Backup Contracts

 

I am listing a property and my Seller has entered into a contract with “Buyer 1.” We also received an offer from a second competing buyer, “Buyer 2.” We countered Buyer 2’s offer with a backup contingency. The closing date on Contract 1 is approaching and Buyer 1 has asked for an extension. If we extend the closing date in Contract 1, are Buyer 2’s rights to buy the property still subordinate to Buyer 1’s rights? In other words, may we extend the closing date under Contract 1 without putting Buyer 2 into first position?

The answer depends upon the text of the backup contingency. In the case of Sandstone Investments v. Edward Williams, 53 P.3rd 687 (Colo.App. 2001), the Seller entered into a contract with Buyer 1. The Seller later entered into a contract with Buyer 2. Contract 2 acknowledged the existence of Contract 1 and Contract 1’s closing date of July 1. Contract 2 contained a contingency providing that if Contract 1 “was not consummated,” the listing broker was to notify Buyer 2 of that fact, and Buyer 2’s contract would become effective.

Contract 1 did not close on July 1 and instead, the Seller and Buyer 1 extended the closing date to August 2nd. Buyer 2 was not consulted about the extension of Contract 1. Later, Buyer 2 filed a lawsuit asserting that Contract 1 had not been consummated by July 1 and seeking specific performance. The Colorado Court of Appeals ruled in favor of Buyer 2.

The Court stated that “classifying [Buyer 2’s] contract as a ‘backup’ contract, . . . does little to forward the analysis of the parties’ respective rights and obligations. The term ‘backup’ here indicates only that, in accordance with its specific terms its effectiveness was subject to an express condition precedent, . . . ” The actual language of the backup contingency is much more important than the “backup” label. The outcome of these cases depends on the wording of the backup contingency.

In the Sandstone case, Contract 2 was contingent upon Contract 1 closing by a specific date. In analyzing precedent from another state, the Court of Appeals suggested it would have ruled differently had the backup contingency excused the Seller from performing on Contract 2 if Contract 1 had closed at all, rather than identifying a specific closing date of July 1.

The Seller argued that with or without the consent of Buyer 2, the Seller could extend the closing date under Contract 1. The Court did not disagree but stated that “. . .by agreeing that [Buyer 2’s] contract would become effective if there was no closing [of Contract 1] by July 1, the Seller became obligated to close under Buyer 2’s contract pursuant to its terms, unless [Buyer 2] consented to an extension of [Contract 2].”

Other problems arise in back up situations. What if it is clear to the Seller and Buyer 2 that Contract 1 has terminated, but Buyer 1 asserts that Contract 1 hasn’t terminated? Does the Buyer 2 have the ability to force Seller to close, subjecting the Seller to a competing specific performance law suit from Buyer 1?

May the Seller kick Buyer 1 out of the deal if a better Buyer 2 comes along? The answer to this question is “no” unless Contract 1 clearly creates such kick out rights for the Seller. Sometimes listing brokers try to create such kick out rights by putting language into a counter-offer which reads something like “This contract is subject to a first right of refusal.” Yet such language misses the mark. The buyer doesn’t need a first right of refusal as the buyer already has the property under contract. At best, the right of first refusal phrasing confuses the situation. At worst, it suggests to the Seller that unless Buyer 1 does something to avoid being kicked out of a deal (like waiving a home sale contingency) the Seller can terminate Contract 1 if a better offer comes along-when the Seller has no such rights.

Backup contingencies and kick out clauses come in different flavors. Some would tend to favor the Seller, while others would tend to favor the second buyer. Brokers should work with their attorneys to ensure that the backup contingency they use fits the intention of that broker’s clients.

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