Your Purchase Agreement May be an Unenforceable Option
Many standard purchase agreements give a buyer the right to terminate the agreement for any reason prior to expiration of a “contingency,” “due diligence,” “feasibility,” or “free look” period. In Steiner v. Thexton, 163 Cal. App. 4 th 359 (2008), the Court of Appeals held that those purchase agreements are really option agreements rather than purchase agreements.
Perhaps more importantly, although Martin Steiner, the “buyer” seeking to enforce his rights in the case, had made a deposit and incurred significant expense in an effort to obtain a parcel split, the Court of Appeals nonetheless held that the “option agreement” was unenforceable because Steiner had not given consideration for what it was now treating as an option right. The Court of Appeals supported this second holding by pointing out that the deposit was refundable and also by holding that Steiner’s right to terminate the agreement for any reason whatsoever whether or not he ever sought a parcel split made his promise to seek that parcel split illusory. To the Court of Appeals, any steps Steiner had taken to obtain the parcel split were gratuitous.
The Court of Appeals’ opinion rightly caused concern throughout the real estate community. In March, that opinion was overturned when the Supreme Court issued Steiner v. Thexton , Ca. Sup. Ct., 03-18-2010, 10 C.D.O.S. 3391, by which the Supreme Court held that the “Real Estate Purchase Contract” underlying the case was enforceable because Steiner’s efforts towards obtaining the parcel split “cured” the illusory nature of his initial promise to seek it. However, although Mr. Steiner now has an enforceable agreement, the Supreme Court’s decision left plenty for real estate professionals to be concerned about. Members of the real estate community should especially note the following:
- Sometimes a “Purchase Agreement” is really an option agreement. The Supreme Court made clear that a “purchase agreement” that includes a buyer right to terminate for any reason prior to expiration of a “contingency,” “due diligence,” “feasibility,” or “free look” period is really an option agreement.
- Option agreements are unenforceable unless consideration is given for the option. The Supreme Court affirmed that if the “purchase agreement” is really an option agreement then, like all option agreements, it will not be enforceable unless the optionee gave consideration for the option right. Therefore, if a buyer under a purchase agreement with a “free look” period didn’t give consideration for what the courts will treat as his option to purchase the property, the agreement will be unenforceable.
- Purchase deposits may not be consideration. The Supreme Court expressly declined to hold that Steiner’s deposit constituted consideration for the option, although it left open the possibility that it might have.
- Partial performance may be consideration. If the buyer confers a benefit on the seller that the seller bargained for but that the buyer did not effectively promise to confer, that benefit may constitute consideration for the option and transform an unenforceable agreement into an enforceable one.
In future agreements, if an owner and potential buyer desire to give the buyer a “free look” at the property during the feasibility period, then they should expressly provide in the agreement that the buyer is giving something in exchange for that “free look.” A buyer could undertake express feasibility performance obligations in exchange for the “free look.” However, those performance obligations could give rise to disputes about feasibility period performance, which both parties generally desire to avoid. It is therefore safer for the parties to instead provide that a portion of the purchase deposit or a separate deposit will be retained by the seller as consideration for the “free look” even if the buyer exercises its right to terminate the agreement.
Please note that the information contained in this newsletter is not intended to provide specific legal advice. You should consult with an attorney and not rely on any information contained herein regarding your specific situation.