Parties’ rights when loan declined due to association’s insufficient reserves

QUESTION: I’m the listing agent on a property that was supposed to close tomorrow. We used the Offer to Purchase and Contract (Form 2-T) and attached the Owners’ Association Disclosure Addendum (Form 2A12-T) to the Contract because the property is a condominium that’s regulated by an association. I just got a call from the buyer agent. She says the buyer’s lender has decided not to make the loan because the association has insufficient reserves. Neither the buyer agent nor I had any idea that the loan might be denied for such a reason as that. The buyer agent says the buyer feels that he should get a refund of his Earnest Money Deposit under the circumstances. Is the buyer entitled to a refund of the EMD?

ANSWER: Based on the facts you’ve given us, probably not. There is no loan condition in the Contract that gives the buyer the right to terminate the contract if the buyer’s lender won’t make any loan required to complete the purchase. Since the Due Diligence Period has passed, the buyer no longer has the right to terminate for any reason or no reason. Thus, if the buyer is unable to close on account of not getting his loan, that is likely a breach of contract that would entitle the Seller to receive the Earnest Money Deposit as liquidated damages according to paragraph 23(a) of the Contract.

Although the seller makes certain representations about any owners’ association regulating the property in the Contract, the Residential Property and Owners Association Disclosure Statement, and/or the Owners’ Association Addendum, it is still primarily the buyer’s obligation to conduct an investigation of the association during the Due Diligence Period. If the buyer is financing the purchase, it is important for the buyer to understand that lending guidelines may affect the purchase of a unit in a condominium complex, including eligibility requirements regarding such things as limits on the percentage of units that can be past due on the payment of association dues, minimum owner occupancy ratios and minimum reserve requirements.

It is unfortunate that the buyer may lose his deposit under these circumstances, especially if his lender was tardy in obtaining and/or reviewing information about the condo association’s financial status. In the “old days,” the loan condition extended right up to the date of closing and if the lender decided at the last minute not to make the loan, the buyer could terminate the contract and get the earnest money deposit back. One of the reasons the “due diligence” contract was adopted was to more fairly balance the risk between the buyer and seller of the sale not closing due to the buyer’s loan not being approved. This was accomplished by shifting that risk to the buyer at some mutually agreeable date during the transaction. The date that the risk shifts to the buyer is the date that the Due Diligence Period ends. Nobody is happy when a transaction falls through, but in our view, this is a good example of how the Contract is intended to work in a situation like this.