Contracts in Real Estate Transactions
Real estate has value because its ownership entitles the owner to exercise, or perhaps to sell, certain rights.
Because rights are not tangible items, they can be safeguarded only through binding contracts and other legal tools,
most of which are placed in public records to protect the owner’s interest and to defend against the claims that third
parties may assert with regard to the property.
I. We can characterize contracts in various ways:
A. Unilateral vs. Bilateral – most contracts are bilateral, with each party acting (or promising to act) in a certain
way; e.g., a contract to buy real estate. Some contracts, though, are unilateral, in which one party promises to act
only if a specified condition is fulfilled; e.g., a listing contract (seller pays commission only if broker performs).
B. Valid vs. Voidable vs. Void vs. Unenforceable – for a contract to be valid, all essential elements must be present.
A voidable contract has one or more elements missing; the wronged party has the choice of enforcing or avoiding
(e.g., dual agency). A void contract is contrary to public policy, so the law does not view it as a contract (courts will
not enforce it) even though offer, acceptance, etc. are present (e.g., a contract employing someone to burn down a
house to collect fire insurance proceeds). An unenforceable contract is not valid because of legal requirements other
than the elements of a valid contract (e.g., violates statute of frauds).
What are these elements that cause a contract to be valid and enforceable? They are agreement, consideration,
parties acting under free will, parties who are legally competent, and a legal purpose. Also, as noted before,
contracts involving real estate must be in writing to comply with the statute of frauds.
1. Agreement – also called “mutual assent” or “offer and acceptance.”
a. Offer – a promise to act in specified way if the other party will act in some other specified way. Must:
i) Not be a joke, not a statement made under duress. More subtly, not an invitation to make an offer.
ii) Be communicated to specific party, the offeree. You can’t deem an action on someone’s part to be
acceptance of an offer if they don’t know an offer has been made; e.g., resort gives someone a
free weekend visit but doesn’t tell them that by showing up they’ve accepted an offer to buy a
iii) Have complete, definite terms. Must give information as to identity of parties, identity of property, time
of performance, price, how price is to be paid, any other important issues.
Termination of offer – offer is not open to acceptance forever (fortunately); it terminates by:
i) Lapse – offeror states date when offer terminates; acceptance after that date is either disregarded or
viewed as new offer. If no stated period, it’s based on what is “reasonable” based on type of
property and local custom.
ii) Revocation – offeror withdraws offer prior to acceptance, either expressly or by conveying other info.
that implies offer has been revoked (e.g., seller sold the house to someone else).
iii) Rejection by offeree. May be outright, or conditional (most home sales are conditioned on buyer’s
ability to get financing under reasonable terms, including a specified minimum amount of principal
needed and maximum interest rate the buyer is wiling to pay), or counteroffer (offeree changes
some of the terms). If original offeror accepts condition/counteroffer, there is still a contract.
iv) Operation of law – death or insanity of either party, or the destruction of subject of contract (e.g.,
house is destroyed by a tornado).
b. Acceptance – offeree agrees to abide by terms of contract, as stated in the offer (which may have originated when
the party who was the original offeree made a counteroffer to the original offer). If acceptance is not complete and
unconditional, it is actually a counteroffer.
2. Consideration – technically, a legal benefit foregone or a legal detriment accepted. More informally, it’s
generally money paid, or a promise to give something of value (money, real estate) to another party, who promises
other consideration in return.
Characteristics of consideration:
a) May be money, securities, or even an agreement to act or refrain from acting in some specified manner.
b) Must relate directly to the agreement at hand; can’t be in return for previous favor. Example would be a
promise to give land to someone who just saved your life; you could back out and rescuer could
c) Need not reflect an objective measure of market value.
3. Reality of assent – must be a meeting of the minds, and all parties must act of their own free will. If these
elements do not exist, wronged party can rescind contract and demand return of any consideration given. Rescission
a) Fraud – intentional misstatement or concealment of a material fact, e.g. structural condition of house.
(House that floods after any heavy rain, housed reputed to be haunted, “snake house”.)
b) Innocent misrepresentation – material, but not intentional. 1965 vs. 1966 construction date probably
is not material. Example might be a structural defect that the seller did not initially know about.
c) Duress – one party acts under threat to his/her safety or property, or safety or property of a loved one.
d) Undue influence – party was in position of trust that allowed him to take unfair advantage of another.
For undue influence to be proven, all these conditions must be present:
* Susceptibility to influence on one party’s part
* Opportunity for other party to exert undue influence
* Disposition or tendency for party to exert undue influence (e.g., keeps victim isolated from other
* Appearance that undue influence has occurred (e.g., actions are totally out of character for victim, like
removing their children from will and leaving all property to a new caregiver)
[Questions of undue influence tend to arise when a person gives, or leaves in a will, real estate or other valuable
property to someone other than closest relatives, or favors one relative while excluding others.]
e) Mutual mistake – if both parties were in error, with regard to a verifiable fact (otherwise it might be
misrepresentation). Example might be misunderstanding over which of two parcels was being sold.
[Has to be the case that one party still wants to enforce, or they’d just agree to tear up contract.]
4. Legally competent parties – if you’re a minor, mentally ill, or intoxicated, you don’t have legal capacity to enter
into a contract, and legally competent parties should not contract with you, because you could later disaffirm. You
get back your money, and must return any property received (no matter what shape it is in).
For minors, contracts are voidable, even after reaching legal age (if they act within reasonable time; otherwise they
are ratifying). If you lie about your age, you can be sued for damages.
For insane persons, contracts are voidable if the person did not understand actions but had not been judged legally
insane. Void by law if the person had already been judged insane. You would want to contract only with this
person’s legal guardian.
For drunkards, contracts can be avoided if the intoxicated person did not understand what they were doing, as long
as they act within a reasonable time of becoming sober and understanding their earlier actions.
5. Legal purpose – the terms of contract can not violate:
a) Common law – court case precedents. Example is deed with an unreasonably restrictive covenant not to
b) Statutory law – laws passed by local, state, or federal legislative bodies. Example is the sale of land on
condition that the buyer not resell to non-whites.
c) Public policy – example would be an agreement to make campaign contributions in return for a favorable
Depending on circumstances, an illegal contract may be totally void, or the legal provisions may be enforceable and
only the illegal portions seen as void (likely the case in example b just above).
6. In writing – Since 1677, when the British Parliament enacted the first statute of frauds, governing jurisdictions
(including all 50 states in the U.S.) have required some contracts to be in writing to be enforceable. All real estate
contracts come under statute of frauds provisions (though verbal contract may become enforceable after one or both
parties have substantially performed as agreed, such that a contract and its major terms could be inferred).
A contract may be an expressed agreement, or may be implied (deemed by the court to exist) through a series of other
documents (signed letters, canceled checks). Parties, property, and price should be clearly identified.
Points to note:
* Real estate sales contracts, mortgages, and easements always have to be in writing (as do sales of personal property
greater than $500 in value).
* While other contracts may be oral yet enforceable, proving what was agreed on in those situations can be quite
II. Remedies for a Breach of the Contract
If one party fails to complete obligations under an enforceable contract, the other party may pursue certain legal
A. Buyer – if seller defaults, buyer may seek relief in the form of:
1. Specific performance – deliver deed to the specified real estate.
2. Damages – a dollar amount received to place the buyer in a position equivalent to what would have been
realized if the seller had performed under the contract. (e.g., G agrees to sell H a factory site but
then backs out. H must buy an alternative site that costs the same, but needs $10,000 in repairs to
bring it up to the quality of subject; H sues G for $10,000).
3. Rescission – terminate the contract and get back any consideration paid (called “restitution”).
4. Liquidated damages – before contract is signed, parties agree on amount that a breaching party must
B. Seller – if buyer defaults, seller may seek relief in form of:
1. Specific performance – purchase the specified real estate (unusual).
2. Damages – collect money lost as result of having to find another buyer and hold the property longer.
3. Rescission – terminate contract and return buyer’s money or terminate contract, but keep buyer’s. money.
Generally, it is OK to keep the money if it represents earnest money (a good-faith deposit) and not
a down-payment (which typically must be returned).
4. Liquidated damages
III. Types of Real Estate Contracts
Though a contract can consist of a combination of documents (letters, cancelled checks, etc.), it is normally one
specific document, often of a standard form type used in a specific locality. Such form contracts are acceptable, in
fact probably desirable, to use if they serve parties’ needs as effectively as a more specific document could. It is not
unusual for the standard form contracts used in a given market area to have been designed jointly by a committee of
attorneys and real estate brokers, and ultimately approved by their local or statewide professional associations. Then
brokers can fill in the blanks (names, addresses, dates, dollar amounts, whether appliances remain) on these form
contracts without being accused of the unauthorized practice of law.
A. Listing Agreement – contract between a real estate owner and a broker, promising payment of a commission
to the broker if the broker locates buyer who is ready, willing, and able to buy. It is an employment contract that
establishes a special agency relationship between the owner and the broker.
B. Deposit Receipts and Offers to Purchase – during negotiations, oral offers and counteroffers are likely to be
utilized. But to form a binding contract (recall the statute of frauds), there must be a written document showing offer
and acceptance, and spelling out the important terms.
The party that draws up and signs the document is bound under the terms of the contract; the other party may accept
or reject those terms. Acceptance may, strangely enough, be oral. But there must eventually be a signature or the
contract becomes unenforceable.
“Deposit receipt” is a more complete document than a mere offer to purchase, in that a deposit receipt acknowledges
the receipt of earnest money and spells out conditions of payment of the broker’s commission.
In Illinois, it is usually a document called a “proposal to purchase” that is used to make a binding offer. Under
Illinois law, the word “offer” in a document prevents it from being a binding contract (seen as confusing).
C. Contract for the Sale of Real Estate – makes the transaction legally enforceable. Spells out the parties, the
property, and all important conditions (e.g., date of delivery). It must specify:
a. Seller – with adequate legal proof that the party acting as the “seller” has title, and has authority to sell. It
becomes especially important when the actual seller is a corporation or the beneficiary of a trust.
b. Buyer – with adequate proof that the buyer has contractual capacity (e.g., is not a minor) and is financially able to
c. Quality of title – typically fee simple, but whatever quality of ownership is required should be specified.
d. Property description – full and accurate legal description, if possible. The contract is void if the property can not
be clearly identified. Also, any other items (e.g., personal property) to be included in the sale should be specified.
e. Price – how much money and when it is to be paid. These items should be specified unambiguously, and any
mortgages (to a bank or the seller) should be specified.
f. Type of deed – depends on the quality of the seller’s title.
g. Title exceptions – any restrictions on the seller’s title should be specified. There are always some (zoning laws,
utility easements), but the buyer has a right to know what is being purchased. Especially important to note:
* Leases – not usually recorded in public records unless they are long-term
* Special tax assessments that have not yet been recorded [if recorded, then buyer has constructive
h. Earnest money – a good faith deposit. If contract is completed, earnest money is applied to the purchase price. If
the contract is breached by buyer, earnest money may serve as liquidated damages (usually paid to listing broker).
i. Prorating of items paid in advance and with positive balance at the date of closing – property taxes,
homeowners’ insurance (if the buyer assumes the seller’s policy), rents received (if rental property).
j. Evidence of title – the seller must normally provide evidence that title is good. Possible types of evidence:
* Abstract of title – a history of a property’s ownership based on publicly recorded transactions,
from the government’s original grant to the present owner. Prepared by a lawyer or an
* Attorney’s opinion of title – after examining abstracts and public records, an attorney writes a
letter stating her opinion as to the title’s quality.
[Problems with abstracts and opinions: no “deep pocket” to sue if loss results from title searcher’s negligence.]
* Title insurance – an insurance policy that compensates a buyer’s financial loss if title is later
found to be defective. (Discussed in more detail below.)
* Torrens certificate – (named for Sir Robert Torrens in 19th century Australia). Title is
registered with the county government, just like a car title is registered. Upside: once the
government recognizes an owner, proof of ownership in subsequent transactions becomes
easy. Downside: determining certifiable ownership the first time is a very involved
process, involving public notices and court hearings. Used to be used in Cook County
to some extent, but the county government no longer enters new Torrens registrations.
k. Destruction clause – specifies who must insure the property between the contract date and closing date.
One method is for the seller to insure, but with buyer having the right to collect the policy proceeds and rebuild.
l. Escrow provision – needed if a third party will facilitate the transaction (common in California).
m. Possession clause – tells when the buyer gets possession.
n. Time Is of the Essence clause – if contract does not state that “time is of the essence,” either party can take
additional time (a reasonable period) to complete his/her obligations.
IV. Special Topics involving Real Estate Contracts
A. Installment Land Contract, or “Contract for Deed” – seller lends most of the purchase price to the buyer, and
then retains title as security. The buyer does not get a deed; buyer has a contract to purchase the property and get a
deed after paying all installments. Agreement should include identifying information (property, parties, price) found
in any contract. It should also specify that the buyer gets immediate possession, and it is best if a third party (escrow
agent) holds the deed and payments, because a defaulting buyer may lose all prior payments as liquidated damages.
B. Option – an option is an enforceable contract, in which the option holder pays the property owner a stated fee
to keep an offer open at a stated price for a stated time. The option fee may or may not be applied to the purchase
price. Similar to the option is the right of first refusal, except in the latter contract no stated sales price is specified
(the party holding the right must meet the best terms offered by one or more other bona fide offerors).
C. Contract for the Exchange of Real Estate – similar to other contracts, except consideration is in the form of real
property given up (and maybe added cash or personal property, known as “boot”). Transactors might complete a
“like-kind exchange” of property instead of a traditional purchase/sale to save on federal income taxes.
D. Assignment – rights in a real estate contract normally are assignable (through gift, sale) to another party. An
assignment can be useful to a buyer who wants an agent to negotiate in his place, perhaps to conceal the buyer’s
E. Escrow arrangement – oral or written contract under which buyer and seller agree to let a third party, the escrow
agent, handle all money and documents. A neutral party therefore can verify performance by all parties before the
transaction is closed. Also prevents problems in the event of the death or incapacity of one of the parties; the other
party is dealing with the escrow directly, and dealing only indirectly with the other party to the transaction.
V. The Closing Process
A real estate transaction must follow a more formal procedure than do other types of transactions for a number of
* Large dollar values are involved
* Lack of solid evidence of seller’s ownership and good title until transaction is well under-way
* Legal matters (statute of frauds, fair housing laws)
* Need to prorate certain expenses
Steps in the transaction:
Formal contract, with offer (and perhaps a series of counteroffers) and acceptance, consideration, competent
parties, all major terms specified.
Usually there are contingencies, such as a favorable report from home inspector and buyer’s ability to obtain
standard financing, which nullify the offer if the outcomes are not to the buyer’s satisfaction.
Note: a listing is not an offer to sell; rather, it is an invitation for buyers to make offers to purchase. However, if a
buyer offered the full listing price in cash, agreed to all other terms specified in the listing, and had no unreasonable
or unusual demands, but the seller refused to sell, then the seller might be 1) obligated to pay a commission to the
broker and 2) subject to penalty under the fair housing laws.
A. The closing
The closing, or settlement, of a transaction is a meeting at which the buyer and seller, their brokers and attorneys, and
the lender (and perhaps an escrow agent) exchange money and documents to bring about the conveyance of a bundle
of rights from the seller to the buyer. The closing is organized by the lender or one of the attorneys (or an escrow
agent). In our area it is typically organized by the lender, who computes all relevant dollar amounts and reports the
transaction to the Internal Revenue Service (since real estate transactions can have tax implications).
The sale contract should specify a date and place for the closing. Enough time should be allowed so that the title
search, inspections (appraiser, termite), and document preparation (mortgage, deed) can be completed. That time
periods used to be 6 weeks or so; now it is down to perhaps two weeks (sometimes less) as lenders have gained better
access to computerized information (e.g., credit histories), and it may fall to a matter of days or even hours as
If the contract does not contain a “time is of the essence” clause, the closing may take place a reasonable time after
the stated date without any penalty to the party causing the delay.
B. What is exchanged at the closing?
1. Cash is paid to the seller, normally in the form of a cashier’s check from the buyer’s lender (in this area, the
closing typically takes place at the office of the buyer’s lender).
2. A deed is given to the buyer. It is prepared by the seller’s attorney, with some of the language dictated by law,
some by the seller’s wishes or bargaining strength (e.g., type of deed), and some reflecting the buyer’s wishes (e.g.,
taking title as joint tenants). It is important that everyone’s name be spelled correctly. The deed should convey
marketable title (no major questions or defects) to the buyer.
3. Affidavit of title is given to the buyer – signed statement that no activity (e.g., bankruptcy or potential liens) that
might endanger the title has occurred since the title search was completed. Lien waivers may be required if the seller
has hired anyone to do work maintaining or improving the property.
4. Seller’s mortgage is released, or discharged – the attorney or lender who organizes the closing should obtain
information from the seller’s lender(s) on the amount owed up to the date of the closing (these reduce the amount
payable to the seller), along with any overages in impound accounts (these increase the amount payable to the seller).
The buyer’s lender will not provide a loan until all money owed by the seller has been repaid. The two lenders must
cooperate, or the closing process can be delayed.
5. Homeowner’s insurance documents, if buyer takes over the seller’s policy.
6. Title insurance policies – usually in Illinois the buyer pays for the lender’s policy, and the seller pays for buyer’s.
One recent newspaper article indicated that the policy that protects the lender’s claim might cost about $600, while
the policy protecting the owner’s interest might cost about $500 (one-time charges that then provide insurance
coverage as long as the loan remains outstanding or the buyer still owns the property). The lender’s policy might
costs a little more, even though the lender’s claim declines over time as principal is repaid, because the lender
typically has more money at risk in the early years following a purchase, when title problems would be more likely to
7. Receipts or bills for property tax payments (recall that the prior year’s taxes are typically prorated based on local
8. If the improvements are new construction, a certificate from local government stating that the property is fit for
occupancy (some Illinois communities require such a statement even for older properties).
9. Termite inspection report is given to buyer and lender by seller.
10. Commissions are paid to brokers from sale proceeds.
11. Buyer should receive a bill of sale for any personal property purchased with the real estate.
12. For income-producing properties, copies of leases, maintenance contracts, and employee records should be given
to the buyer.
C. What are the costs paid at closing? Some examples are:
“Debits” for buyer: downpayment, loan application fee, discount points, mortgage insurance, credit report fee,
premium for lender’s title policy, recording fees for deed and buyer’s mortgage.
“Debits” for seller: property taxes prorated for the period when the seller still owned the property, premium for
buyer’s title policy, attorney fee for document preparation, broker’s commission, recording fees for release(s) on
seller’s mortgage(s), transfer tax paid to state and county ($1.00 to state of IL, 50¢ to county – higher in Cook – for
every $1000 of transaction price, rounded to the nearest $500.) [You can look at the state tax stamps on a deed to get
a close estimate of the sale price; $185 in tax means that the sale price was about $185,000.]
At the closing, there may be several accrued (still owed by the seller) or prepaid (already paid by the seller) expense
items. Prepaid items could include insurance premiums, homeowner association dues, or utilities (especially heating
oil in an on-site tank) already paid for, along with property tax paid for in advance. In Illinois, however, property tax
is paid in a later year, so property tax typically is an accrued item that must be prorated at closing.
Different methods for prorating exist; we will concentrate on the “actual days in the year” method typically used in
practice (although the license exams in Illinois used to assume monthly proration, with twelve 30-day months).
For example, 2008 property taxes of $2,800 are to be paid in June and September of 2009. Closing is held on March
31, 2009. So at closing, the seller should pay to the buyer:
$2,800 for 2008 plus 91/365 of $2,800 = $698.08 for 2009; total of $3,498.08.
Local customs generally treat the seller as liable for tax on the day of the closing. Note also in our example that
2009 taxes are estimated to be the same as 2008’s, but the actual tax could end up being higher. In the typical
transaction, the buyer just accepts the loss. (One mitigating factor is that the buyer gets to collect a few months’
interest on the tax money prepaid by the seller at closing.)
E. Real Estate Settlement Procedures Act (RESPA) [1974, amended 1975]
This act was designed to 1) curb lender abuses – which it did – and 2) reduce settlement costs – which it did not.
RESPA applies when any lender that is federally insured, or that lends more than $1 million per year, lends on a 1-4
family owner-occupied property. The lender must:
1. Provide every potential borrower with a HUD informational pamphlet on closing costs.
2. Give a good faith estimate of closing costs when the application is completed, and give an exact figure one
business day prior to closing.
3. Collect only a small cushion over amounts actually needed in “impound” (or escrow) accounts for property tax
and insurance payments handled by the lender
4. Provide a copy of the Uniform Settlement Statement (example in text) to all parties.
F. Escrow closings – as opposed to ordinary conference, or “face-to-face,” closings – are used extensively in
California and some other jurisdictions (not much in Illinois). An escrow is a disinterested third party that holds all
money and documents until all parties have performed as specified under the agreement. This type of closing is said
to be helpful in encouraging all parties to perform; it also works well in situations involving many parties, or if a
seller dies (or just has a change of mind) during the transfer process (the deed transfer is said to “relate back” to
when the grantor delivered it to the escrow agent). •