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Court Invalidates Purchase Agreement as Option Lacking Consideration

By: Howard D. Coleman, David L. Kimport, Kenneth S. Kramer
06/27/08

In Steiner v. Thexton (2008) 163 Cal. App 4th 359, the California Court of Appeal for the Third Appellate district found that a document entitled "Real Estate Purchase Contract" did not, in fact, constitute an agreement for the purchase and sale of real property, but, rather, constituted an option. The court further held that since the option lacked consideration, it constituted nothing more than an ongoing offer of the seller to sell the property, which could be withdrawn at any time prior to its acceptance or exercise.

The case has significant implications for agreements for the purchase and sale of real property, particularly with respect to transactions involving longer contingency periods to obtain land use approvals, and, potentially, for agreements containing typical discretionary due diligence periods.

The Steiner Court determined that because the seller obligated itself to sell and left it discretionary with the buyer whether it would buy at any time during an approximately three year period following the date of the agreement, the agreement constituted an option contract, and not a purchase and sale agreement. The Court focused particularly on the provision of the agreement which stated:

"It is expressly understood that the Buyer may, at its absolute and sole discretion during this period, elect not to continue in this transaction and this purchase contract will become null and void."

Having determined that the agreement was an option and not a purchase and sale agreement, the Court then went on to find that the option lacked consideration, making it an ongoing offer to sell which was not enforceable by the buyer. The buyer argued that certain provisions in the agreement established consideration for the option, including that the buyer (a) would proceed expeditiously with obtaining "the parcel split", (b) would indemnify the seller for any costs associated with its investigations, and (c) would provide seller copies of all materials obtained by buyer. The Court, however, held that since such obligations took effect only upon the buyer’s actually taking actions to which such provisions would apply, and the buyer in fact had no obligation to proceed with investigation of the property or obtaining subdivision or entitlement approvals, the agreement lacked consideration at the time the parties entered into the agreement. The Court also held that because the $1,000.00 initial deposit was either to be returned to the buyer if it did not proceed with the purchase, or applied to the purchase price if it did, such deposit also did not constitute consideration for the option. It seems that the provision of the contract in Steiner that the buyer "will move expeditiously with the parcel split" at least arguably could have been interpreted as consideration. As noted above, however, the Court held otherwise.

The California Supreme Court has clearly held in Bleecher v. Conte (1981) 29 Cal. 3d 345, that mutuality of obligations is adequate consideration for a real property purchase agreement. The Steiner court distinguished Bleecher on the basis that in Steiner the buyer could terminate at its discretion and accordingly did not have any obligations to seller, thus overriding any argument that mutual obligations existed which could be asserted to constitute consideration. In this regard, we note that the agreement in Steiner did not contain a provision typically seen in real property purchase and sale agreements that the contract is entered into for good and valuable consideration, the receipt and sufficiency of which is acknowledged by the parties.

Under Steiner a party seeking to purchase real property contingent upon an extended period of time to obtain zoning, subdivision or other land use entitlements, should either clearly identify the agreement as an option and provide the seller adequate consideration for the option preferably in the form of a non-refundable option fee, or identify the agreement as a purchase and sale agreement and ensure that there is an adequate mutuality of obligations, such as a clear obligation to commence and pursue obtaining entitlements, to bring the agreement within the Bleecher decision. The Steiner Court’s reference to Civil Code Section 1606, also serves as a reminder that the adequacy of consideration may need to be factored into the analysis.

A more interesting dialogue involves the application of Steiner to the due diligence provisions under typical real property purchase and sale agreements which permit (but often do not obligate) the buyer to undertake its due diligence, to terminate the contract based upon the buyer’s discretionary determination on or before the expiration of the review period, and to receive the return of the good faith deposit upon any such termination. Under Steiner, a court could interpret such due diligence provisions to constitute an option and to lack consideration to the extent that the good faith deposit is subject to return upon a buyer’s determination not to proceed with the transaction. Below are two alterative approaches, as well as potential concerns of each, which might help avoid a result comparable to Steiner:

1. Payment of Actual Consideration. Provide for payment of a relatively small fee upon signing of the contract as consideration for the contract, as is often done in a number of other states. Such payment should be found by the court to constitute consideration for the option should the court elect to treat the due diligence period under such contract as an option period. Existing law establishes that the consideration for the granting of an option need not be great if the purchase price for the property is relatively close to its market value at the time that the contract is entered into. Note that if a court were to find the contract to be an option and that consideration existed, the adequacy of such consideration could be a factual issue which would then be within the purview of the trial court to decide.

2. Establish an Affirmative Duty on the Buyer. Provide that the buyer has an affirmative obligation to undertake its inspections in order to bring the contract closer to the Bleecher decision. Since most current real property purchase agreements state that the contract is based upon the mutual covenants and conditions stated therein (a provision which was absent from the contract in Steiner), the combination of such language and the existence of a buyer obligation to undertake due diligence should be accepted by a reviewing court as evidencing mutual consideration sufficient for enforcement of the contract as a bilateral purchase agreement and not a unilateral option.

There are no doubt additional approaches which may be taken to assure that the contract terms, whether accepted as a real property purchase agreement, or later interpreted to have been an option, establish adequate consideration to avoid the result in the Steiner case. Under any circumstances, parties will need to be aware of the potential application of the Steiner decision to real property purchase and sale agreements.

To view a copy of the decision, please click here.

For additional information about the case, please contact Ken Kramer, Howard ColemanRen Smith and/or David Kimport.

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