The California Supreme Court recently clarified the question of whether a real estate purchase agreement which grants the buyer the right to terminate the agreement in its sole discretion during his due diligence period is the equivalent to a unilateral option agreement which the seller (or optionor) may terminate at will.  In the 2010 case, Steiner vs. Thexton, the California Supreme Court held that a buyer who provides separate and independent consideration under his purchase agreement (in addition to a deposit in escrow which is fully refundable to the buyer prior to expiration of the due diligence period) constitutes a bilateral contract which cannot be terminated by the seller.

A unilateral option agreement exists where the owner of real property (the optionor) grants the potential buyer (the optionee) the right to purchase the optionor’s real property, in the optionee’s sole discretion, at a specified price but where the optionee does not pay any option consideration to the optionor.  Because the “unilateral contract” is not supported by any consideration from the optionee, the optionor, like the optionee, is free to cancel the unilateral option agreement at any time without liability upon notice to the optionee.  This scenario changes 180° where the optionee posts a nonrefundable option payment which the optionor retains whether or not the optionee elects not to purchase the real property.  This nonrefundable payment creates a “bilateral” option agreement supported by consideration from both parties (the optionor’s offer to sell the real property and the optionee’s payment of the nonrefundable consideration) which is binding on both parties unless the option term expires without the optionee exercising his option.

In Steiner, the buyer deposited $1,000 as a fully refundable deposit in escrow and was granted a period of approximately three years in which to conduct his due diligence investigation, with the buyer retaining the absolute right to terminate the purchase agreement at any time and recover his entire deposit.  More than one year into the due diligence period the seller attempted to terminate the purchase agreement.  The buyer sued to specifically enforce the purchase agreement.  The trial court ruled in favor of the seller and termination of the purchase agreement because, in effect, the trial court found the purchase agreement to be a “unilateral option contract not supported by any nonrefundable consideration.”  The Court of Appeal affirmed this judgment.  The Supreme Court reversed these rulings on the basis that, during the due diligence period, the buyer expended several thousand dollars to effect a parcel split necessary for the sale of the real property.  The Supreme Court found this to be the “independent nonrefundable consideration” necessary to make the purchase agreement bilateral and enforceable by the buyer.

The Steiner vs. Thexton case stands for the legal proposition that independent consideration is required for the buyer to make his purchase agreement bilateral and non-terminable during the due diligence period.  Drafting a purchase agreement in which the buyer has the absolute right to terminate the purchase agreement during due diligence and recover his entire deposit back from escrow is, in essence, a unilateral option agreement unsupported by consideration from the buyer.  Under this scenario, the seller can terminate the agreement during the due diligence period.

To avoid this result, we recommend that buyers’ attorneys provide that their buyer clients pay the seller non-refundable “independent consideration” upon execution of the purchase agreement to create a binding bilateral agreement.  A clause similar to the following is recommended:

“As consideration for Seller’s agreement to enter into this Agreement, concurrently herewith Buyer shall deliver directly to Seller $100 (the “Independent Consideration”), which Independent Consideration shall be retained by Seller as Seller’s sole property immediately upon receipt and which Independent Consideration shall be nonrefundable to Buyer in all events.”

The “independent consideration” need not be a large sum.  A clause such as the foregoing should help insure that the purchase agreement is bilateral and hence not terminable by the seller during the due diligence period.  The real estate attorneys at Carr McClellan have a breadth of experience and the practical knowledge and judgment to help you with purchase agreements and all of your real estate legal needs.