In a correcting market, speculative buyers often find themselves caught between expectations and reality. Harpreet Hans explores the consequences of defaulting on a purchase agreement
Many of us have seen buyers line up for hours to purchase a property from a builder they have researched for months. The buyers pre-register with the builder; examine models, layouts, prices and location; and come armed to purchase. In the case of many freehold properties, buyers are required to purchase firm, without financing and lawyer review conditions. Once you sign on the dotted line, there’s no turning back – unless you’re prepared to deal with some serious consequences.
Entering into an Agreement of Purchase and Sale is, quite simply, entering into a firm and binding contract. The purchase price, dates and terms of the purchase are clearly set out. The buyer is required to purchase the property from the seller at the price set in the agreement on the date set for closing. Any failure to complete the transaction, aside from the seller’s failure to deliver a clear title or the home in the same state as purchased, is generally considered a default.
Splashed in the news recently have been desperate requests from several homebuyers for financial assistance in fulfilling their contracts, either via price reductions from builders or government loans. These homebuyers typically have purchased newly built homes at set prices. Due to a decline in market prices over the past year, the same homes are sometimes being sold by builders at lower prices. Comparable resale homes are also being sold at lower prices.
The newly built homes, therefore, are not likely to be appraised by banks at the same value as the purchase price. Buyers will then be required to pay the difference between the sale price and the bank-appraised value, along with the down payment on the appraised value. This is often a truly dire setback, placing buyers in a situation that is not at all financially feasible.
Builders, even sympathetic ones, are generally unwilling to renegotiate the prices on firm contracts. In my experience with various new-construction builders, they have been firm in their argument that they rely on the purchase price to enter into subsequent trade contracts and cannot renegotiate at a later stage. They essentially take the view that a contract is a contract. When buyers enter into contracts below market value and make a profit at the time of closing, the gain is not shared with the builder. Likewise, the loss shouldn’t be shared either.
What happens if you don’t close?
There is no exit clause in a firm Agreement of Purchase and Sale. The first consequence of default is forfeiture of the deposit. The deposit is a payment made in good faith to secure the performance of the contract.
Failure to close the transaction results in immediate forfeiture of the deposit.
For builders, who hold the deposit in their lawyer’s trust accounts, the contract allows them immediate access to the forfeited deposit. For resale sellers, the deposit is typically held in a real estate brokerage’s trust account. These funds remain in the brokerage’s trust account until a mutual release or court order is provided, allowing for the release of the funds. In either case, buyers aren’t likely to see their deposit returned in these times of declining market prices.
The second consequence is the threat of being sued for any consequential damages associated with failing to close. For example, if the seller (builder or resale) incurs a loss by having to relist the property for sale, sell the home for a lower price due to declining market prices, carry the home for a few more months, expend legal fees, etc., the seller can sue the buyer for the loss. The deposit offsets the amount of the loss, but it is unlikely to be sufficient to fully absorb it.
In a recent case before the Ontario Superior Court, buyers defaulted on an Agreement of Purchase and Sale, leaving the sellers with extreme financial damages after forcing them to resell their home for a lower value in line with lower market prices. The court decided wholeheartedly in favour of the sellers and awarded them $470,000.
The follow-up question from clients is inevitably, “How likely is it that I will be sued?” As much as I would love to provide a statistic to my clients, it’s an impossible calculation to make. A seller’s analysis of the pros and cons is based on the individual case. Some sellers will sue for a $5,000 loss, while others wouldn’t bother to sue for a $100,000 loss. The analysis will weigh a
number of factors, including:
- costs of litigation
- stress of litigation
- health and age of the seller
- financial status of the seller
- assets owned by the buyer
- quantum of the losses
The life lesson is simple: Regardless of whether your market is rallying or in decline, you are required to honour your contract to purchase.
Harpreet Hans is a partner with Gunding & Hans LLP in Milton, Ontario. She practices exclusively and extensively in the area of real estate law and mortgages.