Homebuilder Contract Risks
By: Robert Nagle
In an economic environment where new home sales are at significant lows compared to their heyday just a few years ago, and home builder confidence has just hit a 9 month low, it is surprising to me that home builders continue to put forward strongly seller-oriented contracts. These home builders seem willing to let a deal go before agreeing to anything but the most routine changes. A real estate agent who represents a buyer may be well-advised to urge him to retain legal counsel to review the risks involved with a home builder contract; otherwise the client may end up assuming significant risk without understanding the implications of the contract he has signed. This article touches on 10 general items of concern:
1. Earnest Money should only be held by the title insurance company and NOT by the home builder. There are still many circumstances whereby the Seller could fail to perform. If so, the Buyer may be looking at an uphill battle in getting his money back, which oftentimes is a sum that is disproportionate to the actual damages that a home builder actually incurs. Also, especially in today’s economic times, the builder might spend the money before closing and there is no guaranty that he will not have gone out of business before the closing.
2. Even if the contract provides that the Buyer has the right to terminate, home builder contracts may provide that a portion of the Earnest Money nonetheless gets to be retained by the home builder.
3. With respect to the mortgage loan contingency, make sure that the Buyer as well as the home builder is able to approve the loan terms. In addition, watch out for hidden costs such as language that states that if Buyer determines to select a different lender later in time, Seller has right to cancel all incentives, all earnest money gets forfeited to Seller, and Buyer has to put up additional earnest money.
4. The ADRE Buyer Advisory instructs Buyers as to the importance of reviewing all documents encumbering title, so make sure the builder’s contract provides the Buyer with a title review contingency period.
5. It is customary in Arizona for the parties to split escrow fees and for the seller to pay for title insurance. Watch out for the builder shifting these costs to Buyer.
6. Be wary of self-serving language in the contract such as: (i) Seller is free to re-orient the house without Buyer’s approval; (ii) Seller is free to deviate from the approved plans without in all circumstances requiring Buyer consent; and (iii) there’s no “changing one’s mind” if a change order is requested but the added cost is too high.
7. Be careful to look for time periods and other obligations as “binding” on buyer even when the builder hasn’t signed the contract.
8. These contracts often provide that if the builder alleges that Buyer has defaulted, there is no obligation for the builder to notify Buyer of the default in writing nor an opportunity to cure the default. Further, these contracts usually provide that Seller’s remedy against a defaulting Buyer is not limited to keeping the earnest money (such a limitation is referred to as “ liquidated damages”); rather, Seller frequently can pursue recovery of its actual damages.
9. Buyers need additional remedies to protect against a builder default beyond specific performance or getting back the earnest money. Buyers will have expended significant time and expenses on this home and just getting their deposit back does not make them “whole.”
10. Look out for unreasonable limitations on resale coupled with extraordinarily high liquidated damages amounts in the event of a violation.
Interestingly, a home builder I recently worked with justified the builder’s recalcitrance as follows: “As you realize this contract was written by attorneys hired by [home builder] to protect the builder’s interests. It was approved by the Arizona Department of Real Estate. We would really like to build [your client] … a home but you would need to agree to the terms and conditions as written in the purchase contract.”
In the current environment where home builders are anxious to sell homes, this kind of an attitude is unacceptable and buyers should at least be made aware of the unconscionable provisions in many of these contracts.
Nagle Law Group’s experienced residential real estate team has been practicing real estate law for over 20 years. Robert Nagle is a partner with Nagle Law Group, focusing on residential transactional matters, and can be reached at 602-595-3156 or firstname.lastname@example.org.