Throughout Canada and particularly Southern Ontario, we have seen a recent dramatic shift in the housing market, with the average selling price down nearly 9 percent since the beginning of 2022.
This shift is a result of the rapid increase in mortgage rates by the Bank of Canada. Since March of 2022, the Bank of Canada has raised the benchmark interest rate from 0.25 per cent to 1.5 per cent, with rates expected to rise to 2.25 per cent. Rising interest rates have resulted from the excess demand in the Canadian economy driving inflation.
Many buyers are now in situations where they cannot close. Many existing transactions are becoming distressed, and many sellers are filing legal claims against buyer’s for defaulting.
Why are distressed deals occurring?
A high number of buyers are now unable to close due to:
- Lender appraisals determining the maximum mortgage size are coming in significantly below the agreed sale price.
- Individuals who bought a new home before selling their own cannot get as much money for the sale as they initially forecasted.
Recently, when these situations have occurred, some sellers will re-negotiate with the buyer and lower the price of their home to ensure they close the deal. However, many buyers are not as fortunate.
Many sellers are dependent on the amount of their list price to put a down payment on their new home. Accordingly, they may be unable to re-negotiate the purchase price when a buyer’s financing falls through. This causes a chain reaction. Where a buyer’s financing falls through and cannot close, this can lead to their counterparty being unable to follow through on another deal.
Seller’s legal rights when the deal cannot close:
The Agreement of Purchase and Sale “APS” is a legally binding document setting out the terms and conditions of the transaction agreement.
If the buyer does not have the funds to close, they breach the legally binding APS contract. The seller is not obligated to accept the payment and close the deal and can bring forward a legal claim.
First, a seller can accept the breach, resell the property to determine the damages, and then sue the buyer for these damages. Second, a seller may refuse to accept the breach and sue the buyer for specific performance of the contract i.e., sue the buyer to force him to close.
In Park Avenue Home Corp v Malik, [2022] OJ No 658, 2022 ONSC 973, the court ruled in favour of the seller when the lender appraisal value came in significantly lower than the sale price, and the buyer breached the APS. The court held:
Para 35 “In my view, it is clear that the decrease in the value of the Property
was a result of a general decline in the real estate market. By purchasing a
home, the Plaintiff assumed the risk of fluctuations in the market value of
the Property. A drop in the market for real estate is not unforeseeable and
not a valid basis for being let out of an Agreement of Purchase and Sale.”
Yet, a lawsuit might not be your best option. Sometimes, it is to the seller’s benefit to settle.
The legal costs to litigate in Superior court are high.
Where will you get your money if your buyer does not have any property? Depending on the buyer’s financial situation, the seller is often unable to recover the damages awarded or only recovers a small amount. The process for the Plaintiff to receive damages awarded from individuals who do not have the money is difficult, and the court will NOT collect money for you.
Furthermore, due to Covid-19, there is a significant backlog in the court system. Many sellers would likely not be able to sue for a long time, forcing sellers to be on the hook while waiting for years to come as the court is backlogged.
Alternatives to litigation:
1. If the lender appraisal determines the value of the property to be lower than the purchase price, the seller can negotiate a new price to better reflect the appraised value
2. Extend the closing if the seller still wishes the transaction to close
3. Accept the breach, terminate the transaction, and keep a percentage of the deposit
Buyer Protection:
The number of distressed deals currently piling up in Canada highlights the importance of having a legal professional protect your interests in real estate closings.
To avoid potential lawsuits, buyers must include appraisal and financing conditions in the APS.
A condition gives the parties the right to back out of their contract under specified circumstances negotiated between the buyer and seller. These conditions must be met or waived to complete the transaction.
An appraisal condition protects the buyer and helps ensure a property’s market value corresponds to a minimum specified amount of money and that the buyer is not overpaying. If a property fails to appraise for enough money, a lender may require the buyer to make a much larger monthly payment. However, if the property’s appraised fair market value is lower than the minimum specified amount of money, the buyer has the option to back out of the transaction.
A financing condition (or a “mortgage condition”) protects buyers if financing falls through. If the buyer cannot obtain acceptable financing before the end of the condition period, they can back out of the contract, A well-worded financing condition will indicate that the financing you obtain must be “satisfactory to the Buyer”. This means that the terms and conditions of the financing obtained (interest rate, payments, etc.) must be satisfactory to you – not just that you were able to obtain financing.
Some of the items included in a mortgage contingency clause include:
- Type of loan to be secured
- The amount the buyer must secure in financing
- The maximum interest rate the buyer deems acceptable
- Maximum origination points or fees the buyer will pay to secure a loan
- Whether another property must be sold to qualify for financing
References:
https://www.youtube.com/watch?v=tbt1tk_xE-w
https://www.youtube.com/watch?v=6S8pT8KhKZ0
Park Avenue Home Corp v Malik, [2022] OJ No 658, 2022 ONSC 973
This article is prepared as a service for our clients to provide general information. It is not intended to be a complete statement of the law or an opinion on any subject. While we endeavour to ensure accuracy, one should not act upon this article without a thorough examination of the law after the facts of a specific situation are considered. We would be pleased to provide additional details or advice about specific situations if desired. No client solicitor relationship is established unless a formal retainer is entered into.
