Dysfunctional Real Estate Contracts

Today’s mini-review is of Dysfunctional Contracts and the Laws and Practices that Enable Them: An Empirical Analysis, 46 Ind. L. Rev. 797 (2013), by Debra Pogrund Stark, Dr. Jessica M. Choplin, and Eileen Linnabery.

Apparently, many real estate contracts limit buyers’ remedies to return of earnest money, and many courts enforce such limitations. The problem is that if a buyer’s only remedy for breach of contract is the return of earnest money, then the seller hasn’t really bound himself to anything. If the seller doesn’t want to perform, all he has to do is return the earnest money. This encourages the kind of strategic behavior that contracts are supposed to prevent. For example, a seller may agree to sell real estate, but if the property's market value increases, the seller can breach the contract, return the earnest money, and sell the property to a second buyer at a higher price. The seller essentially gets to speculate on the buyer's dime.

Further, many buyers don’t understand the meaning of these limitation of remedy clauses, even if they read them. The authors conducted a study which suggests more than a third of people who read a limitation of remedies clause fail to comprehend that their remedies have been limited. The authors use this finding to challenge some courts’ reasoning that buyers knowingly consent to the limitation of their remedies.

The authors offer several reforms, and two are particularly interesting: (1) enacting legislation that prohibits limiting buyers’ remedies to the return of earnest money, and (2) replacing the exacting standards of unconscionability with a "reasonable limitation of remedy” test similar to that used in evaluating liquidated damages.

This article is state-of-the-art in its use of empirical research to aid legal analysis. It not only provides interesting data, but it also marshals that data against flimsy intuitive arguments still common wherever people talk about contracts.

[Kenneth Ching]

[Image by thinkpanama]