Flood Damage to Properties Under Contract
On September 16, 2013, the Colorado Office of Emergency Management released its initial estimate of the number of homes damaged by the recent flooding. Officials estimate that the flooding damaged 17,494 homes and destroyed another 1,502 homes. The damage will undoubtedly affect potential home sales and, it will be critical that consumers and their REALTORS® understand the complexities and legal issues regarding homes that were under contract at the time of flooding.
Section 19 of the Contract to Buy and Sell Real Estate (Residential) provides that a property must be delivered in the same condition that existed on the day the contract was signed. If a buyer and seller are under contract and the property was subsequently damaged by flooding prior to closing, the extent of the damage will determine the rights and obligations for both buyer and seller.
The Ten Percent Rule
If the amount of property damage is less than 10 percent of the total purchase price, the seller must repair the damage before the closing date. If the seller completes the repairs, the buyer is obligated to purchase the property. However, the buyer has the right to terminate the contract if the damage is not repaired by the closing date.
If the amount of property damage is more than 10 percent of the total purchase price, the seller is not obligated to repair the damage to the property, but the seller can elect to repair the damage. In either case, the buyer can choose to terminate the contract or continue with the purchase.
If the buyer continues with the purchase, he or she is entitled to a credit at closing for all insurance proceeds received by the seller for the damage and the amount of any corresponding insurance deductible. If the seller has not received insurance proceeds by the closing date, the parties can either extend the closing date or have seller assign the proceeds of the insurance payment and credit the corresponding deductible amount to the buyer. Notably, the insurance proceeds credit cannot exceed the purchase price.
Example
A buyer contracted with a seller to buy a house for $250,000, but, before closing, the house sustained $20,000 in flood damage. In this scenario, the seller must repair the house. If the seller completes repairs by the closing date, the buyer must purchase the house or be in breach of contract. Conversely, if the amount of damage was $30,000, the seller is not obligated to repair the damage to the house. The buyer can choose to terminate the contract or continue with the purchase. If the buyer chooses the latter, he is entitled to a credit that equals the amount of insurance proceeds the seller receives.
Considerations
A number of issues can arise when dealing with the contract and property damage. First, a licensed professional should inspect the house to determine the extent and cost of the damage. Flooding can cause severe foundational and structural damage, some of which is not readily apparent. By having a professional inspect the home, buyers and sellers can be more informed about the repairs that are needed and the amount of damage that has occurred. This information is important because it determines what rights and obligations a buyer and seller have, as previously noted.
Second, if the property damage is less than 10 percent of the total purchase price, the seller must repair the damage, even if the seller will not receive any insurance proceeds for the damage. The repair is required by section 19.1 of the contract, and the seller will breach the contract if no repair is completed.
Finally, damage to an inclusion, fixture, or utility is handled in a similar way as damage to the actual house. If one of these items is damaged, the seller must repair or replace it with its equivalent before the closing date. If no repair or replacement has occurred by the closing date, the buyer can choose to terminate the contract or receive a credit for the repair or replacement. Naturally, if an HOA is responsible for the item, the seller does not have the responsibility to repair, replace, or credit the buyer.
Buying or selling a house that has been damaged by flooding or other causes can subject a buyer or seller to additional stress. REALTORS® are qualified to help clients through this stressful process and increase the likelihood that a damaged property still closes and that the legal issues have been properly addressed for both buyer and seller.
Steve Morgan is COO and General Counsel for the Colorado Association of REALTORS®. The Colorado Association of REALTORS® is the state’s largest real estate trade association that represents more than 19,500 members statewide. The association supports private property rights, equal housing opportunities and is the “Voice for Real Estate” in Colorado. For more information visit ColoradoREALTORS.com.