Use ‘satisfactory to purchaser’ clauses with care [May 2008]

Many experts and commentators are stating that the property market is on the wane.  Real estate sales figures tend to suggest that in some centres the market has certainly cooled off from its highs in 2006 and 2007.  Whether for a property investor this is a good time to consider buying, I will leave to the observation of the experts – the economists and the financial analysts.  However in a softening market the focus swings back onto different contractual terms in the conveyancing transaction.  It is that feature that I wish to highlight. 

The particular feature that is very important is the strength of the bargain and the nature of conditions inserted by a purchaser in an agreement.  In a softening market vendors find it more difficult to sell property and are therefore keener that the contracts are less conditional than they would have accepted in a busier market.  Secondly, where conditions are inserted vendors are more vigilant to ensure that the purchaser investor complies with the conditions or at least makes a fair and reasonable attempt to comply.

Contrast this to the busier market where good property sells quickly and easily.  In that situation purchasers often do not have the luxury of inserting conditions such as due diligence conditions as they just have to put in an unconditional offer to acquire the property.  Even if they do insert conditions and have a "change of heart" vendors are less likely to be concerned because other contracts are easy enough to attract.  That is not so in a softening or waning market.

Therefore purchaser investors need to be very careful about the conditions they insert in the contract and how they perform those conditions.  If a vendor suspects that a purchaser has simply not made a due effort to satisfy the condition – eg finance or due diligence, the vendor is more likely to hold a purchaser to the contract and retain the deposit.

Subjective or Objective Assessment?

For that reason, it is useful to analyse a recent High Court decision where the issue of the words "satisfactory to the purchaser" were considered in the context of a builder's report clause.  In this case the vendor was concerned that the purchaser was simply trying to "opt out" of the contract using the builder's report clause as an exit strategy.  The vendor sought to enforce the contract against the purchaser.  Therefore it can be seen that my hypothesis above does in fact occur from time to time and is likely to occur more over the next financial period while the market is slowing down.  The facts in this case were that it was a contract for a property of $1.45 million and upon resale the vendor had lost $230,000.  In this case the vendor was seeking damages against the purchaser, who had relied upon a clause in the agreement which read as follows:

"This agreement is conditional upon a building report satisfactory to the purchaser within 7 days of the signing of this agreement by both parties."

This is a fairly typical clause and could be used for a variety of different other circumstances, such as a geotechnical report or a valuation report and the like.  The principal point in the case was whether the expression "satisfactory to the purchaser" was a subjective assessment or an objective assessment of a reasonable person possessing knowledge of all the background facts and information.

The purchaser had obtained a report.  An interesting fact in this case was the question of whether the report was a builder's report.  The Court determined that even though the report was in a short form, it contained all the elements of what could be described as a builder's report sufficient to give the purchaser enough information about the property and its good and bad features. 

The Judge determined that the standard to be used by a purchaser was the objective assessment of a reasonable person not a subjective assessment.  The purchaser had to consider all of the facts and could not determine that the report was unsatisfactory for subjective reasons, such as that the purchaser had changed their minds or that the purchaser feels that the report has features that are negative but that have no influence on the use and benefit the purchaser would make of the property as an investment. 

In the case in question the Judge determined that the purchasers had obtained a building report and had acted both objectively and properly in rejecting the report which contained details identifying defects with the property which the Judge felt was quite reasonable and fair in the circumstances.  The purchaser had cancelled the contract and the Judge indicated that that was a proper cancellation in the circumstances.

Therefore the purchaser, in deciding that the particular feature, eg the due diligence aspects of the property are satisfactory, must look at matters objectively.  In the case of an investment property, it would have to be whether the investment is realistic from a financial and economic perspective.  In fact from an investor's point of view, a due diligence clause can provide a purchaser with a fair opportunity to decide whether the proposition is what they want.

Demonstrating steps have been taken

Purchasers always have to be careful in satisfying conditions that they can demonstrate that they have taken fair and reasonable steps to try and satisfy the condition.  Otherwise if the vendor suspects that the purchaser has simply rested on their laurels, then they can be accused of not making a fair and reasonable effort.  This can lead inevitably to a possible claim by the vendor that the purchaser is simply gone cold on the deal and made no effort.  Contract law expects a purchaser to make a fair and reasonable effort and failure to do so can offer a vendor a course of action against a purchaser.  In a recent case against a farmer in the Waikato the wording of a finance condition was:

"Suitable finance to complete the purchase on terms and conditions acceptable to the purchaser."

The Court found that this was no more than a glorified option and found against the farmer who had failed to make proper effort to satisfy the condition. 

Therefore the points that purchaser investors need to draw from these facts and cases are the following:

1                     It is quite acceptable to include words such as "satisfactory to the purchaser" in conditions.

2                     The tests that the Courts have adopted is an objective test as to whether or not it is satisfactory to the purchaser.

3                     Subjective assessments and expressions like "at the purchaser's absolute discretion" will be construed against the purchaser.

4                     Purchasers must make fair and reasonable efforts to attempt to satisfy the condition.

5                     A purchaser might expect to justify any dissatisfaction by reference to a report, an analysis or objective facts that led them to be dissatisfied with the condition.

For more information contact  Tim Jones at tim.jones@glaisterennor.co.nz

 

The contents of this newsletter are of a general nature only. While the information is believed to be correct no responsibility is accepted for its accuracy. Readers are advised to establish the applicability of information in relation to specific circumstances and not to rely solely on the text of this newsletter.

 

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