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COMMON MISTAKES IN DRAFTING CONTINGENCIES

By: Dan Kloberdanz

A "condition precedent" or "contingency" is an event which must exist or occur before the parties to a contract are obligated to perform under the contract. Arizona courts tend to follow the general rule that in order to make a provision in a contract a contingency, it must appear from the language of the contract itself that the parties intended the provision to operate as a contingency. Therefore, if a party intends that he or she is not obligated to perform on the contract unless a certain event occurs, the contract should specifically state that the occurrence of such event is a contingency to the contract.

The most common mistake in drafting contingencies is that the event intended to be a contingency is written more or less as a covenant to perform a certain act. For example, the following language is likely to be inadequate to create a contingency: "The buyer will obtain a new conventional loan at 8% fixed rate for the amount of $200,000." This language lacks the "magic" contingency language because it does not provide that the contract is actually contingent upon the buyer obtaining the loan. Rather, the contract merely requires the buyer to obtain such a loan. Thus if the buyer fails to obtain the loan, the seller would have the right to sue the buyer for specific performance or for damages caused by the buyer's breach of contract.

We often see two other common mistakes in drafting contingencies.

First, we often see contracts where the contingency event itself is too vague. For example, with regard to a loan contingency, at a minimum the type of loan should be described with a maximum interest rate and principal balance, the length of the loan, and the time in which the loan approval is to be obtained. The financing section of the most recent AAR contract forms provide an excellent checklist of the type of information which should be contained in any loan contingency.

Second, we often see contingencies which do not sufficiently explain the "what if" part of the contingency, i.e., what happens if the contingency is unmet? A well-drafted contingency provision should address the following "what if" issues:

1) If the contingency is unsatisfied, does one or both of the parties have the right to cancel the contract (or does some other remedy exist)?

2) If the right to cancellation exists, which party has the right to cancel the contract (the buyer, seller, or both,) and can the contingency be waived by one of the parties?

3) When does the right to cancellation take effect?

4) What type of notice of cancellation is required, if any, and when and where must such notice be delivered?

5) What happens to the earnest money?

6) Upon cancellation, who is entitled to inspection reports and other due diligence documents?

As an example, if the buyer desires to make the contract contingent upon successfully completing a tax exchange, all of the above issues should be addressed in the contract. Most importantly, the contract should address the type of tax exchange required, when the buyer can cancel due to the contingency being unmet, and what happens to the parties' contractual rights and the earnest money. If these issues are sufficiently addressed up front in the contract, the parties are less likely to have a dispute when the contingency is unmet.



This article is offered as general guidance only and is not to be relied upon as specific legal advice. For legal advice on a specific matter, please consult with your broker or an attorney who is knowledgeable and experienced in that area.

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