A subject-to clause, also known as a contingency clause or suspensive condition, is a condition in a contract that must be satisfied before the contract comes into force. Put simply, subject-to clauses "pause" a contract until the conditions are met, or until the time periods has passed and the contract cancels automatically.
Most real estate contracts contain subject-to clauses. They come in all kinds of shapes and sizes, but the most common subject-to clauses are the good old "subject to mortgage" clause and the "subject to sale" clause.
The purpose of subject-to
These subject-to clauses are meant to allow buyers to make an offer on a property, even if they are not currently in a position to finance the purchase. The buyers can now try their utmost to fulfil the conditions of the purchase agreement in the time allowed by the subject-to clause. I if the buyer's efforts to fulfil the conditions of the sale fail, they can still get out of the contract without being penalised.
For example: When a buyer needs a home loan to buy a property, a lender needs to make sure that the property offers enough value to secure the mortgage. This means that the lender requires a physical inspection of the property, and the inspection can only be done after the purchase price has been determined. The "subject to mortgage" contingency clause allows this process to take place, without negatively affecting the buyer.
Also, in South Africa, where real estate prices have increased dramatically in recent years, most buyers cannot afford to buy a new property without selling their previous home. The "subject to sale" contingency clause allows them to make an offer on a property, even before finding a suitable buyer for the old house. If they are unable to sell within the subject-to period, they will not be bound to the purchase agreement.
Subject-to misuse
Subject-to clauses are necessary tools for most buyers in South Africa, but they can be used in ways that disadvantage sellers.
Some "buyers" will try to take advantage of subject-to clauses to try and "flip" properties for a quick buck. "Flipping" properties by tying them up for a period of time using subject-to clauses are not common in South Africa, because the transaction would usually attract double transfer duty. This makes it unlikely for flippers to make any profit off a flipped South African property, but in other countries, "flipping" properties have become a real problem.
Some "subject to sale" buyers also misuse the subject-to clause. These buyers want to secure a new home, but want to sell their old homes at prices that don't reflect the true market value of the property. A "subject to sale" contract like this is doomed to failure. And although the buyer is not negatively affected, the seller sure is.
Subject-to contingencies "tie up" properties and take them out of the market, even if the time period is relatively short. This is a problem for sellers, because they cannot continue to actively market their property. Many subject-to clauses never get fulfilled, leaving sellers to scramble to get their properties back in the market after being sadly disappointed.
Subject-to protection
How can sellers balance a buyer's need for subject-to clauses in the sales agreement with their own need to sell the property? How can sellers protect themselves?
Luckily this is not a new problem, so there are steps sellers can take. But these techniques only reduce the risk and negative effects of subject-to clauses. It is still best not to have any subject-to clauses in your contract of sale.
Four techniques that can be used to protect a seller's interests in a contract that includes subject-to clauses include:
Get a commitment
When a Subject-to condition is inserted in a purchase contract, a seller who wants to protect his position should include a commitment by the purchaser to do their utmost to satisfy the condition. The term "utmost" may not seem too forceful (probably because it isn't), but at least it will give the seller a leg to stand on when the purchaser is not performing and the seller wants to hurry things along and get the buyer to stop dragging his feet.
Control the time
The seller should set a specific period of time within which the subject-to condition must be fulfilled. This time period can be negotiated between the parties and will differ from situation to situation.
For example, a "reasonable period of time" for obtaining mortgage approval will depend on the property, the real estate market, the buyer's circumstances, the lender's standard procedures, and the type of mortgage the buyer is applying for. Usually a period of about one to two weeks is enough to make an application for finance and getting a decision back from the lender. But in special cases, a lender could give an answer within just three days.
If the time limit in the subject-to clause is almost up, and the mortgage application is almost through, the seller can still decide to give an extension. Sellers usually don't want to "blow" the transaction at this late stage and start the hunt for a buyer again, right from the start. But in a sellers' market, sellers are much more likely to stick to the time limits in the subject-to clause, because finding a replacement buyer will be reasonably easy.
Control the terms
Sellers can also control the wording of the subject-to clause, to "encourage" the buyer to perform as soon as possible. This type of control is as flexible as the seller's imagination.
A "subject o mortgage" clause, for instance, can be worded in such a way that, should the buyer fail to obtain financing by a certain date and time, the seller will be entitled to provide financing at less than favourable terms. This would most probably motivate the buyer to try and get his own financing as quickly as possible.
The terms of the "subject o mortgage" clause could also empower the seller to apply for and accept mortgage financing on behalf of the purchaser. This puts the control over the mortgage application squarely in the lap of the seller, and prevents time wasting shenanigans by the buyer.
72-hour clause
The last (and probably most effective) way to protect the seller's interests is including a 72-hour clause in the contract of sale. If you don't know what a 72-hour clause is, you most probably just know it by a different name. The 72-hour clause is also known as a "kick-out clause", "release clause", "escape clause", or "first refusal clause".
A 72-hour clause states that the seller can continue to market the property, and if another suitable buyer is found, the seller may accept the offer, subject to the cancellation of the first contract. The subject-to buyer will then have 72 hours (or any other period of time) to fulfil all the conditions of the contract. If the buyer cannot perform in this time period, the contract will lapse and the new contract will come into effect.
A 72-hour clause can be of particular value when another buyer with a less conditional or more attractive offer comes along. It also allows the sellers to keep marketing a property that attracts a lot of interest, or which needs to sell fast.
The problem with a 72-hour clause is the fact that, while being useful to the seller, they aren't too popular with buyers who don't want to wait in line for a purchase that might happen or not. A "back-up" buyer takes a gamble with his time and is very often disappointed.
The last word on subject-to
Subject-to clauses are generally for the benefit of the buyer. The seller should therefore, in an attempt to protect his own interests, try to limit the number and scope of the subject-to clauses in the sales contract. The fewer subject-to conditions there are to be satisfied, the closer the seller gets to the final purchase and sale of the property.
