The stress of settlement

For some investors, the ‘worst case scenario’ of investing in property isn’t just an unlikely hypothetical situation, but is an unfolding reality that could destroy their portfolios. We examine issues that arise around settlement and what to do if you cannot settle on a property.

After the sales contract on a property becomes unconditional, backing out is no longer an option – but sometimes circumstances arise where arranging settlement becomes impossible. So what can go wrong and how can you recover from settlement setbacks?

Common scenarios

There are many reasons a buyer may miss settlement but often the issue is financing, according to lawyer Rhett Doyle from Quorum Business Lawyers.

“The most usual circumstance is where a purchaser has not had their finance pre-approved. Alternatively, they may have had a pre-approval but subject to conditions and for whatever reason those conditions might not be able to be met,” Mr Doyle says.

In some cases, finance might be dependent on a favourable valuation from the bank. If the bank’s valuation comes in below the purchase price, the amount they’re willing to loan may not be sufficient, Mr Doyle warns.

With private treaty purchases, this situation is less common because contracts are often subject to finance approval, according to property adviser Philippe Brach from Multifocus Properties & Finance.

However, auction purchases are generally unconditional from the moment the hammer falls. While buyers often seek pre-approval for finance before auctions, they must take care not to over-pay, Mr Brach warns.

“If it's an auction, the bank has the option to go and value the property. If they decide it's not worth what the buyer has paid for it, then the buyer has to find the difference from their own cash,” he says.

Off-the-plan properties also pose an additional risk because there may be a delay of up to two or three years between signing the contract and applying for finance, Mr Doyle says. If the market falls, the property may be worth less than the contract price. “Then you're going to the bank asking for funding on the basis of an acquisition price in the contract which may well be greater than the market value,” he says.

According to experienced investor Munzurual Khan from Keshab Chartered Accountant, funding may also be held up if the buyer is relying on another property to settle simultaneously and this transaction is delayed. Outside of finance, the buyer may not have had sufficient time to complete title searches by settlement day, Mr Khan says.

In some circumstances, the issue comes from the vendor not complying with certain contract terms. “If you settle, that means you agree with the vendor that particular clauses of the contract have been fulfilled. As the purchaser, you have the right to say I can't settle because the vendor has not fulfilled their side of the contract,” Mr Khan says.

What are the consequences?

Conveyancing law varies from state to state but most jurisdictions have similar provisions in regards to settlement. If the buyer fails to complete, the vendor is entitled to charge interest for every day of delay, Mr Khan says.

In addition, the vendor can serve a notice to the buyer ordering them to complete the transaction within a set time frame – usually a minimum of 14 days, according to Mr Doyle.

“The real danger is, at the expiration of that notice period, the vendor can take action to terminate the contract and claim the full amount of the deposit,” he says.

However, the situation could escalate further – the vendor also has a right to sue for damages. “If the vendor can demonstrate that they have lost money because of the buyer then they could potentially sue the buyer for the costs they have incurred,” Mr Brach says.

If the property sells for a lower amount than the original contract price, the first buyer may be on the hook to cover the shortfall, Mr Khan warns. As such, on a $500,000 purchase, the buyer may lose their $50,000 deposit, pay interest and also marketing and sales costs to re-advertise the property. Then, if the property sells to a third party for $470,000, the buyer may have to pay a further $30,000.

However, Mr Doyle says vendors rarely exercise their option to sue due to the expense and effort involved. “Deposits are generally sufficient. A vendor will know that they have the right to terminate and they can immediately access that substantial deposit but to pursue anything else, there is a cost,” he says.

This is particularly true in hot markets, where vendors can resell their properties quickly and may fetch a higher price, Mr Doyle says. When the vendor tries to pull out of the contract, buyers have similar remedies. “If the vendor comes in and says they cannot settle because of X, Y, Z reason, then the vendor can extend settlement for a certain period of time. After that, if the vendor cannot settle, the buyer has the right to get the entire initial deposit back from the vendor,” Mr Khan says. “The buyer also has the right to go to the court and enforce the contract, potentially compelling the vendor to sell the property. But practically, that becomes quite expensive.”

What are your options?

As a buyer who fails to settle, your options are limited once a notice to complete has been issued. Mr Doyle recommends getting your lawyer to comb the contract for any loopholes. Failing that, he suggests trying to negotiate. “If it's only a short period – I'm talking a period of weeks, maybe a month – a vendor may be prepared to accept just interest in that period provided they have some comfort that a purchaser will be able to settle at the end,” Mr Doyle says.

Alternatively, the vendor may agree to a cash sum in payment for an extension, or an increased purchase price, he suggests. If vendors refuse to negotiate, buyers may have to look at alternative finance methods, whether through extracting equity from other properties, offering additional security to the lender or seeking assistance from family, Mr Khan says.

To avoid running into these sorts of issues, Mr Brach urges buyers to do their due diligence and get finance approval in place before the contract goes unconditional. “With an existing house, you can get the bank’s approval before you have to settle. That's the best way for sure because you have all your ducks in a row,” he says. For auction or off-the-plan purchases, Mr Brach recommends investors keep funds on hand in case the valuation comes in below the purchase price. While $50,000 would generally be sufficient, he suggests investors have access to up to $100,000 in volatile markets.

According to Mr Doyle, the costs of missing settlement can go deeper than mere financial losses. “It's not just the dollar cost,” he says. There is a lot of stress. I know it causes purchasers a lot of lack of sleep.”