Daily Development for
Monday, November 23, 1998

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

VENDOR/PURCHASER; CONDITIONS; FINANCING CONTINGENCY: Unless the contract provides otherwise, failure of a mortgage lender to actually fund the mortgage loan is not a basis upon which a buyer can terminate a purchase contract by reason of failure to obtain a mortgage commitment.

Malus v. Hager, 312 N.J. Super. 483, 712 A.2d 238 (App. Div. 1998).

A residential real estate contract contained a mortgage contingency provision which gave the buyers the opportunity to terminate the contract if they failed to obtain a mortgage commitment. To do so, the buyers were required to give notice to the seller within a given time. The buyers obtained a mortgage commitment within the specified period and a closing was scheduled.

Four days before closing, the employment of one of the buyers was terminated. The next day, the sellers, unaware of this development and expecting to close a few days later, moved out of their home and placed their belongings in storage until they were able to complete their own relocation.

Unfortunately, under the terms of the mortgage commitment, the lender reserved the right to cancel the commitment "if prior to funding, your financial condition or employment status adversely changes... ." Based upon the buyer's loss of employment, the lender exercised its right and declined to fund the mortgage.

The buyers sought return of their deposit, but the sellers refused to return the money. The buyers relied on an earlier trial court level case which, under similar circumstances, required that the deposit be returned to the buyer.

Here, however, the Appellate Division disagreed with the trial court and with an earlier Appellate Division case, which had held that the mortgage contingency clause means that not only the mortgage commitment, but also the availability at closing of the mortgage proceeds together constitute the condition precedent to the purchaser's obligation."

According to the instant appeals court, to permit this construction would be to place the parties in an intolerable state of limbo until the closing is finally consummated. The court believed that, after a certain point, a contract of sale for a home should be an enforceable agreement. Further, confusion and uncertainty can only result from extending the mortgage contingency clause to the date of closing, as a matter of law.

The appeals court observed: "If the parties wish to provide in their contract for an eventuality such as this, they are free to do so. We decline, however, to impose the risk of an otherwise firm deal unraveling upon an unknowing and blameless seller, leaving him with no ability to recoup his increased expenses."

Comment 1: Although undoubtedly this is a point as to which many would disagree, the editor is inclined to view the mortgage contingency clause as a true "mortgage contingency," designed to operate when a mortgage cannot be had. So long as to buyer applies for a mortgage and continues to cooperate with the mortgagee in good faith, the buyer should be excused from performance if the mortgage is not available, whether due to failure or fraud of the mortgagee or mortgagee's exercise of contingencies to loan that are standard and known to or reasonably to be anticiapted by both buyer and seller. That construction certainly was available to the court here, as the very title of the form contract read as follows: "If performance by buyer is contingent upon obtaining a mortgage."

It is true that here, as is common in these broker supplied agreements, there was an express period of time within which the buyer was supposed to assert the financing contingency, but the fact of the matter is that mortgages are never really committed until the last second. Sometimes circumstances change in ways that are beyond the control of the parties but give the mortgagee an "out."

Further, mortgagees may fail to meet their commitments. Where, through no fault of the borrower, the mortgagee doesn't fund the loan, the contract should be avoided. Brokers are reluctant to encourage the drafting of contracts in this way because such contracts are not "closing oriented," and brokers are so oriented. So we might expect that the standard forms that brokers virtually require to be used in most residential transactions will not give the buyer much leeway here. But the courts should step in and recognize that we have consumer instruments as to which, for the most part, there is little real understanding on the part of either side, and give these documents readings consistent with fairness.

Comment 2: The editor is cognizant of the fact that the seller will get burned when buyer's mortgagee pulls out, because seller will have relied upon the buyer's mortgage being funded in order to make seller's own deal in buying a new house. But excusing the buyer from performance doesn't really solve the seller's problems anyway. Typically the primary consequence to the buyer is forfeiture of the earnest money, and if the seller has committed elsewhere, this won't really help the seller to close on his new property. In fact, if the seller's new mortgagee is informed that the seller hasn't completed the closing on the seller's old property, the seller's mortgagee may also refuse to fund!!!

In short, as a practical matter, when unforeseen circumstances prevent a critical mortgage from being funded, the whole house of cards comes down. It's no one's fault, really, and it doesn't happen that often. In residential deals where the parties are effectively unrepresented, the documents should not be read to penalize the buyer for the unforeseeable and unpreventable.

Comment 3: Of course, the editor feels quite differently about commercial contracts generally and about residential contracts where the buyer has counsel and there is the opportunity to bargain. But the latter situation is very rare in most parts of America today. Usually both buyer and seller are delivered to a contractual relationship devised for them by others to a uniform standard as to which they have little detailed understanding or power to alter.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 16, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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