Court Of Appeals Issues New Decision Regarding Option Contracts

By January 10, 2018 Articles, Real Estate
Court Of Appeals Issues New Decision About Option Contracts

When it comes to real estate transactions, more often than naught, the “devil” is in the details. The Arizona Court of Appeals, Division One, recently provided a roadmap to the rules concerning the specificity of an agreement required to obtain specific performance of an option to purchase real property. In Offerman v. Granada, LLC, 1 CA-CV 16-0407, 2017 WL 5352664 (App. Nov. 14, 2017), the Court held that a lease agreement which contained an option to purchase was not specific enough to enforce because the parties did not agree on one or more “important, essential or material terms,” which include “identification of the parties, a description of the subject matter of the contract, the purchase price and the time and conditions of payment.”

The parties entered into a two-year lease of a home, and they added the following language to the lease agreement:

At the completion of the 24 month lease, the Tenant has the option to purchase [the] property . . . for a sales price to be determined at that time by an independent appraiser acceptable to both Tenant and Landlord. (Terms and Conditions to be stipulated by both parties at such time).

If the Tenant chooses to exercise his right to purchase this property at the end of the 2 year lease agreement, he shall be credited $200.00 of each $1900.00 of monthly rent paid towards purchase.

The acceptable condition of the property when Tenant takes occupancy will be considered the condition Tenant agrees to accept at time of closing. All inspections and contingencies to be performed and satisfied prior to initial move-in. Property to be sold AS-IS.

As the end of the lease term neared, the tenant notified the landlord that he intended to exercise the option to purchase, and asked the landlord to name an independent appraiser per the terms of the option provision of the lease agreement. The landlord did not respond, and tenant retained an appraiser who provided a valuation of the property, which the tenant shared with the landlord. Instead of relying on the tenant’s appraisal or commissioning its own, the landlord then sent the tenant a draft purchase agreement with a proposed sales price much higher than the appraised value, which the tenant rejected.

The tenant sued the landlord for breach of contract, alleging that the landlord had failed to agree on an independent appraiser, and refused to respond to the tenant’s efforts to exercise the option by instead proposing an inflated purchase price.  The tenant asked the trial court to order specific performance of the purchase option and to set the purchase price at the appraised value. After a bench trial, the judge found that the tenant was entitled to specific performance of the option and entered a judgment to be used as the escrow instructions for the sale. The landlord then appealed.

The Court of Appeals overturned the trial court and held that the option clause in the lease agreement did not contain terms definite enough to warrant specific performance in favor of the tenant. The court explained that while “[a]n option does not require ‘completeness in every detail,’” “[t]he necessity for clearly defined terms is even more critical when an option is concerned.” Id. at 2 (internal citations omitted).

Citing the Restatement (Second) of Contracts, the Court went further and held that “[t]he more terms the parties leave open, the less likely it is that they have intended to conclude a binding agreement… In some circumstances, terms may be ‘certain enough to provide the basis for the calculation of damages but not certain enough to permit the court to frame an order of specific performance . . . and to determine whether the resulting performance is in accord with what has been ordered.’” Id. (internal citations omitted).

The Court further detailed the deficiencies in the language of the option clause by concluding that (1) although the landlord and tenant “agreed on a mechanism to establish price by selecting an ‘independent appraiser,’ the selected appraiser had to be ‘acceptable to both Tenant and Landlord;’ (2) [t]he parties failed to provide an alternative method for selecting an appraiser for the impasse that ultimately occurred;” and (3) “the parties did not establish a means to determine the many other remaining undefined terms,” “[f]or example, the option is silent as to the timing of payment or closing, terms of payment (earnest money, down payment, financing, and allocation of closing costs), condition of title upon conveyance, method of conveyance, and whether escrow would be handled by a title agency.” Id. at 3.

The Court also cautioned against language in an option which is merely “an agreement to make an agreement.” Id. It is important to distinguish “cases where ‘the parties have purported to agree on a contractual provision and have done so in a vague and indefinite manner,’ which are inappropriate for specific performance, from ‘cases in which [the parties] have remained silent as to a material term’ where ‘the reasonable conclusion is that [the parties] understood the law would imply the omitted term.’” Id. (citations omitted). In this case, the Court found that the parties clearly intended to negotiate the option’s additional terms at a later time, and held that specific performance is unavailable if the contract “leave[s] any material or essential term for future negotiation.” Id.

The bottom line is that “[o]n a claim for specific performance, it is not within the superior court’s authority to flesh out an option agreement that lacks certainty.” Id. at 4. Put another way, “the court’s role is not that of contract maker. While custom, usage and implications can be used to prove a contract’s existence, they cannot be the basis for providing numerous essential elements of an agreement.” Id. (citations omitted).

It is important for real estate professionals who are guiding their clients through drafting option language to encourage them to specify as many terms as possible, and to not leave terms for negotiation or determination at a later date. In most cases, it is recommended that an experienced real estate attorney review such language before the parties sign on the dotted line.

If you or anyone you know has questions regarding a real estate transaction, please call our office today to schedule a consultation with Philip A. Overcash or Christopher J. Charles.

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