Property / Real Estate

Is Good Faith Needed in Due Diligence?

When may a purchaser lawfully exercise the right of cancellation of a conditional sale and purchase agreement pursuant to a due diligence clause.

A recent case* decided in the High Court is relevant to those who are interested in purchasing or selling property. The High Court decision establishes when a purchaser may lawfully exercise the right of cancellation of a conditional sale and purchase agreement (Agreement) pursuant to a due diligence clause.

Clause 17

The case centered around clause 17 of the Agreement which read:

"The agreement is subject to the purchaser being satisfied with a due diligence investigation to be carried out by the purchaser in respect of such aspects of the property that the purchaser deems relevant. In the event the Purchaser [sic] is not satisfied with any aspect of the due diligence investigation then the purchaser may cancel this agreement by notice in writing to the vendor and the purchaser shall not be obliged to give reasons for such cancellation and/or non-satisfaction of this condition. The date for the satisfaction of this condition shall be .... 4 September 2009. This condition is inserted for the sole benefit of the purchaser".

The purchasers, having cancelled the Agreement, sought the return of their deposit. The vendors resisted on the basis that the purchasers had not acted in good faith in exercising their right to cancel the Agreement in non-satisfaction of the due diligence condition.

Decision

The crucial issue for determination was whether clause 17 limited the purchasers right to exercise their right of cancellation in any significant way.

The Court held that an agreement can be worded so as to make the satisfaction of a condition entirely a matter for the subjective determination of a purchaser. In this case, this is essentially what the parties had done using phrases such as:

"...the purchaser being satisfied..."

"...such aspects of the property that the purchaser deems relevant..."

"In the event that the Purchaser is not satisfied with any aspect..."

"...the purchaser shall not be obliged to give reasons..."

"This condition is inserted for the sole benefit of the purchaser."

The Court took the view that, ultimately, it is a matter of interpretation of the clause at issue, and further stressed that it is a matter of wording of the individual agreement. If a clause provides for a subjective determination without any obligation to disclose reasons, it is difficult to see how it can restrict the matters that the purchaser can take into account. The Court went further to state that the very heart of a due diligence investigation is determining that the property has the value being ascribed to it, and the likelihood of it retaining that value.

In this case, the purchasers' view of that value was based on floor colouring and blinds. The Court held that those were legitimate facts to be taken into account by the purchasers during their due diligence investigation. The purchasers were also clearly uncomfortable that the other units in the development had not sold, and they were concerned with the financial viability of the vendor.

The Court took the opportunity to reiterate that in the absence of an express term, there is no reason to imply a duty of good faith in an agreement. While the Court will consider applying a duty of good faith into a contract such as a franchise agreement or an agency agreement (which has what has been described as a "relational character"), the Court is unlikely to do so in respect of transactional agreements such as an agreement for sale and purchase of land.

Finding in favour of the purchasers' claim, the Court instructed the immediate release of the deposit (plus interest).

The case provides a timely reminder of the importance of fully understanding and being aware of the implications of any additional terms to a standard agreement for sale and purchase.

If vendors wish to have purchasers exercise their rights in "good faith" they must ensure clauses such as "due diligence" are drafted specifically to say so. The case also reinforces the importance of taking legal advice BEFORE signing any agreements.

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* Susan La Rosa and Ivan Letica v Macennovy Trust Limited

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The contents of this publication are general in nature and are not intended to serve as a substitute for legal advice on a specific matter. In the absence of such advice no responsibility is accepted by Brookfields for reliance on any of the information provided in this publication.

 

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