AZREB.com | Article by Daniel Kloberdanz
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
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.