Drafting Better Contingencies

 

I. Affirmative Obligations vs. Contingencies.

Many contract issues which could be addressed by affirmative obligations could also be addressed by contingencies. The first step in writing contingencies is deciding whether you wish to create an “affirmative obligation” or a “contingency.”

An affirmative obligation is a provision which requires one of the parties to do something. With an affirmative obligation, if the required performance does not occur, the party obligated to perform breaches the contract.

With a contingency, if the desired act does not occur, then one or both of the parties are excused from all or some portion of their contract obligations.

A. Intended Affirmative Obligation Examples

The following sentence is an example of an affirmative obligation: “The seller shall pay any encumbrance against the property before closing from the proceeds of this transaction or from any other source.” If the proceeds from the sale of the property are not sufficient to pay off the existing loans against the property (i.e., if the seller is “upside down”), then the seller must bring money to the closing to pay the liens. If the seller does not do so, the seller is in breach of the contract.

The following is another example of an affirmative obligation: “Seller shall furnish to Buyer, at Seller’s expense, a current commitment for an owner’s title insurance policy in an amount equal to the purchase price on or before _______________.” If the seller fails to provide the title commitment by the specified date, the seller has breached the contract.

B. Inadvertent Affirmative Obligations

The following are examples of clauses in which one party understood the language to create a contingency, where instead the language creates an affirmative obligation. “Seller to provide Buyers with a copy of the well permit on or before closing.” After the buyer and seller agreed to the contract, the seller learned that the well did not have a permit. The seller assumed that his inability to get a well permit terminated the contract saying “I guess the deal is off now.” But while the seller’s inability to obtain a well permit excuses the buyer’s obligation under this contract, the buyer also has a breach of contract claim against the seller, probably giving the buyer to the remedies of damages, specific performance, or both, depending upon the contract language.

Consider the following: “Seller to obtain a certification from a licensed engineer certifying that the house is structurally sound.” Before closing, the seller hired the engineer who determined that the house was not structurally sound and could not be made structurally sound without great expense to the seller. If the seller doesn’t fix the house so that she can obtain the certification, is the seller in breach of the contract? Yes.

II. The ABC’S Of Drafting A Contingency.

Once you have decided to write a contingency, your language must address the ABC’s of contingencies: A. What is Action necessary to satisfy the contingency? B. By when must the contingency be satisfied? and C. What are the Consequences of the contingency not being satisfied?

Contingency Example

Consider the following: “Buyer’s obligations under this contract are conditioned upon Buyer closing on the sale of Buyer’s current home located on Magnolia Drive by March 15. If this condition isn’t satisfied, then this contract shall terminate.”

This language addresses the ABC’s. What is Action necessary to satisfy the contingency? The Buyer must close on the sale of Buyer’s current home. By when must the contingency be satisfied? March 15. What are the Consequences of the contingency not being satisfied? The contract terminates. (Section 23 of the Real Estate Commission Approved contract defines termination to mean that both the buyer and the seller are relieved of their obligations under the contract and the buyer gets her earnest money back.)

III. Conclusion.

First decide whether you want to address an issue with a contingency clause or an affirmative obligation. If you and your client or customer choose a contingency, then the contingency must address the ABC’s.

A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.

Jon Goodman is a shareholder with Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm. His practice areas include Real Estate,Brokerage Law, Contracts, Land Use, Leasing, Real Estate Title, Association Law, Business Law, and Finance. Contact Jon Goodman.

Disclaimer — Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.

JONATHAN A. GOODMAN