March/April 2003
Specific Performance –
The Right Tool For The Right Job
By Barry MacNaughton
When real estate prices rise or fall rapidly, it is not at all uncommon for the buyer or seller in a real estate transaction to have second thoughts and try to cancel the transaction before closing. We now live in an era of rapidly escalating prices and, if some of the economic doomsayers are to be believed, we could soon find ourselves in an era of rapidly falling real estate prices. How does a buyer or seller compel the other party to complete a transaction when that party believes the underlying economic basis for that transaction no longer exists or will not exist when the escrow closes? The answer is a decree of specific performance. This is a powerful remedy, littered with hidden traps.
First, The Basics: Specific performance is a judicial decree which requires the recalcitrant party to perform under the written terms of a real estate purchase and sale contract. In other words, the buyer has to buy or the seller has to sell. In addition, since most real estate purchase and sale contracts contain an attorneys' fees clause, the prevailing party in a specific performance action can often recover the costs of requiring the other party to complete the transaction. The Court must determine that the consideration to be paid to the seller is fair and reasonable as of the time the parties entered into the contract, without considering subsequent events. Thus, while a judge has some limited discretion to adjust the purchase price, a specific performance action can require a seller to sell the property now worth $3,000,000 for the previously negotiated $2,000,000 price, or require a buyer to pay $3,000,000 for a property now worth $2,000,000. Given that it is usually 12 to 24 months from the time a transaction is cancelled to the time a specific performance action comes to trial, there can be a large spread between the negotiated price and the actual value of the property in question.
Now, The Traps: First and foremost, the party seeking specific performance must completely perform all required obligations under the contract. That performance obligation is excused only where the other party breaches the contract by nonperformance or gives unequivocal notice that it is canceling the transaction. For a buyer, that means you have to make all required escrow deposits on time, provide all required financial information, give all required assurances of an ability to perform, make all necessary inspections, obtain an unconditional written commitment from the financing lender (if there is to be one) and pay actual performance by tendering the purchase price at the time required. For a seller, that means making the property available for inspections, acquiring all necessary information to clear liens and encumbrances, and having the ability to transfer title at the close of escrow.
Most specific performance actions that fail do so because the party seeking to enforce the contract does not fully perform. It is easy to fall into the trap of not making the required escrow deposit, sending financial information, lining up the unconditional written commitment for financing or meeting other contractual requirements. After all, why should you tie up your money, time and effort when you know the other side is not willing to go through with the transaction? Similarly for sellers, why go through the time and hassle of making the property available for inspections, clearing title defects, getting payoff demands from lienholders and encumbrances when you know the buyer cannot or will not perform? The answer is simple. If you don't meet your contractual obligations, you can't enforce the other side's contractual obligations. You cannot have your cake and eat it too – you can't avoid your own expensive or inconvenient obligations and expect a Court to require the other party to perform its obligations.
Another trap is the requirement of almost immediate performance after a decree of specific performance is entered. In order to succeed on a specific performance claim, you have to convince a Court that you were capable of complete performance at the time required in the contract and that you remain capable at the time of trial. Part and parcel of that burden is acknowledging that a Court's general reaction will be to require you to make good on your claims of an ability to perform and to do so now, not 45 or 60 days after the judicial decree is entered. That means you may not get 45 or 60 days to make further inspections, you may not get time to negotiate repairs or changes (not that the seller is likely to entertain those negotiations after trial), and most importantly, you may not have time to secure financing. You must have all of these elements in place and an ability to perform immediately. For sellers, this means you need to be able to clear all liens and tender clear title right away. Sellers will not have time to negotiate mechanic's liens, short pays with lenders or any similar steps. A decree of specific performance requires immediate action – it is not a chance to open a new 60-day escrow.
Finally, a specific performance decree usually requires an accounting for the benefits and burdens of the property during the case. Theoretically, a specific performance decree tries to put the parties in the same position as if the transaction had closed on schedule. Thus, a buyer is entitled to all of the rents and profits the seller received during the case, and is entitled to recover any increased financing or consultation costs. The seller is entitled to a credit for taxes, insurance and maintenance costs paid, but not for voluntary improvements. Both parties should carefully document all income and expenses during the case.
These requirements must be taken into consideration when commencing a specific performance action. A buyer must be ready to perform at a moment's notice and be willing to take the property under changed market conditions for the purchase price. The buyer may be able to adjust that price based on evidence of necessary repairs or seller misrepresentations, but such items might have to be adjusted in a second lawsuit. A seller must be willing to sell the property for the agreed upon price almost without reference to market changes during the course of the case.
Specific performance is a powerful tool which can yield effective results, particularly for buyers in a rapidly appreciating market and sellers in a depreciating market. Any party seeking specific performance must go into the matter with eyes wide open and be willing to commit the time and resources necessary to fully perform even where the other side doesn't fully perform. Specific performance can be the essential tool for the right transaction. +
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If you have any questions regarding this bulletin, please contact Barry MacNaughton, Esq., at 310.281.6342 or bmacnaughton@ecjlaw.com. If you would like a copy of this publication sent to you directly, or if you would like to reprint this article, please contact Cynthia S. Kaiser at 310.281.6328 or ckaiser@ecjlaw.com.
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