3 Real Property Law Reporter July 2010 89

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00"t What You. Pay For By Stevens Ai Carey John R. Cauble, Jr.,

and Richard H. MacCracken

Introduction In May 2008, California’s Court of Appeal for the

Third Appellate District held, in Steiner v Thexton, that a purchase agreement with a "free look" provision lacked consideration and was therefore an unenforceable option. Steiner v Thexton (2008) 163 CA4th 359, 77 CR3d 632 (superseded opinion; reported at 31 CEB RPLR 117 (July 2008)). In March 2010, the California Supreme Court found that the purchase agreement was an option, that it initially lacked consideration because of the buyer’s right to freely terminate before performing any obligations, but that the option became irrevocable when the buyer later partly performed its agreed-upon promise to seek a parcel split, Steiner v Thexton (2010) 48 C4tti 411, 106 CR3d 252 (reported at 33 CEB RPLR 64 (May 2010)), This ar-ticle will explain ’a free look, some of the legal concerns it raises, how these concerns were addressed by the Cal-ifornia Supreme Court in Steiner, and considerations for buyers when drafting a free look in the future.

What is a Free Look? Definition

"Free look" is not an established legal term, except perhaps in regard to various insurance products for which a free look may be mandated by law. See, e.g., Harnett & Lesnick, The Law of Life and Health Insur-ance §* 5,02 [3], 6.02 [7][b][i] (2009); see also 5 CFR §875.101. You won’t find "free look" in Black’s Law Dictionary or in Garner’s Dictionary of Modern Le-gal Usage. You won’t even find it used in the Steiner decision. Yet the term "free look" is commonly used by real estate professionals; it appears in many law firm bulletins and articles discussing Steiner. See, e.g., Bernhardt, Midcourse Corrections.’ The Cost of Free Looks�Ruminations an Steiner v Thexton, 33 CEB RPLR 61 (May 2010); Ravid, State Supreme Court Finds Contract With Option Agreement Eforceabie, Los Angeles Daily Journal, Apr. 8, 2010, p 7. It is also mentioned in many resource materials concerning real estate purchase transactions. See, e.g., Berges, The Com-plete Guide to Investing in Rental Properties 60(2004); Morse, Robert’s Guide to Commercial Real Estate In-vestments 70 (2008); Legaldocs Purchase Agreement (available at https://www.legaldocs ,com/RawLandPur-chaseAgrjLaspx).

Unfortunately, the notion of a free look is somewhat amorphous: The wording may vary considerably from contract to contract and the meaning may ’vary depending

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on whom you ask. As used in this article, a "free look" means the buyer gets a free evaluation period before it becomes bound to purchase the property: Basically, the buyer has the opportunity to change its mind and get its deposit back It is "free" both from the risk of forfeiting a deposit and from limits on its right to terminate, Thus, the essential elements of a free look in a real estate sale are: � A buyer’s evaluation period, which is typically called

a "due diligence," "inspection," "study," "feasibility," or "free look" period;

� A buyer’s unrestricted right to terminate during the free took period, which the California Supreme Court in Steiner referred to as an "escape clause"; and

� A buyer’s right to a refund of its deposit if it terminates the agreement during the free look period.

Example The following is a sample (rather than a model) free

look provision: Buyer shall have 30 days from the date of this Agree.

meat to conduct its due diligence with respect to the Property. Buyer shall have the right during such period to terminate this Agreement for any reason or no rea-son, in which event Buyer’s deposit shall be immediately refunded to Buyer and the parties shall have no further rights or obligations under this Agreement except those obligations that expressly survive termination.

Legal Concerns Raised by Free Looks Before Steiner

Is a free look too good to be true? Perhaps it makes sense when the free look is mandated by law to pro-tect consumers. But outside the consumer context, if a contract gives a party the unfettered right to cancel the contract and get its money back without taking any risk, wouldn’t it be illusory? Indeed, "it has been fre-quently held that agreements are void ... for lack of mu-tuality, and consideration ... when they contain an ab-solute and unconditional right of revocation." County of Alameda v Ross (1939) 32 CA2d 135, 145, 89 P2d 460; I Miller & Starr, California Real Estate §1:159 (3d ed 2000); 1 Witkin, Summary of California Law, Contracts §231 (10th ed 2005). For this reason and others discussed below, many practitioners were concerned with the issues posed by a free look long before Steiner.

Avoiding an Illusory Contract

It is the combination of an unrestricted termination right and a lack of separate consideration from the buyer that may doom the free look. As explained by the Califor-nia Supreme Court, "[w]hether these problems [with con-tracts subject to unlimited termination rights] are couched in terms of mutuality of obligation or the illusory nature of a promise, the underlying issue is the same�consid-eration." Mattel V Hopper (1958) 51 C2d 119, 122, 330 P2d 625,

Limited Termination Right One way to establish consideration and avoid an il-

lusory contract is to place some limits on the buyer’s discretion to terminate the contract, Such limitations are often stated in the sale contract, especially in the form of a so-called "satisfaction" clause when it pro-vides an express standard for the buyer’s satisfaction be-fore termination is permitted. See, e.g., Bleecher v Conic (1981) 29 C3d 345, 348, 213 CR 852 (obligation to buy was conditioned on approval of plat map and various re-ports, which could not be unreasonably withheld). Even when there is no express limitation, it has been stated that "courts are ... prone to examine the context to conclude that the escape hatch was intended to be [limited so that] the promise is not illusory." Third Story Music, Inc. v Waits (1995) 41 CA4th 798, 805, 48 CR24 747. Thus, a number of California courts have held that "satisfaction" clauses generally do not render a sale contract illusory be-cause a good faith or reasonableness standard may be im-plied. See, e.g., Mattel, supra (sale subject to obtaining leases satisfactory to buyer required subjective good faith determination); Kadner v Shields (1971) 20 CAM 251, 262, 97 CR 742 (sale subject to approval of CC&Rs and encumbrance to be assumed required "objective measure of reasonableness"); Larwin-Southern Cal., Inc. v .1GB Inv. Co. (1979)101 CAM 626, 162 CR 52 (sale subject to various matters, including buyer’s approval of tenta-tive map with conditions satisfactory to buyer, required subjective good faith determination).

Unlimited Termination Right With Consideration However, many buyers do not want to limit their right

to terminate. If so, separate consideration should avoid the need to impose a limitation on the termination right to save what might otherwise be an illusory contract. See, e.g., Wolf v Wall Disney Pictures & Television (2008) 162 CA4th 1107, 1121, 76 CR3d 585 ("if the express purpose of the contract is to grant unfettered discretion, and the contract is otherwise supported by adequate considera-tion, then the conduct is, by definition, within the rea-sonable expectation of the parties and ’can never violate an implied covenant of good faith and fair dealing" (ci-tations omitted)); Third Story Music, 41 CA4th at 808 (implied covenant did not apply to promise to market, or refrain from marketing, at election of company holding distribution and marketing rights, when there was guar-anteed compensation); Black Light Corp. v Ultra-Violet Prods., Inc. (1961) 195 CA2d 473, 15 CR 852 (unquali-fled termination right within 30 days after any year does not render contract unenforceable if there is consideration for contract), See also Storek & Storek, Inc. v Citicorp Real Estate Corp. (2002) 100 CA4th 44, 57, 122 CR2cI 267 (reported at 25 CEB RPLR 198 (Sept. 2002)).

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Difficulty Identifying an Unlimited Termination Right

Sometimes, it may he difficult to predict whether the courts will interpret a termination right as unlimited.

Express Provisions

If a termination right clearly and expressly reflects the intent of the parties, the California Supreme Court has indicated that the implied covenant of good faith has no application. Carma Developers (Cal,), Inc. v Marathon Dev. Cal., Inc. (1992) 2 C4th 342, 374, 6 CR2d 467 (right to recapture/terminate lease on request to assign or sub-lease). Thus, if the contract is supported by consideration (in Carma, the lease was a bilateral agreement supported by mutual covenants), the parties should be able to agree to an unlimited termination right. One of the decisions cited (and quoted) by the California Supreme Court in Carma stated that in some cases, the implied covenant imposed a requirement for good cause for termination when the contract was silent, but that "[n]o obligation can be implied ... which would result in the obliteration of a right expressly given under a written contract." Gerdlund v Electronic Dispensers Intl (1987) 190 CA3d 263, 277, 235 CR 279 (right to terminate "for any reason" does not mean "for any good reason"). Consideration was not an issue in Gerdlund.

Purpose and Context

However, the purpose and context of the transaction should not be ignored. A court might look beyond the specific contract provision—and even beyond the entire contract—to ascertain the true intent of the parties, even if the language of the contract seems clear and unam-biguous on its face but is reasonably susceptible to a dif-ferent interpretation based on testimony and other evi-dence. See, e.g., Posner, The Parol Evidence Rule, the Plain Meaning Rule, and the Principles of Contractual Interpretation, 146 U Pa L Rev 533, 539 (Jan. 1998) (in California, after the 1960s, "soft" parol evidence rule has prevailed); CC §1647; CCP §1856(c) and (g); Law Revision Commission Official Comment to CCP §1856 (§1856(c) rejects notions that (1) language is interpreted by rules of construction, rather than context in which it is used, and (2) ambiguity must initially be established as condition to admissibility of extrinsic evidence). Pa-cific Gas & Elec. v GW Thomas Drayage (1968) 69 C2d 33, 37, 69 CR 561 ("rule that would limit the de-termination of the meaning of a written instrument to its four-corners [sic] merely because it seems to the court to be clear and unambiguous, would either deny the rele-vance of the intention of the parties or presuppose a de-gree of verbal precision and stability our language has not attained"); Wolf, 162 CA4th at 1126 ("if extrinsic evidence reveals that apparently clear language [is] sus-ceptible to more than one reasonable interpretation, then extrinsic evidence may be used to determine .. , intent" (citing Pacific Gas & Elec., 69 C2d at 37)). Moreover,

a court might still look to the implied covenant, despite the existence of independent consideration, when the ex-ercise of a right by one party would frustrate the other party's right to receive the apparent benefits of the con-tract. As noted by the California Supreme Court, "it has been suggested the [implied] covenant requires the party holding [a discretionary] power to exercise it 'for any pur-pose within the reasonable contemplation of the parties at the time of formation—to capture opportunities that were preserved upon entering the contract, 'nterpreted objec-tively.'" Carma Developers, 2 C4th at 372. For exam-ple, in Locke v Warner Bros. (1997) 57 CA4th 354, 66 CR2d 921, the court held that the implied covenant ap-plied to a studio's rejection of proposed motion picture development deals, despite the fact that the proposing di-rector was receiving compensation, an office, and an as-sistant. Because there was testimony indicating that the studio never intended to work with the director, there was a triable issue of fact regarding a breach of the implied covenant. (Query: What would happen i f a buyer at-tempted to tie up a property with an apparent free look contract and no intention of buying, e.g., in order to take it off the market to avoid interference with the buyer's ac-tivities on adjacent property?)

Examples

One might expect, for example, that if the buyer's ter-mination right was based on its satisfaction "in its sole judgment andtiscretion," it might have an unrestricted termination right, but if its satisfaction was not qualified by any standard, then a good faith standard might be im-posed. In the following two cases, however, the exact opposite conclusions were reached:

• In a case involving the purchase of a $2.5 million boat, the purchase was contingent on the completion of 'a trial run and marine inspection report "to the satisfac-tion" of the buyer, PMC, Inc. v Porthole Yachts, Ltd. (1998) 65 CA4th 882, 76 CR2d 832. The testimony at trial established that the satisfaction clause was in-tended to allow the buyer "to terminate the agreement for any reason" and that the buyer "decided not to buy

because ... it could not obtain financing." 65 CA4th at 889, 891. The court concluded that under these cir-cumstances, the seller could not rely on the implied covenant of good faith to find a breach by the buyer. 65 CA4th at 891.

• In another case, the buyer's approval of various reports and a tentative tract map with satisfactory conditions was based on its "sole judgment and dis-cretion" (and failure to approve meant disapproval), which the seller argued created an unrestricted termi-nation right. Larwln-Southern Cal., 101 CA3d at 632. The court disagreed, finding in this case that although the buyer's approvals were to be given or withheld in its "sole judgment and discretion," that "judgment and discretion must be exercised within the parameters

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of the implied contractual duty of good faith and fair dealing." 101 CA3d at 640, See also Guntert v City of Stockton (1974) 43 CA3d 203, 117 CR 601 (recapture right, based on landlord's determination in its "sole discretion" that development proposal for premises was viable, was subject to reasonableness standard).

Curing an Illusory Contract

Given the fact that courts "do not favor arbitrary cancellation clauses" (Ross, 32 CA2d at 144 (quoting 1 Williston on Contracts 365, §105)), it is not surprising that there were few cases before Steiner in which Cal-ifornia courts recognized the existence of a free look that was not supported by consideration. In Torlai v Lee (1969) 270 CA2d 854, 76 CR 239, the court found that a buyer's right to approve the building and certain leases created an unlimited termination right; this was, in effect, a free look. The court concluded that the contract was a mere offer or option that never ripened into a bilateral contract because no consideration had been given and the approval was not given within the approval period. (Oddly, there was no discussion of the implied covenant.) In Kowal v Day (1971) 20 CA3d 720, 98 CR 118, the buyer reserved the right to rescind for 45 days after the close of escrow, which was tantamount to a free look. However, in this case, the contract was not lost. The court found that, while the buyer's unrestricted rescission

' right rendered the buyer's purchase obligation illusory, the buyer's delivery of possession of a car to the seller pursuant to the contract constituted part performance that was adequate consideration to create an irrevocable option. Thus, even though a free look without consid-eration may create a revocable option, it may be cured (to create an irrevocable option) with consideration in the form of part performance. It is also possible that a free look without consideration may be cured by the application of promissory estoppel. Indeed, Kowal may have been a good candidate because the buyer, who planned to occupy the building it was buying, had can-celed its current lease and arranged to lease a portion of the building it did not intend to occupy. These actions were not bargained for in the contract and therefore did not help the buyer's part performance argument. It is odd that the buyer did not argue promissory estoppel because courts have applied the doctrine to render an otherwise revocable offer (due to lack of consideration) irrevocable. See, e.g., Drennan v Star Paving Co, (1958) 51 C2d 409, 333 P2d 757, in which the court held that a general contractor's detrimental reliance on the bid of a subcontractor in preparing and submitting its own bid rendered the subcontractor's bid irrevocable.

The Practice Before Steiner

Before Steiner, some practitioners in California did not seem particularly sensitive to the free look issue. Indeed, before the intermediate appellate decision in Steiner, if a buyer's counsel requested a change to a California seller's

contract form to add the payment of some independent consideration (e.g., by making a portion of the deposit nonrefundable) in conjunction with an unrestricted ter-mination right, one might occasionally have encountered a puzzled response from the seller's counsel,

Texas Led the Way

By contrast, Texas lawyers got religion early, with a little prodding from the Texas courts. See, e.g., Culbert-son v Brodsky (Tex App 1990) 788 SW2d 156; Bald-win v New (Tex App 1987) 736 SW2d 148; Hott v Pearcy/ Christon, Inc. (Tex App 1983) 663 SW2d 851, 853. For many years, attorneys in Texas routinely included independent consideration (e.g., $100) to avoid an illu-sory contract. See, e.g., Ellis and Abramowitz, Contracts as Commodities: Issues and Approaches in Regard to Commercial Real Estate "Earnest Money" and "Option" Contracts—A Texas Lawyer's Perspective, 16 St Mary's L J 541, 564 (1985). Interestingly, in 2004, the Texas Supreme Court adopted the position of Restatement (Sec-ond) of Contracts §87(1)(a) that mere recitation of con-sideration is sufficient to support an option contract if it is in writing and proposes a fair exchange to be ac-cepted within a reasonable time, even if it is not paid. 1469-Eight, Ltd. v Joppich (Tex 2004) 154 SW3d 101. Despite this decision, it is the authors' understanding that the practice in Texas generally has not changed,

Confusion in California

Perhaps there was a feeling among some California lawyers that California courts were unlikely to find that relatively common California contracts were illusory. That sentiment may have been reinforced by Storek and Third Story Music, both of which struggled to reconcile two apparently conflicting notions that appear in Carma: • "[W]here one party is invested with the discretionary

power affecting the rights of another [s]uch power must be exercised in good faith" (Carma, 2 C4th at 372); and

• "[N]o covenant of good faith and fair dealing can be applied which forbids ... acts and conduct [authorized by the express provisions of the contract]" (Carma, 2 C4th at 374).

Attempting to resolve this conflict, the courts in Storek and Third Story Music concluded that the implied covenant could, in fact, contradict an express covenant in limited circumstances, saying:

[T]he courts are not at liberty to imply a covenant di-rectly at odds with a contract's express grant of discre-tionary power except in those relatively rare instances when reading the provision literally would, contrary to the parties' clear intention [to have a binding agreement], result in an unenforceable, illusory agreement.

Storek, 100 CA4th at 57; Third Story Music, 41 CA4th at 808. Thus, even though neither Storek nor Third Story Music found that the implied covenant applied to the con-

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tracts involved in those cases, the Storek decision stated, in apparent harmony with Third Story Music, that "when a party is given absolute discretion ... the courts will im-ply a covenant of good faith and fair dealing to limit that discretion in order to create a binding contract and avoid a finding that the promise is illusory." 100 CA4th at 57. Even if there were independent consideration (and there-fore no illusory contract issue), there was a risk a court might look beyond the four corners of the contract, as in Locke, to determine whether the implied covenant should be applied. In light of these cases (and Larwin-Southern Gal., supra, and Guntert„supra), the greater concern of some California lawyers was what had to be done in draft-ing a free look to ensure that the buyer would not be sec-ond-guessed. Some practitioners felt that any reference to "discretion" was at risk of being limited, especially if the contract were not otherwise supported by consider-ation, Consequently, many California lawyers, particu-larly those who had been involved in real estate transac-tions in Texas and represented clients who didn't want to be second-guessed, routinely drafted purchase contracts for buyers with unrestricted termination rights for any reason or no reason during the free look period and, as is the practice in Texas, required some independent con-sideration.

Adequacy of Consideration

Storek and Third Story Music also raised a question as to the adequacy of consideration when stating that there is no need to impose the implied covenant to avoid an illusory contract if the contract is "supported by ade-quate consideration." Storek, 100 CA4th at 57 (empha-sis added); Third Story Music, 41 CA4th at 806 (same emphasis added). The Storek court reiterated its con-cern about the adequacy of consideration, saying "when the contract is adequately supported by adequate con-sideration." Storek, 100 CA4th at 57 (emphasis added). In most of the transactions in which the authors were involved before Steiner, the independent consideration ranged between $100 and $1000. Although the authors are not aware of any California Supreme Court holdings directly on point, intermediate appellate cases have re-peatedly stated that any amount of consideration is ade-quate to establish an irrevocable option. See, e.g., Tor-/at, 270 CA2d at 858 (option based on consideration, whether it be proverbial peppercorn or some other detri-ment, is binding); Kowal, 20 CA3d at 727 (any con-sideration is sufficient to render option binding on op-tionor); Wheat v Morse (1961) 197 CA2d 203, 206, 17 CR 226 ("[An] option given for consideration, however small, is irrevocable" (quoting Stough v Hanson (1941) 46 CA2d 504, 506, 116 P2d 77)). This rule has been de-scribed as "well settled" (Stough, 46 CA2d at 506) and so "firmly fixed" that it "would be legislating ... to change a rule of law so clearly established" (Wheat, 197 CA2d at 206). See also California Real Property Sales Trans-actions §8,11 (4th ed Cal CEB 2007); 3 California Real

Estate Law & Practice §70.21[1] (2009); 1 Witkin, Sum-mary, Contracts, §§169, 205. Specific performance, of course, requires "adequate" consideration. CC §3391(1). But in the option context, an appellate court has stated that this "adequacy" requirement pertains to the consid-eration to be paid for the underlying property once the option is exercised and not to the consideration paid for the option itself. Marsh v Lott (1908) 8 CA 384, 97 P 163. Nevertheless, some commentators suggest that, in setting the amount of consideration for an option, practitioners should take into account the price to be paid for the un-derlying property and the duration of the option in order to establish adequacy. See, e.g., 3 California Real Estate Law & Practice §70.21[1] (2009); Real Property Sales §8.11; 1 Miller & Starr, California Real Estate §1:58 (3d ed 2000).

The Steiner Case Free Look Provisions

The free look provisions in Steiner, 48 C4th at 415 n2, were worded as follows (emphasis added):

TERMS OF SALE:

2. During the escrow term, Seller shall allow Buyer an investigation period to determine the financial feasi-bility of obtaining a parcel split for development of the Property. Buyer shall have no direct financial obligation to Seller during this investigation period as Buyer will be expending sums on various professional services needed to reach the financial feasibility determination....

CONTINGENCIES: The Buyer shall have from date of acceptance until the closing of escrow to satisfy or waive the items listed herein below:

2. Buyer at his sole option and expense will con-duct all necessary investigations, engineering, architec-tural and economic feasibility studies as outlined earlier in this Contract,

7. It is the intent of Buyer that the time period from execution of this contract until the closing of escrow is the time that will be needed in order to be successful in developing this project. It is expressly understood that the Buyer may, at its absolute and sole discretion during this period, elect not to continue in this transaction and this purchase contract will become null and void.

There did not appear to be any express contractual pro-visions referring to a refund (or other disposition) of the deposit on termination, but the contract was to become "null and void" on termination. Therefore, the deposit ar-guably would have been returned to the buyer, as the trial and appellate courts concluded. (Unless otherwise indi-cated, this article assumes that the deposit would have been so returned.) Although the supreme court raised some question about the refundability of the' deposit, it was able to ignore this issue because it found there had been part performance. 48 C4th at 422 n12. According to the seller's appellate answer brief, the buyer testified that

sis to interpret this provision to require the,rettfrn of the part ies to their original positions because the part perfor-mance might then be erased, A discussion of the confu-sion surrounding such termination provisions and, in par-ticular, the use of the word "void" is beyond the scope of this article. See, e.g., Levin, The Varying Meaning and Legal Effect of the Word "Void," 32 Mich L Rev 1088 (June 1934); 2 Corbin on Contracts §6.10-6.16 (1995); I Witkin, Summary, Contracts §925-929; I Miller & Starr, California Real Estate §1:103 (3d ed 2000). If the buyer wants a refund of its deposit, it should expressly provide for it.

Covenants The covenants in Steiner included the following (48

C4th at 415 n2): � "Upon the Seller’s acceptance escrow shall be opened

and $1000 ... shall be deposited by Buyer, applicable toward purchase price." (Alteration in original.]

� "Buyer will pay for the required civil engineering and surveying for the entire parcel map."

� "Buyer at his sole option and expense will conduct all necessary investigations, engineering, architectural and economic feasibility studies."

� "In the event that this contract is terminated prior to the close of escrow, Buyer shall deliver to Seller the originals or copies of all information, reports, tests...."

� "Buyer will move expeditiously with the parcel split."

Court of Appeal Decision The court of appeal in Steiner found that the buyer’s

termination right was not restricted and that the purported sale contract was not supported by consideration and con-stituted an unenforceable option. 163 CA40 at 371. The court of appeal was not impressed by the covenants stated in the contract. In particular, the obligation to conduct all necessary investigations was not meqning ’_u I ,,because it was at the buyer’s "sole option" and the other obligations could he eliminated by the express termination right. The court of appeal also rejected Steiner’s argument that his reliance on the agreement made up for the lack of consid-eration under a promissory estoppel theory. The court of appeal noted that, under Restatement (Second) of Con-

The supreme court agreed that the t,ermination right was unrestricted. teiPler 48 C4th at 418. The termi-nation right was not expressly tied to any approval or other determination. It was simply a right to terminate the contract in the "absolute and sole discretion" of the buyer�which, according to the supreme court, appeared to apply "even if all contingencies had been satisfied." 48 C4th at 418. It is conceivable that this language could have been limited by the implied covenant of good faith and fair dealing. Indeed, the buyer argued in one of his briefs that the termination right should have been limited to situations in which the contemplated parcel split and development approvals had become unreasonably expen-sive or time-consuming. But the buyer also "testified at trial that the (contract] gave him the power to terminate the agreement at any time for any reason, including if he had found a better deal," 48 C4th at 418.

Consideration The supreme court disagreed that there was no consid-

eration. While the supreme court acknowledged that "[i]t is true that Steiner’s promise to undertake the burden and expense of seeking a parcel split may have been illusory at the time the agreement was entered into, given the lan-guage of the escape clause," it concluded "as a matter of law that [buyer’s] part performance of the bargained-for promise to seek a parcel split created sufficient considera-tion to render the option irrevocable" and that "[buyer’s] part performance cured the illusory nature of [buyer’s] promise." 48 C4th at 422.

Two Requirements The supreme court explained that there are two re-

quirements that must be satisfied for consideration--one statutory and one judicially mandated. � The statutory requirement is CC §1605, which re-

quires one of two alternatives: The buyer must confer (or agree to confer) a, benefit or suffer (or agree to suffer) prejudice. The supreme court emphasized that "either alone is sufficient" to satisfy the statute, 48 C4th at 421.

� The judicial requirement is that the consideration "must actually be bargained for as the exchange for the promise." 48 C4th at 421 (quoting Bard v Kent (1942) 19 C2d 449, 452, 122 P2d 8).

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The supreme court found there was both a benefit and a prejudice (even though only one of these was needed) and that it was bargained-for consideration, 48 C4th at 422,

Potential Confusion Unfortunately, the supreme court may have muddied

the waters in two respects, First, the supreme court stated that "the outcome may have been different had [buyer’s] efforts been exclu-sively in their own interest," 48 C4th at 422 n] 1, Pre-sumably, this remark was not intended to undercut the supreme court’s clear statement that CC §1605 im-poses alternative requirements that can be satisfied with a prejudice to the buyer rather than a benefit to the seller, See 48 C4th at 421; see also 48 C4th at 422 n12. Instead, it is presumably intended to address the judicial requirement of "bargained-for" consideration and merely suggests that, typically, a contract would not require a buyer to take action solely for the buyer’s benefit. Second, in Steiner, the supreme court acknowledged that the court in Prather v Vasquez (195 8) 162 CA2I 198, 327 P2d 963, "reacheda seemingly different re-sult," 48 C4th at 424, The court in Prather found that the buyer’s contractual obligation to pay all the escrow termination fees on termination did not constitute con-sideration because that obligation did not benefit the seller. 162 CA2d at 205. The Prather court also found that the buyer’s efforts to seek development approvals did not constitute consideration because they were not bargained for, 162 CA2d at 205. Rather than ex-pressly and directly disapproving the apparently dif-fering aspect of Prather, the supreme court in Steiner stated that "[ejven if Prather were correct, it is fac-tually distinguishable" and then proceeded to distin-guish the case. 48 C4th at 425. Again presumably, the supreme court did not intend to undercut its clear statement that CC § 1605 does not necessarily require that the buyer confer a benefit in favor of the seller in order for the buyer to establish consideration.

Possible Third Requirement�Adequacy of Consideration

Finally, after noting that the performance rendered by buyer included taking "substantial steps toward obtain-ing the parcel split" and incurring "significant expenses doing so" (Steiner, 48 C4th at 422), the supreme court stated that "[w]e have no occasion to consider whether any act, no matter how small, would be sufficient part performance to make an option irrevocable." Steiner, 48 C4th at 422 n 10. Was the supreme court implicitly call-ing into question the rule set out in Wheat, supra, Stough, supra, and similar cases to the effect that any consider-ation, however small, is sufficient to render an option

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irrevocable? Presumably not, since the supreme court went on to suggest that the mere fact that Steiner left a refundable $1000 deposit tied up in escrow during the contract period might have been sufficient consideration because the deposit was required by the contract and was a prejudice to the buyer. Steiner, 48 C4th at 422 n12, Instead, the supreme court may have been saying that, even though courts do not engage in second-uessing re-garding the sufficiency of the bargained-for consideration for an option, when the bargained-for consideration fails at the outset because it consists of an illusory promise, the court may evaluate whether the performed portion of that consideration is a sufficient portion of the total op-tion consideration to render the option irrevocable under the part performance doctrine. See 48 C4th at 422 n.l 0.

What would have happened in Steiner if the agreement also contained a nonrefundable payment of $100 in con-sideration for the contract? Would the option necessarily be irrevocable because of the $100 consideration existing at the moment of contract creation? Or might the court have found that the consideration for the option was both the $100 payment and the agreement to pursue the parcel split? If so, would the court have considered the $100 by itself sufficient, or instead engaged in a part performance analysis because the bulk of the option consideration was illusory?

Option The supreme court found that the buyer’s unlimited

termination right created an option. Steiner, 48 C4th at 418. The fact that the agreement is not called an option is not determinative. Allen v Smith (2002) 94 CA4th 1270, 1279, 114 CR2I 898; Welk v Fainbarg (1967) 255 CA2d 269, 272, 63 CR 127. The key is whether the buyer gets to decide whether to buy. Johnson v Clark (1917) 174 C 582, 586, 163 P 1004. If an option is not supported by consideration, as was initially the case in Steiner, it,is’ merely a revocable offer, Kelley v Upshaw (1952)39 C2d 179, 191, 246 P2d 23 (quoting Thomas v Birch (1918) 178 C 483, 489, 173 P 1102), If the offer is accepted be-fore its revocation, a bilateral contract of sale arises under which both parties are bound, Auslen v Johnson (1953) 118 CA2d 319, 321, 257 P2d 664, In Steiner, acceptance of the offer did not occur before the attempted revocation; therefore, the contract had not ripened into a bilateral con-tract. 48 C4th at 420. However, in the court’s view, while the various obligations in Steiner to take actions in the’ future were illusory at the time the contract was signed, Steiner’s part , performance of the obligations created suf-ficient consideration to render the option irrevocable. In the court’s words, "plaintiffs’ part performance cured the illusory nature of their promise." 48 C4th at 422. For a critique of the manner in which the supreme court ad-dressed consideration and part performance and whether the illusory nature of the contract was curable, see com-mentary of Professor Jon Sylvester at 33 CEB RPLR 64 (May 2010).

96 Jul:

Promissory Estoppel In light of its determination that Steiner’s partial per-

formance supplied the missing consideration for the op-tion, the supreme court did not address the court of ap-peal’s rejection of Steiner’s promissory estoppel argu-ments. Steiner, 48 C4th at 415, For a critique of the court’s failure to rely on a promissory estoppel theoiy, see 33 CEB RPLR 64 (May 2010).

After Steiner Limits of Discretion�Does the Implied

Covenant Have Any Role in Interpreting an Apparent Free Look Provision?

Steiner indicates that the implied covenant of good faith and fair dealing does not apply in the context of an expressly unrestricted termination right, 48 C4th at 419. But it may not always be clear what a court will find to be an unrestricted termination right. In Steiner, the termination right, although discretionary, was based on the "absolute and sole discretion" of the buyer and was not expressly tied to any condition or contingency. 48 C4th at 414. As the supreme court stated, this "broad and express language permitted [the buyer] to terminate the Agreement even f all contingencies had been satis-fied." 48 C4th at 418 (emphasis in original). Moreover, as noted previously, the buyer "testified at trial that the term gave him the power to terminate the agreement at any time for any reason, including if he had found a bet-ter deal," 48 C4th at 418, Thus, there seemed to have been three factors that made it clear there was an unre-stricted termination right: � The termination right was not tied to any contingency

or condition. � The termination right was exercisable in buyer’s "ab-

solute and sole discretion." � Testimony (of the party requesting application of the

implied covenant) indicated that the termination right was unrestricted,

As discussed earlier, there may have been some risk in using the word "discretion," but the testimony of the buyer eliminated any doubt; The supreme court seemed to find the reference to "absolute and sole discretion" per-suasive when stating that "no ambiguity exists" because the "agreement plainly gave ... ’absolute and sole dis-cretion’ to cancel the transaction" and "the ’absolute and sole’ right to withdraw," Steiner, 48 C4th at 419. But when the facts are not as clear-cut, the result may not be as certain.

Satisfaction Clauses In many contracts, unlike the contract in Steiner, the

buyer’s due diligence termination right is expressly tied to its satisfaction with the property or some aspect of the property.

2010 33 Real Property Lew Reporter

CAR Form Residential Purchase Agreement

The standard California Association of Realtors (CAR) California Residential Purchase Agreement and Joint Escrow instructions (RPA-CA) includes a con-tingency for "Buyer’s acceptance of the condition of, and any other matter affecting the Property" (RPA-CA, III OA) with a corresponding termination right (RPA-CA, ¶14B(3)).

Perhaps because of concerns raised by the Steiner in-termediate appellate decision, CAR amended its form contract (effective April 2010) to add an express obliga-tion to act in good faith in removing contingencies: "Any removal of contingencies or cancellation ... must be ex-ercised in good faith," RPA-CA, 114. The supreme CQUI’t, in Steiner, also attempted to allay CAR’s fears (expressed in its amicus curiae brief) by stating that "bilateral con-tracts subject to a contingency, which are widely used in real estate transactions, are not affected by our holding." 48 C4th at 419 n8.

The new language in the CAR form, while clearly cre-ating a "good faith" limitation and thereby avoiding any illusory contract argument (which is the primary goal of the brokers), leaves open the question as to what good faith means, as discussed further below.

CEB Form

What if the agreement states that the buyer can act in "its sole discretion"? Consider, for example, the clause that appears in California Real Property Sales Transac-tions 4.171-5 (4th ed Cal CEB 2007):

3.5,1 Due Diligence. Buyer’s obligation to purchase the Property is expressly conditioned on its approval, in its sole discretion, of the condition of the Property and all other matters concerning the Property.... On or be-fore the Contingency Date, Buyer will deliver written no-tice to Seller accepting the Property, or terminating this Agreement...."

Would such a discretionary standard be limited by the implied covenant if there were no independent consider-ation? See Larwin-Southern Cal., Inc. v JGB Inv. Co. (1979) 101 CA3d 626, 638, 12 CR 52 (court rejected seller’s argument that buyer’s right to approve reports in its "sole judgment and discretion" made contract illusory by holding that buyer’s discretion was subject to good faith standard). Might the implied covenant apply even if there were consideration? See Guntert v City of Stockton (1974) 43 CA3d 203, 117 CR 601. Would the termina-tion right be viewed as a separate alternative to approval rather than a consequence tied to, and arising from, the disapproval? What if the buyer has actually indicated its satisfaction with the property but terminates because the financing market collapses or because there is an unre-lated stock investment opportunity that seems more prof-itable? The answers are not clear and may depend on the facts.

-- - --

low.

Implied Standardfor Satiac clauses California ease law does not provide the clearest of

road maps for determining the appropriate standard that should be used to interpret a satisfaction clause without an express standard.

Early Reluctance to Limit Discretion Early California cases involving satisfaction clauses

seemed to reflect judicial reluctance to impose implied standards that would limit discretion, with rare exception, In 1919, the California Supreme Court reviewed the law generally regarding satisfaction clauses. 7 ffany v Pacific Sewer Pipe Co. (1919)180 C 70O, 702, 182 P 428. Quot-ing secondary authorities, the supreme court suggested that, if a contract clearly provides that a matter is subject to the satisfaction of a party, then that party’s judgment is generally free from second-guessing, subject to (accord-ing to one of the quoted authorities) the requirement in most jurisdictions that the party act in "good faith." 180 Cat 702. However, the supreme court noted an exception to this general rule for satisfaction clauses relating to con-struction of a building or the like in accordance with plans and specifications; those clauses may be subject instead to an objective reasonableness requirement (presumably on the theory that satisfaction relates to an objective crite-rion--namely, compliance with plans and specifications). 180 C at 702. Three prior California cases cited by the supreme court (involving construction work in connec-tion with a house, a tile roof, and an elevator) had recog-nized this reasonableness requirement, but in 74/Jany, the supreme court stated that "[i]n other [California] cases, where the question ofjudgment was involved, the oppo-site rule had been applied." 180 C at 704. In TIJfany, an employment contract referred to an owner’s satisfaction with a brick gla7er’s work. The supreme court found that the owner’s "decisionthat he is not satisfied is conclusive onthe pther party and tlpon the court," 180 Cat 705.

Good Faith v Reasonableness Tests Over the years, the ieasonbleness rule for the eon-

structiOn exception seemed to become the Standard for a much broader categoiy of Satisfaction clauses. Shortly after 7ffany, the supreme court stated th rea at a sonable-ness test applies when "the question is merely one of operative fitness or mechanical utility, and especially to

� Those involving "commercial value or uality, opera-tive fitness , or mechanical utility," which are subject to what appears to be an objective reasonableness test; and Those involving "fancy, taste or judgment," which are subject to what appears to be a subjective good faith test.

Mqltei v Hopper (1958) 51 C2d 119, 123, 330 P2d 625.

Determining the Applicable Category The category into which a particular satisfaction clause

should fall was not always easy to predict. For example, after the supreme court in Collins, 47 C2d at 882, had stated that satisfaction with a soils report and approval of a map fell within the first category and therefore should be subject to a reasonableness test, one might have expected similar treatment for satisfaction with leasing; however, in Mattel, supra, the supreme court stated that "the factors involved in determining whether a lease is satisfactory

are too numerous and varied to permit application of a reasonable man standard" and concluded that it more appropriately falls within the second category and should therefore be subject to a subjective good faith test instead, 51 C2d at 123.

Objective Good Faith -

If things were not crystal clear in 1958 at the time Of the Mattel decision, the lines of demarcation were definitely blurred in 1959, when the supreme court, in Rodriguez v Barnett (1959) 52 C2d 154, 338 P2d 907, stated that "an objective criterion,�good faith�controls the exer-cise of the right to determine satisfaction [under a sat-isfaction clause]." (Emphasis added.) 52 C2d at 160. A subsequent intermediate appellate court decision, Kadner v Shields (1971) 20 CAM 251, 97 CR 742, stated that "[t]bis decision is somewhat of an anomaly," offering the following possible explanation (20 CAM at 263 05):

Perhaps what the Stpreme Court has said is that the stan-dard of approval ,*N strictly at the personal, evaluation and choice of the buyer (he can actually make a decision which In the greater probability of things the Judicially manufactured reasonable man would not), but whether he did this in good faith must be examined quite objectively and without giving particular weight to any

98 July 2010 33 Real Property Law Reporter

cu- red re"

ur-nia ess rty. be

me

thaV’t reasonably to support the determinati criterion ef goodfaith was satisfied in Bleech :. :h ve been suggest covenant might impose either an ob standard, depending on the facts. Jr court, in Carma Developers (Cal), ) Cal., Inc. (1992) 2 ch 342, 6 CR authorities suggesting that the imp] impose both subjective and objectrv party violates o\’enant if it subj in the validity of its act or if its co unreasonable," 2 C4th at 372. If.thienough, in 2002, the court of appci Inc. v Citicorp Real Estate, Inc. (21 57, 122 CR2d 267, used the satisfa cases, particularly Mattel, as thoul those cases imposing a reasonablen pendent of the implied covenant, tin reasonableness standard avoided the of the implied covenant. 100 CA4th

While it may be difficult to recon cies in the foregoing cases, by spel standard, the. ,pgrtjes may be able to duce, uncertainty

Interpreting an Express S Standard

As noted above, both the new C chase contract form and the form i Real Property Sales Transactions bo standards for the buyer’s satisfactio: But it is not entirely clear how tho interpreted orwhether they will be i way in diffeient sale transactions It clear whether they will result in a si test, an object1e reasonableness test something else Sole Discretion

Contrary to the etpectations of "sole diseretipn" does not necessaril no limitation on the exercise of disc no other party gets to participate in I process, but ft doesn’t necessarily r

thansole4iscre-I, a common meaning of "sole" is "only," unon meaning of "absolute" is "free from limitation" See Webster’s New Universal

bictionary (1996) See also Diamond & at 425 ("When the contract’s terms con-dant absolute discretion with regard to a ect Of performance that specific grant

yen effçct ", De Wakhe v Togo s Eateries al, July 21 1 2008, No 07-2901).2008 US 08417 (implied covenant held inapplicable ring party "absolute discretion") But even I, absolute discretion in a satisfacflofl clause y free fioni doubt Unless it is clear that the cled no limitation and there is consideiation, ei�tisk that the implied covenant of good pply. See, e.g., Storek & Storek, Inc. v 1 Estate, Inc. (2002) 100 CA4th 44, 57, 122 ndicating that implied covenant may apply ory contract"when a party is given absolute Beal Bank v Lot 9 Indus (Oct 21, 2003, certified fotpi.iblication) 2003 Cal App Un

S56 (court rejected lender’s contention that lU te discretion," in connection ’with lender’s iale that would convert certain recourse debt Be debt, were "crystal clear" and not subject )V.enant). While the Steiner de cis iorappcars t weight to "absolute discretion" language Be questions as to the continuing validity of asoning), the absolute discretion language

plied directly to a termination right that was y tied to a satisfaction clause; testimony in rated that the parties did not intend to Impose the buyers termination right in that case If

ints an unlimited termination right, It Would ii tie termination to a satisfaction Clause, to Latnn "for any I’eason or no reason" or use

and sole diScretion" language of Steiner to make sure

............e buyer’s (and, One would

ler’s) ’words and actions are consistent with xpectation that there is no resttiction on its mate

33 Real Property Law Reporter _.!

Good Faith interpreted to include a right to terminate for economic How will the gOou ait standard Ifl 11e orm will "good faith" b" ,1 h CAR form financial reasons, unrelated to the results of the prop.

�c��:;�� � . . be viewed? uoouratn

.nsu11JerenLmeamngs1nu1IerenI

, . ,j w p b’t Co.9th eiv due uIi2ieflC� , � ’�. C�;, ho dos V es u con 7 Burton, fl 1 I’ i’ "d ’h See, rea q, on r t

., + ex , Q , , . ,

,,r LVVL)292A. ij . ’...L1ster s rig o Lermrna ç,. ..

. :, eA Common i.&w uuty to rerjorTh rn tiooa .iØiii, . nary i...

, .1’ ’) .p) I ’1 / 1 Æn ,l 4’ Cl

uetermrneu ma US WU unace e in o

. h tent, iiCiu UuuCi 1aW flOw o give is r n fl * + 4 f1 ev i l K4’1II4i yJWuI W/ 980),.:

tractS 2O 5(a) These meanings ha’e changed oVer time Oe p,iLOflflfl

+ ’. k ur 1 ted to formt or flT111Ø &O uiK reason e a For eamp1e, the general dengionof"goodfith" in Ar content o mafl.scr1 tide Ainifornicommercial Code (UCC) was once I- Purpose and Context of Transaction

M to "hłnesty in faot" a subjective sand1ard but it Is now generally defined (as it was defiied in 4rticle 2 As discussed pievious1y *n connection wth Locke v

Driginally), to be both "honesty in tet’ and the obser Bs (1997) 57 CA4th 354, 66 CR.2d 921, re gardiess ot whethet a buyer’s termination right is tied to vance of reasonable commercial standards of fair deal-

ing," both a subjective and an objective "I"est See, e g, a satisfhctlon olause, and regaidless ofWhether the sats Moses, The New Defirtltkm of Gciod Faith In Revised4r- faction clause has an express or impfld standard the pur

tic/c 1, 35.1.3CC U 47 (2002); Corn C § 1201(20) (which, ..?..�f pose and coiiith ransactionitiay be takeniitoic- count, For example, query: What would have happened "good in 2006, replaced the prior definition of faith

§1201(19) to make the change noted above). As noted in Steiner if $100 of independent contract consideration

above, the California Supreme Court in Rodriguez char- had been paid, but the buyer had entered into the contract

acterized good faith as an objective criterion, 52 Cd at with the sole purpose of delaying the parcel split (and no intention of buying)? 160. Thus, how an express good faith standard will be

interpreted is by no means free from doubt. For the sake Consideration�What Consideration Is of clarity and more predictability, it may be advisable to Required to Support an Unrestricted specify whether an objective or a subjective test (or both) Termination Right? is intended For example, if the parties desire to impose If the buyer wants an unfettered right to terminate the a subjective good faith standard, they might define "good purchase contract, then it must ensure that the contract is faith" as "honesty in fact" as that phrase is used in the supported by consideration. 0CC (recognizing that while "honesty in fact" is included in each of the definitions of "good faith" that appears in Recited or Presumed Consideration the UCC, it is not defined in the UCC itself), or they might Is it enough to recite a certain amount (e.g., $100 or simply refer to the buyer’s "subjective good faith judg- $1000) has been paid as consideration for entering into ment." the contract? As noted earlier, according to Restate-

Reasonableness ment (Second) of Contracts §87(l)(a), it may be suffi- cient under certain circumstances, even if it is not paid,

Even if the parties decide on a standard of objective However, that is not the law in California, See ICe/icy reasonableness, there is still a chance they may be sur- ROUSE (1961) 188 CA2d 92, 97, 10 CR 235 (option prised by how a court interprets this standard. For ex- agreement held revocable for lack of consideration de- ample, in Peak-Las .Poslras Partners v Boliag (2009) 172 spite its recitation of "good, valuable and adequate con- CA4th 101,90 CR3d 775, the seller had agreed not to un- sideration"). See also 1 Witkin, Summary, Contracts reasonably Withhold its consent to escrow extensions and §207 (10th ed 2005); Bard v Kent (1942) 19 C2d 449, the court rejected the seller’s argument that, based on thq 451, 122 P2d 8 (option recited that it was granted in con- facts the seller had, his refusal to extend was reasonable sideration of $10, but it was stipulated that money was and that he was under no duty to investigate the facts, 172 not paid); I Miller & Starr, California Real Estate § 1:53 CA4th at 106. (Query: Would a reasonableness standard (3d ed 2000). Note also that while a "written instrument for a due diligence approval be applied only to the actual is presumptive evidence of a consideration" (CC § 1614), results of the buyer’s due diligence, or might a court ques- that presumption is rebuttable; while Evid C §622 pro- tion whether the buyer had a duty to further investigate?) vides that facts recited in a written agreement are conclu- Further, the Peak Las Positas Partners court considered sively presumed to be true, it expressly excludes recitals that the Seller had made its objections to extension in bad of consideratiOi faith; hence, the court apparently imported a subjective clement in a ddition to the reasonableness standard 172 Promised)Coneluoratlon CA46at 108 The supreme court in Sterner indicated that the op- Scope of Approval tion was initially revocable because no consideration was

The buyer should also consider whether the scope of given by the buyer at the moment of contract forma- tion--the buyer’s covenants did not count as consider-

its approval is broad enough. For example, the right to ation because of the buyer’s "escape clause." in other disapprove based on property due diligence may not be words, the covenants were illusory at the instant of eon-

July 2010 ’ Real Property Law Reporter

tract formation because the buyer could escape from them ment for the option contract ...In the event that the op by terminating a moment later. Therefore, if a buyer tionee does not exercise the option and he regains the

wants covenant to count as consideration at contract thing deposited, the optionor has received the benefit of formation seth. at the option is irrevocable, the covenant the use of the thing, and the optionee has suffered the should survive termination detriment of not havthg the use of the thing deposited

Paymentand Other (Whole or Part) Performance The consideratiofl requirement i thereby satisfied

of an 0611§’ In most thstances, however, the buyer will stiongly prefet

The safest approach may be o actually make a re to keep the deposit in escrow, in which event it may be I8S1 srnipiy to give the aeller the Interest earned on quired payment or perform a reqtured obligation to avoid

a considctàhok -19 sue As noted in Steiner, shouldn’t 4OPOSIt while it s in Scrow ThiS arrangement still

matter whether the obligation involves a prejudice to the gn’es the se1cr the benefit of some USC of the money and a detriment to the buyer See Steiner, 48 C4ih buyer or benefit to the seller, but it is essential

bargained for 48 C4th at 421 Thus, it may not be suf- at 422 nl2 Pina1ly while specific pexormance requires

ficient to inbur costs (such as due diligence and other in- adequate" consideration under CC §3391(1), the court in Marsh stated that this rbquirement pertains to the con- spection costs) if the contract does not require the buyer

to do so. See, e.g., Bard, 19 C2d at 452 (architect’s sideration to be paid for the underlying property once the

drawings were not bargained for); Kelley, 188 CA2d at option is exercised and not to the consideration paid for the option itself. 8 CA at 389. 97 (consulting lending institutions regarding financing,

starting topographical study and survey, and preparing Option Versus Sale Contract and recording map were not bargained for); Kowal v Day Inadvertently Creating an Option

� (1991) 20 CAM 720, 726, 98 CR 118 (cancellation of � buyer’s lease of other premises, contracting to lease por. Having a free look (with an unrestricted termination

tion of subject building to another party, ordering blue- right) is not the only way to create an option. More gen- erally, it may be possible to create an option by simply

address, and changing address on business certificates eliminating the seller’s right to specifically enforce the were not bargained-for consideration, but seller’s use of contract. This is commonly done in real estate contracts

that make retention of the deposit the seller’s sole remedy buyer’s car was bargained for in escrow instructions), The detriment must be bargained-for consideration. Con- for the buyer’s breach of its obligation to purchase. ,John-

sequently, if a contract were illusory because the buyer son v Clark(1917) 174 C 582, 586, 163 p 1004 (if con- tract gives buyer discretion to decide whether to buy, con- had the unrestricted ability to terminate its unperformed

obligations, then to enhance the likelihood that part per- tract creates option); Welk v Fainbarg (1967) 255 CA2d

formance would save the contract, the buyer would likely 269, 276, 63 CR 127 (test of whether instrument is option or contract of sale is whether obligation of buyer to buy be better off if the contract covered what the buyer would

actually do in any event, can be enforced by specific performance (citing Scarbery v Bill Patch Land & Water Co. (1960)184 C2d 87, 100,

Adequacy. 7 CR 408)); 1 Miller & Starr, California Real Estate §2.8 But what is enough? According to Witkin, "there is no (3d ed 2000) (liquidated damages clause that provides re

requirenlent of adequacy to make the contract enforce- covery of specific sum as seller’s sole remedy in event able in &i. action at law." See Witkin, Summary, Con- of buyer’s default and excludes specific performance as tracts §205 (10th ed 2005). See also Horton v Kyburz remedy is, in effect, an option). (1959) 53 C2d 59, 65,346 P2d 399. As discussed above, Differences Between Options and Sale numerous intermediate appellate cases have stated that Contracts any amount of consideration is adequate to establish an irrevocable option. See Marsh v Loll (1908) 8 CA 384, The parties should give some thought to the come-

97 P 163 (option payment of $0.25 against purchase price quences of having an option rather than a bilateral con -tract. In addition to the need for consideration for the o- of$ 100,000); Slough v Hanson (1941)46 CA2d ,116

P2d 77 (option payment of $1.00 against purchase price tion, there may be differences from a bilateral purchase

of $2500); and Wheat v Morse (1961)’197 CA2d 203, contract relating to:

17 CR 226 (option payment of one dollar against pur- 0 Time being of the essence; chase price of approximately $20,000). Alternatively, a ’ Strict enforcement; buyer might simply let the seller hold the deposit. This Bankruptcy; approach is supported by Kowal, in which the court stated � Condemnation; (20 CAM at 728):

� Casualty; and When an optionee, acting pursuant to the bargain,

places something of value in the hands of his optionor, � Remedies (including retaining option consideration as the use of that thing satisfies the consideration require- a substitute for liquidated damages),

33 Real Property Law Reporter Jul

See, e.g., California Real Property Sales Transactions §*8.20, 8.21, 8.23, 8,29, 8.30, 8,33, 8,39(4th ed Cal CEB 2007).

Promissory Estoppel Nothing in the intermediate appellate Steiner decision

is likely to be considered encouraging for a party seek-ing to support an option under a promissory estoppel the-ory. However, in rejecting Steiner’s promissory estop-pel arguments, the court of appeal was likely influenced by the somewhat unusual facts of the case�which, in its view, suggested that the equities did not favor Steiner, These apparently included the fact that Steiner was an experienced developer who had initiated the discussions pursuant to which the relatively inexperienced Thexton agreed to the sale; Steiner had drafted the contract; and Steiner reserved a cancellation right for himself. In a sit-uation where the equities are more balanced, the buyer might have better luck with a promissory estoppel the-ory.

Conclusion and General Recommendations

The Steiner decision serves as a useful reminder of a number of basic issues relating to free looks, � First, if the free look provisions do not clearly and ex-

presly reflect the intent and reasonable expectations of the parties that the buyer,’s termination right is free from restrictions, then it may not he. In Steiner, the language was clear, express, and consistent with the positions of the parties.

� Second, an unrestricted termination right means that what the parties may view as a bilateral purchase agreement is in substance an option, as there was in Steiner,

� Third, if that optiol is not initially supported by con-sideration, then it may be lost if it is revoked by the seller before it is made irrevocable (by, for example, part performance, as occurred in Steiner) or is exer-cised (by, for example, expiration of the free look ter-mination right).

In light of these issues, California buyers and their counsel may want to consider the following when draft-ing a purchase agreement with a free look or other due diligence termination right.

Binding Contract

Avoid a revocable option by either a Limiting the buyer’s termination rights; or � Providing for independent consideration.

Clear Termination Right If the buyer wants to use a limiting standard to avoid

an option or a consideration issue, then it should use an express standard and make clear whether it is intended to

y 2010 101

be subjective, objective, or both. If the buyer Wants to avoid being second-guessed by application of an implied standard, its termination right should be: � Untied to any approval or other determination; � Exercisable in the buyer’s absolute and sole discre-

tion, for any reason or no reason; and � Supported by independent consideration, as discussed

below.

Independent Consideration To provide consideration to support an unrestricted ter-

mination right, consider obligating the buyer to make a nonrefundable option payment to the seller or, alterna-tively, provide that a portion of the buyer’s deposit made on execution of the contract is nonrefundable.

Amount

Under existing cases, a nominal amount should be legally sufficient. Extremely small amounts (without other consideration) might invite a challenge, but there is no magic number that should be used. Even a pro-portionate approach may be unsatisfactory: In Marsh, Stough, and Wheat, the option consideration ranged from 1/4000th to 1/25th of one percent, but using the high end of that range would mean $40,000 for a $100 million purchase, The authors suspect that in most transactiofls, practitioners will continue to use amounts between $100 and $1000.

Unconditional Surviving Obligation

Provide that the obligation to make a nonrefundable payment is unconditional and survives any termination of the contract, so that the covenant provides consideration even if the buyer neglects to pay.

Bargained-For Consideration

Provide that the nonrefundable payment is the consid-eration for the buyer’s option to terminate during the free look period, and recite that it has been bargained for as adequate consideration for this option, (As discussed ear-lier in this article, however, recitals are not dispositive.)

Whatever steps the ’buyer and its counsel take to craft clear and explicit language, they should understand that the facts and circumstances of the transaction may be rel-evant even in the absence of any ambiguity within the four corners of the contract.

The authors thank Samuel D. Byars, of Armbrust & Brown, Billie .1. Ellis, Jr., ofLocke LordBissell & Liddell, Alan D. Hegi, ofKelly Hart & Hallman, Michael H. Saks, of Wright Ginsberg Brusilow, and Steven A. Waters, of Haynes and Boone, for their input regarding the custom and practice of Texas lawyers in dealing with free looks. The authors also thank Wesley R. Montalvo, Saloni S. Shah, and the CEB stafffor their cite checking.

’S

Copyright © 2010 Continuing Education of the Bar. Originally appeared in the July 2010 issue of RealProperty Law Reporter. For more information on the publication, please visithttp://ceb.com. Reprinted with permission.