Real Estate Jukebox: You Get What You Give - Making a Purchase Agreement with a Due Diligence Period Enforceable

You Get What You Give

Last week, the California Supreme Court issued an important decision* that could affect any party entering into a contract for the purchase and sale of real estate in the State of California.

ISSUE: A purchase contract that allows the buyer to terminate for any or no reason in the buyer's sole and absolute discretion during a specified period (such as an inspection, due diligence or contingency period) may be characterized as a unilateral option contract. Until the option is exercised, an option contract is enforceable only if consideration is given for the option (thereby rendering the option irrevocable).

SUGGESTED SOLUTION: Parties entering into a purchase contract should specify sufficient, bargained-for consideration to be conferred upon the seller in exchange for any "free look" or due diligence period granted to the buyer. Here are some TIPS:

• Consider making at least a modest portion of the buyer's deposit non-refundable.
• Consider requiring the buyer to perform certain inspections and due diligence and to provide the seller with copies of non-proprietary reports in connection therewith in the event that the buyer does not proceed with the sale.
• Consult with counsel in structuring bargained-for consideration.

THE STORY: In September 2003, Paul Thexton, as seller, and Martin Steiner, as buyer, entered into a written agreement under which Mr. Thexton agreed to sell Mr. Steiner a 10-acre parcel of real property for $500,000. County approvals for a parcel split and development permits were required.

The agreement provided that Mr. Steiner, at his own expense, could pursue the necessary approvals and permits; however, like many purchase contracts that grant the buyer a "free look," Mr. Steiner was not obligated to do anything and could terminate the agreement at any time in his sole and absolute discretion.

After entering into the agreement, Mr. Steiner did pursue the approvals and permits, spending up to $60,000. In October 2004, Mr. Thexton decided that he no longer wished to sell the property and instructed the title company to terminate the escrow. Mr. Steiner sued for specific performance to enforce the agreement.

WHAT HAPPENED? The trial court ruled in favor of Mr. Thexton, finding that the agreement was an unenforceable option that was not supported by consideration, and the California Court of Appeals agreed. Although the California Supreme Court reversed, it held that the agreement between Mr. Thexton and Mr. Steiner did constitute an option; however, it found that Mr. Steiner's efforts in seeking a lot split (which would benefit both Mr. Steiner and Mr. Thexton) constituted sufficient consideration, so the option was irrevocable by Mr. Thexton.

WARNING: Almost any purchase contract may be deemed to be an option if the buyer has a right to terminate the purchase contract for any or no reason. Such an option must be supported by sufficient, bargained-for consideration or the purchase contract may be unenforceable.

* Steiner v. Thexton (2010) 84 Cal.Rptr.3d 37.