A common provision found in real estate purchase agreements allows the prospective buyer a period of time to inspect the property prior to closing and to terminate the agreement if the buyer is not satisfied with some aspect of its inspection. Some termination clauses are drafted quite broadly and allow the buyer to terminate the agreement for virtually any reason. Other clauses are more narrowly drafted and may limit the buyer’s right to terminate the agreement only if he is dissatisfied with the status of title or the environmental condition of the property, for example.
The Tennessee Court of Appeals recently analyzed the rights afforded a buyer of real estate under the following termination provision, contained in a commercial real estate purchase and sale agreement:
7. INSPECTION PERIOD/CANCELLATION. Purchaser shall have the right to inspect the Property in all respects for ninety (90) days after the delivery to Purchaser of all the documents described on Exhibit A (the “Inspection Period”). . . . All and any such inquiry, inspection and examination of the Property and related issues, including, but not limited to, survey, title work, environmental issues, sol tests, borings appraisals, zoning and utilities must be satisfactory and acceptable to Purchaser, and if not, Purchaser may, in its sole discretion, cancel this Agreement upon written notice within the Inspection Period.
The property being sold consisted of 4.18 acres of land the buyer intended to develop and lease to retail tenants. However, before the 90-day inspection period ended, the buyer came to realize that due to the general downturn in the economy, it would be unable to secure the tenants it needed to make the planned development profitable. Except for the poor economic climate’s effect on the buyer’s ability to find tenants for its planned development, the buyer apparently was satisfied with the property in all respects.
The buyer timely notified the seller that it was terminating the purchase agreement due to the general economic downturn and asked for a return of its earnest money deposit. The seller refused, claiming that termination due to an economic downturn was not allowed by the termination provision of the contract.
The termination provision allowed the buyer to terminate the agreement if its “inquiry, inspection and examination of the Property and related issues” were unsatisfactory or unacceptable to it. The buyer said the economic downturn was plainly included within the class of “related issues” for which termination was permitted under the agreement. The seller, on the other hand, argued that the buyer’s inability to secure tenants was plainly not the type of “related issue” contemplated by the termination provision of the purchase agreement.
The Court of Appeals held that the buyer’s right to terminate the agreement if its inspection of the property and “related issues” was unsatisfactory could not reasonably be interpreted as giving the buyer the right to terminate due to an economic downturn. Also, the buyer’s right to terminate “in its sole discretion” was not sufficient to allow it to terminate the agreement since the exercise of that discretion was not unrestrained. The court felt that after construing the contract as a whole, the class of permissible “issues” upon which termination could be based was limited to those issues relating to the physical and legal fitness of the property.
This case tells us that a buyer who expects to have the unfettered right to terminate a purchase agreement during its inspection period had best ensure that the termination provision of the agreement is drafted broadly enough to afford it this right. The provision also needs to require the buyer to pay the seller some nominal amount of money if it exercises its right to terminate. Otherwise, the contract is illusory and unenforceable due to a failure of consideration.
Philip B. Whitaker, Jr., is a share-holder in the Chattanooga office of Baker, Donelson, Bearman, Caldwell & Berkowitz, P.C.