Let's Terminate Use of the Word Rescind
Okay, everybody. gather round. This includes you, escrow folks. It is time for a team discussion. We have an industry-wide misunderstanding of what happens at the end of a failed transaction and the paperwork that is needed to send departing parties on their way. The misunderstanding results in lots of confusion for all of us, the professionals, so imagine what it does to our collective clients.
Here is the problem: when a sale fails, it is rarely appropriate to “rescind” the transaction, but invariably, escrow and brokers alike will seek or use a “rescission” agreement to end the transaction. Of course, I am generalizing, but the analogy is real. As an industry, we believe that every sale-failed transaction should be “rescinded” when in reality, almost no transaction should be “rescinded”. Instead, transactions should be “terminated” and the agreed terms of the terminated transaction should then dictate what happens to the earnest money and any other outstanding issues. Let’s start with two basic definitions:
“Rescission” means to revoke, repeal, reverse, annul, nullify, void, invalidate, abolish, vacate, abrogate. To leave contract parties in a position as though the contract had never existed. To rescind an agreement is similar to what the Christopher Reeves “Superman” did at the end of that 1978 film classic. If you are too young to remember, find it and watch it. In that final scene, Superman flies backwards around the earth so fast that he spins back time and creates an opportunity to alter reality. He changes events that happened and made it so that they never happened at all. That is what it means to “rescind” a contract. It is interesting that Superman is clearly anguished over the fact that he is about to create an alternate reality yet in our industry, we do it every day without giving it a second thought.
“Terminate” means bring to an end, conclude, finish, stop, wind up, discontinue, cease.
The distinction may seem subtle, but with respect to the legal rights and obligations of the parties, the difference in these two actions is enormous and can result in diametrically opposed outcomes. If a contract is “rescinded” that means the parties agreed to create an outcome that is the same as if the contract never existed in the first place. In other words, if seller believes that buyer is liable for damages done to seller’s property during buyer’s inspection, based on the terms of the inspection contingency, a rescinded transaction means that those inspection contingency terms are voided … invalidated … wiped away as though they never existed. Seller may have no claim for recovery of damages caused by buyer’s inspection because based on the rescission agreement, the inspection contingency never existed and neither did the protections for seller that are built into the contingency language. Similarly, buyer paid for an inspection and appraisal and is ready to close only to find out that contrary to the purchase agreement, seller has insufficient funds to clear title and cannot close. The buyer who agrees to rescind that agreement may also “rescind” any claim buyer might have had to recover buyer’s losses based on seller’s breach.
So… why do brokers and escrow closers routinely demand use of a “rescission agreement” to end a real estate transaction? Is it because of wording used in the statewide forms?
‘Rescission’ means to revoke, repeal, reverse, annul, nullify, void, invalidate, abolish, vacate, abrogate. To leave contract parties in a position as though the contract had never existed.
‘Terminate’ means bring to an end, conclude, finish, stop, wind up, discontinue, cease.
No. The statewide forms treat this issue correctly. Consider the following examples.
Form 35
(Inspection Contingency).
“This inspection contingency shall conclusively be deemed waived unless … Buyer gives notice … 2) disapproving the inspection and terminating the Agreement. … If Buyer disapproves the inspection and terminates the Agreement, the Earnest Money shall be refunded to Buyer.” Notice that the word “rescind” is not used with reference to buyer ending the sale based on the inspection contingency.
Form 22B
(Home Sale Contingency).
“If Buyer has not sold Buyer’s property … by the end of the Contingency Period, then this Agreement shall terminate and the Earnest Money shall be refunded to Buyer.” Again, note use of the word terminate and absence of the word “rescission”.
Form 22A
(Financing Addendum).
“If Buyer … is unable to obtain financing … this Agreement shall terminate. The Earnest Money shall be refunded to Buyer after lender confirms ….” (Paragraph 5.)
“If Buyer has not previously waived the Financing Contingency, Seller may give notice of termination of this Agreement ….” (Paragraph 3(b).) Once again, although both buyer and seller are granted some right to terminate, neither party is given the right to “rescind”.
All of these contingency provisions contained in the statewide forms system give the right, under certain circumstances, to “terminate” the purchase agreement. Each of the contingency provisions then goes on to explain the rights of the parties following termination of the agreement as contemplated by the terms of the contingency provision.
Finally, consider Form 21 or any of the statewide Purchase and Sale Agreement forms. The Earnest Money provision says: “Upon termination of this Agreement, a party or the closing agent may deliver a form authorizing the release of Earnest Money to the other party or the parties.” There is no reference in the statewide purchase agreement forms as to what might happen when the agreement is “rescinded”. Rather, the terms of the agreement, to which the parties agree, contemplate that if the sale fails to close for any reason, the parties will “terminate” the purchase agreement and then abide by the agreed terms regarding post-termination rights and obligations.
Because the statewide forms contemplate that a party may “terminate” the purchase agreement, there are numerous termination notices included in the statewide forms “90” series. Each correlates to the purchase agreement provision that the party uses to terminate the agreement. By comparison, there is only one Rescission Agreement (Form 51). So then, why has our industry created this falsehood that leads broker and escrow professionals to believe they need a “rescission” agreement every time a transaction goes sideways?
It is likely because brokers and escrow have very different ideas about what should be required before earnest money is released to one of the parties. In transactions where earnest money is held by escrow, escrow requires joint instruction from the parties for the release of the earnest money. To many brokers, this seems to conflict with the plain language of the statewide forms. For example, Form 35R (Inspection Response for Form 35) sets forth one of buyer’s response options as “Buyer inspection of the Property is disapproved and the Agreement is terminated. The Earnest Money shall be refunded to Buyer.” Buyer has the unilateral right to terminate the purchase agreement, consistent with the inspection contingency, so why does escrow require something more before releasing the earnest money to buyer?
From escrow’s perspective, this is a very different situation. Escrow is a fiduciary to buyer and seller and holds the earnest money in trust for the benefit of both parties. If escrow were to release money to seller that belonged to buyer, or vice versa, escrow would be liable to the party who is entitled to the funds. If the transaction has failed, then escrow stands to receive no compensation for the liability it will assume in releasing the earnest money. As a result, escrow will not release earnest money without clear, agreed instructions from the parties or the protection that comes with adherence to the statutory process for resolution of earnest money disputes set forth in RCW 64.04.220.
To bridge the gap between broker and escrow perspectives, the common refrain is “we need a rescission agreement.” Unfortunately, that statement is born out of a misunderstanding. In reality, industry professionals need to turn to the language of the purchase agreement specifying that “[u]pon termination of this Agreement, a party or the closing agent may deliver a form authorizing the release of Earnest Money ….” In many cases, the purchase agreement is already terminated. With the example of Form 35R, assuming buyer’s termination was timely, buyer did, in fact, terminate the agreement by sending the signed notice to seller with the termination provision marked. Thus, there is no reason to “rescind” the agreement that has already been terminated. To the contrary, escrow simply needs a “form authorizing the release of Earnest Money,” a form also known as, Form 50.
Using a Form 51, Rescission Agreement, when the parties actually only want to terminate the purchase agreement and disburse the earnest money is a mistake. The consequences of that mistake may include one or both of the parties releasing claims they did not intend to release and rescinding a contract on which they are still reliant for determination of legal rights and obligations. In fact, there are very few instances where a Form 51 should be used. Going forward, when escrow needs instructions for the release of earnest money, reach for Form 50, “Authorization to Disburse Earnest Money,” and let Form 51 collect some well-earned dust.
Members, if you’d like to submit questions to the Legal Hotline, e-mail legalhotline@warealtor.org. The Legal Hotline lawyer does not represent Washington Association of REALTORS® members or their clients and customers.