Contracts: Practice Questions & Explanations

A valid real estate contract requires: (1) offer and acceptance (mutual assent or 'meeting of the minds'); (2) consideration (something of value exchanged, even if symbolic); (3) legal purpose (the contract cannot require an illegal act); (4) competent parties (legally capable of contracting); and (5) in most cases, the writing requirement of the Statute of Frauds (real estate contracts must generally be in writing to be enforceable). A notarized or witnessed signature is not generally required for the contract itself, though some states require it for the deed transferring title. Verbal real estate contracts can be valid in principle but are nearly impossible to enforce because the Statute of Frauds requires writing.

Earnest money is a good-faith deposit the buyer pays at the time of signing the purchase contract. It demonstrates serious intent (a buyer with cash at risk is more likely to follow through) and provides the seller some compensation if the buyer defaults. The amount is negotiable, typically 1-3% of the purchase price in residential transactions. Earnest money is held in escrow by a neutral third party (typically the listing brokerage, a title company, or an attorney) and applied to the down payment or closing costs at closing. If the buyer defaults without legal cause, the seller usually keeps the earnest money; if the seller defaults or contract conditions are not met, the buyer gets it back. The amount and treatment are spelled out in the contract.

A liquidated damages clause in a contract specifies, in advance, the amount of damages the non-breaching party may claim if the other party defaults. In residential real estate, the most common form is that the seller may keep the buyer's earnest money as liquidated damages if the buyer defaults. The advantage is certainty — both parties know up front what is at stake. To be enforceable, the agreed amount must be a reasonable estimate of likely damages (not so large that it is punitive); courts will not enforce liquidated damages clauses that look like penalties. The buyer typically gives up the right to be sued for additional damages by agreeing to the cap. Liquidated damages are different from actual damages, which require proof of loss.

EARNEST MONEY (also called a good-faith deposit or escrow deposit) is a sum the buyer deposits when a purchase contract is signed, demonstrating commitment to the transaction. Key points: HELD IN TRUST by the listing broker, selling broker, or escrow company — not by the seller or agent personally (this is a trust account requirement); NOT the buyer's down payment (that comes at closing); AMOUNT: typically 1-3% of purchase price in most markets; FORFEITURE: if the buyer defaults without contractual justification, the seller may be entitled to the earnest money as liquidated damages (governed by the contract); RETURN: if the sale falls through due to a failed contingency (inspection, financing), the earnest money is typically returned to the buyer.

ESSENTIAL ELEMENTS OF A VALID CONTRACT: (1) OFFER AND ACCEPTANCE (mutual assent / 'meeting of the minds'); (2) CONSIDERATION (something of value exchanged); (3) LEGAL CAPACITY (parties must be of legal age and sound mind); (4) LEGAL PURPOSE (the contract's objective must be lawful); (5) For real estate — IN WRITING (the Statute of Frauds requires contracts for the sale of real estate, and leases over one year, to be in writing to be enforceable); STATUTE OF FRAUDS: A law requiring certain contracts (including real estate transfers) to be written and signed; CONTRACT VALIDITY TERMS: Valid (legally binding and enforceable); Void (no legal effect, e.g., illegal purpose); Voidable (one party can cancel, e.g., signed by a minor or under duress); Unenforceable (valid but cannot be enforced in court, e.g., a verbal real estate sale agreement); these contract fundamentals are core national exam content.

LIQUIDATED DAMAGES: An amount agreed upon IN ADVANCE in the contract as the compensation a party will receive if the other party breaches/defaults — avoiding the need to prove actual damages later. IN REAL ESTATE: Commonly, if the BUYER defaults (backs out without a valid contingency), the SELLER may keep the EARNEST MONEY DEPOSIT as liquidated damages; the contract specifies this remedy; PURPOSE: Provides certainty and avoids litigation over actual damages; the amount must be a reasonable estimate of potential damages (not a penalty — courts may not enforce amounts that are punitive rather than compensatory); EARNEST MONEY: The deposit the buyer puts down to show good faith; if the buyer defaults, it may be forfeited as liquidated damages; if the buyer cancels under a valid contingency (financing, inspection, appraisal), they typically get it back; OTHER REMEDIES for breach: specific performance (court orders completion of the sale), actual damages, rescission; liquidated damages is a key contract remedy concept on the national exam — a pre-agreed sum (often earnest money) that compensates without proving actual loss.

CONTINGENCY: A CONDITION written into a purchase contract that must be satisfied (or waived) for the contract to proceed to closing. If a contingency is not met, the protected party (usually the buyer) can cancel the contract — typically recovering their earnest money. COMMON CONTINGENCIES: FINANCING (loan approval contingency — buyer must obtain a mortgage); INSPECTION (buyer can have the property inspected and cancel/negotiate based on findings); APPRAISAL (property must appraise at or above the purchase price for the loan); SALE OF BUYER'S CURRENT HOME (buyer must sell their existing home first); TITLE (clear, marketable title); PURPOSE: Contingencies protect the buyer from being bound to purchase if key conditions aren't met; DEADLINES: Each contingency has a deadline; failing to act/remove by the deadline may waive it; REMOVAL/WAIVER: When satisfied or waived, the contingency is removed and the contract proceeds; a contract with fewer contingencies is more attractive to sellers (more certain) but riskier for buyers; contingencies are fundamental contract knowledge on the national exam — conditions protecting parties, with earnest money typically returned if a valid contingency fails.

The Statute of Frauds, adopted in some form in every state, requires that certain contracts — including those for the sale or transfer of an interest in real property — be in writing and signed by the party to be charged in order to be enforceable in court. This protects against fraudulent claims based on alleged oral agreements about land. Leases longer than a specified term (often one year) also generally must be written. An oral agreement to sell land is usually unenforceable even if both parties admit it existed. Because nearly every real estate transaction depends on a written, signed contract, the Statute of Frauds is essential contract-law content.

A contingency is a condition written into a purchase agreement that must be met before the contract becomes fully binding or the parties are obligated to close. Common examples include financing contingencies (the buyer must obtain a loan), inspection contingencies (the buyer may inspect and object to defects), appraisal contingencies, and the sale of the buyer's current home. If a contingency is not satisfied within its time frame and is not waived, the party it protects can usually cancel the contract without being in breach and recover the earnest money deposit. Contingencies allocate risk and are central to how real estate contracts operate, so they appear often on the exam.