CALIFORNIA – The California Supreme Court has upheld and clarified protections for real estate buyers to have time to investigate properties before purchase, particularly for developers in hot markets.

Experts said the ruling levels the playing field, requiring more upfront commitments from buyers but protecting them from losing their option after significant exploratory  investment.

The so-called "free look" option to acquire real estate really isn't free if a developer wants to ensure that the seller doesn't revoke the option in favor of another buyer while investigating how difficult a particular parcel will be to develop, according to the court's March 18 opinion in Martin A. Steiner v. Paul Thexton and Siddiqui Family Partnership.

The court affirmed a 2008 appeals court decision that a document labeled as a sale contract is really an option to purchase if the buyer has an "escape clause" giving "sole and absolute discretion" to walk away from the deal, even if contingencies in the document are satisfied.

The seller may revoke an option with such an "escape clause." However, the option becomes irrevocable if the potential buyer gives the seller "sufficient consideration," though the court didn't specify what would be enough.

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"There's no such thing as a 'free look,'" said Katherine Oberle, a real estate attorney with Walnut Creek-based Morgan Miller Blair, which has represented North Bay developers, investors and landlords.

The appeals court ruling surprised real estate developers who relied on such an "escape clause" to investigate properties, particularly during the real estate boom, according to Ms. Oberle.

"It was very common for buyers to tie up a piece of property while they investigated it or got approvals," she said. Some options lasted only for a few weeks, or a weekend in a few cases.

In the case, Mr. Steiner wanted to develop homes on 10 acres of a 12-acre parcel in the Sacramento area where Mr. Thexton lived. In a sale agreement he drafted in 2003, Mr. Steiner offered to buy the land in three years for $500,000 if he was able to obtain the lot split for Mr. Thexton's house and project approvals and permits. Mr. Thexton went along with application for a tentative parcel map in 2004.

By that October, Mr. Thexton said he no longer wanted to sell, but Mr. Steiner pursued entitlements and obtained map approval. Mr. Steiner then sued for specific performance of the agreement.

The trial court sided with Mr. Thexton, saying that the $1,000 provided at the opening of escrow wasn't "consideration" for the seller and was then a revocable option. The court rejected Mr. Steiner's argument that the option required him to pursue entitlements because of the escape clause and that the claimed $60,000 in engineering and other entitlement work done couldn't make the option irrevocable.

The appeals court agreed.

The Supreme Court decided the option was revocable at the outset, but the work done thereafter counted as consideration.

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Tux Tuxhorn, whose Santa Rosa-based company developed and sold hundreds of acres of property to homebuilders in Sonoma County, said the environmental regulations and government entitlement requirements, sometimes conflicting, make it extremely difficult even for experienced developers to buy property without significant due diligence.

"When the market was way too hot, land sellers said, 'Gimmie cash, or I have four other guys in line,'" Mr. Tuxhorn said. "If you look around, you will see a lot of people in trouble because they paid cash instead of taking a 'free look' in optioning."

Basics of real estate investment "went out the window," with builders buying hundreds of acres as home prices were appreciating in double digits annually, because sellers were getting multiple offers, according to Mr. Tuxhorn. For the past two years, his company has been consulting with banks and accountants on determining value of properties taken back from developers.

Mr. Tuxhorn said the court decision will give developers the time they need to investigate the cost and time required for development.

"When we go back to a more normal market we will see more developers taking options and find ways to minimize risk going forward," he said.

Standard contracts produced by the California Association of Realtors, which filed a brief in the case, have been changed since the appeals court ruling to require separate consideration for the option portion of a contract, according to Ms. Oberle.

But attorneys should review whether an option agreement obligates a prospective buyer to "confer a benefit" to the seller or "suffer a prejudice" and whether such benefits or prejudices induced the seller to offer the option.

That means any contractual consideration needs to be spelled out in the contract and actually paid, as it hadn't been in one of the cases the Supreme Court cited, according to Ms. Oberle.

Steiner v. Thexton is case No. S164928.