Found a defect at preclosing home walk-though: How do we make sure the seller pays?

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Question:

I’m in a contract to buy a house, and the closing is in two days. It rained hard the night before my walk-though. When my broker and I entered the house the next morning, we saw a stream of water running from a drain outside, going under the patio door and through the living room. In addition to whatever caused the leak itself, which has not been determined, the basement carpet is wet and stained. We’re negotiating with the seller to pay for repairs, but how exactly will this be handled financially, with the closing so soon?

Answer:

To ensure that the seller makes the repairs, and honors all of the other, related promises from your negotiations before the closing, you should create a repair escrow.

To do so, at or prior to the closing, you and the seller should write out an agreement spelling out all of the repair work to be completed by the seller, the procedure for paying contractors who do the work and refunding the balance back to the seller, and any other terms you have negotiated. Then, at the closing, you ask the settlement agent to hold back the seller’s proceeds, or a portion of the proceeds, and place the money into an escrow account.

The settlement agent for your closing, be it the title insurance company or a separate escrow company, may be the best choice for “escrowee,” the party to hold the seller’s proceeds, and to follow the instructions you and the seller describe in the agreement. Title and escrow companies are in the business of holding funds and making payments based on instructions listed in escrow agreements. Given that this company is already settling your closing of escrow, it may act as escrowee for this separate arrangement, for a small additional fee. The title or escrow company will give you a form document, called “escrow instructions,” which you can use as a starting point for your agreement. In states where the closing is done by an attorney, the attorney acting as your settlement agent can be the escrowee and help you prepare the agreement. Sometimes, the listing agent will act as escrowee.

If you have a lender, the escrowee will show the portion of the seller’s proceeds going into the repair escrow on the settlement statement or HUD-1, and will notify the lender. The lender must approve of the repair escrow and how it is shown on the HUD-1.

In addition to stating the amount of money to be held, and designating the escrowee, the agreement should include a detailed description of the work and a list of the documents the seller will furnish to prove that the work is complete, completed properly, and that the contractors have been fully paid.

The agreement may also include a description of the warranties you will receive from the contractors, if any, and any other terms to be met before the escrow company may disburse the balance of the sale proceeds to the seller.

If possible, you should get a plumber out to the property right away, to give you a description of the work expected and an estimate of the cost. However, so near to the closing, it might be difficult to do this. If you cannot get an estimate before the closing, you and the seller can agree that all of the proceeds of the closing will be held in the repair escrow until the estimate becomes available.

If the full amount of the sales proceeds far exceeds the expected cost of the repairs, you can agree to some smaller portion of the proceeds, but do not be afraid to ask for an amount that exceeds the expected repair costs before you know the extent of the problem. It is possible, and even likely, that the cause of the leak involves more work than everyone might originally believe to be the case. A leak as you describe might be caused by a broken drain, broken drainage tiles underneath the property, incorrect grading, roots growing in the drain, or problems at the buffalo box that connects the property to the municipal water line or sewer.

If you receive the plumber’s estimate, and it shows that the work will be less costly than the amount held, you can disburse the excess proceeds to the seller and hold an amount closer to the amount shown in the estimate. However, even after you receive the estimate, you should continue to hold an amount of money substantially greater than the estimate, as a cushion for any unexpected problems completing the repairs.

The agreement should describe the repair work to be done in as much detail as possible. If little detail is known before the closing, you can always state that the agreement will be amended when the plumber’s estimate is received, and then attach it as an exhibit to the agreement when it is received.

Also, the repair escrow should outline the procedure that the escrowee will use to pay the contractors. You can require that the escrowee pay the contractors directly from the funds held in the repair escrow rather than allowing the seller to pay the contractors, and seek reimbursement from the repair escrow. It is particularly important that the escrowee pay contractors directly from the funds in the repair escrow if you live in a state where an unpaid contractor may automatically receive an interest in the property similar to a mortgage called a “mechanic’s lien.” In states where an unpaid contractor may acquire a mechanic’s lien, the contractor should give the escrowee construction paperwork before receiving payment.

Construction paperwork includes a “contractor’s sworn statement,” and “lien waivers.” The contractor’s sworn statement is a standardized form that complies with the construction laws of your state. On the form, the contractor lists any subcontractors who completed a portion of the work under the contractor’s supervision, and the portion of the contract price that should be paid to the listed subcontractors. Then, in exchange for payment, each contractor and subcontractor gives the escrowee a lien waiver. A lien waiver is like a receipt, but has the special legal effect of preventing the contractor or subcontractor from acquiring a lien on the property.

The agreement may include additional provisions to ensure that the repairs are done in a skilled and well-executed manner. You may ask for time to inspect the work before payment is made, and require remediation, or the payment of damages, for incomplete or faulty work. The contractor should give all warranties to you in your name, and not to the seller. Include details about what will happen to the money in the repair escrow if the work is not completed in a timely fashion. As the buyer, you may want to include a schedule of increasing penalties to the seller, and state that you will have the right to use the funds in the escrow account to complete the repairs yourself.

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