Daily Development for
Tuesday, March 25, 1997

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

VENDOR/PURCHASER; BUYER'S DEFENSES; FRUSTRATION OF PURPOSE: Doctrine of commercial frustration does not excuse purchaser of real estate from performing under sales contract when purchaser enters contract for purpose of developing business park and subsequent county regulations prevent such use.

Felt v. McCarthy, 922 P.2d 90 (Wash. 1996).

The purchasers initially obtained a purchase option on a parcel of real estate which they planned to develop as a business park. The vendors agreed to help get the parcel rezoned for this use. But purchasers' rezoning efforts were dismissed without prejudice because the purchasers owned only a small proportion of the property that was the subject of the rezoning efforts. The purchasers nonetheless purchased the parcel, giving an unsecured promissory note to the vendors, assuming an old mortgage on the property, and giving a promissory note, secured by a trust deed on the property, to a third party. (This third party note was later foreclosed in the midst of the events here, but this foreclosure was not a factor in the court's holding.) Subsequently, the county in which the property was located adopted wetland protection regulations making the parcel suitable for use only as open space or a single homesite. The purchasers then defaulted on the note held by the vendors, and the vendors brought suit. The purchasers claimed commercial frustration, and the trial court and court of appeals both granted summary judgment.

The Supreme Court of Washington affirmed, relying on Restatement (Second) of Contracts section 265 (1979) and holding that for the doctrine of commercial frustration to apply, the contract must have been entered into by both parties on the basis of a purpose that later was frustrated. It is not enough that one party to the contract simply knows of the other party's purpose in entering the contract. Both parties must share that purpose. In the words of the Restatement:

"The object must be so completely the basis of the contract that, as both parties understand, without it the transaction would make little sense. Second, the frustration must be substantial. It is not enough that the transaction has become less profitable for the affected party or even that he will sustain a loss. The frustration must be so severe that it is not fairly to be regarded as within the risks that he assumed under the contract. . . . [T]he non-occurrence of the frustrating event must have been a basic assumption on which the contract was made."

Thus, even assuming that the property had become impossible to develop and had dropped in value by 80%, the buyers had assumed the risk in this case, since all parties were fully aware of the zoning problems at the time the property was sold.

The court goes on to conclude that even if the sellers had shared in the assumption the business park would be successful, buyers' frustration was not "substantial" as required by section 265, comment a. Buyer's claim of frustration rested on the property's alleged drop in value from $310,000 to $50,000. However, the court stated, a decline in market value is not sufficient in and of itself to support a finding of frustration.

There were several concurrences. The most interesting was that of Judge Sanders, who would have found frustration, but would have upheld the lower court on entirely separate grounds.

On the frustration point, Justice Sanders points out that the real cause of the reduction in value was the new federal activity concerning wetlands. The zoning problems in existence at the time of contract were not the cause of the buyer's undoing. In fact, the concurrence maintains, both parties appeared to expect that these problems would be resolved, as they had been with other properties in the neighborhood. With regard to the wetlands regulations, the concurring judge noted that neither the seller nor the buyer, (a lawyer who incidentially argued the case on appeal) could have foreseen the problem:

"McCarthy may have been a skilled land use lawyer, but clairvoyance about future governmental actions is beyond any mortal."

But Judge Sanders nevertheless would not have permitted commercial frustration as a defense because the contract to which the doctrine was sought to be applied had already been fully executed. There was only an unsecured note outstanding, and the obligation to perform on this note was not in law part of the original contract, but rather a separate payment obligation.

Comment: The outcome of the case, of course, is easy to understand. As between a retired rural couple and a land use lawyer/developer who drafts the contracts, it seems appropriate for the risk of changes in land use regulation to fall upon the buyer/lawyer. But we should keep in mind that the appeals court is in control of the recitation of facts. Obviously the buyer felt that the sellers were "plugged in" to the overall scheme.

In general, the frustration of purpose doctrine should be narrowly applied when it comes to changes in land use. Where the parties close without achieving necessary land use changes, it seems quite apparent that future developments affecting the public land use decisions are a risk of the= buyer.

Also, isn't the point made by Judge Sanders correct? The buyer would have had no excuse at all if he had paid cash. Why does the substitution of a note for case make a difference?

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