DIRT  Development for Monday, March 16, 2009
by: Ira Meislik
Meislik and Meislik
Montclair, New Jersey

General Editor: Patrick A. Randolph, Jr.

VENDOR/PURCHASER; ATTORNEY’S REVIEW CLAUSE:  Where a broker prepared form contract for the purchase of real property expressly allows its termination if the attorney for either the seller and buyer disapproves of the contract within some time period, a party’s attorney is not bound by the covenant of good faith and fair dealing when making his or her decision.

Moran v. Erk, 11 N.Y.3d 452, 901 N.E.2d 187 (New York 2008)

A contract for the purchase of residential real estate was expressly “contingent upon approval by attorneys for seller and purchaser by the third business day following each party’s attorney’s receipt of a copy of the fully executed contract (the “Approval Period”).  … If either party’s attorney disapproves this Contract before the end of the Approval Period, it is void and the entire deposit shall be returned.”  The contract and the rider (which contained that language) were form documents copyrighted and approved by both a regional association of real estate brokers and the local county bar association.

Right after signing the contract, the buyers developed qualms and ultimately decided to buy a different house.  They instructed their attorney to disapprove the contract, and their attorney did so within the required three-day period.  The lawsuit that followed reached the New York Court of Appeals, its highest court.  Immediately, that court recognized that this type of attorney approval contingency was routinely included in real estate contracts in New York State.  Citing various lower court decisions, it pointed out that “[r]equiring a real estate contract to be ‘subject to’ or ‘contingent upon’ the approval of attorneys for both contracting parties ensures that real estate brokers avoid the unauthorized practice of law …, and allows both contracting parties to have agents representing their respective legal interests … .”  The Court pointed out that the contract’s language meant what it said: “no vested rights are created by the contract prior to the expiration of the continge

ncy period.” 

The sellers argued that the contract “created an implied limitation upon an attorney’s discretion to approve or disapprove the contract.”  In making its argument, the seller contended, and both the lower court and the intermediate appellate court agreed, “that the implied covenant of good faith and fair dealing implicitly limits an attorney’s ability to approve or disapprove a real estate contract pursuant to an attorney approval contingency period.”  The Court of Appeals rejected this argument as misconstruing “the implied covenant of good faith and fair dealing under New York law.”

According to the Court of Appeals, “[t]he implied covenant of good faith and fair dealing between parties to a contract embraces a pledge that ‘neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.”  So, the Court of Appeals was not troubled because it held that “the plain language of the contract in this case [made] clear that any ‘fruits’ of the contract were contingent on attorney approval, and that any reasonable person in the [seller’s] position should have understood.”  In New York, the covenant encompasses only “promises which a reasonable person in the position of the promisee would be justified in understanding were included.”

Most importantly, the Court of Appeals relied on the principle that “[c]larity and predictability are particularly important in the interpretation of contracts.”  Consequently, it refused to read “a bad faith exception into an attorney approval contingency” because this would be a “novel notion … entirely dependent on the subjective equitable variations of different Judges and courts instead of the objective, reliable, predictable and relatively definitive rules” of plain text contractual language.  What was also of concern was that the disapproving attorney was subpoenaed to testify about communications, and that disclosure of those communications might be detrimental to the attorney-client privilege.

With all of that in mind, the Court of Appeals held that “where a real estate contract contains an attorney approval contingency providing that the contract is ‘subject to’ or ‘contingent upon’ attorney approval within a specified time period and no further limitations on approval appear in the contract’s language, an attorney for either party may timely disapprove the contract for any reason or for no stated reason.”

Comment 1: This approach to balancing the market’s need or desire to allow real estate brokers to have parties quickly sign contracts, but allow either a borrower or seller to then get an attorney’s advice, probably began in the settlement of an “unauthorized practice of law” attack by the New Jersey bar against the real estate broker community.  That resulted in a New Jersey Supreme Court “consent” order of the settlement between the brokers and the attorneys.  In 1981, the New Jersey State Bar Association sued the New Jersey Association of Realtor Boards, and the “three day attorney review provision” was adopted by settlement of that suit in 1983.  The Supreme Court approved the settlement.  See N.J. State Bar Association v. N.J. Association of Realtor Boards, 93 N.J. 447 (1983).  The Settlement was augmented by the adoption of an administrative regulation: N.J.A.C. 11:5-6.2.

Comment 2: A personal observation – the system has worked pretty well.  Its utility from 1983 until at least 2008 probably supports the argument that the “attorney review clause” is not one of the 1,000 or more myriad claimed reasons for the current economic turmoil.  Please avoid attacking the editor over “how it kills deals.”  First, there is no evidence that it does.  Second, all of those arguments have disappeared in New Jersey.  The marketplace seems to have adjusted.

Comment 3:  Basically, the attorney review clause is best understood as saying that a party’s attorney, following the notice rules strictly, and serving notice within the tight (3-  business day timeline follow receipt of the contract by each side) may terminate the contract for any reason or no reason at all.  Giving a reason only leads to trouble.  Long ago, New Jersey case law accepted the reality that a party may have told its attorney – “I want out.”  Basically, the courts have said that such a discussion between a party and its attorney involves the express or implicit giving of advice.

Comment 4:  New Jersey case law teaches that attorneys aren’t always careful about giving notices.  The courts has been pretty “bright-lined” about this.  The New Jersey “official” version requires notice to the broker and the other party and that it be sent by certified mail, by telegram or by delivering it personally.  Send the notice by fax alone has been ruled insufficient without regard as to whether the fax was received.  The most recent case saying that did, however, have issues about whether it was received, but the court there essentially wrote that it didn’t matter.  In doing so, it said that fax was not the functional equivalent of the now outdated “telegram.”

Comment 5: In the history of the attorney review clause in New Jersey (the editor remaining cognizant that the reported case was a New York case), the courts have not been stupid.  In one case, it wouldn’t allow an attorney to disapprove a contract when the same attorney had negotiated changes to the contract even before it was signed.  These are not the words of that case, but it was “one bite of the apple only.”

Comment 6:  It is common practice for opposing attorneys to agree to extend the time period for disapproval, often somewhat casually, but almost always with a clear agreement.

Comment 7:  Now as to this case.  In our view, the New York Court of Appeals has a good understanding of the implied covenant of good faith and fair dealing.  Parties are not expected to exercise an otherwise perfectly good and expressed contract right in a way that is contrary to what was a valid and understood expectation of the other party at the time of signing.  Here, the court is saying that each party knew and expected that the contract was contingent on a successful attorney review period.  What it didn’t say, and what it probably knew intuitively, was that the contract would be no more than three business days old and that isn’t a long enough period of time for a party to complain that the other side exercised a “right of rescission.”  That such a right might be abused didn’t outweigh the benefit of allowing brokers to prepare contracts, even though not licensed attorneys, but doing so in a final way so that a party to that contract could get legal advise if it chose to d

o so.

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