A Contract Series – Part 7b The Arizona REALTORS® Residential Resale Purchase Contract Due Diligence Section: Inspection Period and Buyer Disapproval

This is Part 7b of a series of articles discussing the major provisions in each of the sections of the Arizona REALTORS® Residential Resale Real Estate Purchase Contract (10/22) (“Contract”).  The Due Diligence Section is addressed in two sub-parts because there are so many issues to address.  The previous articles in this series can be located at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com)

 DUE DILIGENCE SECTION: INSPECTION PERIOD AND BUYER DISAPPROVAL

Inspection Period Notice

Prior to expiration of the Inspection Period, the buyer may deliver a signed notice of any items disapproved and cancel the contract or provide the seller the opportunity to correct or address the item(s) disapproved.

 ·        The buyer must ALWAYS list the items disapproved, regardless of whether the buyer elects to cancel or allow the seller the opportunity to correct or address the item(s) disapproved.

 o   If buyer’s notice fails to specify items disapproved the buyer’s election (cancellation, correct or address) will remain in effect but the buyer has failed to comply with a provision of the Contract and the seller may deliver to Buyer a cure notice pursuant to Section 7a.

 o If Buyer fails to cure by identifying items disapproved before expiration of the cure period, Buyer shall be in breach and Seller shall be entitled to the earnest money.

 ·         There are two reasons why the buyer is required to specify the items disapproved even when electing to cancel.  First, the seller should be informed of the reason for the cancellation. Second, although the buyer is entitled to cancel at the buyer’s sole discretion, this right must be exercised in good faith; thus, stating the reason for cancellation gives some evidence of whether the buyer is acting in good faith.

 ·         The buyer is required to list the items disapproved when electing to allow the seller to correct or address the items disapproved so that the seller can understand and evaluate the request. 

AAR’s Buyer’s Inspection Notice and Seller’s Response form (BINSR) is available for the notice of items disapproved during the Inspection Period. The Contract specifically states that all desired Inspection Period inspections and investigations must be conducted prior to delivering the notice and all due diligence items disapproved are to be provided in a single notice.  

Buyer Disapproval

This subsection applies to the Inspection Period notice and all other provisions in which the buyer is allowed an opportunity to disapprove of items.

If the buyer, in the buyer’s sole discretion, disapproves of items as allowed in the Contract, the buyer must deliver a signed notice of the items disapproved and state in the notice that the buyer elects to either cancel or allow the seller an opportunity to correct or address the items disapproved. 

 ·         During the Inspection Period, the Buyer’s Inspection Notice and Seller’s Response form (BINSR) should be used for the notice.  The BINSR contains provisions for the following.

 o    Confirmation that all Inspection Period items and verifications have been completed.

 o   The buyer’s election – premises accepted, premises rejected, or the election to provide the seller an opportunity to correct or address the items disapproved.

 o   A space to list the items that the buyer disapproved as required by the Contract.

 o   The seller’s response if the buyer provides the seller an opportunity to correct or address the items disapproved.  The seller may:  agree to correct or address the items disapproved as requested in the BINSR, decline to correct, or address any of the items, or other respond to the disapproved items in an attached addendum.

 o   The buyer’s election if the seller has not agreed to correct all the items that the buyer disapproved as requested in the BINSR.  The buyer may cancel the Contract or accept the seller’s response.

 o   The BINSR also contains a section to be completed if the buyer declines to conduct an inspection - an acknowledgment that against the broker’s advice, the buyer waived their right to inspections. 

o The BINSR form requires that the buyer acknowledge that “all desired Inspection Period inspections and investigations must be completed prior to delivering this notice to Seller.”

 o All Inspection Period inspections and investigations must be conducted prior to delivering the BINSR to the seller.

 ·         Notice of disapproval outside the Inspection Period.  Any notice of disapproval to which the buyer is entitled that falls outside of the Inspection Period, should be made in a separate signed writing, not on the BINSR form.

 

o   For example, the buyer has five days after receipt of the Title Commitment and any subsequent exceptions to provide notice to the seller of any items disapproved. 

 

o   Additionally, if the seller delivers the SPDS late (say on the eighth day after Contract acceptance rather than the third), the buyer’s disapproval of any SPDS item should be made on a separate writing on day 13 after Contract acceptance.

 

If the buyer, in the buyer’s sole discretion, disapproves of items as allowed in the Contract, the buyer must deliver a signed notice listing the items disapproved and state in the notice that the buyer elects to either:

(1) immediately cancel the contract in which case:

(a) If buyer’s notice specifies disapproval of items, the earnest money shall be released to the buyer.

(b) If buyer’s notice fails to specify items, the cancellation is effective, but the buyer has failed to comply with the Contract and seller may therefore deliver a cure notice to the buyer pursuant to Section 7(a).

If buyer fails to cure their non-compliance within three days after delivery of the cure notice, the buyer is in breach and seller is entitled to the earnest money. However, if buyer delivers notice specifying item disapproved of prior to the expiration of the cure period, buyer is entitled to a return of their earnest money. 

OR

(2) provide the seller an opportunity to correct or address the items disapproved, in which case:

(a) The seller must respond within five days or as otherwise provided after delivery of Buyer’s notice of items disapproved.

o   The seller’s failure to respond within the specified time period is deemed to be a refusal to correct or address any of the items disapproved.

(b) If the seller agrees in writing to correct any items disapproved, the corrections must be made, any repairs completed in a workmanlike manner, and any paid receipts evidencing the corrections and repairs delivered to the buyer within three days or an otherwise specified number of days prior to the COE Date.

o   Ensure that the seller understands that all agreed upon repairs/improvements must be in a workmanlike manner (of good and acceptable quality) and must be done by a licensed contractor if the repairs cost $1,000+, are not of a casual or minor nature, or require a building permit pursuant to A.R.S. §32-1121.  

 

o   If the seller fails to complete the repairs three days prior to the COE Date and the buyer delivers the cure notice, the seller will be liable for breach of contract and breach of warranty if the repairs are not completed by COE. 

If the buyer elects to provide the seller an opportunity to address the listed items disapproved, such as with a reduction in purchase price, a pay down of points on the buyer’s interest rate or a credit at COE, the buyer should attach an addendum setting forth with specificity how the buyer is requesting the seller to address the items disapproved.  The word “address” gives a broad scope for buyers and sellers to agree on how to deal with disapproved items.

o   If the buyer wants to make it clear that the buyer will not accept the repair of any items disapproved, the buyer may want to list the items disapproved on the “Items Disapproved” blank line section of the BINSR and add language such as: “Buyer is solely requesting that Buyer’s disapproved items be addressed by the seller as set forth in the attached addendum.” 

    o   When the buyer is submitting an addendum to request a credit or price reduction, the addendum should not state that the credit or price reduction is “in lieu of repairs.”

 o   Stating that a price reduction or credit is “in lieu of repairs” could cause a dispute if the repairs ultimately cost more than the price reduction or credit.  The addendum should simply state “Seller to credit Buyer $X in closing costs” or “Purchase Price is $X.”

o    Nonetheless, it would be advisable for a buyer to obtain several bids to determine the cost of the repair of the disapproved items prior to submitting the addendum. 

 o   Additionally, the buyer should contact their lender prior to submitting the addendum to confirm the buyer can receive the credit because a lending program may only allow for a buyer to receive a certain amount of credit.

 o   As the BINSR sets forth, if Seller agrees to address the items disapproved by credit or price reduction, the addendum must be submitted to the buyer’s lender and escrow company.  As a rule, any time contractual terms are modified, the lender and escrow company must be notified.

(c) If the seller is unwilling or unable to correct or address any of the items disapproved, the buyer may cancel the contract within five days after delivery of the seller’s response or after expiration of the time for the seller’s response, whichever occurs first, and the earnest money shall be released to the buyer.

If the buyer does not cancel the contract within this time period, the buyer is obligated to close escrow without correction of those items that the seller has not agreed in writing to correct or address.

o   Instead of declining to correct or address the items disapproved by the buyer, the BINSR provides an option for the seller to respond to the buyer’s notice on the blank lines of the BINSR or on an addendum if applicable.  The seller could respond with an addendum offering the buyer different terms than what the buyer requested. 

o   If the seller agrees to correct or address some, but not all, of the items disapproved, the buyer has two options: cancel the contract within five days after receiving the seller’s response or accept the premises with the correction of only those items the seller agreed in writing to correct.

o   The seller’s failure to respond is deemed a refusal to correct any of the items disapproved.  In such a case, the buyer has five days after the expiration of the time period for seller’s response to elect to cancel the contract or proceed with the transaction without the correction of the items disapproved.

Verbal discussions will not extend these time periods and only a written agreement signed by both parties will extend response times or cancellation rights.

o      Any agreement to extend the Buyer Disapproval time periods must be agreed upon in writing and signed by all parties. For example, these time periods may be extended with the following agreement signed by both parties:

 o   “Buyer received seller’s response on (date). Seller is currently unwilling to correct or address the following items disapproved by buyer: (list items) Pursuant to the Contract, buyer is entitled to cancel this Contract on or before (date). Buyer and seller hereby agree to modify the Contract and extend the buyer’s right to cancel this Contract and receive the return of all earnest money until (date) to allow the parties additional time to negotiate the items disapproved.”

 The buyer’s failure to give notice of disapproval of items or cancellation within the specified                   time period shall be deemed the buyer’s election to close escrow without correction of any                       disapproved items.

o        o  The buyer is not entitled to change the buyer’s election once the election has been made.  If the buyer disapproves of items, the buyer must state in the notice that the buyer elects to either immediately cancel the contract or provide the seller an opportunity to correct or address the items. If the buyer gives the seller an opportunity to correct or address the items, the buyer has made the election and can no longer “immediately cancel” the Contract.

 o   The BINSR contains an acknowledgment that the buyer is not entitled to change or modify the election after the notice is delivered to the seller.

o Ensure that the buyer has taken the time allotted to perform all inspections and investigations and has thoroughly considered the options before making an election.

o A buyer is not entitled to enter into multiple contracts, with the intent to buy only one, without disclosing this fact to the seller, just because the buyer can cancel the contracts during the Inspection Period at the buyer’s sole discretion. 

 o A buyer and seller have legal duties to each other arising out of their contractual relationship, which include the covenant of good faith and fair dealing. As one court explained, notwithstanding the breadth of the power of exercising a contractual right at a party’s “sole discretion,” that right may not be exercised capriciously or in bad faith. In short, buyers and sellers must deal fairly with each other. 

Conclusion

The Inspection Period and Buyer Disapproval time periods are critical in most transactions and emotions can run high.  However, professional agents will have prepared their clients, effectively negotiate any issues that arise, and protect their clients by following the Contract time periods. 

 Next Article – Remedies Section

K. Michelle Lind, Esq. is an attorney who currently serves Of Counsel to the Arizona REALTORS®.  She is also the author of the book - Arizona Real Estate: A Professional's Guide to Law and Practice (3rd Ed.) . 

For more real estate related articles, visit Michelle’s Blog at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com)

This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.  4/27/23

A Contract Series – Part 7a The Arizona REALTORS® Residential Resale Purchase Contract - Due Diligence Section

This is Part 7a of a series of articles discussing the major provisions in each of the sections of the Arizona REALTORS® Residential Resale Real Estate Purchase Contract (10/22) (“Contract”).  The Due Diligence Section is addressed in two sub-parts.  This article will address the buyer’s due diligence and the next article will address the Inspection Notice and Buyer Disapproval process.  The previous articles in this series can be located at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com).

All homes have flaws, even those well-maintained or newly built. Conducting due diligence before closing escrow on a home is a crucial step for a buyer. The buyer’s failure to conduct their due diligence can lead to unanticipated costs or problems after close of escrow (“COE”) and ultimately lead to a dispute or claim against the seller and/or brokers in the transaction.   If the during their due diligence period the buyer discovers home defects that they would like fixed, pursuant to the Contract, the buyer has time to negotiate with the seller, who may agree to fix the defects, credit the buyer for anticipated costs, buy down the buyer’s interest rate or even lower the purchase price.

DUE DILIGENCE SECTION

This section is entitled “Due Diligence” to reflect the fact that both inspections and investigations of the home should be performed during the Inspection Period.

Inspection Period

The buyer’s inspection period is 10 days after Contract acceptance unless otherwise indicated. During the inspection period, the contract obligates the buyer to:

 

                   i.            conduct all desired physical, environmental and other types of inspections and investigations to determine the value and condition of the premises;

·         Explain to the buyer the importance of hiring a professional home inspector licensed by the Arizona State Board of Technical Registration.

·         Educate the buyer that home inspectors are generally not licensed contractors and are limited in their ability to opine on the condition of certain systems and structures. Therefore, a licensed contractor may be needed to conduct further inspections.

·         Be familiar with the scope of a home inspection.  Pursuant to R4-30-301.01(A) “...a certified home inspector shall conduct a home inspection in accordance with the “"Standards of Professional Practice" adopted by the Arizona Chapter of the American Society of Home Inspectors, Inc. on January 1, 2002…”

                ii.            make inquiries and consult government agencies, lenders, insurance agents, architects and other appropriate persons and entities concerning the suitability of the premises and the surrounding area;

              iii.            investigate applicable building, zoning, fire, health and safety codes to determine any potential hazards or defects in the premises; and

               iv.            verify any material multiple listing service (MLS) information.

The buyer is also advised to investigate the presence of sex offenders in the vicinity or the occurrence of a disease, natural death, suicide, homicide or other crime on the premises or in the vicinity, if deemed material.   

The buyer is advised to consult the Buyer Advisory provided by AAR to assist in the due diligence inspections and investigations.

·       Emphasize to the buyer the importance of using the Buyer Advisory to investigate the property as the advisory is intended to prompt the buyer to consider investigating items that the buyer may not have previously considered.

• Consider using the Buyer Advisory to investigate your own home.  This exercise will assist you in becoming more familiar with all the resources available and help you educate your buyers.

The buyer remains obligated to keep the premises free and clear of liens, indemnify and hold the seller harmless from all liability and repair all damages arising from the inspections.

The buyer is also obligated to provide the seller and broker(s), at no cost, copies of all inspection reports concerning the premises upon receipt. 

Square Footage

The buyer is advised that any reference to square footage is approximate and must be investigated during the inspection period if material. The Contract states:

“BUYER IS AWARE THAT ANY REFERENCE TO THE SQUARE FOOTAGE OF THE PREMISES, BOTH THE REAL PROPERTY (LAND) AND IMPROVEMENTS THEREON, IS APPROXIMATE. IF SQUARE FOOTAGE IS A MATERIAL MATTER TO THE BUYER, IT MUST BE VERIFIED DURING THE INSPECTION PERIOD.”

·       This language should bar a buyer’s claim for misrepresentation as to the square footage of the property.

• The subsection places squarely on the buyer the burden of verifying the square footage, which can be done by an appraiser or architect.   

Wood-destroying Organism or Insect Inspection

If current or past wood-destroying organisms or insects (such as termites) are a material matter, the buyer must investigate the issue during the inspection period at buyer’s expense. If the lender requires an updated Wood-destroying Insect Inspection Report prior to COE, it will also be performed at buyer’s expense.

 ·         If wood infestation is found during the updated inspection and the lender requires it to be treated before approving the buyer’s loan, the buyer and seller will be required to negotiate whether the treatment will be performed and, if so, at whose expense.

 ·         If the treatment is not performed and the lender will not approve the buyer’s loan, the unfulfilled loan contingency provisions will apply.

 ·         The Arizona Department of Agriculture has guidance on termites for both homeowners and real estate professionals. 

 Flood Hazard

The buyer is obligated to determine flood hazard designations or the cost of flood hazard insurance during the inspection period. The buyer is advised that if the home is in a special flood hazard area, the lender may require the purchase of flood hazard insurance and it may also affect the ability to encumber or improve the premises.

 ·         The Federal Emergency Management Agency (FEMA) maps flood hazard zones and these maps are used to determine flood insurance rates.  A buyer can enter the property address at the  FEMA Flood Map Service Center to investigate whether the property is in a flood hazard zone. 

 Insurance

If homeowner’s insurance is material, the buyer is obligated to apply for and obtain written confirmation of the availability and cost of homeowner’s insurance during the Inspection Period. The buyer is advised that any desired insurance should be in place at COE.

 Sewer or On-site Wastewater Treatment System

This paragraph indicates whether the premises is connected to a sewer system, conventional septic system, or alternative system and must be initialed in every transaction. It is important to mote that the premises may be served by more than one of these systems and, if that is the case, it should be documented by the seller in the SPDS. 

 If a sewer connection is a material matter to the buyer, it must be investigated during the inspection period.

If the premises are served by a conventional septic or alternative system, the AAR On-Site_Wastewater_Treatment_Facility_Addendum should be completed and is incorporated into the Contract.

 ·         This addendum addresses the required pre-transfer inspection, conventional septic system pumping, documents that the Contract requires the seller to provide to the buyer, repair costs, buyer disapproval, the required notice of transfer form, transfer fees and any additional terms. 

  ·         Pursuant to Arizona Department of Environmental Quality (“ADEQ”) Rule, all on-site wastewater treatment systems must be inspected prior to transfer. A.A.C. R18-9-A316 requires that within six months before COE, the seller must retain a qualified inspector to perform a transfer of ownership inspection of the on-site wastewater treatment facility. See On-site Inspection and Transfer (azdeq.gov)  for the ADEQ Instructions For Preparing A Report of Inspection for more information. 

 Swimming Pool Barrier Regulations

During the Inspection Period, the buyer agrees to investigate all applicable state, county and municipal swimming pool barrier regulations and agrees to comply with and pay all costs of compliance prior to occupying the premises unless otherwise agreed. If the home contains a swimming pool, the buyer acknowledges receipt of the Arizona Department of Health Services approved private pool safety notice, which can be found at residential-pool-safety-notice.pdf (azdhs.gov).

 ·         A list of many of the political subdivisions in the state with pool barrier laws can be found at Pool Barrier Laws & Information | Arizona Association of REALTORS® (aaronline.com).

 ·         Because of the importance of educating all buyers about pool safety, the buyer should initial this paragraph in every transaction, whether or not there is currently a pool on the premises.

 Buyer Acknowledgment

The buyer recognizes, acknowledges, and agrees that the broker(s) is not qualified, nor licensed, to conduct due diligence with respect to the premises or the surrounding area.  The buyer is instructed to consult with qualified licensed professionals to assist in the buyer’s due diligence efforts. Because conducting due diligence with respect to the premises and the sur­rounding area is beyond the scope of the broker’s expertise and licensing, the buyer releases and holds harmless broker(s) from liability for any defects or conditions that could have been discovered by inspection or investigation.

·         This provision should be initialed in every transaction. 

 ·         However, keep in mind that The Arizona Department of Real Estate (ADRE) Commissioner’s Rule A.A.C R4-28-1101(I) requires that a real estate agent take reasonable steps to assist a client in verifying the accuracy of information relevant to the transaction.. The rule also requires reasonable care in obtaining information material to a client’s interests and relevant to the transaction and that an agent accurately communicates this information to the client.  See:  Applying “Trust but Verify” in a Real Estate Transaction.  

Home Warranty Plan

The buyer and seller are advised to investigate the various home warranty plans and acknowledge that different home warranty plans have different coverage options, exclusions, limitations and service fees. Also, most plans exclude preexisting conditions. If a home warranty plan is to be purchased, the Contract specifies who is responsible for ordering it, with what options, from what company, and at a cost not to exceed a specified amount.  If the buyer declines the purchase of a home warranty plan, the buyer’s election should be indicated.  In either case, the buyer’s initials are required by this section. 

 Walkthrough(s)

The seller grants the buyer and buyer’s inspector(s) reasonable access to conduct walkthrough(s) of the premises for the purpose of satisfying the buyer that any agreed upon corrections or repairs have been completed, and that the premises are in substantially the same condition as of the date of contract acceptance. If the buyer does not conduct the allowed walkthrough(s), the buyer releases the seller and broker(s) from liability for any defects that could have been discovered. 

·       The walkthrough provision recognizes that more than one walkthrough may be required, i.e., the buyer may desire a walkthrough three days prior to COE to confirm agreed upon repairs have been completed.

 ·         A buyer should conduct their pre-closing walkthrough at least three days prior to the scheduled date for close of escrow and utilize the  Buyer Pre-Closing Walkthrough form.

 Seller’s Responsibility Regarding Inspections and Walkthrough(s)

The seller is obligated to make the premises available for all inspections and walkthrough(s) upon reasonable notice by the buyer. The seller is also obligated to have all utilities on, including any propane, until COE to enable the buyer to conduct these inspections and walkthrough(s).

 ·         If the seller fails to make the premises available for inspections or walkthroughs, or fails to have all utilities on, the buyer should issue the seller a cure notice pursuant to Section 7a.  If cured by the seller, the parties should then execute a written agreement to extend the buyer’s inspection or walkthrough for the length of time of the delay caused by the potential breach. 

 IRS & FIRPTA Reporting (Foreign Sellers)

The Foreign Investment in Real Property Tax Act (‘FIRPTA) provides that if a seller is a Foreign Person, the buyer must withhold federal income taxes up to 15% of the purchase price unless an exception applies.  If FIRPTA is applicable and the buyer fails to withhold the tax, the buyer may be held liable for the tax. The buyer agrees to perform any acts reasonable or necessary to comply with FIRPTA and IRS reporting requirements and the buyer is responsible for obtaining independent legal and tax advice. 

 ·         For more information regarding FIRPTA, see FIRPTA Withholding | Internal Revenue Service (irs.gov)

 Next Article – Due Diligence:  Inspection Notice and Buyer Disapproval

K. Michelle Lind, Esq. is an attorney who currently serves Of Counsel to the Arizona REALTORS®.  She is also the author of the book - Arizona Real Estate: A Professional's Guide to Law and Practice (3rd Ed.) . 

For more real estate related articles, visit Michelle’s Blog at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com)

This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.  4/13/23