Real estate contracts - Creation and construction

Learning Outcomes

This article examines the fundamental principles governing the creation and construction of real estate contracts as tested on the MBE. It focuses on the Statute of Frauds requirements, the essential terms needed for a valid contract, the implied covenant of marketable title, and the allocation of risk of loss under the doctrine of equitable conversion. After reading this article, you will be able to identify the requirements for an enforceable land sale contract, analyze title issues, determine risk of loss, and evaluate remedies for breach in MBE fact patterns.

MBE Syllabus

For the MBE, you are expected to understand the specific requirements for creating enforceable land sale contracts and the rules governing their interpretation. This includes:

  • Applying the Statute of Frauds to real estate contracts, including the requirements for a writing, essential terms (parties, property description, price), and signature.
  • Identifying exceptions to the Statute of Frauds, particularly the doctrine of part performance.
  • Understanding the implied covenant to deliver marketable title and what constitutes unmarketable title (e.g., defects in record chain, encumbrances, zoning violations).
  • Analyzing the timing of the marketable title requirement and the buyer's remedies for breach.
  • Applying the doctrine of equitable conversion to determine the risk of loss between contract signing and closing.
  • Evaluating remedies for breach of a land sale contract, including damages and specific performance.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

  1. Which of the following agreements for the transfer of an interest in land is generally required to be in writing under the Statute of Frauds?
    1. A lease for six months.
    2. An agreement granting an easement for two years.
    3. A license to use land for a weekend event.
    4. An agreement to build a fence on a property line.
  2. Under the doctrine of equitable conversion, who typically bears the risk of loss if property under contract for sale is destroyed without fault before the closing date?
    1. The seller, because legal title has not yet passed.
    2. The buyer, because equity regards the buyer as the owner once the contract is signed.
    3. Neither party; the contract is automatically rescinded.
    4. The party who was in possession at the time of the loss.
  3. A seller contracts to sell Blackacre to a buyer. The contract is silent regarding the quality of title. Before closing, the buyer discovers a recorded mortgage on Blackacre that the seller did not disclose. The buyer refuses to close. Which statement is most accurate?
    1. The buyer has breached the contract; the mortgage does not make title unmarketable.
    2. The seller has breached the implied covenant of marketable title.
    3. The contract is voidable due to mutual mistake.
    4. The seller is entitled to specific performance with an abatement for the mortgage amount.

Introduction

Contracts for the sale of land are governed by specific rules distinct from general contract law or the UCC rules for the sale of goods. The MBE tests your understanding of these specific requirements, particularly those related to the enforceability of the agreement (Statute of Frauds), the quality of title the seller must deliver (Marketable Title), the allocation of risk before closing (Equitable Conversion), and the available remedies upon breach. A valid land sale contract requires offer, acceptance, consideration, and compliance with the Statute of Frauds.

Key Term: Statute of Frauds A legal doctrine requiring certain types of contracts, including those for the sale of an interest in land, to be in writing and signed by the party to be charged to be enforceable.

Statute of Frauds Requirements

To be enforceable, a contract for the sale of land must generally satisfy the Statute of Frauds. This requires a writing (or multiple writings that reference each other) that:

  1. Identifies the Parties: Clearly names or identifies the seller and the buyer.
  2. Describes the Property: Provides a description sufficient to identify the subject property. A formal legal description is not required; an address, tax map number, or other description that reasonably identifies the parcel is usually sufficient. Parol evidence may be admissible to clarify ambiguities but not to supply a missing description.
  3. States Essential Terms: Includes the price and manner of payment, if agreed upon. If no price is stated, some courts might imply a reasonable price, but this is less common than with contracts for goods.
  4. Is Signed by the Party to Be Charged: Must be signed by the party against whom enforcement is sought (typically the defendant). An electronic signature is usually sufficient under modern statutes like UETA.

Exception: Part Performance

An oral land sale contract may be enforced in equity under the doctrine of part performance if the conduct of the parties unequivocally proves the existence of the contract. Most jurisdictions require at least two of the following three acts by the buyer:

  1. Payment: Payment of all or a substantial part of the purchase price.
  2. Possession: Taking possession of the property.
  3. Improvements: Making substantial improvements to the property.

If part performance is established, the remedy is usually specific performance, not damages.

Worked Example 1.1

Seller orally agrees to sell her farm, Greenacre, to Buyer for 300,000.BuyerpaysSellera300,000. Buyer pays Seller a 30,000 deposit, moves onto the farm with Seller's permission, and builds a new barn at a cost of $50,000. Seller later refuses to convey the deed. Can Buyer enforce the oral contract?

Answer: Yes, likely. Although the contract is for the sale of land and thus within the Statute of Frauds, Buyer's actions constitute part performance. Buyer paid part of the price, took possession, and made substantial improvements (the new barn). These acts unequivocally indicate the existence of a contract, making the oral agreement specifically enforceable in equity despite the lack of a sufficient writing.

Marketable Title

Unless the contract specifies otherwise, every land sale contract contains an implied covenant that the seller will deliver marketable title at the closing.

Key Term: Marketable Title Title reasonably free from doubt, i.e., title that a reasonably prudent buyer would accept. It signifies title that is not subject to an unreasonable risk of litigation.

Defects Rendering Title Unmarketable

Common defects include:

  1. Defects in Record Chain of Title: Significant variations in property descriptions, improperly executed deeds, or evidence of a prior grantor's lack of capacity can render title unmarketable. Title acquired by adverse possession is generally considered unmarketable until a quiet title action establishes the possessor's rights.
  2. Encumbrances: Mortgages, liens, easements, and restrictive covenants generally make title unmarketable unless waived by the buyer.
    • Seller's Right to Cure: A seller typically has the right to satisfy existing mortgages or liens at the closing using the sale proceeds.
    • Easements: An easement reducing property value usually renders title unmarketable. However, a known or visible beneficial easement (e.g., a utility easement) might not.
  3. Zoning Violations: While zoning restrictions per se do not make title unmarketable, an existing violation of a zoning ordinance does.

Timing and Remedies

  • Timing: The seller is not required to deliver marketable title until the closing date. A buyer cannot rescind before closing based on unmarketability unless it's clear the defects cannot be cured by closing.
  • Remedy: If the seller cannot deliver marketable title at closing (and the buyer did not waive the defect), the buyer's primary remedy is rescission of the contract and return of any deposit. Damages or specific performance with abatement may also be available.
  • Merger: Once the buyer accepts the deed at closing, the contract merges into the deed, and the seller is no longer liable under the implied covenant of marketable title. The buyer's recourse is then limited to any covenants included in the deed itself.

Worked Example 1.2

Seller agrees to sell Blueacre to Buyer, closing in 60 days. The contract requires marketable title. A title search reveals a restrictive covenant prohibiting commercial use, recorded 50 years ago. Blueacre is currently zoned residential, and Buyer intends residential use. Is title unmarketable?

Answer: Yes. Even though the covenant aligns with current zoning and Buyer's intended use, a recorded restrictive covenant is an encumbrance that renders title unmarketable unless waived. It restricts future use and exposes the owner to potential litigation if violated. Buyer can notify Seller of the defect and demand its removal before closing, or rescind if it's not cured.

Equitable Conversion and Risk of Loss

The doctrine of equitable conversion addresses the allocation of risk between the signing of the land sale contract and the closing.

Key Term: Equitable Conversion A doctrine holding that once an enforceable land sale contract is signed, equity regards the buyer as the owner of the real property, even though legal title has not yet passed. The seller retains legal title merely as security for the payment of the purchase price.

Risk of Loss

  • Majority Rule: Under equitable conversion, the buyer bears the risk of loss if the property is destroyed or damaged (without fault of either party) between contract signing and closing. The buyer must still pay the full contract price unless the contract provides otherwise.
  • Minority Rule (Uniform Vendor and Purchaser Risk Act): Some states place the risk of loss on the seller until either legal title or possession passes to the buyer.
  • Insurance: If the seller has casualty insurance and the risk of loss is on the buyer, the seller must generally credit any insurance proceeds received against the purchase price.

Remedies for Breach

If either party breaches the land sale contract, the non-breaching party has several potential remedies:

  1. Damages: The standard measure is the difference between the contract price and the market value of the property on the date of breach, plus incidental costs. Some jurisdictions limit the buyer's damages to out-of-pocket expenses if the seller breaches in good faith (e.g., due to an unknown title defect).
  2. Liquidated Damages: Contracts often provide that the seller may retain the buyer's deposit as liquidated damages if the buyer defaults. This is enforceable if the amount is reasonable (often presumed reasonable up to 10% of the purchase price).
  3. Specific Performance: Because land is considered unique, specific performance is generally available to both buyer and seller.
    • Buyer's Remedy: If the seller breaches, the buyer can compel conveyance. If title is unmarketable but the buyer still wants the property, the buyer can usually get specific performance with an abatement (reduction) of the purchase price to reflect the defect.
    • Seller's Remedy: If the buyer breaches, the seller can compel payment of the purchase price.

Key Point Checklist

This article has covered the following key knowledge points:

  • Real estate contracts must generally satisfy the Statute of Frauds (writing, essential terms, signature).
  • Part performance (payment, possession, improvements) can be an exception to the Statute of Frauds.
  • Land sale contracts include an implied covenant of marketable title, meaning title reasonably free from doubt or risk of litigation.
  • Defects like encumbrances (mortgages, easements, covenants) and zoning violations can render title unmarketable.
  • The seller must provide marketable title at closing; the contract merges into the deed upon closing.
  • Equitable conversion generally places the risk of loss between contract and closing on the buyer (majority rule).
  • Remedies for breach include damages (contract price vs. market value), rescission, retention of deposit (liquidated damages), and specific performance.

Key Terms and Concepts

  • Statute of Frauds
  • Marketable Title
  • Equitable Conversion
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