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This Will Surely Encourage New Home Sales:

With new home sales slumping, and many buyers backing out their contracts even at the cost of losing their deposits for fear of losing even more money as the bubble deflates, builder Brookfield Homes has a great idea: threaten not simply to keep cold-footed buyers' deposits, but to sue them for the difference between the price they contracted for and the price the house actualy sells for: "Some buyers could find themselves on the hook for more than their initial down payment. If a house is resold for less than the original purchase price, 'we are able to go back to the initial purchaser and recoup some of the losses we had there,' says Mr. Hughes of Brookfield Homes." Yep, that will inspire new buyers to put down new deposits [clarification: given that it's both terrible customer relations, and also that it implies that Brookfield's poobahs believe that the value of the homes they've sold on spec is rapidly plummeting, or soon will rapidly plummet].

UPDATE: Of course it's true that many real estate speculators treated nonrefundable earnest money like a call option on rising real estate prices, and I wouldn't feel much sympathy for such a speculator who failed to anticipate (either because he didn't know the law, or because he assumed prices would rise forever) that he could be liable for expectancy damages as well. But it's also hard to feel sympathy for builders facing mounting cancellations: the builders knew rampant speculation was going on in many markets, and could have avoided the problem by only selling homes at or near completion.

Hattio (mail):
What's that saying? Stupid is as Stupid does?
3.4.2006 7:21pm
Robert Racansky:
So if the house sells for more than the original contract, do the buyers who backed out of the original contract receive that difference?
3.4.2006 7:26pm
John Jenkins (mail):
What it says to me is don't sign a contract that allows them to do that. Negotiate a term that says if you walk away the earnest money is all they're entitled to.

Otherwise this looks like straight-up expectations damages.

If I contract to sell you something for X and you pay me Y as a down payment then back out and I have to sell it for some amount (Z) less than X-Y, then I am entitled to (X-Y-Z) if X is greater than Z. If you back out and I try to get what I'm entitled to, how do I become the bad guy?
3.4.2006 7:31pm
Steve Lubet (mail):
I think you meant "earnest money" rather than "down payment."
3.4.2006 7:36pm
Kovarsky (mail):
I actually think the effect of this practice is ambiguous. Sure, it's an added cost to the buyer (in the form of a potential penalty). But in a slow housing market, it's going to allow sellers not always hold out for the highest bid. And this is a real market, so bidding doesn't happen simultaneously. This isn't theory, so the bidding happens sequentially and there is a real cost to the market of waiting on closing in hopes of securing a higher bid (even in a cold market).

My suspicion is that the negative effects on buyer incentives dominate, but in the presence of an undeniable counterveiling effect, it's at least a theoretic possibility that the seller-incentive effect dominate.
3.4.2006 7:51pm
btorrez (mail):
Who says you are limited to buying a home from Brookfield? I think the market will more than likely take care of this.
3.4.2006 8:00pm
Wintermute (www):
I was raised in the real estate business and retired my (full, principal even) broker's license when I got my law one. I could explain all this, but I don't get much respect here; so I'll just whine unless contacted outside this thread. :-P
3.4.2006 8:21pm
pdxnag (mail) (www):
First thing that the seller would have to do is strike out the liquidated damages clause and get it initialed by the parties at the front end of the offer and acceptance phase.

Then, of course, the right to refuse based upon some inspection thing could take up the slack for a buyer with buyer's remorse.

Then the lender and the appraiser could have a pow wow about value too.

Good luck.

I suspect there will be many subdivisions that will have half or fewer homes completed in the near future, and stay that way for an extended period of time. I have seen it before and tried selling into such a declining market.

Don't build spec homes. Simple.
3.4.2006 8:33pm
Wickedpinto:
So if the house sells for more than the original contract, do the buyers who backed out of the original contract receive that difference

I don't understand this. The buyer, generaly, owns the land, or the rights to the land, they contract someone to do a thing on that property, to improve the value of that property, and then the buyer has the right to back out? I always thought that was called theft. The risk assumed by the buyer should be based on the value of the property, and the cost of development. The risk assumed by the contract should be based on the promised cost of the development, and the actual cost of development and subcontracts. It strikes me that the entity that should assume this risk should be the good faith lenders, (of course I'm assuming private development for housing) who promise approval upon completion of the development. (which is another thing I find odd, but is too confusing for me to find the words to relate) That is why I find this confusing, cuz this should be natural, the contractor should be able to recoup the investment, it's just a question of from what entity. To allow one party of a contract to back out without penalty is an attack on the value of the concept of a contract.

In Addition, there are contractors, who even if they get paid still lose money on the deal because their initial bid, or price is lower than what ends up being the actual cost of the project. If a successful contractor takes the risk of losing even if the contract is executed accurately, why should a buyer get off scott free for not honoring the contract at all based on a momentary market decision based exclusively on self interest disregarding the contractual commitment with the builder?

one more addition. Yep, that will inspire new buyers to put down new deposits

Well maybe new buyers won't put down new deposits, but it will likely make buyers (who are a party to a contract) to follow through on the terms of their contract with their contractors.
3.4.2006 9:02pm
aces:
"No tradesman out of Bedlam ever thought of increasing the numbers of his customers by knocking them on the head."

--Benjamin Franklin
3.4.2006 9:02pm
Bruce Hayden (mail) (www):
As I am studying tonight to reacquire my Colorado broker's license, I decided to look at our official CO Real Estate Commission forms, and they are just as I remembered. In a sales contract for residential real estate, there are two alternatives for a buyer defaulting, specific performance and liquidated damages (typically to the extent of the earnest money deposit). When I was working as a broker, back a number of years ago, we almost always selected liquidated damages for the reason illustrated here, esp. since a seller could sue for expectation damages if the specific performance box were selected. In the case of default by a seller, specific performance is always provided.

Unfortunately, big builders often employ their sales people directly, and are thus not legally bound here to use the official RE forms here (and neither am I, as an attorney). So, they might be able to get away with using forms that didn't give you an option of liquidated damages (remember, in the typical RE transaction for used homes, it is the buyer who submits the contract in the first place, and thus can easily make this selection). My guess is that when they are selling directly to the public, many of them use their own forms, and when they sell through a broker, they use the approved forms (many here will pay a somewhat reduced commission to a broker, if the broker brings them the business). I also note from comments to the referenced articcle that some of these home builders are using brokers working for them to list their new houses on the MLS.

I should add though that CO here has weird RE laws, in that attorneys are rarely involved in residential RE transactions here. Rather, almost all such transactions utilize official RE commission forms filled out by licensed RE brokers.
3.4.2006 9:33pm
John Jenkins (mail):
I don't understand this. The buyer, generaly, owns the land, or the rights to the land, they contract someone to do a thing on that property, to improve the value of that property, and then the buyer has the right to back out?

That's one way it CAN work, but that's not what we're talking about here. What happens here is the developer owns the land and subdivides it into lots then builds houses on those lots to sell.

I can't imagine *ever* signing a realtor's form contract.
3.4.2006 9:48pm
Greedy Clerk (mail):
This is illegal in many states -- in California in particular, all home mortgages are nonrecourse, i.e., the lender only has recourse to the land not to the borrower. This is sound policy and to the extent that those would argue that this causes the price of mortgages to go up the market for mortgages in California has not been affected by it.
3.4.2006 10:09pm
John Jenkins (mail):
GC, this isn't a mortgage and so the single-action laws shouldn't matter. It's not a deficiency judgement, but a contract action. Cal. Civ. Proc. Code § 580b would not apply because it wouldn't be a purchase money mortgage (or equivalent) given that the putative buyer did not buy.
3.4.2006 10:48pm
Raw_Data (mail):
I can't see the issue UNLESS the seller/builder has not CLEARLY &SIMPLY explained the term in the sales contract and maybe even verbally in front of witnesses. It's more a matter of disclosure than anything else.

I can't see how it is or should be against public policy. It's a stupid term for a buyer and it indicates lack of faith in the market. If I were a buyer I would be nervous simply because it would be obvious that the seller is concerned about a declining market. And if I perceive that themore knowledgeable seller is worried then I should be too.

I am/would be surprised if very many people agreed to that term. But again, I am not sure I see how it is or should be against public policy. The seller is essentially saying that he wants a bigger penalty if the buyer defaults. That seems to me to be a matter of private negotiation. No?
3.4.2006 11:04pm
Fishbane (mail):
I do share David's feelings, but due to rational self interest, I want the market to cool down just a bit more... I have my eye on five specific properties. When one of them hits a target price range, (all else willing) I'll have a house.

I'm lucky that I'm not tied to a particular location: I'm only planning on a mortage for tax reasons, and buying in a depressed area won't harm the business. And I'm about done with NYC, anyway, its charms notwithstanding.

So, please: make contract negotiation harder. It will lower my costs over the next year.
3.4.2006 11:09pm
Tom952 (mail):
First, we are talking about competent buyers who sign contracts and pay a deposit, and then fail to perform (close the deal). Except for sports millionaires, people are supposed to honor their contractual obligations, right?

Second, suing is one thing, winning is another. There isn't a lot of love for builders floating around. It would be a tough judgement to sell.

I think the builder is just woofing.
3.4.2006 11:30pm
Raw_Data (mail):
"...people are supposed to honor their contractual obligations, right?"

No. Wrong. or at least partly wrong. It's morally right that people fulfill their obligations. But the law doesn't care so long as the non-defaulting party is made whole.

But in fact the "defaulting" party in the contract described by DB would be meeting the terms IF he pays the damages as outlined in the contract. (So he's not really in default at all.)
3.4.2006 11:37pm
John Jenkins (mail):
The seller isn't asking for a bigger penalty on default. Presumably the contract does NOT contail a liquidated damages clause or a clause limiting the seller to the earnest money in the event of default by the buyer.

That being the case, the seller wants his expectancy damages: he wants to be put in the place he would have been had the buyer gone through with the deal. That's the regular measure of damages for a contract claim. There's nothing unusual about it.
3.4.2006 11:38pm
Daniel Newby (mail) (www):
This builder is playing with fire. They have almost certainly accepted cancellations by previous buyers, yet not filed 1099 forms (reporting income from cancelled debt) with the IRS.
3.5.2006 12:06am
Fishbane (mail):
This builder is playing with fire. They have almost certainly accepted cancellations by previous buyers, yet not filed 1099 forms (reporting income from cancelled debt) with the IRS.

An excellent point, in wide strokes.

However, is that really 1099? I am not a tax attorney, but I do my company's accounting, and 1099, unless I'm missing something, is for reporting contractor payments. I've never heard of it being used for cancelled debt.
3.5.2006 12:24am
Lev:
With all due respect (Bernstein)


but to sue them for the difference between the price they contracted for and the price the house actualy sells for


Is not the same as (Brookfield)



"Some buyers could find themselves on the hook for more than their initial down payment. If a house is resold for less than the original purchase price, 'we are able to go back to
the initial purchaser and recoup some of the losses we had there,'


It has been a while....

Suppose Mr. Dork "puts down" $80,000 to reserve a Prize Winning condo at the then selling price, market supported/willingsellers and buyers, of $800,000 under construction by Usedtobeausedcardealer Homes.

Under what circumstances would Usedtobe be entitled to appropriate more than the $80,000 assuming the contract did not limit cancellation damages to the "reservation fee"?

It seems to me mitigation of damages has a big part to play. If the unit was just about completed and the market crashes so that the "second sale" does not cover the costs of construction, then I can see Usedtobe being entitled to the difference between the actual sales price and the cost of construction (+ the $80,000). But if the unit hasn't been nearly completed, then Usedtobe is entitled to less and less the less complete the unit is - if bare ground, entitled to nothing other than the $80,000.
3.5.2006 12:26am
John Jenkins (mail):
Say what? Unless the builder is an accrual taxpayer AND the cacellation was in a different taxable year than the contract was signed, there are no tax consequences at all on the breach to the builder. The earnest money might be income at that time, but I'd think that the earnest money was income when it was received because it was entirely within the builder's control whether it would be returned.

There's no imputed income to the buyer on the breach either. Buyer has received nothing, so there is no debt owed to anyone. Even if there were, wouldn't it be a disputed debt? See Zarin v. C.I.R., 916 F.2d 110 (3d Cir. 1990). If so, then there is no imputed income because the amount paid (i.e. the damages) would be seen as the debt owed.
3.5.2006 12:30am
John Jenkins (mail):
Lev, in your example, the buyer agreed to pay $800,000 and seller agreed to sell for that amount. After the $80,000 payment, the agreed contract price is still $720,000. Unless there is some kind of liquidated damages clause limiting the seller to the $80,000 (as any competent lawyer would have negotiated for) as damages, then the seller is entitled to his expectancy damages which would be $720,000 less the actual selling price. If it sells for greater than $720,000 then the buyer gets lucky but is not entitled to the difference, the contract having already been breached.
3.5.2006 12:34am
Lev:

This builder is playing with fire. They have almost certainly accepted cancellations by previous buyers, yet not filed 1099 forms (reporting income from cancelled debt) with the IRS.


Regardless of whether the 1099 is the right form, I am not sure I get that.

Your theory is that by allowing the cancellation of the reservation, Mr. Coldfootedbuyer has received income from Usedtobeausedcardealer Homes in the amount of the purchase price of the condo, less any earnest money not returned by Usedtobeausedcardealer Homes to Coldfoot.

It seems to me me debt that can be income when cancelled does not come into existence until the unit is actually purchased, the note signed, and title delivered. Then, of course, cancelling the amount of the note is income to Coldfoot. I suppose if the contract to sell specifically provided that Coldfoot owed Usedtobe the full amount of the condo no matter what, even if title to the completed condo is not delivered, then the release would be income to Coldfoot, but that might be a rather unusual contract.
3.5.2006 12:44am
Lev:
John Jenkins

I understand that method of approach, but in "cold storage" so to speak, I have a vague sense that it does not necessarily apply.
3.5.2006 12:47am
Raw_Data (mail):
You guys are making it far too complicated.
3.5.2006 12:52am
Lev:
Raw_Data

You do realize there are a bunch of lawyers that post at the Volokh Conspiracy, and not just lawyers but law perfessors?
3.5.2006 12:55am
John Jenkins (mail):
Lev, I don't know what you mean by "cold storage," but the measure of damages in a contract action is expectancy damages where expectation damages can be ascertained. Restatement (Second) of Contracts § 347.
3.5.2006 1:46am
Jake:
I think the tax consequences would be from the buyer. If we have:
B agrees to buy from Dev for $800, puts down $80.
B decides not to buy.
Dev sells the unit for $500.
Dev agrees not to pursue any action against B.

Then I think B would have $220 in income. The only way he's getting out of it is if he's in the 3rd Circuit, because nobody else is going to follow the wacky logic of Zarin.

I don't see the argument for any income for Dev, though.
3.5.2006 2:00am
Wickedpinto:
I am filled with fury, confusion, and disgust.

mimics (contract laborers) make almost as much as engineers, "Developers" aren't held responsible, and now even those who chose to "build homes" don't care about what they lose? This is not the Eisenhauer DIY family, this is the corrupt, PRO government opportunist.

I can make about. . . .

Well at least 10 well argued points saying that this is an excuse for the financials, and lawyers to make money at the expense of the creators of modern culture, life, and well, the home that I live in.
3.5.2006 2:05am
John Jenkins (mail):
No tax consequences at all. No debt was ever created. At the time the buyer breaches, the buyer has not received anything in return for which there is a debt. All the buyer has received is a promise to perform.

There is no "debt" until the seller gets a judgment against the buyer. Then, if the seller writes it off, it's a forgiven debt. Until that point it's not truly ascertainable what the "debt" is because we don't know what claims or defenses are available. We have a dispute over the amount owed and that is squarely within the recocnized exception for an unliquidated "debt." See Boris I. Bittker and Martin J. McMahon, Jr., Federal Income Taxation of Individuals ¶ 4.5[3][c] (2d ed. 1995).

If the seller does get a judgment and then does write it off, that would be imputed income to the buyer under § 61(a)(12). Until it's reduced to a sum certain, there's no way it can be a forgiven debt. Of course, if a court found no obligation, there would be no debt in the first place. Either way, no imputed income to buyer.

We're ignoring the purpose of the forgiveness of debt income doctrine. The person who has to take the G.I. must have received some kind of benefit. Generally this is cash. When I borrow money from a bank, I get cash and if I don't pay them back, it should be income because it was not income when I borrowed it. Here, the buyer really gets nothing more than a promise to perform in return for his earnest money. The buyer has received nothing in the way of benefit to be taxed. The buyer will always come out in the negative on the deal, thus no G.I.
3.5.2006 2:22am
Raw_Data (mail):
Lev,

Oh I know the posters are professors but it seemed obvious that the commenters, for the most part, aren't.

And so what if they are professors? Bernstein may be a fine attorney in certain areas but he obviously knows little about public works, as was indicated in another post. They are law professors and I suspect that many of them have meager experience in the actual practice of law much less any real world experience outside doing anything. (If that sounds a bit snobbish on my part, it is.)

Anway, I thought getting side-tracked on the tax consequences of the contract term DB had high-lighted seemed pretty funny. If you think otherwise, ok.
3.5.2006 2:32am
John Jenkins (mail):
ACtually, DB was a litigation associate at Crowell &Moring in D.C. before moving on to teaching (and did a one-year stint as a clerk before that as a judicial clerk, where you get LOTS of legal experience). I'm fairly confident that a good number of the commenters are lawyers, law students, or professors. IF that leads the discussion in esoteric directions, well, that's the nature of the particular subjects.
3.5.2006 2:43am
Wickedpinto (mail):
No tax consequences at all. No debt was ever created. At the time the buyer breaches, the buyer has not received anything in return for which there is a debt. All the buyer has received is a promise to perform.

You start out by arguing taxes, but the truth is that in affect the BUYER is making a REAL promise to the developer, based on the very real "good faith lender" to the contractor. Do you know any contractors?

Contractors are Contracters because they get PAID!!! You can COUNT on the fact that contractors are relatively inexpensive as long as they KNOW what the basic income is, that is WHY GC's can make promises to SubContractors.

Okay, if you are right?

I I will SWEAR!! Promise, cross my heart and hope to die, that I will pay 40 times the average hourly income of laborers so that we may all destroy 430 riverside in chicago.

and then? you know what? the view is too nice, to be blocked by a large building, so I will back out.

That argument is FUCKED!!!
3.5.2006 3:21am
Raw_Data (mail):
Well if you insist on staying on subject, then I don't think that this term will go very far and so will have no impact on the market.

Btw, I don't have access to the WJS but the link given by DB isn't precise in describing the term i.e. the language isn't quoted or even paraphrased. (There's only an assertion by a guy from Brookfield perched oddly on the middle of a blog post ; DB, it seems sloppy/ funny to write a post without the key language available.)

So it's really difficult to know what is going on; I'd hardly rely on a blog as a reliable source!
3.5.2006 5:39am
Bruce Hayden (mail) (www):
I never did figure out where in the country they are talking about suing people for backing out of contracts. It has to be a desperation measure, being more worried about selling the present inventory than selling any more houses. After all, who in their right mind is going to do business with a company like that in the future? Even if one managed to get a liquidated damages contract with them in the future, I would still worry about their response to any of the myriad of things that typically need to be fixed in new homes by the builder.

I found interesting a quote somewhere there or linked from there from a Realtor in Phoenix talking about all how the city was landlocked, etc., and so implying that everyone should keep buying, buying, buying. But he ignores a bunch of stuff, including that there is still a lot of open desert there, and more importantly that they have priced a large percentage of the population out of the market. Ditto for Las Vegas. The incomes are just not there to support the current housing prices, never mind where the Realtors are predicting them going. Neither is D.C., where most everyone is somehow connected to the public dole.

I don't see the alure of either one right now. Would any one in their right mind try to raise kids in Sin City? Does anyone like being panhandled whenever you got to 7-11? And why retire there? The air quality in Phoenix has declined so much that a girlfriend's grandson is having serious asthma problems from the pollution a lot of the time - maybe 15 years after an former girlfriend moved to the area from NYC because of her daughter's asthma.

I am typically a cynic, so no one should be surprised that I am now predicting that much of the housing bubble is starting to deflate. The big question I think is how wide spread the bubble deflation is going to be, and how abrupt and intense. I don't expect it to throw us into a recession, but do expect that some will be bloodied.
3.5.2006 9:05am
Bruce Hayden (mail) (www):
John Jenkins

I appreciate your sidetrack on debt forgiveness. It has always bothered me. Not the situation where someone gets money, and then doesn't pay it back. But rather, in this sort of case, where all he gets is debt. I do seem to remember hearing about some sorts of RE transactions resulting in taxable income from forgiven debt even when the taxpayers never really realized anything, but am thankfull that the prospects of that are not that great.

In Business School, I liked tax. It was complicated, and I did better than average understanding it. But then, I had to take tax law in law school, and quickly discovered that it is one of the most complex subjects in law, so I ended up in IP, which is supposed to be complex, but isn't nearly as much so tax, IMHO.

I ran into a fraternity friend from college a decade or so ago, and was surprised to find he was an attorney. I told him I had expected him to be a CPA. Well, he was one of those too, with an MBA, plus an LLM in tax. In short, a tax expert. Yet, it seems that invariably, whenever I ask him a tax question, he has to admit that he doesn't know off the top of his head, because he doesn't do that type of tax. With a lot of places in law, it has become so specialized that even the experts there don't know the whole area.
3.5.2006 9:23am
Fatherofyoungones (mail):
My caveat- not a law professor, an attorney, or real estate professional. Just a one-time homeowner who may purchase a home soon.

What this company has done is not really that smart, but is probably not that damaging to business. Buyers are not interested in the complicated issues of real estate law. They (we) nod knowingly as each paper is passed before us to sign. The buyer nods because they have placed their faith and trust in the agent. If the agent can win their trust (whether desired or not), then the buyer will follow the agent's lead in choices.

Step back to WHY buyers purchase homes. They may want to quit paying rent, like the schools, want status, like the amenities, want to play golf, lake-view, whatever. Once they see want they want, they buy. Few buyers (though there are some) know what a soft market is or how it should effect their position.

A soft market may just be a surge in supply over demand. If the company in this article is established, I doubt that the publicity will do much harm.
3.5.2006 10:09am
Tom952 (mail):
There is another issue - Who is responsible for the losses due to the market drop? The buyer is not, but the seller might be seen to be since the seller made market projections that turned out to be in error. And after all, if the builder cannot realize the hoped for price when he sells, it is because the market took an unanticipated downturn, rather than because the buyer reacted to the market downturn and pulled out. ??

RD:
No. Wrong. or at least partly wrong. It's morally right that people fulfill their obligations. But the law doesn't care so long as the non-defaulting party is made whole.

I do not understand your point posted earlier. I wasn't speaking morally. The law requires contracts to be enforced, right?
3.5.2006 12:08pm
David Gaw (mail) (www):
If you back out and I try to get what I'm entitled to, how do I become the bad guy?
Well, that's the wonderful thing about public relations, of course. You don't have to be the bad guy to lose out. If doing what you are legally entitled to do harms your public image more than it improves your bottom line, you're well-advised not to do it. If suing your potential customers chases away more in business than it brings in in revenue, it's bad business, regardless of whether you're legally in the right.

I'm not sure we'll ever know if this particular strategy is counter-productive, because we can't know how much business it discourages. But speaking for myself, I can say that I'll remember the name Brookfield Homes, and I suspect I'm less likely to buy from them now, having read this story, even though I've never backed out of an obligation like this, and don't think I'd be likely to.
3.5.2006 12:19pm
John Jenkins (mail):
Wickedpinto, I am not arguing there is no enforceable promise. You can read my arguments on that in two places above (expectancy damages).

What I am arguing is that for the purposes of the income tax, specifically 26 U.S.C. § 61(a)(12) there is no "debt" forgiveness of which will give rise to gross income.

In the event that the buyer actually takes the house from the seller (i.e. a seller-financed deal) and then couldn't pay there would be forgiveness of debt income of the difference between the amount of the debt and the FMV of the property at the time it was transferred back to the seller.

In that case the buyer got something for the debt: he took title to the house which is the equivalent of receiving money from the seller and turning around and giving that money to the seller in return for the house.

That's not our situation though. What we have here is a buyer who gives the seller $80,000 of the buyer's money and says to the seller, "build me a house." The seller replies that a house costs $800,000, but the $80,000 is enough to let me know you're serious, so I'll start building it. When I'm done, you give me $720,000 and it's yours. The seller does not pass title to the property at the time of the contract.

If the buyer walks away at or before completion, and the seller either doesn't want or cannot get specific performance for some reason so he chooses to sell it to a third party at a reduced price, say 700,000 (12.5% reduction). The seller is out $20,000 he expected to get, sure, but the buyer never received income (an accession to wealth over which he enjoyed dominion and control) for which he should be taxed.

If the seller does reduce the debt to liquidated form through judical process (suing for breach), then that is clearly an enforceable debt owed by the buyer. If the seller forgives the debt, it is just like the situation where the seller gives $20,000 to the buyer who then returns it to the seller.

If that doesn't happen, the best analogy I know to explain it is a purchase price reduction. If the seller and buyer contract for the house at $800,000 and later the buyer tells the seller he won't pay that and the seller says, "fine, I'll reduce the price to $700,000," even if the seller has financed the house and the buyer has taken title that is not forgiveness of debt income. 26 U.S.C. § 108(e)(5).

The economic effect of the earlier transaction is the same as the purchase money forgiveness. B1 takes title to the house (now owing $800,000) and negotiates the reduction in price (to $700,000) then immediately transfers it to B2 with B2 assuming the debt and B1 getting a novation out. Assuming the property has FMV of $700,000 there is no G.I. because we've disposed of an asset for the exact amount of its FMV and AB (AB would have been reduced from $800,000 to $700,000 under 26 U.S.C. § 1016(a)). You can think of the second transaction as B2 borrowing $700,000 from the seller and giving that money to B1 for the property who then turns around and pays off the debt with the $700,000. B1 will have sold property with an AB of $700,000 for exactly $700,000 so there is no gain recognized under § 1001(a). Paying off a debt is never a recognition event, so there is no G.I. to B1.
3.5.2006 12:22pm
John Jenkins (mail):
Tom952, a contract is a document allocating risk. If the builder builds a house without a contract, then the builder takes all the risk of price fluctuations. When the seller and buyer negotiate the contract, they allocate the risk among themselves. Essentially the buyer takes on the risk of a falling market (will have to pay more) and the seller takes the risk of a rising market (will recieve less than he could have). Responsibility for the market drop is irrelevant (unless the seller did something sufficiently wrong that the contract can be avoided).

The law does require contracts to be enforced, but the method of enforcement in most contracts is not specific performance, but damages. These are real estate contracts, so specific performance may be available, but the seller may not wish to pursue it for some reason or another, in which case he is entitled to damages to make him whole and put him in the positon he would have been in had the buyer not breached.
3.5.2006 12:26pm
Raw_Data (mail):
"The law requires contracts to be enforced, right?"

Yes. And if you release the earnest money to the seller and pay the delta between your own contract price and the price at which the house is eventually sold, you have fulfilled the contract.

Of course we don't even know the precise language used by Brookfield so this whole post is sorta weird in that we are discussing a contract term without knowing its exact language.
3.5.2006 12:27pm
Tim Hadley (mail) (www):
Wickedpinto: you wrote,

"I don't understand this. The buyer, generaly, owns the land, or the rights to the land, they contract someone to do a thing on that property, to improve the value of that property, and then the buyer has the right to back out?"

Typically in the new home construction and sales market in which Brookfield participates, the homebuilder owns the land, builds something on it (either before or after contracting with a buyer), and sells the completed package of land and improvements to the buyer after construction.

I represent a new home builder, and the sales contracts expressly say that they are contracts for the purchase of real property with a completed home on it, not contracts for construction. The buyer does not have the rights or the responsibilities of the landowner that you might find in a typical construction contract.

If the buyer backs out, the seller simply sells the house and land to a different buyer. In a volatile market, though, the market price could drop before that happens. That's the gap that Brookfield is trying, clumsily, to close.
3.5.2006 1:55pm
Huggy (mail):
As a group this thread isn't looking at the big picture. This would work for less than 10 "contracts". Then laws will be passed to stop the practice.
Even those 10 might not work out. Lots of people (but not lawers) would consider the whole thing as "fraud" on the part of "builders". Similar to the "used car" lemon laws.
3.5.2006 4:19pm
John Jenkins (mail):
Huggy, what is it you think is fraudulent and what's with the scare quotes around "contract"? The rules of contract law have developed over hundreds of years and any number of market fluctiations, so your prediction seems unlikely.

The analogy to lemon laws is baseless. Lemon laws are premised on the fact that some products are defective. No one is arguing the homes are defective or damaged in any way. It's a simple market price fluctuation.
3.5.2006 4:24pm
Tim (mail) (www):
Huggy: The kind of damages Brookfield is talking about pursuing have been the standard measure of damages for sales contracts for centuries. They're not typical in real estate contracts these days just because most buyers won't accept it, so the contracts tend to be written so that the earnest money deposit is the seller's only remedy for a buyer default.

I suspect this is one of those scenarios in which the market can and will reprimand the builder's indiscretion without legislative intervention. As the new home sales market softens, the buyer's negotiating power increases. My hunch is that once a builder becomes known for requiring expectation damages, that builder will discover that its prospective customers are purchasing from someone else. If too many new home builders demand expectation damages, their customers will turn instead to the resale market where they will have greater negotiating power and can better protect themselves against price fluctutation risks. Either way, builders probably will learn that demanding expectation damages is a bad idea. Legal, but not smart.
3.5.2006 4:59pm
Lev:
Raw_Data

What was funny was your knowing this place is infested with law perfessors and lawyers, and being surprised, or disconcerted, that things were overcomplicated.


They are law professors and I suspect that many of them have meager experience in the actual practice of law much less any real world experience outside doing anything. (If that sounds a bit snobbish on my part, it is.)


A students become perfessors, B students become judges, C students make all the money. - old joke.
3.5.2006 11:10pm
Lev:
John Jenkins


I don't know what you mean by "cold storage,"


Things vaguely rememebered from something a long time ago.


but the measure of damages in a contract action is expectancy damages where expectation damages can be ascertained. Restatement (Second) of Contracts § 347.


It must be very reassuring to judges and lawyers to know that they need only refer to the Restatement, rather than having to slog through case and statutory law.
3.5.2006 11:14pm
John Jenkins (mail):
Lev, you're losing your argument and now you're resorting to invective. I cited to the restatement for convenience and to show that the general rule is expectancy damages. There are always exceptions, I just don't think this is one and if you think it is, I invite you to cite authority for that since you don't like mine.
3.5.2006 11:30pm
Lev:
John Jenkins

You have lived a very sheltered life if you feel I am resorting to invective.


I cited to the restatement for convenience and to show that the general rule is expectancy damages


That is not quite what you said.


the measure of damages in a contract action is expectancy damages where expectation damages can be ascertained. Restatement (Second) of Contracts § 347.


And, relating to my question asked earlier, the Restatement apparently has several provisions as to how expectancy damages are or may be ascertained, and what may be disregarded in achieving them...as part of the general rule.

§ 347 Measure of Damages in General
Subject to the limitations stated in §§ 351, 352, 353, the injured party has a right to damages based on his expectation interest as measured by

(a) the loss in the value to him of the other party's performance caused by its failure or deficiency, plus

(b) any other loss, including incidental or consequential loss, caused by the breach, less

(c) any cost or other loss that he has avoided by not having to perform.


It appears, that there is ... a general rule... as an alternative to 347

§ 349 Damages Based on Reliance Interest
As an alternative to the measure of damages stated in § 347, the injured party has a right to damages based on his reliance interest, including expenditures made in preparation for performance, less any loss that the party in breach can prove with reasonable certainty the injured party would have suffered had the contract been performed.


The restatement also seems to have a ...general rule...about mitigating damages that would apply

§ 350 Avoidability as a Limitation on Damages
(1) Except as stated in Subsection (2), damages are not recoverable for loss that the injured party could have avoided without undue risk, burden or humiliation.

(2) The injured party is not precluded from recovery by the rule stated in Subsection (1) to the extent that he has made reasonable but unsuccessful efforts to avoid loss.


In relation to the expectancy damages of Usedtobeausedcardealer Homes, there is a ...general rule...as to what is included in the calculation and what is not included.

§ 351 Unforeseeability and Related Limitations on Damages
(1) Damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made.

(2) Loss may be foreseeable as a probable result of a breach because it follows from the breach

(a) in the ordinary course of events, or

(b) as a result of special circumstances, beyond the ordinary course of events, that the party in breach had reason to know.

(3) A court may limit damages for foreseeable loss by excluding recovery for loss of profits, by allowing recovery only for loss incurred in reliance, or otherwise if it concludes that in the circumstances justice so requires in order to avoid disproportionate compensation.


And, of course, there is the general rule on uncertainty, which just might apply to claims for lost profits.

§ 352 Uncertainty as a Limitation on Damages
Damages are not recoverable for loss beyond an amount that the evidence permits to be established with reasonable certainty.


I could be wrong, but these don't seem to me to be exceptions, rather, they go to the essence of the calculation of the claim, which is what I originally referred to/asked about.
3.5.2006 11:58pm
John Jenkins (mail):
This isn't a lost profits case. A lost profits case is where X buys something from Y at price P and wants to sell it at a markup to customers C (or put it in his own product that he will sell to C, or whatever). It's sometimes hard to tell how much Y would make selling to C, so it would be hard to prove. There are no such evidentiary problems here, so even if we want to classify it as a lost profits case, the problem isn't present.

These damages are easily ascertainable and knowable. You want to keep introducing variables to avoid the consequence that the seller should receive the benefit of his bargain with the buyer. The duty to mitigate certainly applies, but selling at the market price is consistent with that duty.

Reliance damages aren't appropriate here, as the comment to § 347 indicates
a. Reliance interest where profit uncertain. Loss in value and cost or other loss avoided are key components of contract damages. See § 347. If the injured party was to supply services such as erecting a building, for example, the difference between loss in value of the other party's performance and the cost or other loss avoided by the injured party will be equal to the cost of the injured party's expenditures in reliance, up to the time of breach, plus the profit that would have been made had the contract been fully performed. To the extent that "overhead" costs are fixed costs, they are not included in the cost of expenditures in reliance for this purpose. See Illustration 6 to § 347. Under the rule stated in this Section, the injured party may, if he chooses, ignore the element of profit and recover as damages his expenditures in reliance. He may choose to do this if he cannot prove his profit with reasonable certainty. He may also choose to do this in the case of a losing contract, one under which he would have had a loss rather than a profit. In that case, however, it is open to the party in breach to prove the amount of the loss, to the extent that he can do so with reasonable certainty under the standard stated in § 352, and have it subtracted from the injured party's


Profit is ascertainable and certain in this case and expectancy damages are the appropriate measure of damages.

Section 351 doesn't apply, because we are not talking about consequential damages.
3.6.2006 12:30am
charles (mail) (www):
Ah! There's a lot of things to learn about....Thanks for making the general public aware of such laws.
3.6.2006 7:34am
Huggy (mail):
I don't think anything is "fraudulent". Only that a case would be made that the builder knew more about the market than the buyer. And that this knowledge could amount to fraud in some instances.
The "legal logic" being passed around here is unlikely to stand up in the court of public opinion. Sure "... Lemon laws are premised on the fact that some products are defective." In my opinion that wasn't the political reason lemon laws were passed. That was the "legal justification" for interfering in private contract law "developed over hundreds of years". Maybe I should have used "seat belt laws".
In this case the defective product would be a "financial instrument" used to contract the building of a house.
3.6.2006 8:18am
Erik H.:
I think you're losing track of the concept that real estate is not fungible, but is unique. Thus the market value of a house can be predicted, but not defined, by appraisals. In this respect real estate gives rise to tricky contract situations.

The market value of a home is only truly defined at the time of sale, and is defined only by what someone has paid for it. That NEVER serves as a guarantee that someone ELSE will pay the same amount, or more, or less. In this case, the buyer and seller had agreed on a market value for the house. The seller had undertaken construction based on that agreement. Under what provision of the contract can you suggest there was any "guaranteed market value" for the buyer?

More to the point, such provisions as damages and right to resell and the like are commonly negotiated over, and the negotiations affect the purchase price. That is a real life expression of the 'contract as allocation of risk' which has been addressed earlier in this thread. Do you want your seller to be limited to $5000 in damages if you back out of your $1,000,000 deal? You have to pay more for the house. Do you want your buyer to drop the mortgage contingency and/or inspection contingency and commit to paying the full amount in amonth? You have to sell the house for less. Do you want your seller to hold the house off the market and agree to a 180 day closing period? You have to give a larger deposit to compensate for the risk you'll back out, lose financing, die, etc. And so on. It is ludicrous to imagine that monday morning quarterbacking is appropriate to remedy a perceived contract "flaw" of this kind.

The obvious corollary, which few here seem to be dicussing, is whether you would grant sellers the power to rescind sales if the market RISES to the same degree it has fallen here. I assume not.

The only issue here is one of informed consent and/or fraud. This mostly comes down to a likely malpractice suit against the buyer's attorney or representative; I'm a real estate attorney myself and would never allow my buyer to sign such a document absent a complete (probably written) acceptance of the serious risks involved. Perhaps the buyer was told it was SOP, which we all know it is not.
3.6.2006 11:19am
dweeb:
"Then, of course, the right to refuse based upon some inspection thing could take up the slack for a buyer with buyer's remorse."

These are new construction - typically there is no inspection contingency because the local building dept. will be inspecting, and the buyer will get a warranty.

"Except for sports millionaires, people are supposed to honor their contractual obligations, right?"

You forgot about spouses.

Fatherofyoungones, people contracting to have a home built tend to look carefully at word of mouth to select a builder, so if other builders are not engaging in this practice, it may drive away new customers.
One marketing statistic builders love to promote is a low rate of litigation.

Years ago, Jaguar tried this same tactic with their XJ220 exotic supercar. When the automotive press tested the first production models, performance was not a amazing as initially boasted, and several buyers cancelled their orders. Jaguar threatened to sue to make them take delivery and pay up. I believe the buyers either rolled over or Jaguar prevailed. You'll notice they haven't offered another exotic since - they ruined their good name in that coveted market.
3.6.2006 3:14pm