I FAILED TO CLOSE MY REAL ESTATE TRANSACTION! WHAT DO I DO?

Troubled Real Estate Market in Ontario

More people than are wondering what happens when a house sale falls through.  It is safe to say that the pandemic has had a profound impact on the real estate market. With continuous restrictions and stay-at-home orders, Ontarians began to reassess their living situations. For many, the home became a place of work and refuge. This led to a surge in housing demand as people searched for homes that better fit their needs. As a result, home prices rapidly increased in all parts of Ontario. Some prices rose by a whopping 111% with not one major market showing less than a 60% growth in price.

However, after two years of red-hot growth, Ontario’s seller’s market is on a rapid decline. As our world emerges from the pandemic, we are once again hit with a new problem that is becoming a major concern for businesses and policymakers alike: inflation. Inflation in Canada is currently sitting at a four-decade high of 8.1% and is expected to continue to rise.

High inflation rates are making the economic landscape less hospitable for Canadian home buyers. With the Bank of Canada implementing stricter mortgage rules and aggressive policy stances, more home buyers are sent to the sidelines as housing affordability becomes extremely stretched.

Why Do People Fail to Close Their Real Estate Transactions?

High-Interest Rates Cause Buyer’s Remorse

In an attempt to combat inflation, the Bank of Canada raised the bank’s benchmark policy rate by 100 points to 2.5%. This, in effect, prompted banks to raise the prime rates as well (i.e. mortgage rates). Currently, the Royal Bank of Canada is offering an annual percentage rate of 5.57% for a 5-year fixed mortgage and 4.48% for a 5-year variable rate mortgage.

So, as home buyers wait for their closing dates, interest rates soar resulting in many buyers’ monthly mortgage payments increasing by hundreds, even thousands, of dollars. Although some home buyers may choose to absorb the costs and go through with the real estate transaction, many simply cannot afford to pay the monthly payments and are forced to back out of the real estate deal. Even with the ability to pay, some buyers choose to walk away from the deal as it may be cheaper to forfeit the deposit than to make payments under the current interest rates.

Buyers Do Not Get Approved For a Mortgage

When deciding whether a buyer will be approved for a mortgage, the bank conducts a stress test which determines whether the buyer will be able to afford mortgage payments if the interest rate fluctuation increases beyond the original contract rate of the mortgage.

As policy rates rise, the mortgage stress test’s qualifying rate is also pushed up. The current qualifying rate for Ontarians is either 5.25% or the contract rate offered by the bank plus 2%, whichever is higher.

Example: Mandy is purchasing a $500,000 house with a $50,000 down payment. Scotiabank offers Mandy a fixed mortgage interest rate of 4.5%. To qualify for this mortgage, Mandy must prove that she can afford a mortgage at a 6.5% interest rate. This means that while she will pay $2,490 monthly under a 4.5% interest rate, she will still need to prove that she can afford to pay $3,014 monthly at 6.5%!

Purchasers who do not meet the bank’s mortgage guidelines are at risk of being declined for the loan. If the purchaser placed an offer and a deposit for a house but later did not qualify for a mortgage, they may not be able to close on their real estate transaction.

House Was Under Appraised

Before a bank gives out a mortgage loan, it orders a home appraisal to determine the property’s current market value. In Ontario, the law states that a home buyer can mortgage up to 80% of the appraised value of the house.

The recent decline in house prices after two years of growth is causing house appraisals to come in lower than agreed-upon purchase prices. This is problematic as mortgagors will not finance above the appraised value.

Example: Robert signed an Agreement of Purchase and Sale in November of 2021 for a house priced at $1,000,000. His closing date is in July 2022. Robert’s mortgage broker completed the appraisal for the home in June of 2022 when the real estate market was in decline. The appraisal came back at $800,000. Since the bank can only lend up to 80% ($640,000), Robert must now make up the difference by paying $360,000 out of pocket.

This appraisal gap leaves people trying to scrape enough money to pay the difference between the mortgaged amount and the purchase price, and often results in a failure to close the deal as it is challenging to come up with such a large amount of money in time.

Buyers Do Not Get Approved For a Mortgage

When deciding whether a buyer will be approved for a mortgage, the bank conducts a stress test which determines whether the buyer will be able to afford mortgage payments if the interest rate fluctuation increases beyond the original contract rate of the mortgage.

As policy rates rise, the mortgage stress test’s qualifying rate is also pushed up. The current qualifying rate for Ontarians is either 5.25% or the contract rate offered by the bank plus 2%, whichever is higher.

Example: Mandy is purchasing a $500,000 house with a $50,000 down payment. Scotiabank offers Mandy a fixed mortgage interest rate of 4.5%. To qualify for this mortgage, Mandy must prove that she can afford a mortgage at a 6.5% interest rate. This means that while she will pay $2,490 monthly under a 4.5% interest rate, she will still need to prove that she can afford to pay $3,014 monthly at 6.5%!

Purchasers who do not meet the bank’s mortgage guidelines are at risk of being declined for the loan. If the purchaser placed an offer and a deposit for a house but later did not qualify for a mortgage, they may not be able to close on their real estate transaction.

What Are the Consequences of Failing to Close a Real Estate Transaction?

If a real estate deal falls through, there can be some severe consequences for both the buyer and the seller.

Consequences For The Purchaser

In Canada, laws are fairly strict and straightforward when it comes to failed real estate transactions. If a buyer fails to close on an agreed purchase of a home, the buyer almost always loses their deposit and, in some circumstances, must even pay additional compensation to the seller.

Which Party Gets to Keep the Deposit?

General contact law states that if one party breaches the contract, the other party may be awarded compensation only if they are able to prove that they suffered damages caused by that breach. However, real estate deals are treated in a special manner. Courts across Canada have confirmed that if a buyer reneges on the purchase, the deposit will be forfeited to the seller even if the seller did not suffer any damages (Tang v Zhang).

Can I Keep the Deposit if the Seller Sold the House to Someone Else?

In some cases, courts will look at whether it would be unconscionable to allow the seller to keep a disproportionately large deposit. If the courts believe this is true, the deposit will be returned to the purchaser. However, only in exceptional circumstances will a court consider a finding of unconscionability (Redstone Enterprises Ltd. v. Simple Technology Inc).

The rarity of this judgment is reaffirmed in a recent 2022 case where the purchaser was forced to forfeit her deposit as a result of the failure to close the deal despite the seller being able to resell the home at a substantially higher price and suffering no other damages. The court said that although it is unfortunate that the purchaser could not finance the deal, the deposit acts as a security to incentivize purchasers to close the transactions in which they enter and there is nothing unconscionable about that. It is all simply contractual.

In the end, not only did the purchaser lose her $70,000 deposit, but she was also ordered to pay the seller’s $12,000 costs of going to court in an attempt to return it.

Will I Have to Pay Damages on Top of My Lost Deposit?

As the 2022 real estate market is cooling off and prices are dropping, purchasers who offered to pay a higher price for their new home a few months ago may be reluctant to follow through with the deal if that home is worth less today.

If the purchaser pulls out of the deal and the seller is not able to sell the home at the same price to another buyer, the original purchaser may be liable for the difference between the agreed purchase price and the price of the new sale of the property (Tribute (Simcoe Street) Limited v. Ali). However, the forfeited deposit will be credited towards the difference, not added to it (Azzarello v. Shawqi).

Any additional costs incurred by the seller in relation to the buyer’s breach will be considered in the damage calculation as well. These costs can include legal fees, staging costs, interest, moving fees, etc. However, not only must the damages a seller proposes be reasonable and foreseeable, but the seller must also mitigate any damages to minimize his loss.

This exact situation happened to a buyer in 2022 (Country Wide Homes v. Cui). In this case, the buyer signed an Agreement of Purchase and Sale to buy a newly constructed home and then reneged on the deal. To mitigate its losses, the seller was forced to sell the property to another purchaser but was only able to do so for $850,000 less than the original price. The seller eventually sued the original buyer for damages. The court calculated the damage award to be worth $906,474 which included broker commission, property taxes, utilities, cleaning fees, a humidifier, lawn maintenance, new house paint, and all other carrying costs from the date of the breach of the Agreement of Purchase and Sale.

Can I Use the Force Majeure Clause to Cancel My Deal?

In contracts, a force majeure clause is added to remove a party’s liability in the case of unforeseeable and unavoidable circumstances that prevent the parties from fulfilling their contractual obligations. With the pandemic causing a rapid fluctuation in house prices, people may want to invoke this clause to get out of their real estate deals.

However, courts have held that a drop in the real estate market is not a radical, unforeseeable event that would be subject to the force majeure clause (Paradise Homes North West Inc. v. Sidhu).

Consequences For The Seller

There are numerous reasons why sellers would attempt to back out of a real estate deal (i.e.: getting a higher offer from another buyer, being unable to find a replacement home, etc.). In some cases, a seller can repudiate a deal legally. For example, the seller can legitimately cancel the contract if there was a contingency in the agreement that was not met.

At other times, reneging on a real estate transaction can be risky. If a seller fails to close the real estate transaction, the seller may have to compensate the buyer, especially if the buyer has been financially harmed. If a seller refuses to follow through with the sale, the buyer generally has two options; the buyer can either sue the seller for damages, or the buyer can ask the court to enforce the sale.

Do I Have to Pay Damages to the Buyer if I Fail to Close as a Seller?

Like buyers, sellers too may be liable for damages if they fail to close a real estate transaction. It is important to note that although the courts will look at the facts of each case, they will not always be lenient when it comes to determining how much to award in damages.

One court demonstrated exactly that when it ordered the seller to pay $11,122,345.27 worth of damages to the purchaser when a deal fell through because the failure to close resulted in the buyer’s loss of millions of dollars worth of profits.

In addition to damages, the court may also order the seller to compensate the buyer by:

• Returning the buyer’s deposit and any accumulated interest.
• Paying any fees the buyer incurred for inspections, appraisals, real estate commission, etc.
• Paying the buyer for any equity loss in their home.
• Paying the buyer the difference in home prices if the buyer purchased a comparable property for a higher price.

Can the Court Force Me to Sell?

Another remedy, although not as common, is called specific performance. Here, the court will order the seller to perform their side of the contract, which is to complete the real estate deal. The court looks at these factors when considering if specific performance would be an appropriate remedy (Canamed (Stamford) Ltd. v. Masterwood Doors Ltd.):

• the unique nature of the property involved;
  • a property’s physical attributes;
  • the purchaser’s subjective interests, or
  • the circumstances of the underlying transaction
• the inadequacy of money as a remedy; and
• the behaviour of the parties.

In this case, the buyers were able to successfully prove that they are entitled to specific performance. The property in question was a medical building. The buyers already owned a similar medical building and the one for sale was the only other medical building available in the area, thus establishing the uniqueness criterion. Secondly, monetary compensation would have been inadequate as the buyers would not be able to obtain the same synergies if they were to buy a commercial building in another part of Ontario. Lastly, the buyers were cooperative and even offered to pay a premium price to obtain this property. So, the courts ordered the seller to follow through with the sale.

Is the Real Estate Broker Entitled to Commission if the Deal Fails?

When a real estate deal fails, buyers and sellers are often too focused on the deposit that they often forget they may be on the hook for another fee: the real estate broker’s commission. It would be fair to think that the broker is only paid upon a successful close of a deal. However, this is not always the case.

The answer to this question lies in the contact between you and your real estate broker. For example, if the Buyer Representation Agreement states that “the buyer agrees to pay … commission even if a real estate transaction is not completed if the non-completion is due to the buyer’s default or neglect”, the buyer will be obligated to pay the agreed-upon commission even if they change their mind after placing an offer for a house.

The seller can also be liable to pay the real estate broker’s commission if they cannot complete the deal. Like the Buyer Representation Agreement, the Listing Agreement would outline when and how much commission should be paid to the broker.

It is important to be aware of what is written in all the contracts you are signing, not just the Agreement of Purchase and Sale.

What Should I Do to Minimize My Losses?

The current state of our economy is undoubtedly making it more difficult for both buyers and sellers to fulfill their obligations in a real estate transaction. Since backing out of a sale could result in significant consequences, here are some steps you should take to minimize your losses:

Advice For Purchasers

• Involve a lawyer early on in your deal to review your Agreement of Purchase and Sale.
• Fulfill your due diligence prior to signing an Agreement of Purchase and Sale. Have an experienced lawyer do a proper property search.
• Increase your chances of getting a mortgage by improving your credit score, saving more money for a down payment, and not incurring more debt before a home purchase.
• If you fail to obtain a mortgage from the bank, look at alternative financing arrangements.
• Ask the seller to do a vendor take-back mortgage.
• Ask for financial help from family or friends.
• Get an appraisal. Get a second appraisal if you are not satisfied.
• Negotiate a mutual release with the seller.
• Insert conditions into your Agreement of Purchase and Sale. Make the purchase contingent on obtaining proper financing, passing an inspection, selling your house, etc.
• Always try to close the deal. Otherwise, try extending it. A few more days or weeks can make a big difference.
• Purchasing a home is one of the largest financial decisions a person will make in their life. Do not rush! Be thoughtful of the offer you place on a home!
• Always get legal advice from a real estate lawyer as soon as possible to avoid any difficulties that may arise.

Advice For Sellers

• Add conditions to the Agreement of Purchase and Sale.
• Mitigate any losses you may incur.
• Meet the buyer halfway when if they are struggling to close. Offering an extended closing time may be helpful.
• Consider doing a take-back mortgage for the buyer.
• Settle fairly. Lawsuits are expensive and emotionally draining for both parties.
• Hire a lawyer to assist you in taking the necessary steps to mitigate your damages.

Purchasing and selling a home can be a stressful, time-consuming, and expensive process. Since the consequences of failure to close are so great, it is best to engage an experienced real estate lawyer from Beffa Law to help you navigate through the process in an efficient and effective manner.