RECENT CASES ON CONTRACT FORMATION, EARNEST MONEY, WAVIER, LIQUIDATE DAMAGES AND THE RESIDENTIAL REAL ESTATE DISCLOSURE ACT – SOME MORE ‘STRANDS’ IN THE ROPE OF THE LAW OF RESIDENTIAL REAL ESTATE TRANSACTIONS

 

 

A few years ago, a series of cases came down with some fairly dramatic statements about the law of formation of real estate contracts; in particular those containing “Attorney’s Review” or “Attorney’s Modification” clauses.  In Olympic Restaurant Corp. v. Bank of Wheaton, (2nd Dist., 1980), 251 Ill.App.3d  594 , 622 N.E.3d 904 , 190 Ill.Dec. 874, the Second District found that the exercise of the attorney’s approval provision in a contract could be summarily used to declare a contract null and void.  The reasoning was that when the clause is evoked the contract reverts to the stage of “offer and acceptance”.  Then in Groshek v. Frailey, (1st Dist., 1995), 274 Ill.App.3d 566, 654 N.E.2d 467, 211 Ill.Dec. 5, the First District agreed and furthered this reasoning with its ruling that the rejection of the contract by an attorney need not state a basis because the right to disapprove is within the attorney’s judgment, limited only by good faith. In dictum, the Court opined that a contract containing an “Attorney’s Approval” clause is a conditional acceptance offer and acceptance, and that invocation of the clause triggers a rejection of the contract, and, at times, a counter offer.   In Hubble v. O’Conner, (1st Dist., 1997), 291 Ill.App.3d 974, 684 N.E.2d 816, 225 Ill.Dec. 825, the court dealt with modifications to the contract and stated that the attorney’s communication of intent to modify must be clear and unambiguous.  These paths culminated in McKenna v. Smith, (1st Dist. 1998), 302 Ill.app.3d 28, 704 N.E.2d 826, 235 Ill.Dec. 253, where the court held that by disapproval an attorney did terminate the contract,  and an attorney need not state a reason for disapproval to comply with “good faith”.

 

These are fairly well recognized as leading cases by residential real estate lawyers. Two recent cases that must be added to the “must read and grasp” list for these same practitioners relating to contract formation and termination are the Catholic Charities and Allen v. Cedar Real Estate cases.

 

 

1. REAL ESTATE CONTRACTS:  FORMATION,  EARNEST MONEY, WAIVER, AND LIQUIDATED DAMAGES:

 

In Catholic Charities of Archdiocese of Chicago v. Thorpe, (1st Dist, December 12, 2000), http://www.state.il.us/court/2000/1991717.html, the first issue was whether there was a contract in existence before the earnest money was deposited, and the second issue related to  the enforceability of a liquidated damages clause relating to that earnest money.

 

The purchaser, Thorpe, entered into a contract on April 29, 1996 to purchase property at 1300 South Wabash in the City of Chicago from Catholic Charities. The contract called for the immediate payment of $10,000 earnest money to be increased to $25,000 upon acceptance of the contract by Seller.  The initial $10,000 earnest money was deposited by personal check which was returned NSF.  The original closing date was extended from June 6, 1996 to June 25, 1996. The purchaser did not appear at the closing, and consequentially, the seller sold the property to a third party and brought suit for the total $25,000 earnest money as liquidated damages under the contract.

 

The purchasers first argument was that the payment of the earnest money was a condition precedent to the formation of the contract, and since the earnest money was never paid, no contract was  formed.  Therefore, they argued, the  sellers were not entitled to  judgment on the contract.  The sellers, of course, argued that the payment of earnest money was not a condition precedent to the formation of the contract, but merely a condition precedent to the seller’s obligation to perform according to the terms of the existing contract.

 

The trial court and the First District both agreed with the seller on this issue.  Citing cases from the D.C. Court of Appeals and Texas,  before turning  to the language of the contract, the Court states very clearly that: “All the Illinois cases which our research has disclosed which found a condition precedent to the formation of a contract contain express language on the face of the contract to support that construction.”  There was no language in this contract to support the position that the intent of the parties here was that the payment of the earnest money was a condition precedent to their agreement; only that the earnest money was to be increased upon the formation of the contract. “Moreover, even assuming that the payment of the earnest money is a condition precedent to the formation of the contract, performance of that condition by Buyer was waived by the Seller.  A party to a contract may waive performance of a condition by the other party where the condition precedent is intended for the benefit of the waiving party.”

 

Since the payment of the earnest money was intended to benefit the seller, Catholic Charities was able to unilaterally waive the payment, and the Thorpe’s attempts to take advantage of their own failure to perform as the basis for avoiding further liability under the agreement was rejected.

 

Turning to the next argument, the Court recognized that the buyer’s argument that the liquidated damages clause in this contract was unenforceable was based on their decision in Grossinger Motorcorp, Inc. v. American National Bank & Trust Co., (1st Dist. 1992), 240 Ill.App.3d 737, 670 N.E.2d 1337.  In Grossinger, the Court held that an optional remedy provision, “which allows defendant to seek actual damages or alternatively retain the earnest money as liquidated damages is unenforceable”.  Since the concept of liquidated damages requires an agreement by the parties that the earnest money is to be fixed as the sum recoverable under the contract in the event of a breach, the ability to reject that remedy and pursue actual damages, indicates that the parties had not reached an agreement to liquidate damages.  “We reasoned that this scheme (preserving the option to pursue actual damages while stating an agreement to be limited to liquidate damages) distorts the very essence of liquidated damages…The preservation of an option to alternatively seek the recovery of actual damages reflects that the parties did not have the mutual intention to stipulate a fixed amount of their liquidated damages…Such a clause ‘is no settlement at all’ as it ‘permits the seller to have his cake and eat it too.”  Affirming the reasoning in Grossinger, the Court remanded the case for a finding of actual damages based on the unenforceability of the liquidated damage judgment in the trial court.

 

The second, recent case for real estate practitioners to consider carefully comes from the 7th Circuit and interprets Indiana law, but is nonetheless illustrative of an important distinction in contract formation.

 

2.  REAL ESTATE CONTRACTS: FORMATION, ENVIORNMENTAL AUDIT AND WAIVER:

 

Although Thomas K. Allen, Jr. v. Cedar Real Estate Group, LLP, (7th Cir., January 3, 2001), http://www.ca7.uscourts.gov.fox.foxweb.exe/Op3?submit1=showop&caseno+99-4090 , applies the substantive law of Indiana, its discussion relating to the distinction between a condition precedent to the formation of a real estate contract versus a condition precedent to performance of the contract, as well as the issues of waiver of a condition in a contract for one party’s benefit, make it a perfect case to follow Catholic Charities of Archdiocese of Chicago v. Thorpe.

 

Allen  made a written offer to Cedar Real Estate Group to purchase a 6.2 acre parcel of land in Lake County, Indiana which had previously been used as a trucking terminal. The site had five underground storage tanks ranging in volume from 500 to 10,000 gallons to store fuel.  Four of the largest of the tanks had been removed and the fifth was left in place, filled with concrete, and a “closure report” was filed with the State of Indiana. Allan made his offer on a preprinted form that specified that the property was to be sold “as is”,  and a typewritten page entitled “Further Conditions” was attached which stated “This offer to purchase is subject to purchaser’s approval of the following:…purchaser’s review of the Environmental Disclosure Document…a current Phase I and Phase II  Environmental Audit with soil borings…Cost not to exceed $5,000 and to be split on 50/50 basis between purchaser and seller.”  Although the agreement as drafted gave Allen the right to investigate the environmental contamination, it did not provide how the discovery would affect his obligation to buy or the seller’s obligation to sell.  Allen accepted, and after a four month period of audits and reviews, Cedar took the position that the sale would be “as is”, and Allen offered only to pay as half of the remediation costs.   Cedar then informed Allen that it had received three other offers, and that all buyers were to communicate their “final and best offer” to Cedar by noon on October 2, 1998.  On October 1, 1998, Allen’s attorney advised Cedar by letter that there was an existing contract between the parties and than any attempt to breach the agreement “by entering into agreements of sale with other parties will be resisted.” Cedar directed its Broker to terminate the agreement and return Allen’s earnest money.  Allen indicated that he was ready to close according to the terms of the contract and that the property would be submitted to the Voluntary Remediation Program of the Indiana Department of Environmental Management, with the costs to be forwarded to Cedar.  Allen filed suit in Federal District Court when Cedar did not respond.

 

The District Court granted summary judgment in favor of Cedar, finding that Allen’s approval of the environmental audit was an unsatisfied condition precedent o the existence of a contract.  The Court of Appeals affirmed.  Allen’s insertion of language that his “offer to purchase…[was]…subject to purchaser’s approval of the following:”,  (setting forth the environmental audit process),  created a condition precedent that needed to be fulfilled before an enforceable agreement was formed.  The language used by Allen indicated a clear intent to condition his offer on an acceptable environmental report.  The Court felt that “Allen’s choice of the word ‘offer’ “ in the “Further Conditions” was telling of his intent and the frame of mind of the parties: “The only reasonable interpretation of this language is that Allen intended to be able to opt out of the agreement if the property turned out to be contaminated.…The right to order an environmental audit would be rendered completely meaningless if Allen had an obligation to  purchase this property regardless of the results.”  Allen was not willing to purchase the property “as is” and the negotiations between the parties indicates that there was no agreement.  Even  Allen’s argument that the “as is” provision of the contract was meaningless because under Indiana law a previous owner/operator could not relieve itself of liability for clean-up was “not relevant” to the decision of the Court. Noting that there are many reasons a party would not purchase contaminated property even if the prior owner was responsible, and the fact that Allen may have been misinformed about Indiana law was immaterial, the Court returned to the fact that “Allen specifically inserted the condition precedent requiring his approval of the environmental audit into the contract, and now he must accept the consequences of his decision.”

Finally, turning to the issue of waiver, the Court found that it was undisputed that Allen never expressly waived the condition of his approval of the environmental audit. Accordingly, although he had the right to waive the condition precedent as one solely for his benefit, there was no indication that he was willing to or did waive.  The condition precedent was neither waived nor satisfied, and therefore there was no enforceable contract.

 

The law of Residential Real Property Disclosure Act litigation, likewise is a developing area of the law with which real estate practitioners must keep abreast.  Beginning with Hirsch v. Feuer, (1st Dist., 1998) 234 Ill.Dec. 99, 702 N.E.2d 265, and Woods v. Pence, (3rd Dist., 1999), 236 Ill.Dec. 977, 708 N.E.2d 563, the courts first enunciated that the Act requires the pleading and proof that the seller had actual knowledge of a defect, and that this knowledge was an issue of fact for the trial. Then, in Miller v. Bizzell, (4th Dist., 2000), 726 N.E.2d 175, 244 Ill.Dec. 579, the court held that the provision of the Act entitling the “prevailing party” to an award of attorney’s fees  applies to both buyers and sellers, and the decision in King v. Ashbrook, (4th Dist., 2000), 732 N.E.2d 730, 247 Ill.Dec. 675, establishes that an action under the Act must be filed within one year from the earlier of the date of possession, occupancy or recording of the deed of conveyance. The award for the  buyer in the King case, however, was affirmed on appeal based not upon the Residential Real Property Disclosure Act count, but upon the count based upon the contract itself.  This distinction between an action on the contract and an action under the Residential Real Property Disclosure Act leads nicely to Provenzale v. Forister, the most recent case examining whether or not a closing has to occur in order to support an action under the Act.

 

 

3. RESIDENTIAL REAL PROPERTY DISCLOSURE ACT; NO ACTUAL ‘TRANSFER’ NECESSARY:

 

There aren’t many cases in the appellate decisions that end with a mandate that affirms in part, reverses in part, vacates in part, and remands for further proceedings to the trial court, but just this occurred in Justice Rapp’s decision in the recent case of Provenzale v. Forister, (2nd Dist. January 23, 2001), http://www.state.il.us/court/2001/2000108.html, adding to the accumulating law in the area of post-closing real estate transactional law and the Illinois Residential Real Estate Disclosure Act.

 

The Provenzales filed a complaint after their contract to purchase residential real estate from the Foristers failed to close.  In October, 1994, the Foristers executed a Residential Real Property Disclosure that stated that the property was not in a flood plain.  It appears that the Listing Agent put that disclosure form in the file and held on to it until May 1996, when it was given to the Provenzales as prospective purchasers.  (Another fine example of a real estate agent following the form but certainly not the substance of the intent of the disclosure law.)  In July, 1996, apparently relying on the disclosure, the Provenzales entered into a contract for the purchase of the property.  When and exactly why the transaction did not close isn’t clear, (although there is reference in the opinion to the fact that Mr. and Mrs. Forister had separate attorneys, and this implies that they may have been involved in a divorce), but it didn’t close, and  after the Provenzales filed their third amended complaint, the trial court entered an order dismissing all counts on a mixed 2-615 and 2-619 motion.  The order also granted Ruth Forister’s motion for forfeiture of the earnest money, and awarded attorneys fees of $30,483.74 and $13,123.25, respectively, to Ruth Forister and Harold Forister.

 

As the pleadings grew in the trial court, there were a number of factual allegations that Harold Forester claimed that the property flooded, stated so orally to the Provenzales, and so admitted in filings challenging the property’s tax assessment before the county board.  Nonetheless, the ultimately successful motion to dismiss at the trial level was based on the proposition that since there was no transfer (remember the contract never closed), there was no violation under the Disclosure Act.  Section 10 of the Act states that it applies to “any transfer”, and therefore Forister argued that an actual transfer of title to the property was a necessary element for a cause of action.  In support, the Foristers noted that the one-year statute of limitation period in Section 60 of the Act commenced for the earliest of the date of possession, occupancy, or recording of a conveyance – requiring a “transfer”.  Since there could be no limitation on an action without an actual transfer, they reasoned,  a cause of action must be predicated on the occurrence of an actual transfer.  The Provenzales, in rebuttal, argued that the Act requires the sellers deliver the disclosure report prior to the signing of the contract, imposes obligations irrespective of the actual transfer, and therefore “the trial court misinterpreted the word ‘transfer’ as a verb rather than a noun…”

The Second District opinion begins by adopting the position that if actual transfer was intended as an element of a cause of action under the Act, the provisions  requiring the delivery of the disclosure report prior to the contract becoming effective  would be meaningless because this is a pre-transfer duty. Additionally, while “ordinarily the buyer discovers the material defect after the property is conveyed.”, the decision notes that the buyer’s remedies under Section 55 of the Act belong to the “prospective buyer of real property who discovers false information on the disclosure report before closing the transaction even though the property was never transferred.”  The Court dismisses the enticing argument that using “transfer” as a measuring date for limitation purposes is meaningless unless a sale is closed, by noting that even though there is no measuring date for limitations without closing, the Code of Civil Procedure provides a general limitation that all civil actions be commenced within five years after the cause of action accrued, and therefore these types of situations would not be in limbo indefinitely.

 

The decision also reiterates  the law that “an individual who casually sells his or her own single-family home is not subject to liability under the Consumer Fraud Act”,  and chides the mixing of 2-165 and 2-619 motions, and concludes by reversing the award of earnest money and attorneys fees.

 

Accordingly, we are left with the law requiring the filing within 1 year of the date of possession, occupancy or recording under King’s interpretation of the Residential Real Property Disclosure Act, but, if there is no “transfer” of possession, occupancy or recording, the Provenzale case appears to give the buyer five years to bring an action under the Code of Civil Procedure in an action based on the contract.

 

These then are more “strands” of the rope making up the developing case law by which practitioners in the area of residential real estate may either hang themselves or be pulled to safety.

 

 

By Steven B. Bashaw

Steven B.  Bashaw, P.C.

Suite 1012

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