Specific performance

Enforcement of real property purchase agreements

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“Specific Performance” is a powerful legal remedy afforded to parties to certain contracts where there has been a failure of performance on one side. In California, the remedy is established by statute in the California Civil Code at Sections 3384 to 3395. Most commonly, a court action for specific performance is used to compel performance of either the buyer or the seller of real property, enforcing the specific terms of the real estate purchase agreement. This remedy is often pursued regardless of whether other monetary remedies may be available to the party not in breach.

The scenarios in which an action for specific performance can be employed are numerous. Imagine a situation where auto dealer holds the assets of an auto dealership in one corporation but holds the real property where the dealership operates in another corporation, also controlled by the same dealer, subject to a lease to the dealership. The dealer decides to sell the dealership to a buyer, who is granted a long-term lease on the dealership property and who is also granted an option to purchase the real property at a future date. A few years later, the buyer decides to timely exercise the option to purchase the real property at the option price but the seller now believes that the option price is too low and does not want to sell. As long as the buyer can show that the option contract is not so ambiguous as to be unenforceable and that the buyer is able to perform and pay the full option price, the buyer can obtain a court judgment against the seller forcing the sale to the buyer -- regardless of whether the option price is now considered to be below the value of the property.

This is primarily because the law has long recognized real property as unique in such a way that monetary recovery would not fully compensate a buyer for being unable to purchase the property. In fact, California law – like many other states – provides for a legal presumption that monetary recovery would be inadequate to compensate for a breach of a real property purchase agreement. The law imposes a conclusive presumption with regard to residential property when the buyer intends to occupy the property and, in all other instances, a presumption shifting the burden of proof as to the adequacy of monetary remedies. (Cal. Civ. Code § 3387.)

Is the right to specific performance limited to buyers?

No. Although it is unusual, a seller also has a legal right to bring an action for specific performance against a defaulting buyer under California law. Many real property purchase agreements provide for “exclusive” remedies to sellers. Commonly, such a remedy provides exclusively for the payment of liquidated damages resulting from a buyer’s breach (i.e. a specific sum or method of calculation for money that is payable by the buyer of the buyer breaches), in which instance the purchase agreement itself may prohibit an action for specific performance. However, in cases where the seller’s specified remedy is not exclusive, the remedy of specific performance is considered to be held mutually by the buyer and seller. This means that the seller can typically elect whether to pursue monetary remedies or the remedy of specific performance. (Cal. Civ. Code § 3389 and § 1680.) Nevertheless, in the alternative to an action for specific performance, a seller may prefer to pursue a sale to a different buyer and merely seek monetary damages against the breaching buyer. For example, a seller may seek damages such as the difference between a lower price paid by a second buyer as versus what the first buyer agreed to pay in a downward market and/or the interest on the unpaid purchase price between the date of performance and the date of judgment.

Can a buyer who succeeds at compelling specific performance also obtain damages?

Yes. If the buyer of real property brings an action for specific performance, that buyer may also obtain a damages award for any consequential damages caused by the seller’s refusal to perform. For example, with rental property, the buyer is losing out on rent payments made during the period between the date for closing and the date the buyer is finally able to take ownership. These lost rents are a consequence of the seller’s breach. Similarly, in our scenario above, to the extent the buyer with the option continues to pay rent for the property the buyer optioned to buy, beyond what the buyer would have paid if able to close on the option, the excess rents payments may be a consequential injury to the buyer (subject perhaps to an offset of what the buyer would have paid on any financing). Also, if the cost of the buyer’s financing increased during the period of breach, and the buyer had to pay a higher interest rate for the same loan, that may be considered a consequential injury to the buyer. Of course, interestingly, the breaching seller may seek to offset interest that the seller may have made on the purchase funds had they been paid when intended. In this way, the court effectively conducts an “accounting” between the parties to render each whole in the end.

It is important to note, however, that the attorney’s fees and costs incurred in pursuing or fighting an action for specific performance are not considered a consequential loss associated with the breach. Rather, under California law, only a prevailing party may recovery attorney’s fees and costs if such is provided by the real property purchase agreement executed by the parties. (Cal. Civ. Code § 1717.)

When can specific performance be denied by the court?

First, it should be noted that many types of contracts are not subject to an order for specific performance, including contracts pertaining to personal services and contracts that are not “sufficiently certain to make the precise act which is to be done clearly ascertainable.” (Cal. Civ. Code § 3390.) Second, even in instances in which the type of contract would ordinarily be subject to a remedy of specific performance, the party seeking performance must be able to establish an ability to fully perform both at the time the contract was entered into and at the time any judgment for specific performance is rendered. That is, under California law, specific performance “cannot be enforced in favor of a party who has not [or cannot] fully and fairly performed all of the conditions precedent on his party to the obligation the other party,” unless the failure to perform is only partial and is either “entirely immaterial” or “capable of being fully compensated…” (Cal. Civ. Code § 3392.) For example, if a buyer is unable secure necessary funding, he may be denied specific performance or conversely, if a seller is unable to timely deliver over clean and clear title, the seller may be denied specific performance against a buyer.

Even if a party can meet this legal standard, a court may also deny specific performance against a party where that party can establish it would not be “just and reasonable” (Cal. Civ. Code § 3391(2) – although that does not necessarily merely mean that the deal previously struck was a bad deal for the breaching party. Rather, such a defense would be more likely successful if forcing the transaction would unduly imperil the breaching party and subject them to bankruptcy, receivership or other such detriment. Finally, the breaching party may successfully defend an action for specific performance if that party can establish the underling agreement was the product of fraud or unfair business practices or the result of a “mistake, misapprehension, or surprise” (unless the contract specifically provides for compensation in the event of mistake). (Cal. Civ. Code § 3391(3)-(4).)

How do you prevent the seller from selling the real property before the court decides the case?

As we have explained in an earlier published article, the most significant protection a buyer has to try to ensure that property is not sold to someone else while an action for specific performance is being sought is the power of the lis pendens or Notice of Pendency of Action.

“The significance of a Notice of Pendency of Action is that, by giving notice of a pending legal action involving claims affecting real property identified in the Notice, it protects the interests of the named parties. Once recorded against the property, making the Notice apparent to those who review property title records, the Notice also gives priority to any judgment obtained by the party who recorded the Notice as of the date the Notice is recorded, over subsequent interests obtained which affect the real property. California Civil Procedure Code (CCP) §405.01 et seq. Thus, the Notice can effectively deter subsequent transfer or encumbrance of the identified real property, since it indicates that property ownership rights are in dispute, and the rights of the party who recorded the Notice will have priority, if successful in their claims.”

Final thoughts:

Real estate contracts can be fraught with pitfalls for the unwary. Contract terms and conditions may be included that provide – intentionally or unintentionally – ways to evade performance of a contract in a way that specific performance cannot prevent or remedy. Or, as noted above, the terms may not be sufficiently certain so as to be enforceable by a court. Parties entering into any substantial transaction should seek representation from a qualified professional. At Scali Rasmussen PC, we can provide superior legal counsel at front end (such as the preparation or negotiation of buy-sell agreements) and we can be there if things go wrong during the transaction through our experienced team of litigators. Indeed, in some instances, the best remedy is to pursue the legal right of rescission – essentially the opposite of specific performance in which a transaction is reversed or unwound rather than ordered to be performed. (Watch for an upcoming Ahead of the Curve article on the remedy of rescission.)