Real estate contracts: secrets you should know

By Robert Taylor

When you sit down with your real estate agent to review a contract, either as a buyer or a seller, your agent generally selects a form to use. Typically, a buyer or a seller has no control over which contract form is used, or must rely on the agent to make minor modifications to that form if desired.

In the Bay Area, excluding the city of San Francisco (which has developed its own form), you are presented with a real estate contract that has either been drafted by the California Association of Realtors (CAR Contract) or by the Silicon Valley Board of Realtors (PRDS Contract). The terms of both CAR and PRDS contracts are developed to make it easy for a novice agent to fill in the blanks. Ninety-five percent of the contract is not editable, with the exception of some key items, such as address, price, loan terms, closing date, escrow company, and additional optional check boxes or fill-ins for personal property or contingency time periods along with options to initial other sections like "Arbitration" or "Liquidated Damages."

The length of the contract forms has doubled since 1980 to its current 10 pages. The increase in paperwork is mostly due to legislation that instituted mandatory disclosures. These disclosures require agents and sellers to report on the condition of the property, natural hazards, Megan's law (convicted sex offenders living in proximity), and the agency relationships that the buyer and seller have to the real estate agents in the transaction.

Who is best served by these standardized forms? Since contracts are developed by real estate professional organizations, it is safe to assume that they are designed to protect the involved agents from liability. This is overt is some instances. For example, all contracts now contain a mandatory, non-binding mediation clause and an option for binding arbitration of disputes. The form is designed so that agents are not bound to mediation even though buyers and sellers are bound to mediation. Additionally, arbitration is initialed by an overwhelming number of buyers and sellers, but agents are not required by to participate in arbitration. Quite obviously, the exclusion of agents from both mediation and arbitration benefits only the agents and not the buyer or seller.

Market forces also alter the forms. The CAR contract does not allow the buyer to present an offer to the seller without a warranty that basic systems of the home are in operating condition; meaning, by default it is an "as-is" contract. The PRDS contract added a check box to the form to eliminate warranties and pest control during the seller's market more than 10 years ago. It is routinely checked because this "is what the seller and their agent expects." Previously, "as-is" transactions were done by a separate addendum and were not the "norm." This shift is contract design was in response to market forces and have greatly benefited sellers and agents. Sellers no longer have to be concerned with pest control work or warranties of anything in the home; and agents benefit by not needing to worry about the complexity of closing transactions that involve pest control work or any other seller repairs.

Buyers are left holding the bag and must typically rely on the seller to provide disclosure reports ordered from vendors selected by the listing agent. Therefore, not surprisingly, I have heard of certain agents not using some inspection companies as to avoid a report that is too critical of the property. The potential for bias is obvious.

There are some basic patterns that occur based on contract design. The first being that if a spot to be initialed exists, then it will be initialed. Each contract has two different clauses for initials. First is arbitration, which I discussed above, and second is liquidated damages. In at least 95 percent of all contracts, both of these clauses are initialed when a buyer presents their offer to the seller — this happens even if the clauses are presented as "optional." If they are not initialed, the clauses do not apply. If questioned by a buyer or seller as to whether such clauses should be initialed, many agents respond that all buyers and sellers typically initial them; therefore, if you want the offer to be accepted, then you need to initial it. In fact, although foregoing to initial it may raise a question about the offer, the lack of initials on either one or both of these clauses may actually benefit the seller from a legal perspective.

For instance, a liquidated damages clause limits the buyer's potential liability for default to 3 percent of the purchase price or the amount of the deposit, whichever is less. This would seemingly benefit the buyer since it appears as if the damages on their default would be capped at 3 percent of the purchase price. Not clearly disclosed in the liquidated damages clause is that the collection of the 3 percent is far from automatic, especially if the seller resells the property to another buyer for the same amount; and further, it does not indicate to the buyer that he or she may be also sued by the agents in the transaction for the amount of commission they would have made if the buyer had not defaulted. So the damage cap may actually be 8-9 percent, depending on commissions due for the transaction. Could the contract be designed to avoid this potential pitfall for the buyer? Yes, but it is not.

Technology also alters how contracts are completed. With the advent of "convenient" electronic signatures, often the agent is predetermining where buyers and sellers initialed and how the form is completed. While we rely on our agents to guide us through the process, the electronic process forestalls the normal conversations the discussion of options that occurred when these forms were completed by hand. Clicking to sign makes the process go faster but who is benefiting from the speed?

In the end, when in doubt, follow the money. Sellers are the source of the money to pay the commissions. Since the listing agent obtains the listing contract from the seller, the contract typically requires the seller to pay commissions to the agent — once a sale is closed, commissions are split with the buyer's agent. It makes some sense, therefore, that the brokers developing the forms might be biased towards protecting the seller and agents in the transaction.

The form presents itself as it is. Modifying the form to a more balanced document would scuttle any potential offer in the present market. The more money involved, the more these types of decisions matter. However, this does not mean that both buyers and sellers should be unaware of the bias. It also means when lots of money is involved, that you may want to control certain aspects of the contract if it is within your power to negotiate those terms in your favor. Not all transaction terms on every sale are dictated by the prevailing market conditions.