Executory Contracts: A Guide to Real Estate
In real estate, an executory contract is a contract which remains to be performed. For example, a purchase and sale agreement where the buyer is entitled to receive a deed at settlement; a written lease agreement where a lessee is entitled to take possession of the leased property until the stated expiration date; and an earnest money agreement where the listed owners are entitled to the return of deposited sums when the conditions for release of funds have been satisfied. By contrast, an executed contract, such as the closing statement, describes a finished transaction where obligations arising under the contract have been performed. Also , a fully performed lease or an agreement for the sale of property where the grantor (seller) has transferred all right, title and interest in the property to the grantee (buyer) is also an executed contract.
In commercial real estate, the term executory contract usually refers to those contracts involving sales of real estate and assignments/transfers related to the sale of real property which are not completed. The importance of recognizing and understanding the significance of executory contracts is that the running of the statute of limitations on the underlying cause of action is tolled until the executory contract is completed (i.e., the deed of conveyance is delivered/final payment is made).
Characteristics of Real Estate Executory Contracts
Real estate executory contracts typically include:
A. Obligations of the Buyer or Seller. Real estate executory contracts generally impose a number of obligations on the buyer or seller, all which should be understood before agreeing to the contract. Obligations such as providing the other party with earnest money, obtaining inspections and appraisals, closing costs and conditions relative to to title should be of significance.
B. Performance. A real estate contract requires the parties to perform certain obligations. Thus, it is very important to be able to spot all of your obligations quickly.
C. Conditions Precedent. A real estate contract will often have a condition which must be satisfied, or waived, in order for the contract to survive. A condition precedent, once satisfied, is not a subsequent condition but instead is sometimes referred to as a precedent condition.
Pros and Cons of Executory Contracts
Executory contracts have the major benefit of offering flexibility in real estate transactions. With an executory contract, a buyer can secure the property before being legally bound to fulfil the agreement, giving them time to research the property in greater depth. With time, a buyer may discover hidden issues with the property that cause them to lose interest in it or that help them to negotiate a better price with the seller.
There is potential downside to agreeing to an executory contract for a property, however. If the seller has not fulfilled their side of the bargain and there are issues with the deal, this can lead to litigation. For example, if a seller discovers that a shovel-ready construction deal means even more expenses for them, they might not want to sign the sale agreement. A buyer may then choose to sue the seller for specific performance, meaning they expect the seller to honour the contract.
Licensing Issues with Executory Contracts
Legal Considerations for Executory Contracts in real estate transactions involve several closely related topics. First, and most important, the writing must satisfy the Statute of Frauds, which requires that the contract contemplate a lease for a term longer than one year, or the sale of real property, or an interest therein. Voiding such a contract does not affect the validity of the transfer of consideration for the contract, but prevents the acceptance of the benefit of such consideration.
In the purchase of real property, the item (property) must be specifically described in order to embody the contract. A real estate broker usually prepares the contract for the parties. For an executory contract to be enforceable in a court of law, it must be signed by the party against whom it is sought to be enforced. In other words, a valid purchase contract must be signed by the buyer and the seller; if there is a mortgage involved, a lender will also have to sign some instrument as well such as an Assumption Agreement as well as a Note and Deed of Trust.
The contractor or seller and the purchaser must be legally competent. A minor can contract under certain circumstances. However, persons deemed incompetent by law may not contract without a guardian, and contracts made with such persons are void .
There is usually an earnest money deposit involved to support the initial cash consideration of the purchase and sale of the property. This is either deposited into a Trust Account with a Real Estate Broker or Attorney.
Terms or contingencies in a contract are called executory because they are only applicable before performance or closing. The terms of a contract or the specific provisions are agreed upon by the parties prior to executing the contract. If a part of the agreement is omitted, the contract is not valid and not binding on the parties.
The Statute of Frauds is a statute that prohibits enforcement of certain types of contracts that are not in writing. The Statute of Frauds states that the following are the only mechanisms by which a contract must be in writing: (1) any interest in lands; (2) any agreement that is not to be performed within one year; (3) any promise to pay the debt of another; (4) an agreement made upon consideration of marriage; (5) a sale of goods with a value over $500.
In real estate, property is generally said to be "land," "immovable," or "realty." According to the Statute of Frauds, a transfer of land may be papered to make it valid.
It is well known that a contract for the sale of real property or any interest in same must be in writing. However, a transfer of an interest in real property without a contract may be valid under the doctrine of part performance.
Examples of Executory Contracts in Real Estate
There are a variety of real estate contexts in which executory contracts can be successfully utilized. Lease-to-own agreements and installment land contracts are two of the most common.
Lease-to-Own
If you’re in the market for new home, it might be worth your while to check out lease-to-own options, also known as rent-to-own agreements. In most cases, these contracts are written as "option to purchase" agreements. This means that the buyer has the option (but not the obligation) to purchase the property from the seller at a set price within a specified time frame. Unless the buyer chooses to purchase the property, the seller is not required to accept any offer made.
Rent-to-own agreements most often consist of three key components:
- A one-time option payment. This is typically a non-refundable fee that is paid by the buyer to hold the exclusive right to purchase the home.
- A monthly rent component. The specified rent amount is slightly higher than the fair market value for the property. The difference is kept in an escrow account and applied to the purchase price of the home if the buyer decides to exercise the purchase option.
- A specified purchase price. The price is determined at the time the lease is signed and will not change regardless of when the buyer chooses to purchase the home (if at all).
Installment Land Contracts
While somewhat less common these days, installment land contracts are yet another way for buyers to purchase a property before they have the necessary funds up front. These types of agreements are most often used when the property is being sold by a private seller rather than a real estate agency.
Essentially a form of seller financing, this type of executory contract allows the buyer to make regularly scheduled payments until the purchase price is paid in full. Once this happens, the buyer assumes full ownership of the property.
There are two ways in which the buyer’s interest is deeded in an installment land contract:
1. "Contract for deed." With this agreement, the deed is held in escrow until payment is complete. At that point, the deed is released to the buyer.
2. "Equitable title." In this case, the seller conveys equitable title to the buyer, thereby allowing him or her to enjoy the advantages of ownership. At the same time, he or she does not assume any of the burdens of ownership until the purchase price is paid in full.
Advice for Purchasers and Sellers Under an Executory Contract
Buyers and sellers entering into an executory contract should conduct careful due diligence to ensure that the contract aligns with their interests. This includes reviewing all provisions of the contract, negotiating terms that protect both parties, and ensuring compliance with state and federal laws. For sellers, it is important to accurately represent the condition of the property, including any known defects or issues, to avoid potential liability for breach of contract. Buyers should also conduct thorough inspections of the property and review any relevant documentation , such as title reports, surveys, and zoning information, before signing the contract to ensure that they are fully aware of the property’s condition and any potential issues. Both parties should also maintain open and clear communication throughout the transaction process, addressing any questions or concerns as they arise. In addition, it is advisable for buyers and sellers to seek the guidance of an experienced real estate attorney to ensure that their interests are protected and that the transaction proceeds smoothly.