As the housing downturn continued its descent in 2006, many home buyers looked to get out of contracts. Some were investors who realized the days of flipping homes every year or two for a 25 percent profit were over, others were traditional home buyers who couldn't sell their current homes and felt trapped.
This situation came to a head in the Washington, D.C., area, where a large number of home buyers sought to terminate purchase contracts with builders and asked for their deposits back, but most builders refused.
Many home buyers then sued to get their money back, which led to a legal issue that brought into question the enforceability of new-home contracts.
According to Beau Brincefield, an attorney in Alexandria, Va., who has handled about 100 of these cases for home buyers, a basic tenet of contract law states that unless both parties have a mutual obligation to one another the contract is not binding. The formal legal term is called mutuality of obligation.
Brincefield explains that the home buyers and their attorneys contend that the contracts used by many builders are so one-sided that they do not legally obligate the builder to build and deliver the house, but they do obligate the buyer to pay. So, under the mutuality concept, if the builder is not obligated to build, the buyer is not obligated to buy and is therefore entitled to a refund and, depending on how the contract is written, it may or may not include interest.
“Unless the builder is bound to build and deliver the house, then the buyer is not obligated to pay [should he or she decide to cancel the contract],” says Brincefield, who says about half of the mutuality cases he has handled have been resolved in negotiated settlements between buyers and builders. The other half are still pending.
In one resolved case, builder NVR settled with 16 home buyers looking to get their deposit money back for contracts worth about $20 million. The homes were worth about $1 million each, with individual deposits in excess of $100,000.
The settlement amount was undisclosed, and NVR refused to comment on the case, but the message is clear: At least in the Washington region, the mutuality issue is real.
“The reality is that the mutuality issue has been raised because we are in a down market,” says Robert Diamond, a lawyer with Reed Smith in Falls Church, Va., who represents builders in these cases.
“During the boom, if someone wanted their money back, builders didn't care because there were so many people looking for new homes,” he explains.
Builders can nullify a mutuality claim by making a contractual commitment to deliver the house within a specific period or offering the buyer his or her deposit plus interest in the case of a cancellation. Until last year, this wasn't an issue since the market was so hot that few people were looking to get out of contracts.
HBA officials in formerly hot markets in Florida and Nevada say the mutuality issue has not been a factor since most builders are simply terminating the contract and offering a refund. According to the HBA in Las Vegas, the builders are just accepting that times are bad.
“Our community's new-home sales are down about 30 percent year-over-year because potential home buyers can't sell their existing homes,” says Monica Caruso, director of public affairs for the Southern Nevada HBA. “Since buyers can't move forward with the purchase of a new home under contract, most builders are refunding the earnest money deposits and canceling the sale,” she says.