Co-Author: Richard Byron Peddie, Esq.
In a previous article, we explored the ambiguity associated with the meaning of “loan approval” in loan contingencies. We examined the existing caselaw on the subject and saw that the law is underdeveloped in this area, leaving the parties unsure as to when the contingency is satisfied. We also saw how some courts have interpreted the loan approval clause as being a condition imposed for the benefit of the buyer only, and how this potentially leaves the seller bound to a buyer that ultimately may never be able to keep up the buyer’s end of the bargain.
Although there are exceptions, the general rule in contract law is that parties are free to make whatever bargains they want. The law will usually only step in to settle disputes over the interpretation of clauses where there is ambiguity. The loan approval contingency is an example of a clause which leaves much room for conflicting interpretations. It is, therefore, easy prey for judicial interpretation.
You can avoid the problems we have illustrated through careful drafting of the loan approval clause. Here are some suggestions which, after consultation with your attorney, could be incorporated into your contracts:
- Consider inserting language which makes the contract conditional upon buyer’s ability to obtain lender’s unconditional approval of the loan:
Use of clear language specifying that conditional loan approval will not satisfy the financing contingency will avoid uncertainty. There is a great variety of possible conditions that the lender could require. Some of these may be minor. For example, the lender may condition its approval by insisting that the buyer produce a valid driver’s license. Since this would be something in the sole control of the buyer, and also easily accomplished by the buyer, the seller may wish to exclude this type of condition from those which would defeat loan approval. Language could be added providing that conditions which are within the sole control of the buyer, and which can be and are performed within a given period of time, shall not be considered conditions which terminate the contract.
2. Stipulate that the loan approval clause is for the benefit of the seller as well as the buyer
Conditions in contracts can be for the benefit of both parties or for one party only. Where they are for the benefit of one party only, contract law allows that party to waive the condition unilaterally, and the contract continues to bind both parties. Since most loan approval clauses do not state that the clause is for the benefit of both parties, some courts addressing this issue have found that the contingency was for the sole benefit of the buyer. In these cases, the buyer was free to waive the protections afforded by the clause and, without loan approval, insist that the seller continue to perform the seller’s obligations under the contract.This approach ignores that the seller often benefits from the financing contingency. A seller has an interest in knowing, as early as possible, whether the buyers will be able to obtain the necessary financing to buy the property. For example, a seller committing to replacement property may need either assurance of the buyer’s financial ability to complete the transaction, or the seller needs the ability to quickly seek out other buyers. This problem can be addressed by stipulating that the loan approval clause is for the benefit of both parties.
Real estate professionals may also want to stipulate that the condition cannot be waived except by a writing signed by both parties. However, sellers and their agents should be careful not to inadvertently waive the loan approval condition by actions or words. The parties should be particularly vigilant about not waiving the condition when agreeing to amendments or extensions of the contract.
3. Language can be included stipulating that loan approval is a condition precedent to performance of the contract
This is a further protection which makes clear what already seems clear from the seller’s viewpoint. The courts, however, have sometimes found that the financing deadline is either acondition subsequent, or a hybrid condition, containing language of both conditions precedent and conditions subsequent.The clause’s classification can have significant impact upon the legal rights of the seller. With a condition precedent, the seller’s obligation only arises after the condition is met, and the burden is on the buyer to show that the condition has been satisfied. (This does not mean that a seller is free to sell the property to someone else before the deadline in the loan approval clause has passed but that the obligation of conveying the property will not arise until the loan approval condition is satisfied).
If, instead, the loan approval clause is classified as a condition subsequent, the seller’s obligation arises immediately upon signing the contract (assuming, for simplicity, that there are no other conditions in the contract). The obligation can then only be extinguished by the buyer’s failure to satisfy the loan contingency, since the obligation already exists.
The classification shifts the burdens and responsibilities of the parties: with a condition subsequent, the seller is already obligated. The seller may need to prove that the contingency was never met. With a condition precedent, it is the buyer who must produce evidence that loan approval was in fact obtained. It is preferable, from the seller’s viewpoint, that fulfillment of the loan approval condition be a condition precedent to seller’s obligation to perform. Ambiguity can be avoided by simply stipulating that this is the case.
Incorporation of the foregoing suggestions (with the approval of an attorney) is an effective way for brokers to clarify financing contingencies. Since the law gives little guidance in this area, careful drafting is the broker’s best method of avoiding unforeseen pitfalls on the way to closing.
A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.