This article was originally published in the New York Law Journal.
by Victor M. Metsch and Stephen W. O’Connell
The perils
Two recent decisions by Courts inKingsCountyandSuffolkCounty, published just days apart, remind us that mortgage contingency clauses in residential contracts of sale require meticulous drafting by counsel, informed understanding and approval by prospective purchasers, and literal compliance in order to avoid forfeiture of the often substantial down payment.
In one action, the buyer lost her deposit. And, in the other proceeding, the down payment was returned. Both decisions turned on the reciprocal obligations of the parties to a contract to be completely candid with each other during the contract negotiation process, on the one hand, and to keep each other fully informed of all material subsequent events after the agreement is signed, on the other.
In Meadus v. Rosenthal, 2010 NY Slip Op 51939 (U) [Civ. Ct. Kings Co. 11/5/2010] (Chan, J.) the Court directed the escrow agent to deliver a $20,000 deposit to the seller. In Nambiar v. Alexander, 2010 NY Slip Op 20456 [County Ct. Suff.Co. 11/9/2010] (Tarantino, J.), the Court ordered the return of a $61,050 down payment to the buyer. Both cases were contract and fact specific, and the outcomes were based on developments after the agreements were signed.
Delay and Deceit Lead to Loss
In Meadus, the plaintiff delivered a $20,000 deposit against the $390,000 purchase price. The buyer undertook to apply for a conventional 15-year mortgage of $190,000 at the prevailing interest rate; had 30 days to obtain a mortgage commitment; and agreed to furnish the sellers with verifications or reports pertaining to the applications. The contract of sale contemplated a closing on November 16, 2009. [The sellers had a binder to purchase another house contingent on the sale of their existing residence.]
The purchaser applied for the appropriate mortgage; the appraisal valued the property at only $385,000; the contract of sale was amended to reduce the purchase price to the appraised value; and the closing date was extended.
The lender subsequently denied the plaintiff’s application for a loan based upon delinquent credit obligations and a prior unacceptable mortgage payment history. The buyer did not inform the sellers of the denial; and, instead, applied for an FHA mortgage in the amount of $309,000. The purchaser thereafter received a commitment for an FHA loan.
The sellers then sought to schedule a closing, only to learn the FHA mortgage loan commitment was revoked due to the buyer’s insufficient income. The contract vendors asserted that the buyer had violated the contract by applying for an excessive loan at a non-prevailing rate. The sellers also contended that the buyer acted in bad faith, when they were induced to extend the closing date, by reason of the purchaser’s failure to disclose the reason why the original loan application was denied. Plaintiff asserted that she acted in good faith by making two loan applications and that she was entitled to return of the deposit.
The Court in Meadus noted that “[e]very contract contains an implied obligation by each party to deal fairly with the other and to eschew actions that would deprive the other party of the fruits of the agreement[.]” The Court found that the buyer’s failure to provide the sellers with the reports of the denial of the initial loan application constituted a willful default that triggered the liquidated damages provision of the contract of sale: “[S]ince plaintiff failed to perform a material term of the contract by withholding information pertinent to her mortgage, and thereby causing defendants to extend the closing date, defendants may retain the down payment as liquidated damages.”
The Court also rejected the plaintiff’s argument that defendants waived their claim to return of the deposit because they knew about, and cooperated with the subsequent FHA loan application. Not only was the second application a violation of the terms of the contract of sale, but the sellers had been duped into extending the original closing date.
Candor and Dispatch Lead to Victory
In Nambiar, the purchase price was $1,221,000 and the down payment was $61,050. The purchasers did not know, at the time the contract of sale was signed, that the property was in foreclosure.
The purchaser/wife, a physician, had left her old position before the contract was signed; and was to begin a new job a month after the agreement was executed. According to the Court: “The Purchasers impressed upon the Sellers their urgency to move into the premises by September 1, 2005, both for the start of the wife’s new position, and for [their special needs] child to begin [classes] in the new school district.”
The mortgage contingency clause in the contract allowed the buyers 30 days [and the Rider inconsistently allowed 45 days] after receipt of a fully executed contract to obtain a commitment from an institutional lender for a $975,000 loan for a 30 year term at a prevailing rate.
After signing the contract, the purchasers ordered a title search and began the mortgage application process. The wife disclosed that she was unemployed at the time of the application; and also informed the lender of her prospective new employment income. A preliminary title report reflected the foreclosure action against the premises.
The closing was delayed while the sellers obtained payoff letters from the foreclosing lender. In the meantime, the wife started her new job and commuted 100 miles a day fromOrangeCountytoLong Island. However, as the Court found, “overall the commuting interfered with her new position and she was terminated about the second week of September, 2005.” As a result, the prospective mortgage lender denied the loan application because “income [was] insufficient for the credit requested.” [The wife obtained a new job in December 2005 and the plaintiffs purchased another home through the same lender in June 2006.]
The Court in Nambiar noted that “[t]his case reflects the pitfalls when parties enter into an agreement which is impacted by too many outside influences.” The foreclosure. The foreclosing lender. The new job. The new school year. The need for possession. A fast track 30-day closing. The drawn-out mortgage application process.
The Court found in favor of the purchasers and directed a return of the deposit. According to the Court, the “Purchasers were prompt in their actions, and acted in good faith.” The mortgage application “was for a proper mortgage amount.” And the potential financing source was “an institutional lender.”
In marked contrast, while the seller was not prohibited from selling the property before a foreclosure sale extinguished the equity of redemption, the Court opined that “the Seller had an affirmative duty to disclose to the Purchaser that the property was in foreclosure.” The contract vendors’ representation in the contract of sale that the “Seller… has the full right, power and authority to sell, convey and transfer [the Premises] in accordance with the terms of this contract” implied that “he ha[d] clean title which surely [was] clouded by the foreclosure action.”
The Court also found that denial of the mortgage application, based upon insufficient income, was not the result of “any intentional act by the Purchasers to undermine the mortgage.”
Lessons Learned
When representing the seller:
* Ask the prospective purchaser to produce written pre-approval from a reputable lender. At least your client will be assured that the buyer has the income and means to obtain financing.
* Ask for a representation in the contract of sale that credit has not been denied and that there are no actions, judgments or liens pending or threatened against the buyer that may result in the denial of credit.
* Do not grant extensions of time to obtain financing without documented proof that that the application process is proceeding.
* Docket and follow-up all significant dates (time to make mortgage applications; last day to obtain a commitment, etc.)
* Keep in regular and routine contact with the buyer’s attorney: avoid last minute surprises.
* Carefully document all extensions of time (e.g. reason for extension; requested by buyer; representation of status of mortgage application; no further extensions, etc.)
When representing the buyer:
* Have your client obtain written pre-approval from a reputable lender.
* Determine the anticipated timetable for the mortgage application process from the prospective lender; and coordinate that timetable with cut-off dates in the contract.
* Insure that the mortgage contingency clause covers uncontrollable events; death; disability; loss of employment.
* Protect your client against intervening lender related events ( e.g. if lender is seized, files for bankruptcy or otherwise goes out of business between commitment and closing).
* Docket and anticipate all significant dates (time to make mortgage applications; last day to obtain a commitment, etc.)
* Periodically check with your client on the status of the mortgage application.
* Act promptly and in “good faith” — keep in touch with the seller’s attorney; and avoid last minute requests for extensions of time.
* Carefully document all extensions of time.
* Keep the seller’s attorney contemporaneously, truthfully and completely informed.
Final Notes
The purchase and sale of a home should be a collaborative and not an adversarial process. The buyer and the seller have a commonality and community of interest. That mutuality of interest is best served by complete candor and disclosure, at the outset, and regular communication and progress reports, after the contract of sale is signed.
The parties should keep each other informed, on a current basis, of any developments that may require a postponement of the closing. For example, the buyer should immediately report any matters that impact the mortgage application process (e.g., delay in obtaining an appraisal or updated survey; confirmations of prior employment, etc,). And, for example, the seller should reciprocally and promptly inform the buyer of any circumstances that may affect insurability of title (e.g., obtaining payoff letters from lenders; securing releases of liens, etc.).
Regular inquiries by the seller and routine status reports by the buyer are the surest way to avoid last minute surprises, emergencies, disputes — and litigation.
Victor M. Metsch and Stephen W. O’Connell are, respectively, Senior Litigation and Real Estate Partners at Hartman & Craven, LLP.