Is a buyer’s concealment of a significant debt a breach of contract?

QUESTION: I am a listing agent. My client (I’ll call her “Seller”) entered into a contract with a buyer who represented, in paragraph 5 of the contract, that he would be obtaining a loan to finance his purchase of the property. Just before the due diligence period expired, we received notice from the buyer’s agent that the buyer was terminating the contract. The agent told me the reason: the buyer’s loan had fallen through because his lender discovered that the buyer had failed to pay any income taxes for the past three years. The buyer is demanding a refund of his earnest money deposit. However, Seller thinks the buyer’s concealment of his financial problems entitles her to receipt of the earnest money deposit. Is she correct?

ANSWER: Not necessarily. Seller would first have to establish that the buyer’s debt to the IRS prohibited him from performing his contractual obligations.

Paragraph 5 of the Offer to Purchase and Contract is the section relating to “Buyer Representations”. As noted in the Guidelines for completing the Offer to Purchase: “Buyer Representations are statements of current facts that Seller may reasonably rely upon in deciding whether to enter into the Contract.” A misrepresentation by the buyer is arguably a breach of contract that would entitle Seller to payment of the earnest money deposit as liquidated damages.

Paragraph 5(c) is entitled “Performance of Buyer’s Financial Obligations”. It reads as follows: “To the best of Buyer’s knowledge, there are no other circumstances or conditions existing as of the date of this offer that would prohibit Buyer from performing Buyer’s financial obligations in accordance with this Contract, except as may be specifically set forth herein.”

Seller was entitled to rely on this representation. However, while the buyer’s failure to pay income taxes for three years was certainly something the buyer was aware of, and while that failure would certainly seem to affect the buyer’s ability to obtain a loan, Seller does not know whether that failure to pay taxes actually prohibited the buyer from completing the purchase. For example, the buyer may have the ability to pay cash for the property.

Paragraph 5(c) does not obligate buyers to provide financial information to sellers. Many if not most buyers have some debts, and buyers don’t have any obligation to tell sellers about those debts. The only exception to this rule is when the buyer knows of a situation that would prohibit the buyer from performing the buyer’s financial obligations under the contract.