Avoiding Seller “Blank Check Risk” For Inspection Resolutions
Any time a seller agrees to repair something for a buyer, there is the risk that the repair will cost much more than the seller expects. Learn the pros and cons of the five basic options for protecting your seller against that risk.
Video Transcription:
Hi, this is John Goodman.We are talking today about how to avoid committing your seller to what I will call blank, check liability, for an inspection resolution items. What do I mean by that? Well, I happen to be looking at a proposed inspection resolution right now, and it has a provision obligating the seller to have a contractor repair and install the hot water heater flue and make sure that it vents properly. Well, probably 90, maybe even 95% for all I know, 99% of the time, these things get done and they come within the budget that the seller expected, and there’s no hard feelings. But in the situations that we see in our office, what happens is, the seller expects that to be a $1,200 expense. And it turns out not to be a $1,200 expense, you know, in order to, bring the flue up to code. Now it requires a bigger bore for the pipe and the bigger bore pipe won’t fit and you know, like a bathtub upstairs where the flue was supposed to vent through the roof, isn’t going to is going to have to be moved and it’s, it’s a nightmare. And so if it can be done at all sometimes in our world, it turns into a $15,000 problem instead of a $1,500 problem.
So the question is how do you protect your seller against those risks? There’s sort of five options. Don’t get turned off. You’re already very familiar with two of those five options. We’re going to go through those two very fast. And then we are going to talk about the three more complicated versions of it,so more interesting ones, not necessarily more complicated and more interesting ones.
So one of the things that you do is you don’t commit your seller, your seller doesn’t commit to making any repairs at all, your seller can either one reduce the price by the expected expense, the $1,500 in the example that I just gave or give a credit to buyer, give a credit to buyer for the $1,500. Therefore, the buyer bears the risk post-closing that these things cost more than the seller expects. Now, those solutions are not ideal for a variety of reasons. One is some buyers aren’t going to be willing to bear that uncertainty. Another is solutions like reducing the price we’re giving the buyer a credit at closing create loan problems. The buyer’s lender may not be content with those kinds of solutions. Another problem with those kinds of solutions is the reduction of the price by $1,500 does not put $1,500 into the buyer’s pocket with which the buyer can fix these things post-closing. If the buyer is borrowing money to purchase the property and in a transaction where the buyer is borrowing 90% of the purchase price, a reduction of the purchase price by $1,500 only saves the buyer 150 bucks does not give the buyer enough cash to fix the problem post-closing.
So we move on to the remaining three kinds of options. One option is in the inspection resolution to cap the amount that the seller is obligated to spend on these things. The problem with those kinds of solutions is they get complicated. What happens if the actual cost exceeds the cap, does the buyer have to make up the difference? Does the contract automatically die? Does the seller get to kill the contract? Is the buyer get to kill the contract who both get to kill the contract? It gets complicated when you put a cap in there; you have to address the scenarios. What happens if the cap is not satisfied?
So another option is to address the inspection resolution with a contingency, not an affirmative obligation for the seller to replace the furnace flue. What do I mean by that? Instead of saying, seller will inspect and repair and replace the furnace flue as necessary to comply with code. Instead of saying seller must or seller will, or seller shall do something. Instead you write an open inspection resolution that says buyer’s obligation to close is contingent upon seller repairing the furnace flue. You make it a contingency. Now I love that solution, but it’s also, it’s a little off putting, for some buyers because the seller isn’t committed to doing anything.
Another variation on that and now we’re at the fifth option. The fifth option is to not create an affirmative obligation, not create a new contingency, but leave the existing contingency operative, the existing contingencies inspection objection. And what you do is just write up an amend extend that extends the resolution deadline. The buyer has already submitted their inspection objection, if the inspection objection is not resolved in the buyer sole and absolute discretion, the buyer can terminate the contract. And the concept is, is that there’s an understanding that the seller recognizes that the seller is going to have to fix these things for this buyer or the next buyer. So the seller is going to work on fixing these things, and hopefully the seller will get these things fixed prior to closing. Hopefully the will be content with the fix. If the seller does get these things fixed prior to closing, and the buyer is content, then, then the buyer’s inspection objection can be withdrawn and you know that on the real estate commission approved inspection objection form there is a mechanism for the buyer to withdraw their inspection objection. And, that’s how these things get fixed.
Now there’s no free lunch with this kind of solution. What is being traded is, is the seller is giving up, being subjected to the uncertainty about the cost. The seller is no longer exposed to, at least in this transaction to the blank check liability, but the seller is exposed to a different kind of risk. And that different kind of risk is that the seller does make the repairs. And then the buyer has remorse about the whole transaction and, and doesn’t agree that those repairs are adequate and the inspection resolution does not get resolved. It’s also, you also have to have a buyer who is willing to tolerate some uncertainty because in this solution, remember the solution of merely extending the resolution deadline, the buyer doesn’t have a commitment that the seller is actually going to make these repairs. Each side, the buyer and the seller are relying on the other side, recognizing that it’s in their mutual best interest to do what they’re expected to do. The buyer is relying on the seller being rational and concluding that it’s in the seller’s best interest to make these repairs, if the seller can do so. The seller is relying on the buyer, concluding that it’s in the buyer’s best interest, that if the repairs are made, that the buyer will close on the transaction.
None of these solutions are ideal solutions. All of the solutions have their pros and cons. Your job is to help your clients, your seller clients, your buyer, clients, understand the pros and cons and pick the solution that is best for them. That’s it for today’s presentation. Remember we live in a complex world, be careful out there.