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In this prior blog entry, we explore the distinction between escrow deposits and earnest money in Ohio, and the fact that these two things are not a measure of or limitation on damages sustained for a breach of a real estate purchase contact.

This article seeks to bust a common myth about an escrow deposit: That a seller must return the earnest money of a buyer he claims is in breach before selling the home to a second buyer.

Here’s the scenario: Buyer #1 signs a contract to purchase a property with earnest money held in escrow by the Realtor, and then fails to perform.  Sometimes the buyer claims one of his contingencies was not fulfilled (financing, inspection, etc.) and the seller disagrees that buyer attempted in good faith to fulfill that contingency.  Other times, the buyer has just flat-out breached the contract.

In either scenario, seller has refused to consent to the release of the escrowed funds back to the buyer.  Indeed, he intends to hold the buyer responsible for the damages arising from the breach.

Now, Buyer #2 comes along, and the seller desires to sell the property to Buyer #2 free and clear of any claims of Buyer #1.  Does he have to release the escrowed funds to accept the second contract?  Does he have to waive the claims against Buyer #1?  No.

Many times the myth is advanced by an office manager of a realty company, either out of wisdom, to avoid unnecessary conflict and clean up loose ends, or because he is simply mistaken. [Indisputably, it may be advantageous to get a full release from Buyer #1 before proceeding with Buyer #2.]

But it would be entirely possible for a seller to sell to Buyer #2, and retain his claims for monetary damages arising from the breach against Buyer #1.  The seller is not required to release the earnest money to Buyer #1 at the time of signing contract #2.

Buyers are typically asked to place earnest money under a real estate purchase contract, residential and commercial. But who is holding this deposit? Can the buyer ever get it back?  Can the seller ever retrieve it out of escrow?  And is this a measure of or limit on damages on breach of contract by either the buyer or seller?

For contracts negotiated through Realtors for existing housing, the deposit is typically held in the Realtor’s escrow account pending closing. This means that neither the buyer nor the seller have access to those funds until surrendered to the seller at closing or returned to the buyer as a result of the failure of one or more contingencies.

Even though the Realtor is the “agent” of one party in the transaction, when acting as escrow agent, he must follow the escrow instructions – i.e., not surrender the earnest money to his client just because he is ordered to do so.  The escrow instructions are contractual provisions – either in the purchase contract or a separate escrow agreement – detailing how the escrow agent is to deal with the escrowed funds, or other escrowed property and documents.

In contrast, contracts with home builders, and For-Sale-By-Owner sellers (“FSBOs”) typically will call for the earnest money to be paid as a deposit directly to the builder or seller. In that circumstance, the seller has the money, and getting it back – even when the contract requires it – could prove problematic. For example, we have represented buyers in contracts in which the builder was headed into insolvency or bankruptcy.  In that circumstance, the earnest money deposit could be completely at risk if precautions have not been made against that eventuality.

Finally, a common misunderstanding of parties to a purchase contract is that the escrow money is some sort of measure of or limitation on damages for the buyer’s breach, or, conversely, that the return of the earnest money “cures” the seller’s breach and is the limitation on his damages as well. However, unless the real estate purchase contract specifically calls out either of those limitations, neither of those propositions is true.

We will explore in a separate blog entry the damages for which a buyer can be exposed for breach of a purchase contract. But as a general proposition, the seller is to be put in a position that he would be in but for buyer’s breach. That means the buyer is responsible for the reduced purchase price when the house sells to a second buyer, and may be exposed for the holding costs (insurance, taxes and maintenance costs) until the property re-sells. The seller, similarly, cannot just ignore his contractual promise to a buyer, and sell the property to another buyer.  He will be responsible to the original buyer for the lost value above the sale price and perhaps other damages to a buyer. The important point is that the earnest money – unless the contract specifically says otherwise – is not a definition of or limitation or either party’s damages upon breach.

Read more here: Myth busters: Further on earnest money >>

This article is the seventh in a series on new construction.  The contents of this series of articles apply to commercial as well as residential projects (this article being the only exception).

The issue of mechanics liens in Ohio is complex and involved in commercial projects.  But in the residential world (one and two-family residences), buyers are fully protected against mechanics liens so long as (i) they have paid the full amount due to the builder and (ii) they did not, before such payment, receive notice of the filing of a mechanics lien.  This protection applies in all three circumstances of (i) homes purchased from builders at the end of the construction process, (ii) homes built on the lot owned by a buyer, and (iii) existing home improvement contracts.

Further, the attempt to assert the right to a mechanics lien by a builder, subcontractor or materialman when these conditions have been met is the basis for a “slander of title” cause of action against such lien claimant.

The circumstances that give rise to liens against residential projects are generally either (i) a dispute between the buyer and the builder or (ii) a dispute between the builder and its subcontractors and materialmen, usually the latter.

The statute that provides this protection is O.R.C. Section 1311.011, which provides:

(1) No original contractor, subcontractor, material supplier, or laborer has a lien to secure payment for labor or work performed or materials furnished by the contractor, subcontractor, material supplier, or laborer, in connection with a home construction contract between the original contractor and the owner, part owner, or lessee or in connection with a dwelling or residential unit of condominium property, that is the subject of a home purchase contract, if the owner, part owner, or lessee paid the original contractor in full or if the purchaser has paid in full for the amount of the home construction or home purchase contract price, and the payment was made prior to the owner’s, part owner’s, or lessee’s receipt of a copy of an affidavit of mechanics’ lien pursuant to section 1311.07 of the Revised Code.

One key question is whether the “owner…has paid the original contractor in full.”  This does not necessarily mean the full contract price, but the actual amount owed after all setoffs and change orders.  Thus, if the original builder defaulted in the performance of its contract, and as a result the buyer does not owe him funds for the completion of the project, then nothing is owed (by the buyer or owner) to his various subcontractors and materialmen.

This statute also does not protect buyers who have actual notice of a lien, and still elect to pay a builder the remaining contract price.  Paying the builder without known lien claims resolved is simply foolish.

When a residential construction projects runs seriously “off the rails,” claims against homeowners can emanate from many parties.  But, unlike the commercial setting, residential buyers and owners are absolutely protected from these later-arising lien claims.

Our way of addressing this on behalf of homeowners is a simple letter to the lien holder to remove their claim or be exposed to damages claims from the buyer, which could include claims for punitive damages and attorneys fees.

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This article is one in a series on the Finney Law Firm blog on new construction.  Read more here:

New construction: The problem of “what” is to be built >>

New construction: The “when” >> 

New Construction: Change orders, allowances, and selections can significantly impact price >>

New Construction: On whose land are you building? >>

New construction: Cost-Plus versus Fixed-Price

New construction: What form of contract?

This article is the sixth in a series on new construction.  The contents of this series of articles apply to commercial as well as residential projects.

We discuss in this series the various difficulties in contracting for new construction of either a commercial building or a house.

Now that these issues have been considered, you are ready to build.  What contact form should you use?

Commercial forms

Most commercial projects involve either (i) a custom contract drafted by an attorney and negotiated between the parties or (ii) the use of standard contract forms from the American Institute of Architects.  In addition, some contractors have their own forms, and major corporate clients may have a standard form they demand to use for their projects.

Residential forms

For smaller builders, some Realtors attempt to use the standard Cincinnati Area Board of Realtors contract for existing housing for new construction projects.  This is almost always a mistake for both parties, as that form does not contemplate the many issues involved in new construction.  (Consideration should be given to a “spec” home, one that is completed or nearly completed at the time of the contract.  The standard CABOR form could suffice as long as construction is sufficiently complete that new construction variables are less important.)

Builders also have their own form of contract.  These may be acceptable, but buyers must read them carefully to understand whether their interests are protected.

Finally, of course, attorneys can draft a customized contract for builders and buyers to protect their interests in the transaction.

Customization

Whether representing the builder or the buyer, I find that almost any form contract (except perhaps the CABOR existing home contract form) can be modified with an addendum to protect my client’s interests on key issues and tightly reflect the terms of that specific transaction.

Conclusion

In any event, the buyer should consider the many variables of new construction in selecting the form of contract to be used and in completing that contract.

This article is one in a series on the Finney Law Firm blog on new construction.  Read more here:

New construction: The problem of “what” is to be built >>

New construction: The “when” >> 

New Construction: Change orders, allowances, and selections can significantly impact price >>

New Construction: On whose land are you building? >>

New construction: Cost-Plus versus Fixed-Price

New construction: Ohio residential buyers absolutely protected from liens in limited circumstances

This article is the fifth in a series on new construction.  The contents of this series of articles apply to commercial as well as residential projects.

When building new, one of the main decisions the builder and the buyer need to address is whether the price will be fixed or vary with the price of materials, subcontracts, permits, etc.

This decision first should hinge off of whether a fixed set of plans for the project have been agreed upon in advance, and important price variables such as site work, soil conditions and governmental requirements have been fully explored.  If so, the project may be ripe for a fixed price contract.  If not, it is difficult for the builder to provide a fixed price, and the project is more suited to a cost-plus arrangement.

A fixed-price contract is as it sounds, for a fixed sum.  A cost plus contract says that the buyer pays all of the builder’s actual costs to third party contractors and material men, along with permitting costs, and then adds a margin for overhead and profit.  There are other options, such as cost-plus, subject to a guaranteed maximum price.

In each of these three contract scenarios, the issues of change orders, allowances and selections can still significantly impact the price.  Read about those here.

Fixed-price

In a fixed-price contract, since the builder is taking the risk for pricing variations and project “unknowns,” it typically wants a higher margin (i.e., profit and contingency) to account for that risk.

Cost-Plus

Sometimes a buyer wants to avoid paying that margin and is thus willing to accept the pricing risks accompanying a cost overrun.  Further, if the scope of the project is not tightly defined at the front-end (what is to be built and when it is to be built), then a cost-plus contract may be the only practical option.

“Headlights on” or “Headlights off”

Because a cost-plus contract can be an open-ended checkbook for the builder, we advise buyers to “turn the headlights on” during that process, and (i) start with a detailed line-item budget of anticipated construction costs and (ii) monitor performance throughout the construction process against that line-item budget.  As the project starts to run off the rails cost-wise, the buyer can rein in the project by scaling back the scope.  In any event, he is not hit with a surprise at the end of the project.

Building a new building is one of the more significant investments a business or individual will undertake, and the pricing of that product is one of the more important decisions in that undertaking.  Consider carefully how the product will be priced before the project starts.

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This article is one in a series on the Finney Law Firm blog on new construction.  Read more here:

New construction: The problem of “what” is to be built >>

New construction: The “when” >> 

New Construction: Change orders, allowances, and selections can significantly impact price >>

New Construction: On whose land are you building? >>

New construction: What form of contract?

New construction: Ohio residential buyers absolutely protected from liens in limited circumstances

 

This article is the fourth in a series on new construction.  The contents of this series of articles apply to commercial as well as residential projects.

When structuring the contractual relationship between a buyer and a builder, one of the first considerations is: On whose land will the project be built?  For, if the builder is building on land owned by the buyer, we are addressing a pure construction contract, where if we are building on land the builder owns, and he will convey title at the end of the project, we are addressing both a construction contract and a real estate purchase contract. and a different set of issues will need to be addressed.

Building on land owned by the buyer

When building on land owned by the buyer, the buyer will own the improvements throughout the construction process, and ultimately control legal access to the site.  If a falling out occurs between the builder and the buyer, the buyer can remove the builder from the job and complete the project with another builder.

Typically in this instance, the buyer will pay the builder in installments as the improvements are completed.  As a result, the buyer will have to obtain his own financing and his own insurance on the project.  The buyer also needs to assure that he has not paid more for the improvements in place  than they are worth at any point in time, for if the builder walks off the job the buyer must have sufficient funds remaining to complete the project with another builder.  Finally, the buyer needs to make sure all subcontractors and material men are paid with each draw, so that mechanics liens do not attach to the project.

Building on land owned by the builder

In a situation where the builder owns the land, the buyer’s is simply buying land, building and other improvements at the conclusion of the construction project.  In this instance, the builder wants a significant down payment from the buyer both to show the buyer’s bona fides in performing under the contract, and also in some cases to finance the construction project.  But the buyer must realize that this is basically an unsecured loan to the builder, and in the event of the builder’s default of the contract, or a contact dispute, the buyer will have a hard — perhaps impossible time — recovering those funds from the builder.

Under this type of contract, the buyer will not pay installments throughout the construction project, but rather the builder will finance the project himself or with third party funds.  The builder will insure the project through closing.

The issue with this type of contract is that buyer loses control of the project: He can’t speed construction, control the job site, or assume control of the property in the event of the builder non-performance.

Also in this type of contract, the buyer needs to protect himself as to quality of title, closing prorations, and other issues typical in a contract for the conveyance of real estate.

Buyer conveys lot to builder

In some instances, the buyer will own the land at the beginning of the project, but convey title to the builder as a sort of down payment.  At the end of the construction project, title to the property is then conveyed back to the buyer. The issues in this instance are the same as “building on land owned by builder,” set forth above, as throughout the project, the builder will own the land and the improvements.

Know the type of construction you intend to undertake, and use a contract crafted to protect yourself in that circumstance.

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This article is one in a series on the Finney Law Firm blog on new construction.  Read more here:

New construction: The problem of “what” is to be built >>

New construction: The “when” >> 

New Construction: Change orders, allowances, and selections can significantly impact price >>

New construction: Cost-plus versus fixed-price >>

New construction: What form of contract?

New construction: Ohio residential buyers absolutely protected from liens in limited circumstances