The Return of Mutuality - the Possible Resurrection of a Defense to Contracts

A recent court case in Fairfax County may jeopardize contract enforceability and impact deals made during a cooling real estate market.

By Timothy R. Hughes

A recent case from Fairfax County Circuit Court potentially calls a significant number of real estate sales contracts into question in terms of enforceability. In the process, the case and its reasoning may have impact outside the narrow application of real estate contracts. Finally, the potential cancellation of underlying sales contracts may have some unexpected financial impacts on the construction industry in the near future.

Background on the Case

The case, Marc A. Busman, Substitute Trustee v. Beeren & Barry Investments, LLC, involved a trustee in foreclosure who entered into a foreclosure sale of a property which provided for a deposit by the buyer. The contract provided further that in the event the trustee defaulted, the buyer's sole remedy would be for the return of the deposit. The buyer backed out of the deal. The trustee resold the property to a new buyer but garnered a lower sales price.

After the subsequent sale, the trustee filed suit against the original foreclosure purchaser seeking damages for the difference in the purchase price. The defendant filed a demurrer arguing that both parties were not "mutually bound" to the agreement. In essence, if the buyer broke the sales contract, the trustee was able to sue for damages and enforce the agreement. In contrast, if the trustee broke the agreement, the buyer's sole recourse was return of the deposit. The buyer would not be entitled to interest, nor could the buyer sue for specific performance to compel the sale of the property.

On December 12, 2005, Judge Arthur Vieregg of the Circuit Court of Fairfax County held that the contract was not enforceable because it lacked "mutuality of obligation". Judge Vieregg sustained the defendant's demurrer and dismissed the trustee's case with prejudice. The trustee noted a petition for appeal. The Supreme Court of Virginia denied the petition on June 1, 2006.

Wide Ranging Impact on Home Sales Contracts

Contract provisions such as those involved in the Busman case are very common, particularly in real estate sales contracts. While the terms differ from the form Northern Virginia Association of Realtors sales contracts, such terms are typically found in the contracts of most major production builders doing business in this area. As such, the case may call the enforceability of a large number of sales contracts into serious question.

In an environment of quickly rising land values, the impact of this decision likely would have been modest. What buyer of property wants to cancel a sales contract when they are walking away from potentially hundreds of thousands of dollars in appreciated land value? As the market is cooling, however, this market dynamic is sure to change. Further, rising interest rates coupled with aggressive use of adjustable rate financing is making many real estate deals look far less attractive and even less workable than a year ago.

Cascading Impact on Others

Terms such as those discussed above are possible in other disciplines, professions, and subcontracts, but are probably more of a rarity. The greater potential impact on those surrounding the builders and developers is the cascading financial impact of cancelled sales. In addition, those who have "pay when paid" or "pay if paid" clauses tying payment to the eventual closing of the property may be hit financially by cancelled land sales contracts.

Conclusion

It is unclear what will be the long term impact of this decision. With the Supreme Court of Virginia declining hearing the case, we will not receive clear guidance from a controlling legal authority. Builders and developers who have this term in their contracts should consider immediately amending their contracts. Further, builders and developers should keep this decision in mind as they move forward towards settlement on on-going contracts that are currently in the pipeline. Individuals and entities in business surrounding builders and developers should be aware of this development and plan accordingly.

Timothy R. Hughes, Esq., is the principal of the Northern Virginia law firm of Hughes & Associates, P.L.L.C. He specializes in construction litigation, corporate and business related representation, and complex civil litigation. He may be reached at tim@hughesnassociates.com, or by phone at (703) 671-8200.