(This is a guest post by Craig Blackmon, an attorney in Seattle whose practice focuses on residential real estate — see www.lawofficeofcraigblackmon for more information. Please note that this post is not legal advice. You should consult an attorney for specific legal counsel.)

The financing contingency is one of the most common contingencies in a real estate purchase and sale agreement. In order to understand it, one must first understand contingencies in general. This past summer, the Washington Court of Appeals examined a financing contingency in Salvo v. Thatcher, 128 Wn. App. 579 (2005). The Court discussed the rights and obligations imposed by such a contingency, and the principles applied by the Court are summarized below.

A contingency is a condition that must be satisfied before the parties have a legal duty to perform under the contract. The parties must make a good faith effort to satisfy the condition. When all contingencies are satisfied (or waived), the contract becomes legally binding and each party must perform its obligations (i.e. the buyer must buy and the seller must sell) or face liability for not doing so. If a contingency is neither satisfied nor waived prior to the stated closing date, the contract expires and the parties are relieved of their contractual duties.

A financing contingency makes the contract contingent upon the buyer obtaining the financing necessary for the purchase. Generally, the buyer must apply for financing within a certain number of days of the contract’s creation (mutual acceptance). If the buyer is unable to obtain the financing despite a good faith effort to do so on or prior to the closing date, then the contract expires and the parties are relieved of their contractual obligations. Because the buyer had a valid reason for being unable to perform under the contract (i.e. purchase the property), the earnest money should be returned to the buyer.

In Salvo v. Thatcher, a nasty dispute arose between the buyer and the sellers when the buyer was unable to obtain financing in time to close as required by the contract. The sellers argued that the buyer failed to give notice of his inability to close; because he did not give notice, he was in default of the contract and thus the sellers were entitled to the earnest money. The Court ruled that the language concerning notice did not supersede the general terms of the contingency, and moreover the notice was optional per the terms of the contract. Accordingly, because buyer could not get financing after making a good faith effort to do so, the contract expired and the buyer was entitled to the earnest money, regardless of his failure to give notice.

Of note, the contractual language at issue in Salvo differs from the language generally used in purchase and sale agreements today. Under the current language, and unlike the language in Salvo, the buyer is specifically required to give notice of the status of the loan application. It is an open question as to whether this different language would lead to a different result under similar circumstances. Regardless, buyers (and sellers too) should fulfill their contractual obligations so that they are clearly not in default. If a buyer unequivocally satisfies its contractual obligations but a contingency remains unsatisfied, then the buyer is in the best position possible to demand a full return of the earnest money.