What is a “Contingency” in real estate? (Civ. Code § 1436.)

Contingencies are conditions or requirements included in purchase agreements that must be met before the agreement moves forward. Contingencies are designed to protect the parties’ interests in the transaction by allowing them to back out of deals or renegotiate terms when certain conditions are not satisfied. 

In California real estate contingencies commonly address financing, inspections, and appraisals. Understanding what contingencies are and how they influence purchase agreements is crucial to protecting the parties’ interests in any real property transaction.  

What is a Contingency?

Contingencies are conditions or requirements that must be met for a real estate transaction to proceed or a contract to become binding. (Civ. Code § 1436.) In real estate contracts, contingencies protect the parties, typically buyers by allowing them to back out of the deal if certain conditions are not met. Contingencies give buyer’s the power and privilege to terminate the contract when the condition is not satisfied without penalty, so long as the buyer is acting reasonably and in good faith. (Crescenta Valley Moose Lodge v. Bunt (1970) 8 Cal.App.3d 682, 687; Mattei v. Hopper (1958) 51 Cal.2d 119, 122.) 

To create a contingency, real estate agreements must include certain conditions that must be met before the transaction can continue, such as abiding to the contingency period, which is the specified timeframe during which buyers must satisfy contingencies to proceed with the transaction. There are many kinds of contingencies, including inspections, appraisals, funding, lender approval, and more. 

What is an Inspection Contingency?

Inspection Contingencies condition the buyer’s purchase obligation on the approval of various inspections and documents before finalizing the property’s purchase. (Civ. Code § 1436.) 

Buyers have the right to conduct inspections, investigations, surveys, tests and other studies at their own expense, unless the parties have agreed otherwise. (In re Barker (2008) 393 B.R. 864, 867.) Generally, these inspections look for wood-destroying pests, mold, and other property conditions like compromised structural integrity. (Ibid.) 

The buyer’s obligation to purchase the property is conditioned upon their approval of inspection results, meaning buyers must be satisfied with the property’s condition based on the conducted inspections’ results. (Beverly Way Associates v. Barham (1990) 226 Cal.App.3d 49, 55.) Buyers must complete inspections and approve or disapprove results during the specified contingency period. Contingency periods are generally defined in the purchase agreement and can be extended by the parties’ mutual agreement. (WDYA Associates v. Merner (1996) 42 Cal.App.4th 1702, 1712-13.) 

Buyers must formally remove inspection contingencies by a certain date to indicate they approve of the property’s condition. If buyers fail to remove contingencies, they may retain the right to cancel the purchase agreement without incurring penalties. (In re Barker 393 B.R. at 867-68.) When buyers remove inspection contingencies, they effectively waive their right to object to any issues uncovered during the inspections, meaning the buyer accepts the property as is and the purchase can proceed. (RSB Vineyards, LLC v. Orsi (2017) 15 Cal.App.5th 1089, 1103-04.) 

By design, inspection contingencies give buyers the right to inspect the property for defects and make the inspections’ approval a necessary condition before can escrow close.

What is an Appraisal Contingency?

Appraisal contingencies allow buyers to back out of real property purchase transactions if the property is appraised at less than the purchase price, ensuring buyers are protected from obligations to pay more than the property’s value. 

Appraisal contingencies typically act as a condition precedent to the buyer’s obligation to complete the purchase, meaning the buyer has the right to cancel the purchase if the property appraises at or below a specified value. (Willemsen v. Mitrosilis (2014) 230 Cal.App.4th 622, 627-32.) 

Contracts may specify the process for selecting appraisers. For example, contracts may allow each party to select an appraiser, and provide that if both appraisers do not agree, the parties must select a third appraiser whose decision will be binding. (Hooper v. Los Angeles Valve & Fitting Co. (1921) 55 Cal.App. 17, 22.) Contracts might also specify that the appraisal result is binding on the parties, meaning both parties must accept the appraised value as conclusive and final. (Northern Acceptance Trust 1065 by Handy v. Amfac, Inc. (1973) 59 F.R.D. 116, 121.) Lastly, Contracts may provide parties with an opportunity to present evidence or information to the appraisers to support their valuation, however, an opportunity to present evidence is not mandatory. (Hooper v. Los Angeles Valve & Fitting Co. 55 Cal.App. at 19-20.) 

What is a Funding Contingency?

Funding contingencies condition buyers’ obligation to complete the purchase on securing financing, meaning buyers can cancel transactions without penalty if they are unable to obtain the necessary financing within the contingency period. (Kays v. Brack (1972) 350 F.Supp. 1243, 1246.) Funding contingencies are also effectively a condition precedent. 

In the funding contingency context, contingency periods protect sellers by ensuring the property is not kept off the market indefinitely while the buyer secures financing. Thus, buyers must secure financing during the specified timeframe to proceed with the transaction. (Kays v. Brack (1972) 350 F.Supp. 1243, 1246.) If buyers are unable to do so, they must notify the seller of the inability to secure financing. This notice allows either party to cancel the sale. (Ibid.) 

Funding contingencies are removed when lenders notify buyers of loan approval. Notification of approval must be deposited into escrow to remove the contingency. (Fogarty v. Saathoff (1982) 128 Cal.App.3d 780, 787.) Like inspection and appraisal contingencies, buyers and sellers reserve the right to cancel the purchase transaction if the buyer cannot secure funding during the contingency period. Additionally, both parties must mutually agree to extend the contingency period to allow the buyer an opportunity to obtain alternative funding if they are unable to do so as they initially expected. 

What is an Example?

“Shawn” and “Julie” own a duplex property together in Southern California, as joint tenants. Julie lives in one unit, while Shawn rents out the other. Over time, Shawn and Julie’s relationship deteriorates, and now, Shawn wants to sell the property, but Julie does not. Unable to agree, Shawn files for partition. Because Shawn and Julie are joint tenants, Julie has the option to buyout Shawn’s interest in the property, however, Julie does not have the funds readily available and must obtain financing. To do so, Julie and Shawn negotiate a funding contingency into their buyout agreement. If Julie is unable to secure financing within 60 days, she will notify Shawn and the court, the partition will proceed, and the court will sell the property. If Julie does successfully obtains the planned financing, she will buyout Shawn’s interest, keep the property, and avoid a partition proceeding. 

Conclusion

Contingencies afford buyers and sellers the flexibility to back out of deals or renegotiate terms in real estate transactions that fail to satisfy certain, negotiated conditions. Protecting your interest, whether you’re buying or selling, is vital in any real estate transaction, especially one involving co-owned real estate. At Underwood Law, our partition attorneys can help you navigate your partition case efficiently and with care. We are here to help.