Dysfunctional Contracts and the Laws and Practices That Enable Them: An Empirical Analysis

Abstract

This article reports on two empirical studies and an experiment that have significant policy implications for contracts and consumer protection law in the context of real estate transactions. The Condo Contract Study reflected that 79% of the form condominium purchase contracts that real estate developers used in Chicago contained a highly unfair remedies clause where in the event of the seller’s default the buyer’s sole remedy was return of the buyer’s earnest money (hence no real negative consequence to the seller) but in the event of the buyer’s default, the seller would be able to retain the buyer’s earnest money (which typically was 10% of the purchase price). We argue that this lopsided remedies clause should be considered to be unconscionable and that it creates an illusory agreement. But this view has so far only prevailed in Florida. Reported case law from other jurisdictions have ruled that this type of limitation of remedy clause is enforceable as the bargained for agreement between the parties, on the assumption that buyers of homes read and understand the terms of the contracts they enter into. We therefore tested this assumption in a Consumer Remedies Experiment in which consumers are provided what courts consider to be “clearly” worded and enforceable (even though highly unfair) limitation of remedies clauses. We found that a large percentage of participants in the experiment had trouble understanding the negative ramifications of these “clearly” worded clauses, thus undercutting the premise upon which the concept of enforcing “bargained for” contract terms rests. As reflected in our experiment, participants rarely understood the rights they have upon default and therefore did not understand the rights they “bargained away” when they signed developer based form contracts. The article also considers the implication of this finding on the debate over the unauthorized practice of law, and argues that this result, and other data reported on in the article, provide important evidence of the public benefit from buyers having an attorney to consult with at the contract formation stage when purchasing a home. The article reports on other data collected and then details four areas of legal reform in light of this data to better protect home purchasers: (i) revise the unauthorized practice of law rules to mandate attorney review and approval of home purchase contracts, further requiring such attorneys to be specially trained and licensed for this type of representation, (ii) enact legislation that prohibits remedies clauses that limit buyers’ remedies to return of earnest money and create safe harbor rules based on mutuality of remedy and true bargaining in the home purchase contract, (iii) replace the substantive unconscionability test with a “reasonable limitation of remedy” test in the home purchase context for limitation-of-remedies clauses, and (iv) enact legislation requiring attorneys’ fees to the prevailing party in the context of enforcing rights in a home purchase agreement when the counterparty is a real estate developer.