Chapter 4

Question 1

Express Contract

Answer 1

Expressed means the use of words, either
written or oral, to show intentions of the parties to the
contract.

Question 2

Implied Contract

Answer 2

the actions of the parties demonstrate their
intent. It looks like a contracting has occurred by the
appearance of things (ostensible). Example: You sit down
at a table at a restaurant and order dinner. It looks like you
have contracted with the restaurant to purchase and pay
for your food. You may say, “I’ll have the Surf & Turf,” but your actions of being there and ordering
are speaking contract much louder than words you may actually

Question 3

Bilateral ContractU

Answer 3

Bilateral – means “two sided.” Most contracts are bilateral contracts in that more than one party is
making a promise to do something. Example: A buyer offers to buy a house for $400,000 provided
the seller puts on a new roof. The seller agrees, “Okay, I’ll take your $400,000 offer, and I’ll have a
new roof on the house before close of escrow.” Both parties are making promises and are
undertaking performing those promises. One promise is given in exchange for another.

Question 4

Unilateral Contract

Answer 4

Unilateral – means “one sided.” Often taking the form of an option contract, a unilateral contract is
binding on one party should the other party elect to perform under the agreement. It is one sided in
that the party with the option does not ever have to perform. An example might be the offer of a
reward. The police will pay $5,000 for information leading to the arrest and conviction of a certain
criminal. The police have no obligation to do anything until someone performs by providing
information that leads to the arrest and the conviction of the criminal. Then, and only then, are the
police obligated to pay the $5,000.

Question 5

Is a lease option a unilateral contract?

Answer 5

In real estate, the “lease-option” is a unilateral contract. The owner of the property (optionor) has
nothing to do and is under no obligation to perform until the prospective purchaser (optionee)
decides to go forward with the purchase.

Question 6

Executed Contract

Answer 6

Executed: An “executed” contract is one that is fully and completely performed. “Executed,” in a
different context, can also mean that the contract has been fully signed by all parties.

Question 7

Executory Contract

Answer 7

Executory: An executory contract is not yet fully performed. For example, a 30 year mortgage is
“executory” until the making of the last payment, if not paid off in full sooner. It is not “executed”
until it is paid in full.

Question 8

Rule of Reason

Answer 8

The rule of reason – Throughout the study of real estate and business in general, you will hear the
term “reasonably” or “reasonable” as a requirement for the actions of real estate agents and
brokers, for the conduct of parties to contracts, and for many other things. The rule of reason places
an obligation on all of us to conduct ourselves as the “reasonable person” would, and to always act in
a reasonable fashion. Reasonable conduct is a factual consideration given the circumstances of a
particular event. In most cases, one does not know for sure if he acted reasonably until someone
claims he did not and the matter is placed before a judge or jury. Ultimately, it is often the judge or
jury who tells us, after the fact, if our conduct was reasonable.

Question 9

What are the required elements of a valid contract?

Answer 9

1. Competent Parties – All parties must be living, of lawful age, of sound mind, and mentally
   competent.

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2. Offer and Acceptance – Sometimes referred to as “mutual assent,” this element shows
   there is a “meeting of the minds;” that an offer was made and acceptance of that offer
   was reached.
3. Legal; Legality of Object – The purpose underlying the contract must be legal.
4. Informed Parties — There can be no fraud, no misrepresentation, and no duress. The
   parties are fully informed, aware of the conditions of the agreement, and consent
   to the terms.
5. Consideration – Consideration may be money, anything of value, or just a statement
   that consideration exists, such as “for continued love and affection” or “for good and
   valuable consideration.”
   The acronym “COLIC” is often used to remember these five essential elements of any
   contract.

Question 10

What is a contract?

Answer 10

A contract is a voluntary agreement between informed and capable parties to do, or to refrain
from doing, something which is legal to do, and which is supported by adequate
consideration.

Question 11

What 2 additional requirements to real estate contracts have?

Answer 11

A contract is a voluntary agreement between informed and capable parties to do, or to refrain
from doing, something which is legal to do, and which is supported by adequate
consideration.

Question 12

Valid Contract

Answer 12

Valid – The contract contains visible evidence of all five essential elements of a contract
(competent parties, offer and acceptance, legality of object, informed parties, and consideration)
and is therefore binding and enforceable on all parties.

Question 13

Void Contract

Answer 13

Void – lacks visible essential elements of a contract (offer and acceptance, legality of object,
consideration); It is not binding on the parties.
If the contract is for an “illegal” purpose (lacking legality of object), it is simply void. You cannot
lawfully contract for an illegal purpose, such as contract for murder or contract for the purchase
of an illegal substance, etc.
If a contract is impossible to complete, then the contract will be considered void. That does not
mean that it is inconvenient or too expensive to perform. This is often a factual consideration
and may end up in court if the parties disagree. For example, suppose there is a contract to
purchase an airplane which is scheduled to close October 2, 2013. On October 1, the airplane
crashes and is totally destroyed. It is impossible to complete this contract - it will be voided.
Likewise, illegal contracts, although void in the eyes of the law, may still be performed. For
example, a contract for murder, clearly a void contract, may still take place.

Question 14

Voidable Contract

Answer 14

Voidable – missing non-visible elements (competent parties, informed parties); appears to be
valid but may be disaffirmed because it is missing competent parties (legal capacity) such as a
minor, or is missing voluntary, informed parties such as a contract executed under
misrepresentation, fraud, or duress. In a voidable contract, the party suffering the legal

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disability has the right to void the contract, provided it is done within a reasonable time. The
other party to the contract, the one who does not suffer a legal disability, does not have the
right of voidability.

Question 15

What are the general rules on a voidable contract?

Answer 15

1. A minor has up to the age of majority and for a reasonable time thereafter to avoid a
   contract.
2. A person lacking mental capacity may avoid upon gaining their capacity and determining
   they do not want to go forward with a contract made during their period of incapacity.
3. A person contracting under fraud, where the other party has told them an intentional
   falsehood or lie about a material fact concerning the subject matter of the contract, has a
   “reasonable period of time” after discovery of the fraud to avoid the contract.
4. A person contracting under a misrepresentation, where the other party has carelessly or
   negligently misstated a material fact concerning the subject matter of the contract, has a
   “reasonable period of time” after discovery of the misrepresentation to avoid the
   contract.
5. If both parties to the contract are truly operating under a mutual mistake, either party
   may avoid the contract (unenforceable). For example, I think I’m selling one property
   and you think you are buying a different property. Again, the parties must act
   reasonably.

Question 16

Unenforceable Contract

Answer 16

Unenforceable – appears to be valid, but if there is a disagreement between the parties in the
performance of duties and the receipt of rights, the courts will not get involved in a resolution.
For example, we know that for a real estate contract to be “enforceable,” it has to be in writing.
If two parties had an oral contract, then got into a dispute over it, the courts would not hear their
case as the required writing did not exist. On the other hand, if the parties did not dispute their
agreement, they could perform their oral real estate agreement as they had intended.

Question 17

What will terminate a contract?

Answer 17

1. Performance – This is the most desirable outcome. The parties perform all of their duties and
   receive all of their rights as agreed.

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2. Mutual agreement – The parties decide they do not want to go forward and mutually agree
   that each should be released from the contract. By mutual agreement, the contract is
   terminated. This is sometimes called a General and Mutual Release.
3. Impossibility – If it is truly impossible for the parties to perform, the contract will be
   terminated by impossibility. As an example, if there is a contract with the homeowner and a
   painter hired to paint the house, and the house burns to the ground, impossibility will
   terminate this contract.
4. Operation of law – Some contracts will be terminated by the courts or statutory prohibition.
   Let us assume that an Iowa corporation has a contract to sell corn to Mexico. Before the
   terms of the contract are performed, the U.S. government prohibits further exports to Mexico
   for agricultural purposes. Since it would be illegal for the Iowa corporation to carry out the
   terms of the contract due to the newly-passed law, the contract would be terminated by
   operation of law.

Question 18

Assignment of contracts

Answer 18

Assignments of contracts – Contracts are freely and fully assignable unless prohibited in the
agreement. However, when one party desires to assign his rights, obligations, and benefits under the
contract to a third party, that original party will remain liable for performance and obligations should
the third party fail to perform. This is called secondary liability.
Example: Ed, the owner of a shopping center leases space to Tom’s bakery. As time passes, Tom
decides to retire although he has 7 years left on his lease with Ed. Tom, noting there is no
restriction on assignment in his lease, finds another baker and assigns the balance of his lease to
the new baker. Time passes, and the new baker fails to make the rental payment required in the
lease. If Ed cannot recover his losses from the new baker, Ed can hold Tom liable for the rental
payment under the concept of secondary liability. Although Tom did not have a restriction on
assigning his lease, Ed did not release Tom from any of the liability created in the original
agreement. How could Tom have been released from all obligations under the original lease? –
by a “Novation” or a “Novation of the Parties.”

Question 19

Novation

Answer 19

Novation – A novation is the substitution of a new contract for an old one. If Tom presented the new
baker to Ed who agrees to contract with the new baker and create a new lease, then Tom is off the
hook by way of a novation. “Nova” means “new” and we are dealing with a new agreement. A
significant change in a provision of the original contract constitutes a novation and it is now a
different agreement. The party seeking assignment is relieved from any further obligation under the
new agreement.

Question 20

Novation of parties

Answer 20

Novation of parties – A novation of the parties is where a new party is substituted for an existing
one. If Tom presented the new baker to Ed, who allows the new baker as a substitute tenant and
allows the assignment, then Tom would be off the hook by way of a novation of parties.

Question 21

Breach of contract

Answer 21

Breach of contract – What if either of the parties to a contract fails or refuses to perform any duties
per the contract? This is considered breach of contract and the injured party has legal remedies
available.

Question 22

If the buyer defaults, what can the seller do?

Answer 22

1. Sue for specific performance – This legal action will require the buyer to perform all duties as
   specified in the contract.
2. Revocation – The seller revokes the contact and retains the earnest money deposit. The
   earnest money deposit is typically money that accompanies an offer to show the buyer’s
   “earnestness” in completing the contract as it is often sacrificed upon a breach of contract.
3. Rescission – The seller decides to call off the contract and return the earnest money deposit
   to the buyer. This is a complete reversal of the contract, putting everyone back to where they
   were before contracting.
4. Sue for damages – The buyer is required to pay the seller for any costs associated with the
   seller’s hardship. The seller may possibly sue for the amount of the purchase price.

Question 23

If the seller defaults, what can the buyer do?

Answer 23

1. Sue for specific performance – This legal action will require the seller to perform all duties as
   specified in the contract including going through with the sale and transferring ownership.
2. Rescission – The buyer decides just to call the whole thing off, get back the earnest money
   deposit, and be done with it. This is a complete reversal of the contract, putting the parties
   back to where they were before contracting.
3. Sue for damages – If the buyer can prove there were direct monetary damages as a result of
   the seller’s breach, then the buyer may be entitled to a judgment against the seller for the
   amount of damages proved. This is quite difficult to do in residential real estate cases.

Question 24

Liquidated damages

Answer 24

Liquidated damages – The remedies either party may recover through litigation may be limited by
the terms of the contract. If the contract pre-addresses the damages that may be received in the
event of default, those remedies are considered to be “liquidated damages.”

Question 25

Punitive damages

Answer 25

Punitive damages – go above and beyond the liquidated damages and may be sought to “punish”
the breaching party and compensate the injured party.

Question 26

Compensatory Damages

Answer 26

Compensatory damages – reimburse the injured party for actual losses suffered

Question 27

Statute of limitations

Answer 27

Statute of limitations – There is a legal limit to the time frame under which the injured party can
legally sue the breaching party and this limit varies from state to state.

Question 28

Time is of the essence

Answer 28

Time is of the essence – This phrase is often seen in real estate and other contracts. Simply put, it
means that if a specific time period is set out in the contract, in which one of the parties is to do
something, and has not done it when the allotted period of time expires, the other party may declare
a breach.
Example: The buyers have agreed to make application for a new loan within 10 days of
signing the contract. The 11th day comes and they have not applied; the seller now has the
right to declare the buyers in breach of the contract.

Question 29

What is a sales contract

Answer 29

The sales contract creates the agreement between the seller
and buyer and clearly spells out the rights and duties of each
party, the purchase price, and the terms and details of the transaction.

No matter what it is called, this is the primary transactional document. It should present the
agreement between the buyer and seller with sufficient detail so that anyone reading it would
understand the agreement the parties have reached.

Question 30

Offeror

Answer 30

The party making the offer

Question 31

Offeree

Answer 31

The party receiving the offer

Question 32

Once an offer is received, the offeree may…

Answer 32

Accept
Counter Offer
Reject
Do Nothing
Withdrawal or Revocation

Question 33

When does an offer become a contract?

Answer 33

An offer becomes a contract when the offer has been accepted by the offeree and
communication of that acceptance has been received by the offeror.

Question 34

Equitable Title

Answer 34

Equitable title – During the escrow period, the buyer is considered to have equitable title or an
equitable interest because the buyer has the property under contract and no one else does.
Equitable title could mean the holder has the right to possess and enjoy all of the rights of ownership
(contract for deed), but, the title records will not show the holder as the owner. The rights
associated with equitable title vary from state to state.

Question 35

Legal Title

Answer 35

Legal title – is secured when the closing is completed, the deed transfers title from the seller to the
buyer, and the deed is recorded. Legal title means that the holder does legally own the property.

Question 36

Contingency

Answer 36

Contingency – a clause written into a contract stating some event must be completed before all of
the duties of the contract can be or will be performed. Contingencies include new loan approval,
An offer becomes a contract when the offer has been accepted by the offeree and
communication of that acceptance has been received by the offeror.

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sale of current residence, inspections to be conducted, etc. If the contingency is not fulfilled or
waived, the contract is voidable.

Question 37

Parol Evidence Rule

Answer 37

Parol Evidence Rule – verbal words and representations will not be binding nor overrule any written
agreements.

Question 38

Options Contract

Answer 38

Option contracts – Option contracts are between the owner of the property, the optionor, and a
purchaser who wants to have a period of time in which to decide on the purchase of the property,
the optionee. This is a unilateral contract in that the optionor has no obligation to perform until and
unless the optionee decides to purchase. At that time, the optionor would complete the sale of the
property to the optionee.
The optionee must usually offer option money, better described as the agreed valuable
consideration, in exchange for the option to purchase or not to purchase. If an option fee is paid, it
should be clear how the fee paid will be applicable to the purchase price if the option is exercised
and if the fee is forfeited if the option is passed over. The option contract will have all of the same
terms and conditions as a typical purchase agreement. It should also be clear as to the length of time
the option runs for, and what conditions, if any, might allow an extension of the option.

Question 39

Right of first refusal

Answer 39

Right of first refusal – The holder of the right of first refusal has the right to match any offer made on
a property. A seller trying to sell a property subject to a right of first refusal, must contact the holder
of the right of first refusal and provide an opportunity to match the transaction and exercise the
right.
The existence of a right of first refusal is a material fact which must be disclosed. Presumably any
informed prospective buyer would want the seller to remove the right of first refusal before
negotiating a sale as the purchaser would in effect be negotiating for the other party. A quit claim
deed could be used to remove the right, assuming the holder was willing to give up the right.

Question 40

American concept of agency

Answer 40

American concept of agency – The American concept of agency evolved from English Common Law
and depicts the duties and obligations originally assigned to an agent of the crown, a very powerful
position in English society. Today, agency refers to the fiduciary relationship between a principal
(the employer) and an agent (the employee). The role of the agent is to deal with third parties on
behalf of the principal. There are many agency relationships such as the relationship of an attorney
to a client or a CPA to a tax client. In real estate agency relationships, the agent is the broker and the
principal is the buyer or seller client.

Question 41

Broker

Answer 41

The broker is an agent who agrees to represent the interests of the principal, who agrees to
let the broker exercise authority on behalf of the principal.

Question 42

Agency

Answer 42

Agency describes the fiduciary relationship between the agent and the principal.

Question 43

The Principal

Answer 43

The principal delegates authority to the agent to represent the principal’s interest in a
transaction. The principal is obligated by contract to compensate the agent and not hinder
the agent’s ability to fulfill the agent’s fiduciary obligations.