Canceling Residential Purchase Agreements
by Larry M. Wertheim

For the first time in almost 20 years, the Minnesota Legislature has altered the statutory procedures for cancellation of residential purchase agreements.  The 2004 Legislature has instituted two new procedures for cancellation of residential purchase agreements that will significantly change current practices.

Background

First, it is important to understand the legislative and judicial background prior to 2004.  Statutory termination under Minn. Stat. Section 559.21 applies to “any contract for the conveyance of real estate … whereby the seller has the right to terminate the same … .”1  In Romain v. Pebble Creek Partners,2 the Minnesota Supreme Court held that statutory termination applies whether the contract is a purchase agreement or a contract for deed.  Under Romain, a contract must be statutorily canceled if the agreement is “sufficiently certain and complete in its essential terms that ordinarily specific performance will lie. … The inquiry is whether a term essential to the final bargain is left open for further negotiations or is dependent on a contingency.”3 Under this reasoning, the Minnesota courts have held that statutory termination is not required in the case of a purchase agreement that is subject to an unsatisfied financing contingency.4

In 1985, as part of a general rewriting of the cancellation statute, the Legislature recognized both the applicability of Section 559.21 to purchase agreements and the difference between purchase agreements, which are typically short-term holding devices, and contracts for deed, which are long-term financing devices. The Legislature modified the cancellation statute to provide that earnest money contracts, purchase agreements, and exercised options “that are subject to” Section 559.21 may be terminated with 30 days’ notice unless by their terms they provide for a longer termination period.5

Despite the shortened cure period allowed for purchase agreements, many residential brokers have believed that the statutory scheme did not adequately address the problems all-too-often experienced in “busted” residential real estate transactions.  Transactions would typically fail either because (a) the seller or the buyer would choose to back out and thereby breach the agreement, or (b) a contingency, typically for financing or inspection, would not be timely fulfilled.  In most situations, the seller and buyer would simply sign a cancellation agreement (as typically required by the form purchase agreement) directing to whom the broker holding the earnest money was to deliver the money.  However, brokers reported that too often either or both the parties would refuse to sign the cancellation agreement. As a result, in the case of buyer recalcitrance, (a) the seller would face the uncertainty of whether, due to contingencies, a Section 559.21 termination was even required and how to secure the earnest money, or (b) if it was determined that statutory termination was required or desirable, the seller would face at least a 30-day delay in waiting out the cure period before getting the earnest money and putting the house back on the market. Since Section 559.21 was only a remedy available to sellers, in the case of seller recalcitrance, a buyer had no extrajudicial recourse whatsoever and had to go to court to recover the earnest money.  Finally, in the case of either seller or buyer recalcitrance, absent a Section 559.21 termination or a court order, brokers holding the earnest money had no mechanism upon which they could rely so as to determine to whom the money should go.

New Cancellation Legislation

As a result of those concerns, the Minnesota Legislature responded and adopted, as alternatives to termination under Section 559.21, two new cancellation procedures for residential purchase agreements, cancellation with right to cure and declaratory cancellation.6 These new procedures apply only to purchase agreements entered into on or after August 1, 2004, for residential real property, which is defined as real property, including vacant land, occupied by, or intended to be occupied by, one to four families as their residence.7 Also, as a matter of nomenclature, although Section 559.21 uses the words “terminate” and “termination,” the new procedures use the words “cancel” and “cancellation” on the theory that realtors (and lawyers) more commonly refer to “cancellation” notices, rather than “termination” notices. 

Of the two, the cancellation with right to cure procedure is the more similar to Section 559.21.  It may be used where a default has occurred or an unfulfilled condition exists after the date specified for fulfillment under a residential purchase agreement, which “does not by its terms” cancel the purchase agreement.8  Under that procedure, a party may serve a 15-day notice on the other party and any third party holding the earnest money, and the contract is canceled if the party upon whom notice is served does not, within 15 days of service, either (a) comply with the conditions in default or complete the unfulfilled conditions, including, if applicable, completion of the purchase or sale, or (b) secure a court order suspending the cancellation.9 

The second procedure, declaratory cancellation, may be used where a default has occurred or an unfulfilled condition exists after the date specified for fulfillment under a residential purchase agreement, which does “by the terms of the purchase agreement” cancel the purchase agreement.10  Under that procedure, a party may serve a 15-day notice on the other party and any third party holding the earnest money, and the contract is canceled if the party upon whom notice is served does not, within the 15 days, secure a court order suspending the cancellation.11  In contrast to cancellation with right to cure (and termination under Section 559.21), under declaratory cancellation, which merely seeks to confirm a cancellation after-the-fact, there is no right to cure the default or to satisfy the unfulfilled contingency. 

In many respects, the new cancellation procedures are virtually identical to those of Section 559.21.  For both cancellation with right to cure and declaratory cancellation, service on the other party must be made in the same manner as Section 559.21, and the statutorily specified forms of the notice are similar, although not identical, to the Section 559.21 notice form.12 In addition, like Section 559.21 terminations, cancellation under the two new procedures cancels the contract, making it void and of no further force or effect. Also, as under Minn. Stat. Sec. 559.213, an affidavit reciting the cancellation and the failure to respond is prima facie evidence of the facts stated therein.13 Finally, injunctive relief under Minn. Stat. Section 559.211 may be obtained by the party served and such action may be commenced by service on the attorney for the party serving the cancellation.14

However, the new cancellation procedures vary from Section 559.21 in important respects.  Obviously, the 15-day period is half the typical 30-day period under a Section 559.21 purchase agreement termination.  Also, in a provision not found in the injunction statute applicable to Section 559.21 terminations generally, if an injunction action to suspend the cancellation under either of these new proceedings is brought, the court “shall” award filing fees, service costs, and attorneys’ fees to the prevailing party in an amount not to exceed $3,000.15  In addition, upon completion of a cancellation under the new procedures, earnest money expressly becomes the property of the party initiating the cancellation and a broker is expressly authorized to release the money to that party upon receipt of an affidavit regarding the completed cancellation proceeding.16  Furthermore, unlike Section 559.21, which is only available in the event of a default, the new procedures are also available where there is merely a failure to timely satisfy a condition.  Finally, and perhaps most significantly, unlike Section 559.21, which is available only to a seller, the new cancellation procedures may be used (and notice initiated) by either a buyer or a seller.17

Due to this final variation — initiating of cancellation by either a seller or a buyer — the legislation of necessity addresses the situation where both parties initiate cancellation by serving the other with notice, i.e., dueling cancellations. Thus, when one party is served with a notice of cancellation under either procedure, if the served party serves a counter-cancellation within the time period allowed by the first cancellation, the effect of the second service is to automatically and immediately cancel the purchase agreement.18  In such event, the broker holding the earnest money has no authority to disburse the proceeds and the issue of who is entitled to the earnest money must be decided in a judicial action.19

Issues and Practical Considerations

By reason of the new legislation, a number of new issues and practical considerations must be faced by a lawyer advising a seller or buyer in a “busted” transaction.  Perhaps most significant is the choice of what procedure to use to cancel a residential purchase agreement.

The legislation also refers to declaratory cancellation upon the occurrence of a default, which “by the terms of the purchase agreement” cancels the contract.  For the reasons outlined above, however, the declaratory cancellation provision should not be read, contrary to Romain, to permit a seller (or a buyer) to effectuate a declaratory cancellation of a definite, noncontingent contract merely upon the default of the other party and without right of cure even if the contract purports, by its own express terms, to provide for immediate cancellation upon a default.  Rather, in that case cancellation with right to cure must be used. 

Caution needs to be used regarding the declaratory procedure because if declaratory cancellation is initiated when cancellation with right of cure is required, the served party could have the procedure enjoined and require the initiator to start anew with a cancellation with right to cure.  Moreover, since a court “shall” award filing fees, service costs and up to $3,000 in attorneys’ fees to a prevailing party in an injunction action,22 the initiation of an improper declaratory cancellation may be quite costly.

Section 559.21 does, however, permit recovery of attorneys’ fees and costs of service.

The provisions of Section 559.217 dealing with the effect of a counter-cancellation are not applicable to a Section 559.21 notice and therefore, the legislation does not address a counter-cancellation to a Section 559.21 notice.  While it is not clear, it appears that a buyer served with a Section 559.21 notice can, within the 30-day Section 559.21 notice period, serve and effectuate a Section 559.217 cancellation so as to nullify the Section 559.21 notice (without needing to obtain an injunction) on the grounds that prior to the running of the 30-day period under Section 559.21, the buyer had already canceled the purchase agreement. In response, the seller then might, immediately after service of the buyer’s Section 559.217 notice (and after withdrawing the seller’s Section 559.21 notice), serve a Section 559.217 counter-notice so as to preempt the buyer’s Section 559.217 notice. In any event in view of the longer notice period under Section 559.21, the safest course for a seller is probably to serve a Section 559.217 cancellation notice, rather than a Section 559.21 notice, in the first place.

No Proceeding. Finally, there is the alternative of not using any of the statutory proceedings.  Declaratory cancellation is a safe harbor (and a means of capturing the earnest money), but the new legislation does not appear to change prior law so as to require a seller or buyer to automatically initiate a confirmatory declaratory cancellation.  Rather, in the case of a residential purchase agreement where, due to lack of definiteness or contingencies, it is clear that it does not meet the Romain test and need not be terminated under Section 559.21, a party may still simply rely on the language in the residential purchase agreement terminating the transaction without using the declaratory cancellation procedure.

Counter-Cancellation. While the basic concepts under the new cancellation procedures should be fairly familiar to practitioners, what is new is the potential of a counter-cancellation by the party first served, an unavoidable mechanism due to the mutuality of the new remedies.  Such counter-cancellation must be initiated by the served party prior to completion of the first cancellation and such second service does have the irrevocable effect of immediately canceling the purchase agreement. However, it also has the effect of frustrating the initial party’s efforts to get a quick determination of entitlement to the earnest money and requires the parties to seek judicial resolution of that issue.  Moreover, a counter-cancellation is far cheaper and easier to effectuate than seeking an injunction under Section 559.211. 

Of course, if the served party does not dispute termination of the purchase agreement and tender of the earnest money to the initiator of the notice, no counter-cancellation notice can or will be served.  If, however, a seller or a buyer has initiated either of the new cancellation proceedings and the served party has grounds to contest the initiator’s entitlement to the earnest money (claiming either that the initiator was actually the one in default or, in the case of service on a buyer, that there was a failure of condition entitling the buyer to the earnest money), there is little reason for the served party to forbear serving a counter-cancellation notice.  The only exception would be in the situation where the served party, typically a buyer, desires the remedy of specific performance.  In that case, a counter-cancellation would automatically cancel the purchase agreement and make specific performance unavailable; therefore, an injunction against cancellation would have to be sought. Except in those circumstances, however, as long as there is a good faith basis for a counter-cancellation,24  such response would appear to always be in the interest of the served party.

Trap for the Buyer.  Finally, there is a trap for the unwary buyer where a seller uses either of the two cancellation procedures based upon an unfulfilled condition. Virtually all residential purchase agreements provide, by their terms, that if the agreement is canceled by reason of any unfulfilled condition, the earnest money is to be refunded to the buyer. However, the baseline rule under the new legislation is that upon a completed cancellation proceeding, the earnest money is the property of the party initiating the cancellation and the broker is to deliver the money to that initiator.  Thus, where the seller commences either of the new cancellation proceedings based upon failure of a condition, unless the buyer enjoins the cancellation or serves a counter-cancellation notice (which would make the baseline earnest money rule ineffective), the seller will get the earnest money upon completion of the cancellation, despite the clear language in the purchase agreement to the contrary.  Since the purchase agreement will have been canceled and of no force and effect, the seller will receive a windfall and the buyer will be without recourse.

When a transaction collapses due, unequivocally, to an unfulfilled buyer condition, sellers are generally willing to negotiate a cancellation agreement with and refund of the earnest money to the buyer in order to remarket the house.  The refusal by the buyer in such circumstances would ordinarily be without justification so that a subsequent seller-cancellation and forfeiture of the earnest money might not be unjust, especially since the buyer could defeat the forfeiture by a counter-cancellation. However, buyers may have good reasons not to sign a cancellation agreement, such as where the seller serves a cancellation notice on the grounds of an unfulfilled seller contingency, e.g., purchase of another home, and the buyer justifiably claims that the condition has already been satisfied or waived.  In that situation, unless the buyer seeks an injunction or commences a counter-cancellation, an unjust outcome, albeit inherent in the statutory scheme, will result.

 Conclusion

The new legislation for cancellation of residential purchase agreements represents an effort to provide an expedited method of allowing sellers and buyers to resolve standoffs between the parties with the broker in the middle holding the earnest money. It has the advantages over Section 559.21 of speed, a remedy for the buyer, and a means of confirming the cancellation based upon a failed condition.  It remains to be seen, however, whether the availability of a counter-cancellation will impair the usefulness of the legislation. 

NOTES
1 Minn. Stat. §559.21.

2 310 N.W.2d 118 (Minn.1981).

3 Romain v. Pebble Creek Partners, 310 N.W.2d 118, 122 (Minn.1981).

4 Jones v. Amoco Oil Co., 483 N.W.2d 718, 724 (Minn.App.1992), rev. denied (1992); Chapman v. Salem Lutheran Church, 301 Minn. 486, 487-88, 221 N.W.2d 129, 130 (1974).

5 Minn. Stat. §559.21, subd. 4(a).

6 Minn. Laws. 2004, Ch. 203, Art. I. Secs.9 and 10.  For ease of reference, references to the new legislation will use the citation to Minn. Stat. §559.217 to which the new legislation is to be codified.

7 Minn. Stat. §559.217, subd. 1(c).  

8 Minn. Stat. §559.217, subd. 3(a). 

9 Minn. Stat. §559.217, subd. 3(b), (c).

10 Minn. Stat. §559.217, subd. 4(a). 

11 Minn. Stat. §559.217, subd.4 (b), (c).

12 Minn. Stat. §559.217, subds. 3(b), 4(b), and 5.

13 Minn. Stat. §559.217, subd. 7(a),(b), and (c). 

15 Minn. Stat. §559.217, subd. 8.

16 Minn. Stat. §559.217, subd. 6. 

17 Minn. Stat. §559.217, subd. 7(d). 

18 Minn. Stat. §559.217, subd. 2. 

19 Minn. Stat. §559.217, subd. 2.  An affidavit regarding the service of the two cancellations is prima facie evidence of the cancellation of the purchase agreement.  Minn. Stat. §559.217, subd. 7(e). 

20 Minn. Stat. §559.217, subd. 2.  In such proceeding, the court is to make such determination without regard to which party first initiated a cancellation proceeding and is granted express authority to consider the terms of the canceled purchase agreement. Ibid.

21 Minn. Stat. §559. 21, subd. 4(a), 559.217, subd. 1(b). 

22 Jandric v. Skahen, 235 Minn. 256, 260, 50 N.W.2d 625,626 (1951). 

23 Minn. Stat. §559.217, subd. 6. 

24 As a result, if there is a failure of a condition and the seller wishes to use Section 559.21, the seller must wait until the buyer fails to come to the closing before declaring a default and initiating a Section 559.21 termination.

25 While the statute does not, on its face, preclude a counter-cancellation by a seller based upon an unfulfilled condition in response to a prior notice from the buyer based upon that same unfulfilled condition, such a notice, whose sole effect is to wrongfully deny an immediate refund of the buyer’s earnest money, would be contrary to the spirit of the legislation. 

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LARRY WERTHEIM is a partner with Kennedy & Graven in Minneapolis.  He worked on behalf of the MSBA Real Property Law Section to help refine this legislation, which was promoted by the MN Realtors Ass’n.