How Satisfaction Clauses Affect Mutuality of Obligation in Real Estate Contracts

Real estate contracts often include contingencies for things such as inspection, financing, and condition of title.  Sometimes the contingencies include satisfaction clauses. These clauses require certain conditions to be satisfactory to one of the parties. If the party has absolute discretion to determine whether or not they are satisfied, that may make them able to effectively withdrawal from the contract for any reason or no reason at all.  In these circumstances, the party with the right of satisfaction arguably did not provided any consideration.

The case of Horizon Corp. v. Westcor, Inc., 688 P.2d 1021, 142 Ariz. 129, (App. 1984) examined this issue. A buyer and seller entered into a contract for the sale of 11 acres of land. The contract contained several conditions subsequent that had to be satisfied according to the buyer’s satisfaction. After the seller entered into negotiations to sell the land to a third party, the buyer tendered full performance.  Seller filed a quiet title action claiming the contract was not binding and it was free to sell the property to whomever it wished.  Buyer filed a counterclaim for specific performance.

The trail court found that the land contract was invalid because the satisfaction clause made the buyer’s promise illusory, and there was no consideration. It found there was not mutuality obligation, and because the buyer could withdrawal at his pleasure, the contract was void.

The Arizona Court of Appeals disagreed. The Court found that when a satisfaction of a party is based on subjective factors, that party is required to exercise their judgement according to the implied duty of good faith and fair dealing. The promisor’s duty to exercise good faith judgment would therefore be considered adequate consideration to support a contract.

In other words, a satisfaction clause does not make a party’s promise illusory because they are still required to act in good faith when determining whether or not they are satisfied. For issues relating to commercial value or quality, an objective reasonableness test will be used.

Determining whether or not good faith judgment was exercised will be a question of fact that depends on the circumstances of each case. If your contract was cancelled due to a lack of satisfaction by the other party, or if you are considering terminating a contract because a condition has not been satisfied, you should consult with a real estate attorney to make decide how to proceed.

Chernoff Law handles real estate litigation matters throughout Arizona. Contact us by calling 480-719-7307 to discuss your real estate matters.