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Risky Business: Who Bears the Risk of Loss in a Real Estate Transaction
A real estate transaction is much more complicated than a buyer simply handing over a check and a seller transferring the deed. There is a whole, convoluted process that commonly spans months. This leads to an important question: During the period after the contract for the sale of real estate has been signed, but before escrow on the sale has closed, who carries the risk of loss of the property? The answer depends on where you live. The majority of jurisdictions follow the doctrine of equitable conversion, which places the risk of loss on the buyer after the contract is signed but before closing. A minority of jurisdictions assign the risk during this period to the seller. The approaches of both jurisdictions will be discussed below, but if you are unsure which rule is followed in your state, contact an experienced real estate law firm, like Adam Leitman Bailey, P.C., for help.
The Majority: Equitable Conversion
The first formal step in all real estate transactions is the negotiation and execution of a contract for sale. However, the buyer does not truly possess title to the property until the deed is conveyed to them at the close of escrow, which can occur a considerable time after the contract is signed. This creates a strange sort of middle ground where neither party has complete legal ownership of the property, so who bears the risk of its destruction? If the buyer bears the risk, then they have no claim against the seller if the property is destroyed prior to closing by a fire, flood, or other act beyond the seller’s control. This is the approach taken by the majority of jurisdictions.
This approach is based on the doctrine of equitable conversion, under which the buyer receives what is known as “equitable title” at the moment the contract for sale is signed. The seller, on the other hand, retains legal title and lien on the property equal to the sale price. The rationale behind this doctrine is that from the moment the contract is executed, the buyer has a right to specific performance of the contract (delivery of the property to them), and therefore it is as good as theirs. As such, it is fair to place the risk of loss on the buyer, according to this approach, since they are for all intents and purposes the owner. This is also the reason the seller receives a lien on the property.
Of course, there are exceptions to this rule. If the seller is the cause of the property’s destruction, then the buyer will not be forced to bear the risk of loss, and the seller is not entitled to the sale price. In addition, if it is discovered that the seller’s title was unmarketable at the time the contract for sale was signed, then the risk of loss will remain with the seller. If you find yourself in the unfortunate situation of determining whether you bear the risk of loss for real property that was destroyed after the contract of sale was signed, you should contact a real estate lawyer like Adam Leitman Bailey.
It is worth noting that, in addition to the doctrine of equitable conversion, the risk of loss will usually pass to the buyer if they take actual possession of the property prior to closing.
The Minority: Risk Stays with the Seller
In a minority of jurisdictions, the seller carries the risk of loss after the signing of the contract of sale and before closing. There is a split among minority jurisdictions over whether this is the case even if the buyer takes actual possession of the property, so be sure to speak with a real estate lawyer to determine what the rule is where you live.
The Trump Card: The Parties’ Intent
The Majority and Minority approaches discussed above apply if the parties fail to allocate the risk of loss in the contract itself. However, if the parties do include bargained-for language in their agreement stating who bears the risk of loss, then the parties’ designation will control. In addition to indicating who bears the risk of loss, the parties can provide for additional protections in the event of a loss – such as the ability to cancel the contract instead of being made to perform.
Conclusion
Nobody wants to think about the destruction of the house they’re trying to buy or sell, but it is an all too real possibility that must be planned for. The best thing the parties to a real estate transaction can do is decide ahead of time who will bear the risk of loss. If they fail to do so, then a majority of jurisdictions place that risk on the buyer, while a minority keep it with the seller.
