The shifting sands of risk of loss

What happens when property is destroyed or damaged between the execution of the agreement of sale and settlement? Is it tough luck for the Buyer? Is the Seller in default for failing to deliver the property as agreed? Who takes the hit for the loss?

Despite the title of this article, you will not likely find any answers while on vacation at the Jersey shore!  Under Pennsylvania law, the principle of equitable conversion provides one solution to this dilemma. Equitable conversion says that upon execution of the agreement of sale, the Buyer obtains an equitable interest in the property and also bears the risk of any loss occurring prior to settlement. This means that if the property is totally destroyed by fire prior to settlement, the Buyer’s obligation to pay the full purchase price remains!

Fortunately, equitable conversion is not the end of the story. Under Pennsylvania law, the doctrine of equitable conversion may be set aside if the sales contract clearly provides that the risk of loss remains with the Seller until settlement. For anyone using the PAR Standard Agreement of Sale, Paragraph 21, titled Maintenance & Risk of Loss, provides for such a shift.  If the property is destroyed or damaged prior to settlement, the Seller bears the loss and the Buyer is not obligated to purchase. There are some additional provisions in paragraph 21 that enable the Buyer to accept destroyed property at Buyer’s election if Seller’s insurance proceeds are also tendered, as well as provisions detailing when the Seller may repair and the like.

Why bring this up? Every now and then we need a reminder of basic real property law as it may significantly impact our clients and customers. On the rare occasion where the agreement of sale is other than a PAR standard form, exercise caution!  In the absence of a risk of loss clause that places the risk on the Seller until settlement, Buyer is at great peril because it is difficult for a Buyer to insure real estate possessed by another. The Buyer should be cautioned to consult counsel or not proceed with the sale unless he/she fully understands the substantial risk involved. While the doctrine of equitable conversion seems at odds with modern practice, it is the law unless a contrary provision appears in the agreement of sale.