When is reasonable to terminate based on a building and pest inspection report?

Residential sales agents have recently raised concerns about some buyers relying on a common special condition - that the contract is subject to the buyer obtaining a "building and pest inspection" - to ‘unreasonably’ justify the termination of a contract of sale or to seek to negotiate the sale price.

Examples of this include buyers pointing to statements made in inspection reports such as “garage floor needs cleaning”, or “cracked bathroom tile” as grounds to terminate or renegotiate.

The standard clause in Queensland

In other States [1], in order for a buyer to rely on a building and pest inspection report to terminate a contract, the issue identified must be acknowledged as “material”, “substantial” or “major”.

However, as Queensland agents are aware, the terms of the REIQ standard residential land sale contract provides that a buyer seeking to terminate based on a building and pest inspection report, must only “act reasonably”. [2]

But what does that mean?

A seller is afforded the right, under clause 4.2(3) of the standard contract, to test whether the buyer has “acted reasonably” by requiring the buyer to produce a copy of the report relied upon to justify the termination “without delay”. The report should be considered in the assessment of what is “reasonable”.

The test for reasonableness

The question of whether or not a buyer has acted “reasonably” in terminating based upon a building and pest inspection report, is best answered by an objective assessment. This includes consideration of issues such as:

• the age of the property;
• the severity of the building and pest problems;
• whether the issues identified in the report were evident upon inspection; and
• the potential cost of the rectification of the defects so identified.

Matters which would, unarguably and objectively, be considered to be sufficiently serious to warrant termination of the contract include matters affecting the value or liveability of the property, such as:

• a major termite infestation;
• latent structural damage;
• extensive water damage.

Issues which might be considered to be of subjective importance and, therefore, not justify termination, include cosmetic issues such as:

• general deterioration;
• wear and tear;
• weathering; or
• cleanliness.

On this basis, a termination based on the prior example of cleanliness of the garage floor or a cracked bathroom tile would be unreasonable.

Can the clause be improved?

To try and improve on clause 4.2, some Queensland agents are reportedly incorporating special conditions into contracts. Examples include:

• Stipulating that the cost to remedy defects must exceed a certain monetary threshold before termination can be justified;
• Specifying that only “major”, “material” or “substantial” defects, or those affecting the structural integrity of the property, will allow the buyer to terminate.

However, there are risks and challenges associated with the use of such special conditions.

• Risk of providing legal advice: this may be considered as the agent impermissibly providing legal advice. It is recommended that special conditions be prepared by the sellers’ solicitors.
• Clarity may not be improved: Adding terms like “material” or “substantial” may not clarify the standard. Arguably, it adds another ambiguous threshold because the question then becomes what is a “substantial” defect, rather than what is it to act “reasonably”?
• Practical limitations: It is not standard industry practice for building and pest inspectors to provide dollar estimates for rectification of the defects identified in their reports. It raises the question of who would determine the estimated cost to remediate.

If the condition is to have any currency, it’s important that the building and pest inspector is made aware of it so they can tailor their report to include a categorisation of the defects - such as “major” or “minor” and a “dollar value” for the rectification of any defects.

Please note, even if the inspector categorises certain defects as “minor” and others as “major”, a successful argument might still be mounted by a buyer seeking to escape the contract based on a number of “minor defects”.

What should agents do?

Even if an agent suspects that a buyer is acting unreasonably in relying on a building and pest inspection report to terminate a contract, the agent must not provide legal advice.

It is recommended that a selling agent refer the seller to their solicitors to seek legal advice on whether the buyer has acted reasonably. The seller’s solicitor may then:

• demand production of the building and pest inspection report,
• press the buyer to justify the decision,
• enter into negotiations with the buyer as to the rectification of the identified defect to preserve the sale.

The same approach of seeking a solicitor’s advice applies to agents acting on behalf of buyers who may be unsure about their position.

While agents often have highly informed and accurate opinions of what may be reasonable conduct, both the agent and the sellers are ultimately subject to the content of the building and pest inspection report and the buyer’s response to it. It is important to understand that a buyer may be able to justify termination based on the report if this is a condition, even if no major defects are identified.

There are very few reported cases in which a seller has sought to hold a buyer to a contract of sale by disputing reliance upon a building and pest inspection report. This is probably because reliance on the clause is often used by the parties as a springboard for further negotiations.

Conclusion

The building and pest inspection report clause affords a buyer an important and necessary right; but the right is one to be exercised “reasonably”.  Reasonableness is to be assessed objectively, in reference to the report commissioned, and in the context of the nature of the property under contract, and what was evident on inspection.

Ultimately, whether the buyer is allowed to terminate, renegotiate, or is pressed to complete the contract, is a matter for the seller to decide based on legal advice.

Read another article: Selling off-market: Seller disclosure obligations.

Or browse our suite of property sales articles.