It doesn’t happen often, but when it does, it can cause a seller and buyer big headaches.
We’re talking about damage done to a property after a contract is signed but prior to closing.
Perhaps the moving company broke the stair spindles when they were carrying the seller’s large dresser down. Or maybe there was a small kitchen fire -- or worse, damage from a major storm. Or perchance a final walkthrough prior to closing revealed damage that wasn’t noticeable when the house was full of the seller’s belongings.
Most standard state and local contracts address this issue. Unfortunately, says National Association of Realtors’ (NAR) General Counsel Katie Johnson, all contracts are different in how they handle the situation. The next steps depend on the language of your specific deal.
In Florida, according to Meredith Caruso of state trade association Florida Realtors, standard contracts contain a risk-of-loss clause which states that if the cost of restoration does not exceed 1.5 percent of the purchase price, the seller must restore the property and closing should proceed as per the contract.
If the cost of repairs exceeds 1.5 percent of the price, then the buyer has the choice of taking the property as-is along with a 1.5 percent reduction in price, or having their deposit returned. If they take the latter option, all parties are released from the contract.
In Colorado, on the other hand, the standard contract says the seller is liable for the repair or replacement of the damage with items of similar size, age and quality. Either that, or the seller can offer the buyer an equivalent credit. If the work is not finished on or before closing, the buyer has the right to terminate the deal or take a credit, not exceeding the purchase price, for the cost.
These are known as force majeure clauses, provisions in the contract that allow a party to suspend or terminate their obligations when certain circumstances beyond their control arise, making performance inadvisable, illegal or impossible.
Sometimes a list of possible events is included with these clauses: war, riots, fire, flood, hurricane, typhoon, earthquake, lightning, explosion, strikes, lockouts, slowdowns and government acts that prohibit or impede any party from performing their respective obligations under the contract.
Both buyers and sellers would be wise to look for a force majeure clause in the contract they are signing, NAR’s Johnson advises. It may or may not be labeled as such -- in the Florida contract, it’s called “risk of loss”; in Colorado, “damages, inclusions and services”; in Texas, “casualty loss” -- but it’s important to find it.
If it’s not there, the attorney suggests, you should negotiate up-front how these situations should be handled and include the agreed-upon details in the contract. In the absence of such an agreement, you’ll be left to the mercy of narrow common-law contract doctrines, which often leave one party or the other highly dissatisfied.
Your state’s Uniform Vendor and Purchaser Risk Act may also come into play, according to Johnson. These laws spell out who bears the risk for damages: the buyer, the seller or both, and at what percentage.
Of course, you can always renegotiate after the fact. Remember, everything in real estate is negotiable, right up until the moment you sign your name on all those documents at closing.
A force majeure clause should address a list of events the buyer and seller want covered, what happens when an event occurs, which party can suspend performance, and what happens if a listed event continues outside a specific time frame.
If the air conditioning fails, the seller should be responsible since they still own the property, says Patricia Beck of RE/MAX Properties in Colorado Springs. But if the house is damaged by flood or fire, the parties might want to make the buyer obligated to close if the damage is less than, say, 10 percent of the purchase price. If they want to bail despite such a clause, they could lose their earnest money deposit.
If the damage is greater and repairs cannot be made promptly, the buyer should be able to terminate the deal, Beck adds. But if they decide to proceed, the seller should be required to transfer any insurance proceeds to the buyer at closing.
Unfortunately, not every event can be foreseen. Take this possibility described by Dale Ross of the Dale Ross Realty Group in Katy, Texas:
If the house floods for any reason -- broken pipe, failed water heater or rising water -- and the insurance claim is substantial, the house might fall into a high-risk insurance situation. That means the buyer might have to pay up to four times the normal amount for homeowner’s insurance “for about two years or until the insurance policy returns to a normal price,” Ross says.
This fact alone could cause a buyer to want to back out. So could a reappraisal by the buyer’s mortgage company, if not because of a possible delay in closing, then because the new value ascribed to the house is so much lower than the original appraisal that the lender will no longer be willing to finance the place.
No financing, no deal.