Hard Landings In a Softening Market: What happens when a home sale falls through?

The news is abuzz these days about the “sudden cooling in Toronto’s once-frothy housing market.” Following the introduction of various Ontario and federal government measures intended to curb what many perceived to be unsustainable real estate price increases, or simply because of a psychological turning point in the market, home prices have dipped. This change in the market has left some buyers in the precarious position of having signed an Agreement of Purchase and Sale (“APS”) near the peak of the market, and being unable to sell their current home for their desired sales price. As we have seen first hand from people contacting our office,  numerous deals are in danger of falling through as panicked buyers try to back out of deals, and sellers are increasingly finding themselves having to decide whether to capitulate to buyers’ renegotiation demands in order to salvage a sale, or whether to insist on the terms originally agreed to before market conditions changed.

So, legally speaking, when can a buyer rescind their agreement to purchase a property? When can the seller keep the deposit? Might a defaulting buyer be liable for damages if the seller is unable to resell the property on terms as favourable as those to which the defaulting buyer agreed? We will address these issues below.

Can the buyer rescind?

The circumstances in which a buyer can safely rescind their agreement to purchase a property will depend to a great extent on the terms the parties have negotiated and included in their APS.

In some cases, buyers will have negotiated conditions such as a financing condition, a condition stipulating that the APS is null and void unless the buyer obtains a satisfactory home inspection within a given amount of time, or an insurance coverage condition. These conditions are generally for the sole benefit of the buyer and often include language allowing the buyer complete discretion in deciding whether to waive them. As such, if these conditions are still “live” (ie. not yet waived), then they can usually be relied on to terminate an APS by a buyer and the buyer will be able to recover any deposit. But buyers should be aware that these conditions will not be enforced in every case (a case study is provided below that illustrates how this principle might play out). Further, if you have already waived these conditions then you will not be able to rely on them thereafter if you later wish to terminate the APS.

What happens when one party approaches the other seeking to vary the terms of the APS, by extending the closing date or renegotiating the purchase price? Generally speaking, the party who is facing a request to vary the terms of the APS does not have any obligation to renegotiate, much less agree to terms less favourable than those which they originally negotiated.¹ Further, in most real estate deals, time is “of the essence”. This means that any delay to the closing date is taken quite seriously and would constitute a breach of the agreement unless the delay is agreed to by all parties. As such, a party seeking to vary the terms of an APS because they are having difficulty closing the transaction should be very careful about how he or she approaches the other party to even propose an amendment, because such actions could be considered an anticipatory breach of the APS, which the other party may be able to rely upon to treat the contract as terminated and sue for damages.²

What becomes of the deposit when a deal falls through?

The answer to the above question will depend on the terms of the APS and the circumstances that resulted in the termination or breach of the APS.

Generally speaking, residential agreements of purchase and sale characterize the payments made by purchasers to the sellers (or the sellers’ agent) accompanying an offer as deposits – they are not characterized as “pre-payments” and the APS generally does not raise issues of penalties or liquidated damages.

In the usual case where the monies are described in the APS as a “deposit”, or to make the case even clearer, a “non-refundable deposit”, or “earnest money”, then generally a court would find that a breach of the APS by a buyer would entitle the seller to keep the deposit.³

Alternatively, if the deposit is found by the court to be “liquidated damages” (in other words, a genuine pre-estimate of the damages the seller would suffer in the event of the buyer’s breach), then the seller would likely be permitted to keep the money if the buyer walks away from the APS.⁴ In the event that a seller breaches the APS, the buyer would generally be able to recover the deposit.

If, on the other hand, the APS characterizes the monies advanced as being a “pre-payment” of the purchase price, then in all likelihood, a court would find that the buyer’s breach of the APS would entitle the buyer to a return of the money,⁵ subject, of course, to the seller’s right to sue for damages flowing from the buyer’s breach. If the court finds that the clause in the APS permitting the seller to keep the monies advanced by the buyer is a “penalty”, then the clause will not be enforceable and the seller will have to return the money, though the seller can still sue for damages for breach of contract.⁶

Even if the seller successfully persuades a court that the monies advanced are a deposit, the buyer may, in certain circumstances, be able to argue that the court should grant relief from forfeiture. Such arguments stand the best chance of succeeding where the buyer can show that the sum of money is out of proportion to the damage suffered by the vendor, and that it would be unconscionable for the vendor to retain the money.⁷

Case study: Coghlan v. Unique Real Estate Holdings Inc.

The foregoing principles were aptly illustrated in a fairly recent case from the Ontario Superior Court of Justice, Coghlan v. Unique Real Estate Holdings Inc.⁸ In Coghlan, the sellers of an apartment building sued the buyer for damages arising from the alleged breach of the APS, as well as a claim for forfeiture of the deposit. The buyer defended the action and counterclaimed against the seller for a return of the deposit. The buyer had negotiated a number of conditions in the APS, including a financing condition and an insurance coverage condition. The insurance coverage condition essentially provided that the offer to purchase the property was conditional for seven business days after the waiver of the financing condition on the buyer arranging “satisfactory insurance coverage”, failing which the offer would be null and void, and the buyer’s deposit would be returned.

The buyer never formally waived the insurance coverage condition, but neither was the condition satisfied by the date set out in the APS. A few weeks later, the buyer emailed the vendor, advising that it had come to his attention that the property might not be a viable investment in the long term, and that he had accordingly decided not to proceed with an inspection of the property, and to seek a release from the seller. The buyer’s lawyer then wrote to the seller’s lawyer, taking the position that based on the insurance coverage condition, which had not been fulfilled by the date stipulated in the contract, the APS had not come into existence and the deposit had to be returned.

The seller brought a motion for summary judgment, seeking a finding that the contract was in existence and that the buyer had breached the agreement.

The motions judge, Mr. Justice J.A.S. Wilcox, began his analysis by deciding whether the insurance coverage condition was a “true condition precedent” (a condition which, if not fulfilled by the completion date contemplated by the contract, would result in the agreement failing to come into existence). If the insurance coverage condition was not a “true condition precedent”, then the failure to satisfy that condition would not automatically render the agreement void. Further, based on the principle that even a “true condition precedent” could be mutually waived by the parties, the court examined the parties’ conduct to determine if the condition precedent had been waived, with the result that the contract remained binding.

The motions judge found that on the facts of the case, the APS had survived beyond the insurance condition date, because the parties had both continued to behave as though the agreement was still in effect (for example, the purchaser was still working on getting insurance, and the parties were making arrangements for further inspections of the building). Neither party had given any indication that the agreement was terminated due to the buyer’s failure to waive the insurance condition. The court found that the purchaser’s real reason for terminating the contract was his realization that he might not be able to sell the building for a sufficient price to make it a viable investment. It was only after the fact that the purchaser’s lawyers sought to rely on the insurance condition to say that the agreement had become null and void as of the date contemplated for satisfaction of the insurance coverage condition.
The motions judge concluded that the agreement existed on the date on which the purchaser terminated it. He then considered what consequences, if any, flowed from the purchaser’s actions.

Relying on a leading decision dealing with the issue of when a court may interfere with the exercise of discretion conferred by a contract, the motions judge held “that the exercise of the discretion is subject to a requirement of honesty and good faith and that fair dealing is implicit in the contract.”⁹ Had the purchaser, in this case, acted reasonably, honestly, and in good faith, or was he attempting to get out of the contract for reasons not related to the conditions? The motions judge found “clear evidence” that the purchaser’s real reason for terminating the transaction had nothing to do with the conditions, and that his subsequent efforts to justify terminating the agreement were not made honestly or in good faith.¹⁰

So what were the consequences for the buyer’s breach? Was the buyer’s deposit forfeit?

The court held that a deposit is considered to be “‘earnest money’ and an indication that the purchaser intends to be bound by the agreement and to complete the transaction.” As long as the deposit was “within [the] reasonable range”, it would be forfeit to the vendor in the event of the purchaser’s default. In this case, the deposit being $50,000 on a purchase price of $950,000 (approximately 5.26%), the deposit was reasonable and therefore forfeit.

The motions judge dismissed the buyer’s counterclaim for a return of the deposit.

Is the seller entitled to damages for breach of contract?

Beyond the loss of the deposit, there are other risks to a buyer from walking away from an APS: the risk of having to pay damages to the seller to compensate for any losses the seller might suffer from the failure to close the APS.

In a recent case out of the Supreme Court of British Columbia, Albrechsten v. Panaich,¹¹ a defaulting buyer was found liable for $360,000 in damages to the seller. The Albrechtsens owned a property in Surrey, which Mr. Panaich agreed to buy for $1.26 million. Mr. Panaich paid a deposit of $60,000. The APS provided that time was of the essence, that it was the entire agreement between the parties, and that if the balance of the purchase price was not paid, the deposit would be forfeited without prejudice to the Albrechtsens’ other remedies. There were no conditions.

Mr. Panaich did not complete the purchase. The court’s reasons are silent as to why. Following the buyer’s breach of the APS, the Albrechtsens re-listed the property for sale. They received and rejected several offers they deemed to be too low. However, after realizing that the real estate market had softened and remained soft, the Albrechsens ultimately accepted an offer for $910,000. The Albrechtsens sued Mr. Panaich for the difference between the $1.26 million he had agreed to pay for the property, and the $910,000 purchase price they ultimately sold the property for after Mr. Panaich’s breach, along with other minor consequential damages. The court granted judgment in the amount of $300,340.35, in addition to the forfeited deposit of $60,000.

Of note, the judgment in Albrechtsen v. Panaich was a default judgment (meaning the defendant did not defend the case), and the court’s order specifically indicated that the order was without prejudice to Mr. Panaich’s ability to seek to overturn the default judgment by a certain deadline.

Conclusion

The following points can be taken from the foregoing:

• Whether a party will be able to rely on a contract condition to get out of an APS will depend to a large extent not only on the wording of the condition itself, but also on the parties’ conduct leading up to and following the alleged breach of the condition. Accordingly, if you are a buyer considering backing out of an APS, or if you are a seller faced with a buyer trying to do so, you should seriously consider obtaining legal advice from a qualified lawyer prior to communicating with the other party or engaging in conduct that might be interpreted as a waiver of the condition.
• Whether a deposit will be forfeit will depend on how the deposit is characterized in the APS, and on whether the amount of the deposit is “within the reasonable range”. A qualified lawyer ought to review your APS and advise you as to whether, as the seller, you are entitled to keep the deposit if the buyer has breached the APS, or, whether, as the buyer, the language of the contract is such that the deposit should be returned to you.
• There may be circumstances in which the buyer may successfully argue that the court ought to grant relief from forfeiture (an equitable remedy permitting the buyer to get terminate the APS and still recover its deposit). A qualified lawyer can help you to understand how strong your case is to argue that relief from forfeiture should apply.
• A buyer seeking to back out of an APS might be liable for more than just the deposit money. In a falling market, the price that a seller is able to get upon relisting the property will likely be less than what the original purchaser agreed to pay. The original purchaser who improperly backs out of the APS will be at risk for having to compensate the seller for the loss. A qualified lawyer will be able to advise you as to what your risks (as a breaching buyer) or your entitlements (as a disappointed seller) are in terms of damages.

If you are in a situation where a housing deal you concluded is at risk of falling through, you should consider seeking the advice of a qualified lawyer sooner rather than later. Competent legal advice will be invaluable to help you navigate through the potential pitfalls and choices facing you.