Have you ever caught a T-shirt that had been shot out of a cannon at a sporting event? Or have you picked one up from a swag table at a convention?
Chances are, the T-shirt didn’t fit you perfectly. Sometimes you get lucky with one that’s not too bad, but other times find yourself with more of a tent that comes down to your knees and threatens to carry you away in a stiff breeze. Think of the standard forms as your free T-shirt. They will fit a vast majority of your transactions pretty well, but there are some situations where the forms we provide just don’t fit.
A few recent discussions on how to properly use the Appraisal Contingency Addendum brought this to mind. Before you use the ACA – or any of our standard forms – ask yourself: Is this the proper use of this form? We produce over 100 standard forms that are used in thousands of transactions a year, ranging from commercial leases to the sales of manufactured housing on leased land. We do our best to cover many instances from the submission of an offer through the location of settlement. But a standard form is not one size fits all.
The ACA in particular seems prone to being used incorrectly and the majority of the questions we field on the Legal Hotline are because the user either doesn’t understand what the form already says or they have a fundamental misunderstanding of the financing contingency in the Agreement of Sale.
Let’s start with what the form already says. It sets a minimum appraisal value and if the property appraises at or above this minimum value, the buyer will complete the purchase. What is this minimum value? It depends. It could be the purchase price. It could be $15,000 less than the purchase price because the buyer will make up that difference in cash. It could be the escalated purchase price based on a Price Escalation Addendum. You have to work with your client to figure out what number makes sense for that transaction and make sure it’s included in the ACA. And as long as that number is met, the buyer will complete the purchase.
However, ask yourself whether the form is even needed in the first place. Is the buyer willing to make up any difference between the appraisal value and the purchase price? If so, that’s like the buyer saying, “I’ll buy the property if it appraises above $0” and you don’t need to use the ACA for that. This isn’t a question for just the ACA, either; there are many instances where people use forms because they don’t know better. Are there subsurface rights that will not transfer to the buyer at closing? If not, then don’t use the Oil, Gas and/or Mineral Rights/Interests Addendum. Your tenant has an assistance animal? Don’t use the Pet Addendum! Do you already have a T-shirt? Put your hands down, you don’t need this one.
The next major source of confusion is what happens if that minimum appraisal value is not met – and that is the difference between Option 1 and Option 2 of the ACA. Option 1 is the buyer saying, “I might be terminating this contract if the appraisal comes in lower.” Of course, the parties can always renegotiate the price or other terms if they want to, but at the end of the day, this option gives the buyer the right to terminate. Option 2 is the buyer saying, “We’ll let the mortgage contingency, if any, determine whether I purchase this property.”
Here’s where agents often make a critical error. If you’re now saying to yourself, “What’s the point of having Option 2 if the buyer can just terminate under the mortgage contingency?,” then you don’t understand the mortgage contingency.
First of all, was it even elected? Because if it was waived then there is no backup contingency and the buyer will be completing the purchase of the property (or likely losing their deposit). Second, even if elected, the mortgage contingency does not give the buyer any permission to terminate the agreement. Read that again. Now go find a copy of the agreement and look there. It says that the seller has the option to terminate the agreement if the buyer is unable to obtain financing, but the buyer must continue making a good faith effort to try to get financing. That could mean making an additional deposit, adjusting the loan-to-value ratio, using a different loan product or any number of things that could make financing realistic for the buyer. And that’s the biggest difference between Option 1 and Option 2. In Option 1, the buyer can simply terminate, but in Option 2, even if they’re unable to get financing they are still at the mercy of the seller in deciding if the contract will be ended early.
Now back to your T-shirts. If your buyer’s plan is to waive the mortgage contingency, Option 2 might not be the best option for you. And if you’re planning to use it, now would be a good time to bone up on just how the mortgage contingency works – paying special attention to how one calculates the loan-to-value ratio for the LTV blank in the form.
This could be just as good a time as any to let you know that as recently as this month, the Standard Forms Committee has considered whether to change the ACA and they have decided not to make any significant changes to the way the form works. There will be changes to the form coming on July 1, along with several other forms, but the function will remain the same.
Brokers can join PAR President Christopher Beadling and PAR Attorneys Desiree Brougher and Kacy Clouser on June 10 at 10 a.m. for the Broker Preview: Standard Forms Update webinar. The webinar will provide brokers with information about new changes coming to several PAR standard forms.
Agents can join PAR President Christopher Beadling and PAR Attorneys Desiree Brougher and Kacy Clouser on June 21 at 10 a.m. for Legal Corner: Standard Forms Update. Changes to the Appraisal Contingency Addendum will be reviewed, along with other updates.