What Happens When A Buyer Doesn’t Close?
Really? Is that where we are in this market?
We’re starting to have conversations like this?
Well, not necessarily. I don’t think this conversation is indicative of the overall market, but rather it would be completely irresponsible for me to not discuss it, given we are seeing a handful of deals not closing as scheduled.
Well, as JF007 wrote on Monday:
…so a thousand listings reviewed to get 6 such scenarios so a .6% rate meh
So while this could be “much ado about nothing,” it could also be viewed as “much ado about something,” since we can no longer claim that all deals close in this market.
Back in 2017 when the market changed, I consistently received phone calls from media members asking, “Do you have any clients that have bought firm and are now ‘stuck’ because they can’t sell their existing home?”
You’ve heard this story before, right?
Try as I might to explain to whoever was on the other end of the line, “No, I actually don’t have anybody in that position,” and continue the conversation, those conversations always ended right then and there.
The media had an idea for a story, and they were going to write that story no matter what. Their job was to find somebody who fit that narrative, and maybe they made a thousand calls to find that one agent who said, “Yeah, that’s happening to me right now.”
But that story, on the front cover of the real estate section, didn’t come with a disclaimer that said, “The rate at which these deals are failing to close is 0.6%.”
The truth is, we have no idea how many of these deals there are, but we do know that the number is more than zero.
Many people in our market don’t want to talk about this, but I welcome the conversation since I like to talk about anything real estate related.
On Monday, we looked at six properties that failed to close, which were subsequently resold, and five of those properties sold for substantially less, in June, than they had in March or April.
So now, let’s ask the obvious follow-up question once again:
What happens when a buyer doesn’t close?
The answer isn’t simple, but that’s because every scenario is different.
Allow me to provide a long-winded yet necessary answer, by starting from the very beginnning…
Let’s say a house is sold on April 1st, 2022 for $2,000,000 with a $150,000 deposit, and it is scheduled to close on June 1st, 2022.
Which of the following reasons is valid for why a buyer may opt out of the deal:
1) The buyer cannot obtain financing.
2) The appraisal came in at $1,800,000.
3) The buyers were engaged to be married and have since split up.
4) The buyers have not sold their house, which they need to do, in order to close.
5) There was a death in the buyer’s immediate family.
6) The buyer’s 2.79% mortgage rate hold expired.
7) Prices in the region where this house was sold have dropped 20%.
8) The buyer has moved to Mars.
Any ideas, folks?
Which of these reasons are valid?
I think 98% of you figured this out.
None of these is a valid reason.
None of these “issues” matter, in the context of the signed Agreement of Purchase & Sale.
John and Kate bought a house for $2,000,000 and split up? Too bad! They’re legally obligated to close.
The appraisal came in low? Interest rates have increased? The buyer lost his job?
Nothing matters. Absolutely nothing.
So let’s now introduce a concept called anticipatory breach, which I wrote about on my blog in full back in 2019, HERE.
Let’s say that the buyers’ lawyer reaches out to the seller’s lawyer and says, “My clients can’t close on this transaction. We aren’t bluffing, we really, truly can’t close. So let’s sign a mutual release, and go our separate ways.”
The sellers have every right to say, “Go fly a kite.”
The sellers would be insane to sign a mutual release, unless the buyer had agreed to forfeit the deposit.
But in my experience, buyers never forfeit the deposit. They always think there’s a way they can get out of the deal.
In this case, the seller’s lawyer would send a notice to the buyer’s lawyer explaining that they will not sign a mutual release, and that they fully expect the buyers to close as scheduled on June 1st.
But guess what? The sellers, in theory, are now free to re-list the property for sale due to this “anticipatory breach.”
Well, because of our next concept called mitigation.
It’s the legal duty of the seller to attempt to mitigate losses at his or her earliest opportunity.
Anticipatory breach is a bit of a grey area, but if the buyer has shown that they aren’t going to close the transaction, then the seller could take this as an anticipatory breach and re-list the property in order to immediately mitigate losses.
Whether or not the seller re-lists, and/or re-sells, let’s say that June 1st comes along and the buyer doesn’t close.
Now the buyer is in breach.
When a breach occurs, the world doesn’t end. It keeps turning.
But a breach is serious and it signals a “part two” of sorts in the life of the transaction.
A common misunderstanding here is that the buyer automatically defaults the deposit, meaning that in this case, the seller keeps the $150,000 that’s being held in trust. That is incorrect.
Irrespective of what happens in other countries or jurisdictions, those funds cannot be released from the trust account without a court order.
The day after the breach occurs, it is up to all parties to attempt to mitigate.
Now, any lawyer will suggest that an attempt to mitigate should begin with one particular party: the buyer.
In some cases of breach, the reason is simple, and a closing of the transaction can be worked out with the buyer, whether that’s a day later or several days later. Maybe a week, maybe a month. But I’ve had cases of breach that were simple and solved.
In this case, where our buyer has said, “I can’t close, I won’t close,” the seller and the seller’s lawyer then have to move on.
In the examples that we saw on Monday, we know that sellers often must re-sell and accept a lower amount.
Let’s say that in our example above, the property is re-listed for $1,995,000 on June 3rd, but doesn’t sell. It’s then re-listed at $1,895,000 on June 23rd, and eventually sells for $1,800,000 on July 5th, with a scheduled closing of September 10th.
Potentially nothing. As Bal wrote in Monday’s blog, not every seller is going to litigate.
But what happens to the deposit?
The seller has to sue for the deposit, and this can often take years.
However, the seller can apply for a summary judgment which is essentially an expedited release of the deposit, without going to trial.
But the seller can look for more than ‘only’ the deposit, whether it’s through a full trial or merely the application of a summary judgment.
Yes, our next concept is a big one: damages.
A seller may sue for damages and this can include just about anything.
In the case above, the obvious loss was the $200,000 difference between what the now-in-default buyer paid in April and what the property re-sold for in July.
But the seller can also sue for the carrying costs associated with owning the property from the originally scheduled closing date of June 1st, and the new date of September 10th.
Property taxes, heat, hydro, water, insurance, alarm system, landscaping, maintenance and upkeep.
But then there’s mortgage interest, and/or any penalties or fees associated with keeping the property longer.
Real estate agents can sue for commissions too.
And what about legal fees? Oh, that’s a big one! As many of you know, our neighbours south of the border are a more litigious society and I’ve often suggested that this is because their system differs from ours in one major way: in Canada, when you lose, you pay the other side’s legal fees.
All told, the damages in this case above are not simply limited to the $200,000 difference in sale price, but rather the list keeps going and going.
The truth is, the litigation could take years, but it’s worthwhile for the seller.
Now, how does the buyer defend him or herself?
For starters, that buyer will likely concoct a scenario whereby there was an undisclosed latent defect that made them scared to close the transaction, or that the seller didn’t provide access to the property for a pre-closing inspection, or any number of made-up claims that could provide a defense.
These defences are usually overlooked and dismissed, especially if there’s a paper trail to show that the buyer requested a mutual release and gave any reason to the contrary, ie. an email from the buyer’s lawyer detailing that the appraisal was low, or the buyer lost his job, etc.
But buyers do have two viable defences:
1) The buyer can claim that a delay in re-listing the property caused further losses.
2) The buyer can claim that the $1,800,000 sale price was below fair market value, and that the seller could have, would have, and should have obtained more.
In our case above, the original closing was scheduled for June 1st and the house was re-listed on June 3rd, so point #1 above can’t really be argued.
As for point #2, this is always subjective. The buyer would have to solicit appraisals and opinions of value from multiple agents and appraisers that argue the market value was higher than $1,800,000. In reality, this isn’t very easy.
The buyer can argue that the property wasn’t marketed effectively, or that access was made difficult, etc. You’re as creative as I am, so come up with some ideas, and I’m sure they’ve been argued. Lawyers who defend buyers in these cases likely have a laundry list of defences.
But absent any viable defence, what happens in these cases?
The sellers win.
I know it’s crazy to believe that a judge would really, truly look at a buyer in court and say, “I hereby order you to pay a sum of $264,183.18,” but it happens. It’s happened a lot.
Do you want a real-life example?
CanLII provides access to court cases as a public record.
Here is one such case from 2020.
The buyer signed an APS for $1,717,224.57 on October 11th, 2016, and this transaction was scheduled to close in November 9th, 2018.
The buyer reneged.
The seller re-sold the property for $1,242,964.11 on May 24th, 2019.
The seller sued the buyer for $353,582.28, which was the amount due on closing, plus costs, minus the initial $100,000 deposit.
On December 1st, 2020, a summary judgment was granted in the full amount of $353,582.28.
The findings were interesting.
Here’s a highlight:
The defendants do not dispute liability. They admit that the scheduled closing date was October 30, 2018, that there was an extension until November 9, 2018, that the plaintiff was ready, willing and able to close, and that the defendants did not close. However, they argue that there are genuine issues as to damages and mitigation which requires a trial.
I find that there is no genuine issue requiring a trial. The defendants are required to put their best foot forward and yet have led no evidence to dispute the damages or to put into question the plaintiff’s mitigation efforts.
The judge refused a trial!
He granted a summary judgment!
That’s how bad the buyer/defendant’s case was, or how wrong their actions were.
Their defence was that they had the property appraised right before the scheduled closing date, and the appraisal was $1,200,000, but that’s not a defence!
Can you imagine if the market worked that way?
This case was open and shut. But was it really ever open?
This case, and every case like it, showed that a buyer can’t simply walk away from a transaction because the market has changed.
Let’s look at one more case.
The buyer signed an APS for $1,729,820.99 on November 19th, 2016.
The deposits paid were $138,000.
Final closing was set for October 22nd, 2018.
The buyer reneged.
The buyer claimed misrepresentation, specifically that the sales agent described the deal as “the opportunity of a lifetime.”
But the most interesting part is the following:
The Defendants say that they paid bribes to the sales agent in order to be able to jump the queue of potential purchasers and sign the APS quickly. This, they contend, excuses their non-closing and puts an end to the reciprocal obligations contained in the APS. That said, there is no authority for the proposition that a person who pays a bribe can have the contract rescinded as a result.
This is the kind of stuff you hear about but don’t believe is true.
I have absolutely zero sympathy for these people.
They wanted a get-rich quick scheme and they paid a bribe to a salesperson at a pre-construction launch to jump the line. They bought, the market dropped, and then they didn’t want to close.
So what happened?
The judge awarded $554,308.41 to the plaintiff.
There are a lot of these cases out there and we don’t need to go through them all.
But the point is: if a buyer walks away from a transaction because the market has dropped, and the seller wants to take litigation the distance, the seller will prevail.
Fortunately, these cases are exceptionally rare. And they typically only happen in a 1-2 month window every 5-6 years when there’s a change in the market.
But when they do happen, the media loves to report on it, so don’t be surprised to read about this in the newspapers in the coming months.
A return to normal in the fall? A dead-cat bounce? A prolonged balancing act?
Don’t worry, we need not decide that today.
We have the rest of 2022 in which to discuss…
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