Free Looks—Canceling a Contract After Inspection

By Mert Buckley

Many real estate contracts contain clauses which allow buyers to cancel the agreement if they are not satisfied with the results of a closer inspection of the property. These contingency clauses are called Feasibility Periods, Due Diligence Periods, Satisfaction Clauses, and Free Looks. They’re enforceable, but a buyer must use “good faith” in exercising them. Here’s what that means.

Kansas Law

Earlier this year the Kansas Court of Appeals approved one of these satisfaction clauses in Hill v. Perrone. The contract “was contingent upon the completion of all inspections to the [buyers’] satisfaction.” The inspection disclosed termite damage and other items, which the sellers allegedly fixed. But the inspection also disclosed that the property had been treated for termites with Chlordane, a highly toxic chemical now banned from use.

The buyers cancelled the contract under their satisfaction clause. The sellers still tried to close, claiming they had already made the repairs requested to the property and completed their obligation under the contract.

The Kansas Court of Appeals ruled for the buyers. It said “satisfaction clauses” are enforceable in Kansas if exercised by a buyer in good faith. The court said a buyer must “fairly and candidly investigate and consider the matter, reach a genuine conclusion, and express the true state of his mind. He cannot act arbitrarily or capriciously, or merely feign dissatisfaction.” And after a buyer has conducted its investigation, “the reasons for not being satisfied are immaterial.”

Recommendations

Satisfaction clauses will be enforceable if the buyer acts in “good faith.” We believe this means a buyer cannot sit back and do nothing, then cancel the contract. The buyer must conduct a reasonable investigation of the property in order to legally cancel the contract.

And then a buyer who has conducted such an investigation does not have to justify the reasons for its dissatisfaction as long as the buyer’s dissatisfaction with the investigation is in good faith.

Final Thought

The results of this case depended on contract language which was clear and comprehensive. The contract was “contingent upon the completion of all inspections to the buyers’ satisfaction.” Different contract language could produce different results.

(Article appeared in Adams Jones June 2002 Newsletter)