A contract is a legally-enforceable promise made between parties. In the civil law, contracts are considered to be part of the general law of obligations. Basic common law contract law addresses four sets of issues:

1. When and how is a contract formed?
2. When may a party be released from the obligations of a contract?
3. What is the meaning to be given to the terms of a contract?
4. What is the remedy in the case of breach of contract?

In order for a contract to be formed, there must be an agreement that consists of an offer and acceptance, consideration, and contractual intention.

This section provides a brief overview of Contract Law issues commonly encountered by parties to contracts.  Please review the list of Contract Law articles below.

Building or Remodeling? Check Out Your Contractor
How Binding is Arbitration?
Homeowners Can Be Liable for Injured Workers
Homeowner's Insurance: Is There More?
In Contract Situations, Consult an Attorney
It's Best to Read the Contract
Lead Based Paint: It's Time to Get the Lead Out
Permission to Build?
Plan in Advance When Disputes May Exist
Retain Legal Counsel in the Event of a Dispute
Sometimes Banks Make Mistakes -- And It Costs Them
What Are Liquidated Damages?
When Leasing Property, Record the Condition
When a Problem Develops, Take Immediate Action
Progress Payment Penalties Don't Apply to Final Payments

 

Building or Remodeling? Check Out Your Contractor

Barry and Sandra Ehrlich hired a contractor to custom build their "dream-come-true house." Their home was to be built on the coast, and was to have clear ocean views. The Ehrlichs hire a contractor who promised to build them "a beautiful home," and after seven months of construction the Ehrlichs moved in.

Unfortunately, the home was poorly built. As a result, the house leaked badly when the rainy season started. Water leaked in almost every location, and nearly every window leaked. Walls became saturated, and the sheetrock in the garage became so wet that the plaster melted and fell from the ceiling. The living room filled with three inches of standing water. Three decks were at risk of collapsing and part of the concrete foundation began to crack. Erlich v. Menezes (1998) 60 Cal. App. 4th 1357.

The Erlichs filed a lawsuit against the contractor for the costs of repair and won. However, they filed the lawsuit seven months after moving in, but the lawsuit process required several years before it was complete.

Had the Erlichs known what kind of house they were to get, they would have undoubtedly used a different contractor. The Court's opinion doesn't say what steps the Erlichs took, if any, to check out their contractor before they hired him. However, in addition to getting references from previous customers, a number of steps can be taken to check out a contractor before signing a contract.

Contractors with poor construction practices may have been in trouble before you meet them. If you know the counties where the Contractor has worked, you can check the records at the County Courthouse. If he's been sued in that county before, the Court will have a record of the lawsuit.

Contractors receive their licenses from the California State Contractors License Board. This Board receives and investigates complaints about contractors. In appropriate cases, the Board may issue citations to contractors who violate the laws regulating contractors. Contractors may be cited for such things as abandoning a job, not paying subcontractors, poor workmanship or other contract violations. In severe cases, the board may suspend or revoke a contractor's license.

Complaints which the Board receives about specific contractors are not generally available to the public. However, information is available from the Board about any citations the Board has issued to a contractor, or any license suspension or revocation. The Board will also confirm whether or not a contractors' license is active or expired.

Several free publications are available from the Board. Two of the publications relating to contractors are "What You Should Know Before You Hire a Contractor" and "Home Improvement Contracts: Putting the Pieces Together." These publications can be ordered by calling the Board's toll free message line at (800) 321-2752. They can also be ordered directly from the Board at (510) 622-2744 or by writing to the Board at the following address: Contractors State License Board, 1515 Clay Street, Suite 1105, Oakland, California 94612.

Legal Footnote: After the Erlich case was decided, the California Supreme Court agreed to hear the case on further appeal. Until the Supreme Court finally determines this case, it cannot be used as precedent in other matters.

Robert B. Jacobs is a Real Estate, Construction and Business Law Attorney in Pleasanton, California. Note: Legal situations differ, and each one is unique. The foregoing information is not intended to be a complete or an exclusive treatment of the subject, and a legal professional should be consulted before deciding if or how the information above may apply to any specific situation.

[back to top]

 

How Binding is Arbitration?

Nobody wants to buy a lawsuit. But most people want to buy a house. So what happens when home buyers discover they bought the house of their dreams but one of the dreams is a nightmare?

The first step is often to call the seller. If the home is new, the seller is usually a developer, and most developers provide a warranty with their homes. In these cases, a buyer can often have the problems fixed at the expense of the seller.

But what happens when the seller is another homeowner instead of a developer? Homeowners often don't have the resources to repair major problems with a home. In some cases, sellers claim they didn't know of problems (when they actually may have). In other situations, even a developer may be unwilling to acknowledge a problem or repair it.

If buyers and sellers can't agree about repairing problems with a house, they usually involve lawyers. The lawyers may exchange several phone calls and letters. If agreement can't be reached, the lawyers file a lawsuit.

Are lawsuits effective? They can be. Every lawsuit is eventually resolved, either by agreement between the parties, or by a judge or jury at trial. Are lawsuits expensive? They can be, and they typically are. The expense depends on how the lawsuit is handled and the length of time before it is resolved. Most trials are held approximately one year after the lawsuit is started. The cost of a lawsuit through trial can be surprisingly high. Is there any way to reduce the costs of a lawsuit? Yes through binding arbitration.

"Binding Arbitration" is dispute resolution without a lawsuit. In "Arbitration", a dispute is submitted to an "Arbitrator" who is often an attorney or a retired judge. Both sides present their case at an "Arbitration" which is similar to a trial. "Binding" means the result is final with no right to appeal.

"Arbitration" is similar to a trial in that both processes use a hearing, or trial, before a decision maker. At Arbitration, the decision maker is an "Arbitrator." At trial, the decision maker is a judge (or jury). In both processes, the decision is final and legally binding between the parties.

Arbitration is different from trial in several ways. Arbitration is less intrusive. In many arbitrations, neither side has the right to ask the other side any questions before arbitration. This can make the process less expensive than a lawsuit, where both sides have the right to ask the other side many questions. Arbitration is often concluded in a matter of months instead of nearly a year. Arbitration is usually thought of as faster and less expensive than trial.

One of the prime differences between trial and Arbitration is the right to appeal. Because Arbitration is designed to be final, there is no right of appeal. Because Arbitration has no right of appeal, the process can be much shorter. But if an arbitrator makes an error, the parties have no recourse. As a result, an Arbitrator is not required to follow the law. His or her decision is final and binding, even if it is legally incorrect. This means that Arbitration may be faster and less expensive than trial, but it may also be less predictable.

There is no correct answer whether trial or arbitration is better in any given situation. Each situation must be evaluated separately.

[back to top]

 

Homeowners Can Be Liable For Injured Workers

As the new homeowner surveys the front yard, an old worn pickup with substantial body damage pulls up to the curb. The faded lettering on the side says "First Class Landscaping and Tree Service." The driver gets out and says to the homeowner "Hey there, you've got a big elm tree here that really needs to be trimmed. I'll have my crew take down those dead limbs, clear out the top, and make it look first rate. The going rate is $800, but I'll do it for $550." Does the homeowner have any cause for concern?

Yes. The homeowner may be able to call references to confirm whether the contractor does good work. But the homeowner also needs to ensure that the contractor is properly insured. If not, the homeowner might be liable for any employee injuries on the job.

A recent California court case underscored the need for proper insurance. Andreini v. Superior Court (1998) 60 Cal. App. 4th 1415. In that case, the homeowner hired a contractor to do touch-up painting on their home. The contractor had an employee. Even though the law required the contractor to carry worker's compensation insurance, he didn't have any.

The contractor's employee climbed onto the roof and began painting the chimney. While painting, the employee lost his balance, fell from the roof and was injured.

If the contractor had purchased worker's compensation insurance, that insurance would have paid the employee everything the employee was entitled to. The employee couldn't also sue the homeowner unless the homeowner had somehow caused the injury. In this situation, the homeowner did nothing to cause the injury. But because the contractor carried no worker's compensation insurance, the law allowed the employee to sue the homeowner so that the employee would have a source of money to pay for his injuries. The homeowner is liable to the employee along with the contractor because the homeowner could have made sure that the contractor had worker's compensation insurance.

This result may seem unfair to the homeowner. After all, most homeowners don't usually ask contractors whether they have workers' compensation insurance, and this homeowner probably had no idea whether or not the contractor was insured. However, the homeowner had the ability to control the situation by requiring proper insurance. In this situation, the homeowner has a valid claim against the contractor for anything the homeowner pays to the employee, but if the contractor has little or no money the homeowner may never recover any amounts paid.

The bottom line? Homeowners who hire contractors are at risk for injuries to the contractors' employees. Homeowners can reduce their risk by asking to see a certificate of insurance showing that the workers' compensation policy is currently in force. And what about the contractor who drops a limb on your neighbor's car? Or on your neighbor? Homeowners should also ask to see a certificate of insurance showing that the contractor has an appropriate liability policy in force with an appropriate level of coverage.

[back to top]

 

Homeowner's Insurance: Is There More?

In the Bay Area, Homeowner's Insurance is a way of life. It's not whether you get Homeowner's Insurance but rather how much you get. Any buyer who has closed a loan knows that the lender absolutely won't lend until the borrower gets Homeowner's Insurance. And with good cause. Lenders want to protect themselves. If that late night kettle of deep-fried won ton turns in to a four-alarm fire, the house may not survive. Proper Homeowner's Insurance should pay for most of the cost of reconstruction. Nobody would be surprised to see the lender require the house to be rebuilt with the insurance money. Without the lender's insistence, the homeowners might otherwise find themselves in Acapulco.

But besides covering the cost to rebuild the house and replace its contents, most Homeowner Policies provide a general liability coverage. This is coverage for injuries, damages, or losses caused by the Homeowner. What kinds of losses are covered? With a proper policy, a homeowner would typically be covered for sudden accidents, or occurrences, that were neither expected nor intended by the homeowner. In other words, if the homeowner's new second story deck falls onto the neighbor's new sports car, the policy should pay for the damage. If a tomato from one of the homeowner's prize tomato plants falls onto a walkway and a guest trips or slips and falls, the policy should pay for the injuries. If the fourth of July sparklers get just a little out of hand, the policy may pay for the cleanup.

But what about damage, injuries, or losses off the premises? Many homeowner policies are general liability policies, which means they will cover damages caused by the homeowners even when they aren't home. Homeowners policies typically won't cover losses or injuries from boats or other water craft. These are the subjects of other kinds of policies. And Homeowners' policies usually won't cover accidents involving vehicles. These are usually the subject of automobile insurance. But the general liablity portion of many homeowner policies is designed to cover the homeowners for damages or injuries negligently caused by the Homeowner wherever they are. There are a wide range of situations where a Homeowners' Policy has covered a claim for damages that didn't relate to the homeowner's house or real property. In one case, a schoolgirl negligently caused a fellow student to break her teeth, and the Homeowners' policy paid for the injuries. In another case, a Homeowner's policy paid for injuries when a tree trimmer fell out the homeowner's tree. In another case, a Homeowner's policy paid for injuries when a homeowner invited a friend to dance on a glass table top and the glass shattered.

Because many Homeowner's Insurance policies will provide coverage for injuries caused by the Homeowner off the premises, homeowners should consider the possibility of such injuries in deciding their limits of coverage. Questions about the specific coverages under a specific insurance policy, or about the proper limits of liability, should be directed to an appropriate insurance agent or competent counsel.

*Legal note: The terms, conditions and coverage of any policy of insurance, including homeowner's insurance, can vary widely depending upon the language in the policy of insurance, exclusions, relevant statutes and other law. Before attempting to determine whether or not any policy of insurance will provide coverage in any given situation, purchasers should consult competent counsel.

[back to top]

 

In Contract Situations, Consult an Attorney

I sometimes counsel with people in a legal dispute who advise me that they used a "standard contract" from a book they bought. Because they used a form contract from a published book, they expect the contract to be authoritative and adequate. If the contract is inadequate for their purposes, they sometimes seem surprised, and always disappointed, that the form contract they used has not served them well.

I have seen contracts for leases - or sales - of real property from published books that were ambiguous and vague. The problem with an ambiguous contract is that nobody is sure what it means. If you want to enforce an ambiguous contract, you may have a problem, because at trial, you'll be asking the judge to compel the other side to perform according to the contract. Problem is, if the contract isn't clear, then nobody's quite sure what the other side should do, or exactly what the other side agreed to. It may then be possible for the other side to "break" the contract, meaning that they may succeed in convincing the judge that they shouldn't be forced to do anything.

It's impossible to evaluate whether all of the contracts from all printed sources are adequate. Prepared contracts are available from bookstores, some stationary stores, and even off the internet. Because each contract must be separately evaluated, nobody can say whether prepared contracts are adequate or not. But I can say this much: some of the poorest contracts I have seen have come from prepared sources that people purchased and then used on their own.

Some prepared sources claim to follow California law. But others do not. The problem is that the California state Legislature regularly passes new laws. If a prepared contract does not consult California Law, then it is possible that portions of the contract may be void or unenforceable because they may violate California state Law. If a prepared contract does follow California law, then it is important to know whether the contract followed the legal updates. A contract prepared three years ago may include provisions that have been recently banned or prohibited.

In addition, many people have an inadequate understanding of the legal foundation of contract principles. Unless they have devoted themselves to a serious study of the law, they may change the contract, or use it in such a way that it has unintended consequences.

The best course of action? Enter contracts with care. And if it's a contract you are concerned about, give serious consideration to having it prepared or reviewed by competent counsel. The information in this article is not a complete treatment of the subject discussed and is not intended to be legal advice. Readers with a specific matter or question should consult an attorney.

[back to top]

 

It's Best to Read the Contract

John Doe home buyer is ready to buy his first home. He is presented with an agreement that seems to have more fine print than Webster's Dictionary. John looks at his broker and says "Do I really need to read all this?" What does it all mean, anyway. Why don't you just sum it up for me?

John's broker tells him "Look -- if you just pay the money as promised, there's nothing in here that will hurt you." John feels that only lawyers understand these contracts anyway, and everything in this contract is probably "standard boilerplate." So John signs it.

Is John right? Probably not. Most people probably feel contracts are written by lawyers for lawyer. And they are probably right. But is the innocent home buyer bound by all those ancient phrases and verbose provisions? Probably yes.

What's a home buyer to do? Read the contract. If he doesn't understand it, then he has two choices: Hold his breath and sign it anyway, or get legal help. Fortunately, many contracts are performed without any kind of a legal hitch, but when there are problems, they can be expensive.

What do many prudent, conservative home buyers do? They take steps to find out what they're signing. Once they understand the contract, they can then evaluate the risks they are taking. Sometimes these risks translate into an adjusted purchase price. And sometimes these risks may kill a deal. But unless the parties understand the risks they are taking, these contractual terms lie in the bottom of a dark file cabinet until a problem arises, and when the problem arises, its outcome may be determined in large part by the very contract that seemed so hard to read.

I recently signed a contract to lease storage space. The manager presented me with a lengthy printed contract, at least fourteen inches long, and gave me a quick explanation of the several paragraphs. When I looked closely at it, she asked "You're going to read the whole thing?" My response was "If I don't do it now, I may not do it later. I'd sooner know what I'm signing before I do it, instead of after." The manager waited patiently while I read the contract. But it was clear from her quick presentation that she had done this before, that she probably gave this brief summary to every new lessee, and that she didn't expect me to read the contract. After I read it, I told her that she had a good contract, and that her company had adequately protected themselves. What I didn't add was that by reading the contract, and understanding it, I had protected myself.

[back to top]

 

Lead Based Paint: It's Time to Get the Lead Out

Lead-Based Paint. Nobody gave it much thought until a few years ago. It was a part of doing business.

But now with all of the concern about the potential health effects from exposure to lead, government agencies have started requiring disclosures of lead-based paint in real estate transactions.

Beginning in 1996, sellers of most residential housing that was built before 1978 have been required to make disclosures about in-home lead-based paint. The source of this legal disclosure is the Residential Lead-Based Paint Hazard Reduction Act of 1992 which was passed by Congress in 1992. Because it's a Federal law, the disclosure requirement is not limited to California.

Before a contract can be completed for the sale of residential housing built before 1978, the seller (or the seller's agent) must take a number of actions. The seller must give the buyer a pamphlet titled "Protect Your Family From Lead in Your Home." The seller must give the buyer a 10 day opportunity to test for the presence of lead in the home. The seller must disclose all known lead-based paint in the home and give the buyer copies of any available reports. The seller must include warning language in the contract. The seller must sign statements certifying the completion of these requirements. And, the seller must keep the signed documents for three full years.

The law does not apply to several types of housing, most notably housing built after 1977. The law also doesn't apply to units that have no bedrooms, such as a loft or a dormitory room. It doesn't apply to housing for elderly or disabled occupants unless children live there. It doesn't apply if a certified inspector has inspected the property and found it to be free of lead based paint. It also doesn't apply to leases for less than 100 days, such as vacation rentals, where the rental won't be extended past the 100 days.

The penalties for non-compliance can be significant. Sellers who knowingly violate the law can be liable for three times the amount of any actual damages suffered due to non-compliance. The law provides for civil money penalties to the United States Government. If a lawsuit is filed, a losing seller may be required to pay the other sides' attorneys fees, costs, and expert fees. And, the law provides for criminal penalties of up to $10,000 for failing to comply with the law.

[back to top]

 

Permission to Build?

It's a safe bet that a close inspection of the pyramid tomb of Raamses II or King Tut won't turn up any permission slips in Egyptian hieroglyphics allowing the great pyramids to be built. No grading inspections. No framing inspections. No final inspection. Perhaps that's one of the perks of being an Egyptian pharaoh: No red tape from the building department.

For the rest of humanity, at least in this country, nothing gets done without a nod from city hall. And when it comes to building, the nod comes from the building department.

Many homeowners are not aware that a building permit must be obtained for repairs or improvements that may seem minor. Chances are good that a permit is required if an expected improvement affects the plumbing, electrical, framing, structural, heating, or air conditioning systems of a home. A building permit can even be required for something that appears to be as mundane as replacing a water heater or other appliance. One of the simplest ways to determine whether or not a permit is required for any specific repairs or improvement is to contact the building department prior to construction.

A major purpose of the permit process is to safeguard against improper construction practices that may make improvements unsafe or defective. Building inspectors typically review construction in progress to determine compliance with applicable building codes and procedures. If the construction does not comply with relevant codes, the construction may not pass inspection. The inspector may require the construction to be changed so that it satisfies the requirements of the building code.

Even though building departments charge fees for building permits and inspections, the services relating to a permit can be valuable even though they may seem routine. Several years ago I handled a case where a homeowner purchased a new water heater. He paid for installation, and the installer removed the old water heater and replaced it with a new one. The installer didn't change the location of the water heater. The original water heater was installed directly on the concrete garage floor, and the new one was also placed on the floor. After the home was built, the building codes changed so that water heaters were required to be raised several inches off the floor. The building codes recognized that gasoline or other explosive fumes can accumulate in garages. If the water heater is raised off the floor, then any fumes may be able to disperse through garage vents before they are ignited by the water heater. In this case, the new gas water heater had a pilot light. A can of gasoline was accidentally knocked over on to the floor of the garage. Explosive gasoline fumes accumulated, and the pilot light ignited the fumes. The vapors burned quickly and caused a fire that leveled the house. If the homeowner had called the building department before installing the water heater, he might have found that the new codes required the water heater to be placed on a stand so that the water heater is off the ground.

Obtaining the proper permits can help promote safe construction. Also, the proper permits can make it easier to sell a home. When a homeowner sells a home in California, he or she is required to disclose to the buyer whether any improvements have been made without necessary permits. If the proper permits have been obtained, then no negative disclosure about permits will need to be made.

*Legal note: Building codes are complex and are constantly changing. Information received from a building department can be useful, but consumers should be aware that even if the building department should provide incorrect information, the consumer may still be liable for complying with state and local law. Consumers should also be aware that if a project does not meet code or is otherwise defective but still passes inspection, the consumer may not be able to assert a claim for making an improper or incomplete inspection.

[back to top]

 

Plan in Advance When Disputes May Exist

An ounce of prevention can be worth a pound of cure - or even several pounds.

I occasionally counsel with clients who have sensed a legal problem was developing long before any lawsuits were filed. These clients may have sensed that the personalities involved would likely lead to litigation, or that at some point a negotiation has started having problems. Some of these clients have taken no preventive action and have hoped the problem would resolve itself without the need for attorneys to get involved. And some of these matters have eventually resolved themselves, but others only seem to get resolved after litigation is filed and thousands of dollars of attorneys fees and costs are spent.

A simple legal motto goes like this: People look most closely at documents the second time they read them. The meaning is this: When contracts or deals are being made, read, and signed, people are often anxious for the contract to be completed, and they may gloss over terms, conditions, disclosures and provisions. But when problems arise as they sometimes do, these same people look at their contracts and their documents a second time, but this time they are looking for assistance for their case. At this stage, the language in the contract or the document can be very important, because frequently the language in the written agreement will control the rights of the parties involved in any dispute. The bottom line? It's a good idea to have the most written protection possible in any contract situation. The problem? Many people who sign contracts have little or no legal expertise in contract law. This means that in order to get the best protection, the parties need to hire an attorney.

It's a difficult problem. Many contracts are drafted, signed, and executed without any kind of significant dispute. California real estate practices rely to a significant extent on this proposition, because California law does not require an attorney to be involved in a house transaction, whereas several other states require an attorney to be involved in such transactions. If the parties knew when a dispute would develop, they could hire attorneys to help them draft contracts for those situations, and could do the others themselves. In a situation where it appears likely a dispute may develop, parties are certainly well-advised to retain legal counsel. But what about situations where all of the parties appear to get along well, and no dispute appears likely?

In such situations, the parties must evaluate their degree of comfort with the risk of a potential dispute or lawsuit. If the parties are comfortable with the transaction, then they may decide to save the cost of retaining an attorney, and recognize that if a lawsuit develops, they will then hire an attorney. On the other hand, if the parties want to maximize their protection in the event of a dispute, they may decide to spend the money up front to have legal counsel review their documents or help them prepare revisions. Competent, thorough legal counsel can frequently make recommendations on contracts that can provide invaluable assistance in the event of a dispute. But there is no easy answer, because of the up-front costs involved. Each person must ultimately decide whether or not they will incur the costs to acquire the contractual protections that competent counsel can provide.

[back to top]

 

Retain Legal Counsel In the Event of a Dispute

At a party several years ago, someone asked me what it was like to be a lawyer. I responded "It's just like L.A. Law. People come into my office each day with the most astounding problems. We resolve everything in an hour, and we handle eight matters a day.

"After the laughter died down, I explained that people who go to law school based on what they see on television or in theatres are likely to be sorely disappointed. In over 10 years of practice, I can count on the fingers of one hand the number of times I've seen a witness break down, or 'fess up, or produce the 'smoking gun,' and admit that he or she was either guilty or wrong. But Perry Mason managed to do it every episode.

My clients are sometimes surprised, and always disappointed, when they learn that people in litigation don't always follow "truth, justice, and the American way." At trial or deposition, attorneys are often civil to each other and to the opposing sides, and may even smile at each other. While litigation may sometimes appear to be civil, in many ways it is a hard-fought contest, with both sides struggling to win, often at a very high cost. Clients are sometimes surprised at the substantial costs involved. But building a case in many respects is like building a house and in significant cases even the costs can be similar.

Because such a conflict often consumes such a significant amount of time and resources, I generally counsel clients to prepare themselves as best they can prior to such an event. By the time a matter gets to litigation, the time for some of the preparations has passed. When clients are concerned about possible litigation, I advise them to have the best contracts they can. How do they have such contracts prepared? By competent counsel. People who aren't lawyers often look at lengthy contracts and think "that's just boilerplate" or it's "just a standard contract." There really is no such thing. At trial, the judge may decide significant portions of your case in your favor - or against you - based on that very contract that at one time appeared so mundane. The best protection? If you're signing a contract that you're concerned about, have it reviewed by competent counsel.

[back to top]

 

Sometimes Banks Make Mistakes - And It Costs Them

With all the recent news about mergers and takeovers, it sometimes seems that the corporate giants of the world just continue to get larger. At times they appear to be firm and unmovable, and the thought of an error on their part seems unlikely.

But that's not always true. Banks -- even big banks -- sometimes just make mistakes. And the opportunistic borrower sometimes may try to profit from such mistakes.

The ability of Banks to make mistakes was underscored in a recent case involving two lenders. A Thrift and Loan Association made a loan to a borrower. The loan was secured by a mortgage on the borrower's home and a commercial property. The borrower and the Association agreed that the borrower would make a substantial payment on the loan in the future. When the borrower made the large payment, the Association would release the mortgage on the borrower's home, and would keep a mortgage only on the commercial property. First Fidelity Thrift & Loan Association v. Alliance Bank (1998) 60 Cal. App. 4th 1433.

The borrower made the payment as agreed. However, the Association made an error. Instead of releasing the mortgage on the borrower's home as agreed, it released the mortgage on the commercial property and kept the mortgage on the borrower's home.

After the borrower received the release of the commercial property, the borrower went out and applied for another loan from a different Bank. The borrower submitted financial records that showed the commercial property had a mortgage. The second Bank searched title records but found no mortgage on the commercial property. When the second Bank asked the borrower about it, the Borrower saw an opportunity, and said the financial statement was wrong. The Borrower said the financial statement should not have shown a mortgage on the commercial property. The second Bank made the loan to the borrower.

Two years later, the Thrift and Loan Association discovered its mistake. It sued the borrower, and received a mortgage back on the commercial property. But it received the mortgage after the other Bank had already given the borrower another loan and after the other Bank had received a mortgage on the same property.

The borrower defaulted on both loans. Both the Association and the Bank foreclosed on the same commercial property. At the foreclosure sale, there wasn't enough money to pay off the loans of both the Bank and the Thrift and Loan Association. Who wins?

The Thrift and Loan Association had the first mortgage on the property. But it mistakenly released its mortgage. The law provides that the first person to receive a mortgage on a property is the first one to be paid. When the Association mistakenly released its mortgage, the Bank was able to make a loan and move to the front of the line with its mortgage. When it came time to sell, the Association was left out in the cold because it was in second position behind the Bank. Releasing the wrong property was a simple error -- but a costly one. Not only did the Association not get paid back on its loan, it also went through two lawsuits: one against the borrower, and one against the other Bank.

The moral of the story? If you're a lender, be sure to look at your documents before you sign them. If you're a borrower? Remember that bank employees (and others) are people too.

Footnote: Ever wonder what became of Judge Ito after all the excitement subsided in Los Angeles? Judge Ito was one of the three judges who heard and decided this case in early 1998.

[back to top]

 

What Are Liquidated Damages?

It happens to every new home buyer. After finding the perfect house at the perfect price, the real estate broker walks in and lays down a contract. Seven pages of single spaced boilerplate in double-talk legalese from the seventeenth century.

"What'll it be? You have the option of selecting 'Liquidated Damages.' As the homebuyer, it's up to you. Do you want 'Liquidated Damages' in this contract, or not?"

The new homebuyer has never heard of 'Liquidated Damages' but it sounds ominous. The real estate broker isn't quite sure what it means, but since it's in the contract, the buyer goes ahead and chooses the 'Liquidated Damages' option. Has the buyer done the right thing?

"Liquidated Damages" can apply to any contract. Most printed real estate contracts contain a "Liquidated Damages" clause. If the buyer and seller agree, then the "Liquidated Damages" clause is included in the contract. So what are "Liquidated Damages?"

"Liquidated Damages" only apply if the buyer or seller breaks a contract. Any time a party to a contract breaks it without justification, the other party is entitled to recover any money they lost because the other party broke the contract. The amount of money they are entitled to is called "Damages." It literally means the amount of damage the party suffered, or the amount of money they lost, when the other party broke the contract.

Before a party can recover any "Damages," they must prove the amount of their damages, which is the amount of money they lost. Sometimes it's hard to prove the amount of money that's lost. If a buyer breaks a contract, how much has the seller lost?

What if the seller loses nothing because the property gets sold to another buyer for more money? The seller has lost nothing, and has no damage. What if a seller refuses to complete the sale? The buyer can buy another property. But how much money has the buyer lost in the first transaction? It's not always clear.

To get around these problems, the buyer and seller can agree to "Liquidate" any damages. This means that the buyer and seller agree up front on the amount of money either side will get if the contract is broken. By agreeing on the precise amount of damages, the parties "Liquidate" the damages, meaning that the amount of damages is certain.

Many printed real estate contracts contain a "Liquidated Damages" clause that limits the amount of "Liquidated Damages" to the amount of the down payment, up to a maximum of 3% of the price of the house. Sellers often don't understand that their buyer can walk away from the contract at any time and pay no more in "Liquidated Damages" than the down payment. If sellers understood this, they might ask for larger down payments.

There are no consistently right or wrong answers with "Liquidated Damages." The decision on whether to agree to "Liquidated Damages" is just one of the many items to be considered when a house is sold.

[back to top]

 

When Leasing Property, Record the Condition

A picture is worth a thousand words -- or in some cases ten thousand words.

I serve as a small claims court Judge twice each year. By law, small claims actions are limited to claims of $5,000 or less. But even though the amount of the claims are smaller, the drama can sometimes be as great as cases filed in Superior Court, where claims have no dollar limit.

One of the most common cases I see as a Judge involves claims between landlords and tenants. The case is often filed by a tenant against the landlord who has withheld part of the security deposit to repair damages. In these cases, the tenant often claims that the damages were present when they moved into the property. The landlord usually claims that the property was in first-rate condition, and that the tenant has either failed to maintain the property or has damaged it.

As a judge, I have the responsibility to decide whether the landlord or the tenant is presenting the more accurate story. It's not always an easy task. Landlords usually have more money, so the tenant may receive more sympathy initially, but Landlords can also appear to have received poor treatment at the hands of the tenant.

Frequently, one side or the other will present pictures of the condition of the house or apartment that shows the damaged conditions. But in almost every case, neither side has taken photographs that show both the "Before" and "After" conditions. Because the photographs only show the conditions after the damage is present, a judge must decided whether or not the damage was present when the tenant moved into the property. The judge must rely on oral testimony -- but this testimony is often uncertain, and is usually contradicted by the other side.

A landlord or tenant who is thinking ahead will sometimes take photographs - or a videotape - of the condition of the property both before and after the tenancy. By using dated photographs, the parties can preserve powerful evidence of the condition of the property in the event a later dispute occurs. Landlords frequently use a written description of damage when a tenant takes possession. When used properly, this process can protect both sides, but a written description does not always accurately describe the extent of the damage. In those cases where a landlord doesn't use a written checklist, a picture can document the extent of damage. A letter to the other side that encloses copies of the photographs, sent by certified mail or federal express, can provide further evidence of the date the damage was present.

Certainly most people don't lease property expecting a dispute. However, a few precautionary steps can help resolve problems later on if both sides will keep accurate records of the condition of the property.

[back to top]

 

When a Problem Develops, Take Immediate Action

The parties have signed a contract, and now it's time for performance. One side begins to sense that important facts in the transaction may not have been disclosed before the contract was signed? What should both parties do?

A contract is an agreement between two or more persons where both sides agree to provide goods, services, or something of value to the other side. What happens when one side fails or refuses to perform? Or what happens when one side begins to feel that the contract was not fairly negotiated, such as a situation where defects in goods or services were not disclosed?

The parties, having entered a contract, now find themselves in a situation where performance is not what was expected. At this point, the party that doesn't receive full performance has a problem, and that party actually has two problems. The first problem is how to get the other side to perform, and the second problem is the potential cost of getting the other side to perform.

When contract disputes arise, many people have a natural tendency to try to informally resolve the problem with the other party. This approach can sometimes be successful, and if successful both parties can save attorneys fees in attempting to resolve the dispute. But what about situations where the other party absolutely refuses to perform, or where the party lacks the necessary resources to perform?

At this point, one or both of the parties frequently seek legal counsel. In some situations, an attorney is consulted early in the process, but in others an attorney is consulted after extensive efforts by the parties to informally resolve the dispute.

What should the parties consider in deciding whether to retain counsel? Cost is often an issue, and in very small matters an attorneys fee may not but justified. But when dealing with matters of any significance, in almost every situation people's rights are better preserved when they consult competent counsel. An attorney is trained to spot legal issues, legal rights, and to counsel clients on how best to preserve their rights. On a practical level, many attorneys deal with disputes, confrontation, and problems on a daily basis, and over a period of time they develop a sense of dispute resolution, and like a river guide, they can sometimes help clients know what to expect. They can often use their experience to help clients see what may be around the next bend. Because such attorneys are experienced in dispute resolution, they can sometimes provide invaluable assistance in helping clients decide which steps are necessary or best for resolving a particular dispute.

[back to top]

 

Progress Payment Penalties Don't Apply to Final Payments

Contractors on a job often have to deal with the issue of getting promptly paid on progress payments. There's a great incentive for owners to delay making payments. Delayed payments can increase available cash for other expenses, and money also has a time value in the form of interest, so a direct and specific economic incentive exists for owners to not make timely progress payments.

The California Legislature is aware of this problem, and has passed a statute that specifically addresses this issue at California Civil Code §3260.1. That statute provides that on private (i.e. non-public) works of improvement, an owner must make payments within 30 days after receiving an invoice unless the owner and contractor agree otherwise in writing. If a good faith dispute exists between the owner and contractor as to whether or not a payment is properly due, then the owner may withhold up to 150% of the disputed amount. However, if no dispute exists, then the owner is subject to a penalty of 2% per month of the wrongfully withheld amount, plus attorneys fees if the contractor sues and wins.

The statute specifically states that it applies to progress payments. The statute doesn't state that it also applies to 'final' payments. A recent court case clarified that the statute applies only to progress payments and not to final ones. Murray's Iron Works, Inc. v. Boyce (2008) DJDAR 660.

In Murray, a homeowner ordered over $200,000 of ornamental wrought iron. The owner asked the contractor if the wrought iron could be plated with real gold instead of imitation gold leaf. The contractor explained that he was unable to do this because he didn't know anybody who could actually apply gold leaf to the iron. However, when the contractor submitted his bid, he didn't specifically state that the gold leaf was to be 'imitation.'

The contract called for a down payment of half of the contract price and the remaining balance on completion. The owner paid half down as required, and made one additional progress payment. After the product was delivered, the owner provided a small punchlist. After the punchlist was completed, the owner sent the contractor a letter stating that he was refusing to pay because real gold leaf wasn't used. At that point, the contractor was still owed $66,222.40.

The contractor sued, and the case went to trial. A jury awarded the contractor the contract amount still due, which was $66,222.40. In addition, the jury awarded $49,004.65 for the 2% per month penalties authorized by Civil Code §3260.1. The trial court also award the contractor $110,000.00 in attorneys fees and $10,090.23 in costs.

The owner appealed and claimed that the 2% per month penalties and the attorneys fees provision only apply to progress payments and not to final payments. The owner further claimed that he made the down and progress payments as required and only the final payment was withheld after the construction was complete.

The Court of Appeal agreed. After a lengthy discussion of the differences between 'progress' and 'final' payments, the Court of Appeal concluded that a 'final' payment is due after work is completed, and that §3260.1 doesn't apply to 'final'payments. Because the owner made the 'progress' payment but not the 'final' payment, the trial court shouldn't have applied the statute or awarded the penalties. As a result, the contractor kept his award of $66,222.40 and his costs award of $10,090.23, but the Court of Appeal reversed the civil penalty award of $49,004.65 and the attorneys fees award of $110,000.00.

The net result? The contractor spent at least $110,000.00 plus his costs on appeal to recover $66,222.40. It was a victory for the contractor ' but not really.

How could this have been different? The contractor could have included an attorneys fees clause in his contract. This would have allowed him to recover his attorneys fees, and would have meant he would have received a judgment for over $176,000.00 instead of for $66,222.40. Also, the contractor could have possibly required more frequent progress payments so that less money was due at the end.

[back to top]