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Buyers Can No Longer Rely on a 'Free Look' at Property

By Terri Molinaro, Esq.

They say there's no such thing as a free lunch. Well, there's also no such thing as a "free look" any more. In the past, standard purchase and sale agreements have given a buyer the right to evaluate a property at no risk before the buyer's deposit money "goes hard." A recent case may change that, and if you want to evaluate a property before committing to purchase it, then you must pay for the right to purchase it in the future or the seller may be able to terminate the contract before you are ready.

The California Court of Appeals recently held that a real estate purchase contract must be construed as an option contract when (i) the seller is required to sell property to a buyer at a stated price for an undefined period, and (ii) the buyer retains the absolute and sole discretion to walk away from the deal without paying the seller a cent. In Steiner v Thexton (2008), 163 Cal. App. 4th 359, the Court made clear that unless and until the buyer pays the seller some non-refundable amount for the right to purchase the property in the future, the contract will be void. In those circumstances, the law treats the contract like an "open offer" that has not been accepted, giving the seller the right to terminate the transaction at any point before the buyer commits to purchase the property, even if the buyer has already spent thousands of dollars on investigating the property.

Steiner, a real estate developer, was interested in buying and developing a 10 acre portion of Thexton's 12.29 acre parcel. For him to do so, the county would have to approve a parcel split and issue development permits. In September of 2003, Steiner prepared an agreement to purchase the 10 acre parcel. The agreement authorized Steiner to pursue, at Steiner's sole cost and expense, the county approvals and permits; however, Steiner was not obligated to do anything, and he retained the "absolute and sole discretion" to elect not to continue in the transaction. Upon execution of the contract, Steiner deposited $1,000 into escrow (to be applied toward the purchase price), and thereafter spent approximately $60,000 in pursuing the necessary approvals and permits.

Thirteen months later, Thexton asked the title company to cancel the escrow. In response, Steiner filed a lawsuit seeking to enforce the contract. The trial court held that the "contract is unenforceable against [Thexton] because it is, in effect, an option that is not supported by consideration. There was no evidence that any money was paid directly to [Thexton] for his grant of the option to purchase the property, or that [Thexton] received any other benefit or thing of value in exchange for the option." Because the $1,000 deposit was to be applied to the purchase price (and would not to be retained by Thexton if the contract was terminated), it did not qualify as consideration. Further, the Court ruled that the $60,000 spent by Steiner in pursuing approvals was not consideration, because Steiner had to pay only if he went forward seeking the county approvals, and the agreement did not require him to move forward.

Since many buyers want to retain the right to cancel a transaction if they determine that the property is undesirable for one reason or another, it is critical that the agreement be drafted correctly to avoid Steiner's fate. One solution would be for the buyer to make a small nonrefundable payment for the right to purchase. Because many form agreements do not address this nuance, it may be time to review your files and make appropriate updates to your transaction documents.

NOTE: A petition for review has been granted by the California Supreme Court for Steiner v Thexton; the outcome of which may change the foregoing analysis.

The above article is provided for informational purposes only. It is not legal advice, nor does it create an attorney-client or any other relationship. You should always contact an attorney for legal advice applicable to your particular situation.