interstate Land Sales Act

            The Interstate Land Sales Full Disclosure Act (ISLA) is a federal law originally enacted to protect buyers of out-of-state home-site lots, but has since been held to also apply to sales of preconstruction condominiums and single-family homes.

            A thorough discussion of ISLA is beyond the scope of this article, but be aware that ISLA is the flavor of the month for unhappy purchasers of preconstruction who are attempting to get out of their contractual commitments, It's important that developers fully comply with ISLA or take advantage of one of its statutory exemptions. Due to ISLA's onerous, costly and time-consuming registration requirements, most developers take advantage of certain exemptions under ISLA.

            One of the most commonly used exemptions for larger projects is the Improved-Lot Exemption (often referred to as the “24-month exemption”), which generally provides that a developer doesn't need to register its project under ISLA if the developer provides a contractual commitment to complete construction within two years after the date the purchaser signs the purchase agreement subject to delays for force majeure (French for greater force).

            The 24-month exemption is problematic because the law is unsettled as to what remedies need to be offered to purchasers in the event construction isnt completed within the two-year period. Courts in some states have agreed with HUD's position requiring that developers offer purchasers the right to specific performance in order to qualify for the 24-month exemption.

            It's clear that developers need flexibility in response to changing market conditions. They typically don't want to be obligated to construct within tight deadlines. A poorly drafted purchase agreement may result in a developer losing its exemption under the 24-month exemption.

            If the development is found not to qualify for the 24-month exemption, then a purchaser would have the right to terminate without penalty subject to ISLA's other terms and conditions. Your form purchase agreement could expressly provide that the seller will complete construction of the property and cause settlement to occur within two years after the date of the agreement, but if settlement doesn’t occur within this deadline, purchasers will have the option of requesting a return of their deposit or they can settle on the unit when it is completed.

            Virginia courts have accepted this language as giving purchasers the rights needed to properly exempt the development from ISLA registration.

Complete agreement

            Lastly, please make sure the purchase agreement is dated and fully signed by all parties, with all blanks to the document completed and all exhibits attached. It is surprising how many executed purchase agreements are incomplete.

            Additionally, the seller should make sure it has complied with all the requirements set forth under its organizational documents — be it a corporation, a partnership or a limited liability company — and that it is in good standing in Virginia.

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Part I – Builders Review of Purchase Agreement

           Virginia has experienced several years now of a declining residential real estate market, marked by periods of low sales, high inventory and declining prices. Note that recently the prices and inventory have stabilized, but certainly activity has slowed again now that the federal tax credits for homebuyers has expired. Given the current state of the residential real estate market, many buyers experience remorse and attempt to terminate their purchase agreements and receive a full refund of their deposit from the seller.

            Unfortunately for home builders, many of their "form" purchase agreements were drafted before the current downturn — at a time when sellers held all of the negotiating advantages — and the resulting agreements were so one-sided in favor of the sellers that some Virginia courts have held them to be unenforceable.   While there are many steps you can take to protect yourself in the event existing purchasers are insisting on a return of their deposit, it also would be prudent to take preventive steps now to make sure your form contracts fully comply with Virginia law to protect you going forward.

            Briefly listed here are the most commonly cited reasons used by disgruntled purchasers in their attempts to terminate their executed agreements, with suggested contract provisions for each of these scenarios.   Part I of this post will address lack of mutuality and provisions relating to the deposit, and Part II will address the Interstate Land Sales Act and other minor issues. Please feel free to contact me for a more detailed discussion of these important issues.

Lack of mutuality

            Many dissatisfied buyers argue they have the right to terminate their agreements with a full refund of their deposit because the signed agreement lacks “mutuality.” Mutuality, in this context, simply means that a valid contract requires promises and obligations from both buyer

and seller.  

            A buyer's typical remedy upon a default by a seller is to either sue for damages or ask for specific performance. This way, when developers attempt to limit buyers' remedies they run the risk of making the contract unenforceable. Developers need to be careful that their form purchase agreements don't go too far in taking away the rights of buyers and limiting any obligations on behalf of sellers.

             In fact, a Virginia court recently held a purchase agreement to be unenforceable for lack of mutuality because the buyer had no right to sue for specific performance. The buyer's sole remedy was a refund of the deposit. It is interesting to note that in its decision, the court suggests that the contract would have likely been deemed enforceable if it had provided for interest to be earned on the deposit.

            Some suggest that your form purchase agreement should not expressly limit the buyer's remedies after default by the seller. In Virginia, if a real estate contract is silent regarding the buyer's remedies, then the buyer has all of the remedies allowed under law including the right to sue for specific performance.

            For preconstruction sales, however, you should provide for specific performance only when the property is constructed. Also, as mentioned above, as an alternative you may want to consider providing for interest to be earned on the deposit.

Deposit as damages

            Your purchase agreement should make expressly clear that in the event of a default by a purchaser, the seller's right to retain the deposit is in the form of liquidated damages and not as any form of penalty. Damages considered to be a penalty will likely not be held to be enforceable.  We can offer suggested language for the provision dealing with seller's remedies after a default by purchaser. 

         We will continue this discussion in Part II next week.

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