Collapsing Deals: A Refresher on the Common Law Principles #524

The current situation with COVID-19 has led to daily changes in the way we live our lives and conduct our business. The rapid changes and daily announcements have led to a lot of uncertainty and questions. In periods of flux, whether economic, political or social, we often see a greater number of collapsing real estate deals, or questions related to potential collapsing deals. As such, it’s a good time to review the law and principles for collapsing deals. In British Columbia, we have many well-established common law principles regarding collapsing deals that can give us a bit of guidance in these uncertain times.

This article will review the law regarding collapsing deals. It is important to note that this article is not intended to be a substitute for independent legal advice. It is strongly recommended that REALTORS^® advise their clients to seek independent legal advice in situations involving a collapsing deal as each situation will be fact-specific.

There are three broad categories of reasons why a real estate transaction may collapse:

1. default or breach of contract;

2. misrepresentation or mistake; and

3. frustration.

This article will review each category and the remedies that may be available to innocent parties in such circumstances.

Default or Breach of Contract

A default or breach of contract typically arises in the following situations:

1. the Seller no longer wishes to sell or cannot sell their property in accordance with the terms of the contract (e.g., they do not have enough proceeds to clear title);

2. the Buyer is unable to complete the purchase of the property (often because of financing or the inability to come up with the down payment);

3. the Buyer does not want to complete the purchase (often because of new information or new economic, political, or social context); or

4. one party to the contract is in breach of one of its obligations under the contract (e.g., the Buyer failing to pay a deposit on time or the seller not being able to deliver vacant possession when the contract requires it).

The breach can be an actual breach (i.e., one which has occurred), or an anticipatory breach where the breaching party demonstrates (by words or conduct) that they do not intend to complete the transaction contemplated under the contract.

If a default or breach of contract does not relate to a fundamental term of the contract, then the innocent party is generally required to still complete the transaction and can sue for damages resulting from the breach or default (for example, if a warranty is untrue). A default or breach of a fundamental term of the contract may relieve the innocent party from needing to complete the transaction, while still entitling them to additional remedies such as entitlement to the deposit and damages as discussed below. The most common fundamental terms in real estate contracts relate to time, payment of funds and clearing title.

Remedies for default or breach of contract may include entitlement to the deposit, damages, and occasionally specific performance. Real estate contracts often specify the consequences of certain kinds of default and may provide for specific remedies that are available upon default.  

Misrepresentation or Mistake

A real estate transaction may also collapse because of either a misrepresentation (usually by the seller or their Realtor) or because of mistake.

There are three different types of misrepresentation: innocent, fraudulent and negligent. The party who relies on the misrepresentation may be entitled to remedies under all three types of misrepresentation (though the specific remedy may differ between the three).

The legal doctrine of mistake refers to a situation where either one party or both parties are mistaken about a fundamental term of a contract. Generally speaking, for there to be relief under the doctrine of mistake, the mistake must have been a common or mutual mistake where both parties were mistaken on a fundamental term of the contract. For example, where both parties make the same mistake in relation to a fundamental term of the contract in the case of common mistake, or the parties are mistaken as to each other’s intentions or obligations in the case of mutual mistake. In rare instances there may be relief for a unilateral mistake by one party, however, the other party must have known or ought to have known about the mistake.

The remedy for misrepresentation can be damages and/or rescission, whereas the remedy for mistake is rescission (or, in certain cases, rectification, which is not covered by this article).

Frustrated Contracts

A contract may be “frustrated” when parties to a contract did not (and could not) foresee an intervening event which makes the performance of the contract impossible. For the doctrine of frustration to be applicable, three things must be present in the given situation:

1. the parties (or either of them) are unable to carry out the contract or parts of the contract;

2. the intervening event causing such inability to perform was beyond the control of, and not the fault of, either party; and

3. the parties did not make any provision in the contract to possibly deal with such an event or the consequences flowing from it.

Generally speaking, it is very challenging to successfully argue that a contract has been frustrated.

The remedy for frustrated contracts can include termination of the contract and restitution (which will not be covered by this article).

Remedies

So what remedies are available to an innocent buyer or seller in the face of a collapsing deal?

There are four common remedies available to the innocent party in the face of a collapsing deal:

1. deposit,

2.damages,

3. rescission, and

4. specific performance.

Before an innocent party elects how to proceed (once there is a breach or a deal begins collapsing), they should obtain independent legal advice to ensure they understand the remedies available to them and they do not inadvertently do something that changes their legal position or limits the remedies available to them.

A brief summary of each remedy is provided below.

Deposit

The innocent party is usually entitled to the deposit. However, it should be noted that even though the innocent party may be entitled to the deposit, if the deposit is being held under the Real Estate Services Act it cannot be released without the consent of both parties, meaning the innocent party may need to obtain a court order for the release of the deposit if the defaulting party does not agree that the deposit can be released to the innocent party.

Generally speaking, depending on the terms of the contract, an innocent seller is entitled to retain the deposit whether or not they suffered any damages. The exception to this is in instances where the deposit is so large, that it cannot be considered a deposit anymore.

Damages

The innocent party can claim for any damages they have suffered as a result of the other party’s breach of contract or misrepresentation (as the case may be). If the innocent party is also retaining the deposit, then they can claim damages in excess of the deposit amount. The claim for damages can be for common law damages or in lieu of specific performance. If a buyer has failed to pay a deposit when due and payable, a seller can seek an award in the amount equivalent to the deposit as either an action for damages or debt.

Rescission

The remedy of rescission is uncommon when dealing with collapsing deals in real estate. Rescission is the “unwinding” of the contract. Rescission is generally used as a remedy if there was a misrepresentation or mistake regarding a fundamental term of the contract and other forms of damages would not be available. By rescinding a contract, the innocent party ‘undoes’ the contract and both parties go back to the position they were in before the contract was entered into. The innocent party may also be entitled to damages to compensate them for any losses suffered by entering into the contract.

Specific Performance

Specific performance is a remedy whereby the court orders the defaulting party to complete the transaction as contemplated in the contract. The remedy of specific performance can be available in limited situations where a property or facts of the transaction are so unique that damages will not be sufficient. This remedy is not very common as the threshold of proof is very high.

COVID-19 and Completing Real Estate Transactions

Although there may be a higher number of collapsing deals or inquiries regarding collapsing deals during the COVID-19 pandemic, Realtors should be aware that real estate transactions continue to complete and close.

Lawyers and notaries have been working alongside the Land Title and Survey Authority (LTSA) and Law Society to ensure systems are in place for transactions to continue closing, even when clients are in self-quarantine. While some law firms and notaries offices have closed, the majority remain open and will continue to remain open as an essential service. Most offices have taken steps to protect their employees and clients, such as having limited numbers of employees in the office, having large numbers of employees work remotely from home, and changing procedures around clients in office interactions to abide by social distancing requirements.

The LTSA has also temporarily approved the swearing of affidavits remotely by video conference for the purposes of land title applications (although clients may still need to meet with their legal representative in-person to satisfy the lender’s funding requirements).

There has recently been a number of clauses being circulated in the real estate industry related to COVID-19 and the automatic extension of completion dates. Realtors should advise their clients to discuss these clauses with their lawyer or notary prior to signing addendums or placing them in new contracts. Some of these clauses, although well-intentioned, do not consider the potential impacts on related deals or do not properly define terms being used within the clause which can lead to the collapse of related deals or disputes.

In closing, it’s important to remember that the usual principles of contract continue to apply in the current environment and real estate professionals need to recognize when to advise their clients to seek independent legal advice regarding their real estate transaction contracts.

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