Defaults and Terminations: It's Not Automatic

Defaults and Terminations: It's Not Automatic

It is important to understand that a TREC contract does not automatically terminate just because the other party defaults; additional steps must be taken to legally terminate the contract, claim the earnest money and enter into a subsequent contract with another party.

Law Talk: 

In their hurry to jump into a backup contract once the first contract goes into default, many parties unwittingly put themselves in a serious legal bind, obligating themselves under two separate contracts at the same time. Why? With very few exceptions, failure of a party to comply with contractual obligations, or failure of a contingency to be met (financing, option period, title/survey objection) will not automatically terminate the contract. In order for either party to be released from contractual obligations, demand the earnest money and enter a new contract, they must first lawfully and properly terminate the first contract in writing.

TREC has made it relatively easy for a buyer to terminate a contract due to failure of a contingency to be met. TREC Form 38-4, Notice of Buyer’s Termination of Contract, provides a written statement which affirmatively terminates the contract: “Buyer notifies Seller that the contract is terminated pursuant to the following:," and then lists various clauses which permit Buyer to terminate. But until the Buyer signs the termination form and delivers it to Seller, the contract is still alive and enforceable. Note that this TREC form does not require Seller to sign; Buyer can unilaterally elect to terminate the contract upon occurrence of the factors listed. But also note: this termination form merely addresses the need to officially terminate the contract; it specifically does not address the right to earnest money (“NOTE: Release of the earnest money is governed by the terms of the contract.”). As pointed out in past issues of this blog, both parties must mutually agree as to the rightful recipient of the Earnest Money before the title company can release it.

Conversely, TREC does not provide any form for a Seller to use to terminate the contract due to Buyer’s default. Again, if Buyer defaults, the contract does not automatically terminate; Seller must deliver written notice of Seller’s election to terminate. Unlike Buyer’s numerous rights to terminate based on contingencies, Seller typically can only terminate if Buyer defaults. And an occurrence of default requires a legal determination, something TREC does not want agents involved in. Hence, no TREC form. The common misconception is that if Seller delivers to Buyer a TAR Form 1904 Release of Earnest Money, then they have effectively terminated the contract and properly made demand for the earnest money. This is just not true. The TAR Form 1904 is merely an agreement between the parties that the contract is terminated, and who is entitled to the earnest money.

Seller’s signature on the TAR form and delivery to the buyer is nothing more than a proposal; it is not enforceable or effective unless and until signed by buyer! In order for a seller to terminate the contract and then sign another contract with another buyer, Seller must first send to buyer a written notice that says something like “Buyer is in default of its obligations under Sec. ___ of the Contract, and that pursuant to rights afforded under Sec. 15, Seller hereby terminates the contract and demands the earnest money.” Until Seller actually terminates in this way, and delivers the notice in strict conformity with Sec. 21, the contract is still alive despite Buyer’s default.

Rights of termination are frequently misunderstood, but extremely important in establishing the rights to earnest money and entering into subsequent contracts.

This Title Tuesday Tip is provided courtesy of Rattikin & Rattikin, LLP, attorneys and counsel for Rattikin Title Company and is not a legal representation or statement of law. Please confer with your legal counsel for any and all legal questions.