Co-Author: Richard B. Peddie, Esq.
What is necessary to satisfy a requirement for “loan approval” in a financing contingency contained in a real estate contract?
The answer to this question depends upon two things: (1) what constitutes loan approval under the contract; and (2) whether or not the loan approval clause, and its requirement, can be waived by the buyer alone. Because the meaning of the term “loan approval” is not well defined, brokers should consider clarifying the meaning of the term in their contracts.
Real estate contracts are often conditioned upon the buyer’s ability to obtain financing. In the Colorado Association of REALTORS® Approved Contract, the loan approval clause is found at section 4(b):
LOAN APPROVAL. If Buyer is to pay all or part of the purchase price by obtaining a new loan as specified in Section 3, this contract is conditional upon lender’s approval of the new loan on or before . . . [the financing deadline]. If not so approved by said date, this contract shall terminate.
The operation of this section would seem to be simple: If the purchaser, before the financing deadline, produces proof that she has obtained the loan, the contract becomes fully binding; both buyer and seller are then bound by the contract.
Experience demonstrates that things are not so simple. Purchaser’s frequently produce loan approvalthat is conditional upon the occurrence or non-occurrence of a specified event. For example, the loan approval produced by the financing deadline may be conditioned upon an appraisal of the property serving as collateral for the loan or the sale of a property owned by the buyer. Do these types of “loan approvals” satisfy the financing contingency? When the approval obtained is complicated or of questionable validity, the seller may be left unsure as to whether the financing obtained (if obtained) will be effective and adequate. Because of this, the seller may need to know whether or not she is bound by the contract, especially when other buyers are pursuing the property.
The case law on the subject does not add much clarity. Colorado courts have found that the buyer has satisfied a loan approval requirement even where the buyer’s lender has put significant conditions on its approval. In Fountain v. Mojo, 687 P.2d 496 (1984), the Colorado Court of Appeals found that the buyers had satisfied the financing contingency even though approval was contingent upon buyer’s removal of liens from other properties serving as collateral. The Court held that since “the contract did not provide that the plaintiff’s loan approvals had to be unconditional, we decline to rewrite the contract to add this term.” Id., at 499. In Loukonen v. MacKay, 490 P.2d 78 (1971), the Court found that the loan approval condition had not been met where the buyer provided a letter from the loan broker stating that he had obtained casualty insurance companies as guarantors on the loan, and where those companies conditioned their guaranties on an inspection of the properties.
Reading Fountain and Loukonen together, persons involved in real estate transactions cannot be at all sure as to where to draw the line. The uncertainty breeds disputes – buyers and sellers cannot predict the likely outcome should they end up in court.
To make things worse, some courts have interpreted loan approval clauses as being conditions imposed for the benefit of the buyer only. Such an interpretation has an important impact on the rights of the seller, because contract law provides that where a condition is for the benefit of one of the parties only, that party can waive the condition unilaterally and proceed to enforce the contract. See, e.g.,Lehman v. Williamson, 533 P.2d 63, at 65-66 (1975) (distinction drawn between conditions that can be waived unilaterally, and those that must be waived mutually because they are intended for the benefit of both parties). In other words, under this theory, the buyer could fail to obtain the required financing by the financing deadline and still bind the seller to the contract.
The theory of this view is that the sole purpose of the clause is to allow a buyer unable to obtain the necessary financing to escape from being bound by the contract. In a recent Boulder case, for example, the Court found that “[i]n spite of the conditional language contained in the clause, it is clear that the provision is for the sole benefit of the Purchasers . . . who have a clear interest in terminating a contract which they cannot perform due to lack of funds. Because the clause is for the sole benefit of the [defendants], they had the right to waive the condition . . . [I]t is of no import whether loan approval was obtained.” Ruling and Order, Cummings v. Paswaters, Action No. 94 CV 30, District Court, County of Boulder, Div. 2, July 8, 1994. On a case by case basis, a financing contingency may be for the sole benefit of the buyer. However, this should not be the general rule. In many cases, the seller also has an interest in determining the certainty of the loan approval by the financing deadline. For example, a seller committing to replacement property may need either assurance of the buyer’s financial ability to go through with the transaction or the ability to quickly seek out more stable buyers.
Other courts have found that the loan approval clause was for the benefit of both parties. Where a condition is for the benefit of both parties, it cannot be unilaterally waived by one party. Yet the seller must still beware: even where the seller retains the benefit of the clause, the seller must be very careful not to waive inadvertently the condition. The courts have held that “[a] forfeiture will be deemed waivedby any agreement, declaration, or course of conduct on the part of him who is benefited by such forfeiture, which leads the other party to believe that by conforming thereto the forfeiture, will not be incurred.” Dreier v. Underwood, 238 P. 38, 39 (1925)(emphasis added)(sellers by their conduct induced reliance on extension of deadline for payment and change to form of payment other than that specified in contract and were held to have waived forfeiture clause in contract). In addition, sellers and sellers’ agents must be careful not to waive the condition by inadvertently incorporating waiver language into amendments to the contract. See, e.g., Arbitration Award, Rogers v. Taylor, JAG Case No. 95-176, May 9, 1995, at 4-5.
Ultimately, the ambiguous nature of “loan approval” is best clarified by carefully drafted language in the sales contract. We will discuss drafting suggestions in the next article in this series.
A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.