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A Contract Series – Part 7

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Arizona REALTORS® Residential Resale Purchase Contract – Due Diligence Section

This is Part 7a of a series of articles discussing the major provisions in each of the sections of the Arizona REALTORS® Residential Resale Real Estate Purchase Contract (10/22) (“Contract”). The Due Diligence Section is addressed in two sub-parts. This article will address the buyer’s due diligence and the next article will address the Inspection Notice and Buyer Disapproval process. The previous articles in this series can be located at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com).

All homes have flaws, even those well-maintained or newly built. Conducting due diligence before closing escrow on a home is a crucial step for a buyer. The buyer’s failure to conduct their due diligence can lead to unanticipated costs or problems after close of escrow (“COE”) and ultimately lead to a dispute or claim against the seller and/or brokers in the transaction.   If the during their due diligence period the buyer discovers home defects that they would like fixed, pursuant to the Contract, the buyer has time to negotiate with the seller, who may agree to fix the defects, credit the buyer for anticipated costs, buy down the buyer’s interest rate or even lower the purchase price.

DUE DILIGENCE SECTION

This section is entitled “Due Diligence” to reflect the fact that both inspections and investigations of the home should be performed during the Inspection Period.

Inspection Period

The buyer’s inspection period is 10 days after Contract acceptance unless otherwise indicated. During the inspection period, the contract obligates the buyer to:

  • conduct all desired physical, environmental and other types of inspections and investigations to determine the value and condition of the premises;
  • make inquiries and consult government agencies, lenders, insurance agents, architects and other appropriate persons and entities concerning the suitability of the premises and the surrounding area;
  • investigate applicable building, zoning, fire, health and safety codes to determine any potential hazards or defects in the premises; and
  • verify any material multiple listing service (MLS) information.

The buyer is also advised to investigate the presence of sex offenders in the vicinity or the occurrence of a disease, natural death, suicide, homicide or other crime on the premises or in the vicinity, if deemed material.   

The buyer is advised to consult the Buyer Advisory provided by AAR to assist in the due diligence inspections and investigations.

  • Emphasize to the buyer the importance of using the Buyer Advisory to investigate the property as the advisory is intended to prompt the buyer to consider investigating items that the buyer may not have previously considered.
  • Consider using the Buyer Advisory to investigate your own home.  This exercise will assist you in becoming more familiar with all the resources available and help you educate your buyers.

The buyer remains obligated to keep the premises free and clear of liens, indemnify and hold the seller harmless from all liability and repair all damages arising from the inspections.

The buyer is also obligated to provide the seller and broker(s), at no cost, copies of all inspection reports concerning the premises upon receipt. 

Square Footage

The buyer is advised that any reference to square footage is approximate and must be investigated during the inspection period if material. The Contract states:

“BUYER IS AWARE THAT ANY REFERENCE TO THE SQUARE FOOTAGE OF THE PREMISES, BOTH THE REAL PROPERTY (LAND) AND IMPROVEMENTS THEREON, IS APPROXIMATE. IF SQUARE FOOTAGE IS A MATERIAL MATTER TO THE BUYER, IT MUST BE VERIFIED DURING THE INSPECTION PERIOD.”

  • This language should bar a buyer’s claim for misrepresentation as to the square footage of the property.
  • The subsection places squarely on the buyer the burden of verifying the square footage, which can be done by an appraiser or architect.   

Wood-destroying Organism or Insect Inspection

If current or past wood-destroying organisms or insects (such as termites) are a material matter, the buyer must investigate the issue during the inspection period at buyer’s expense. If the lender requires an updated Wood-destroying Insect Inspection Report prior to COE, it will also be performed at buyer’s expense.

  • If wood infestation is found during the updated inspection and the lender requires it to be treated before approving the buyer’s loan, the buyer and seller will be required to negotiate whether the treatment will be performed and, if so, at whose expense.
  • If the treatment is not performed and the lender will not approve the buyer’s loan, the unfulfilled loan contingency provisions will apply.

Flood Hazard

The buyer is obligated to determineflood hazard designations or the cost of flood hazard insurance during the inspection period. The buyer is advised that if the home is in a special flood hazard area, the lender may require the purchase of flood hazard insurance and it may also affect the ability to encumber or improve the premises.

  • The Federal Emergency Management Agency (FEMA) maps flood hazard zones and these maps are used to determine flood insurance rates.  A buyer can enter the property address at the  FEMA Flood Map Service Center to investigate whether the property is in a flood hazard zone. 

Insurance

If homeowner’s insurance is material, the buyer is obligated to apply for and obtain written confirmation of the availability and cost of homeowner’s insurance during the Inspection Period. The buyer is advised that any desired insurance should be in place at COE.

Sewer or On-site Wastewater Treatment System

This paragraph indicates whether the premises is connected to a sewer system, conventional septic system, or alternative system and must be initialed in every transaction. It is important to mote that the premises may be served by more than one of these systems and, if that is the case, it should be documented by the seller in the SPDS. 

If a sewer connection is a material matter to the buyer, it must be investigated during the inspection period.

If the premises are served by a conventional septic or alternative system, the AAR On-Site_Wastewater_Treatment_Facility_Addendum should be completed and is incorporated into the Contract.

  • This addendum addresses the required pre-transfer inspection, conventional septic system pumping, documents that the Contract requires the seller to provide to the buyer, repair costs, buyer disapproval, the required notice of transfer form, transfer fees and any additional terms. 
  • Pursuant to Arizona Department of Environmental Quality (“ADEQ”) Rule, all on-site wastewater treatment systems must be inspected prior to transfer. A.A.C. R18-9-A316 requires that within six months before COE, the seller must retain a qualified inspector to perform a transfer of ownership inspection of the on-site wastewater treatment facility. See On-site Inspection and Transfer (azdeq.gov)  for the ADEQ Instructions For Preparing A Report of Inspection for more information. 

Swimming Pool Barrier Regulations

During the Inspection Period, the buyer agrees to investigate all applicable state, county and municipal swimming pool barrier regulations and agrees to comply with and pay all costs of compliance prior to occupying the premises unless otherwise agreed. If the home contains a swimming pool, the buyer acknowledges receipt of the Arizona Department of Health Services approved private pool safety notice, which can be found at residential-pool-safety-notice.pdf (azdhs.gov).

  • Because of the importance of educating all buyers about pool safety, the buyer should initial this paragraph in every transaction, whether or not there is currently a pool on the premises.

Buyer Acknowledgment

The buyer recognizes, acknowledges, and agrees that the broker(s) is not qualified, nor licensed, to conduct due diligence with respect to the premises or the surrounding area.  The buyer is instructed to consult with qualified licensed professionals to assist in the buyer’s due diligence efforts. Because conducting due diligence with respect to the premises and the sur­rounding area is beyond the scope of the broker’s expertise and licensing, the buyer releases and holds harmless broker(s) from liability for any defects or conditions that could have been discovered by inspection or investigation.

  • This provision should be initialed in every transaction. 
  • However, keep in mind that The Arizona Department of Real Estate (ADRE) Commissioner’s Rule A.A.C R4-28-1101(I) requires that a real estate agent take reasonable steps to assist a client in verifying the accuracy of information relevant to the transaction.. The rule also requires reasonable care in obtaining information material to a client’s interests and relevant to the transaction and that an agent accurately communicates this information to the client.  See:  Applying “Trust but Verify” in a Real Estate Transaction.  

Home Warranty Plan

The buyer and seller are advised to investigate the various home warranty plans and acknowledge that different home warranty plans have different coverage options, exclusions, limitations and service fees. Also, most plans exclude preexisting conditions. If a home warranty plan is to be purchased, the Contract specifies who is responsible for ordering it, with what options, from what company, and at a cost not to exceed a specified amount.  If the buyer declines the purchase of a home warranty plan, the buyer’s election should be indicated.  In either case, the buyer’s initials are required by this section. 

Walkthrough(s)

The seller grants the buyer and buyer’s inspector(s) reasonable access to conduct walkthrough(s) of the premises for the purpose of satisfying the buyer that any agreed upon corrections or repairs have been completed, and that the premises are in substantially the same condition as of the date of contract acceptance. If the buyer does not conduct the allowed walkthrough(s), the buyer releases the seller and broker(s) from liability for any defects that could have been discovered. 

  • The walkthrough provision recognizes that more than one walkthrough may be required, i.e., the buyer may desire a walkthrough three days prior to COE to confirm agreed upon repairs have been completed.
  • A buyer should conduct their pre-closing walkthrough at least three days prior to the scheduled date for close of escrow and utilize the  Buyer Pre-Closing Walkthrough form.

Seller’s Responsibility Regarding Inspections and Walkthrough(s)

The seller is obligated to make the premises available for all inspections and walkthrough(s) upon reasonable notice by the buyer. The seller is also obligated to have all utilities on, including any propane, until COE to enable the buyer to conduct these inspections and walkthrough(s).

  • If the seller fails to make the premises available for inspections or walkthroughs, or fails to have all utilities on, the buyer should issue the seller a cure notice pursuant to Section 7a.  If cured by the seller, the parties should then execute a written agreement to extend the buyer’s inspection or walkthrough for the length of time of the delay caused by the potential breach. 

IRS & FIRPTA Reporting (Foreign Sellers)

The Foreign Investment in Real Property Tax Act (‘FIRPTA) provides that if a seller is a Foreign Person, the buyer must withhold federal income taxes up to 15% of the purchase price unless an exception applies.  If FIRPTA is applicable and the buyer fails to withhold the tax, the buyer may be held liable for the tax. The buyer agrees to perform any acts reasonable or necessary to comply with FIRPTA and IRS reporting requirements and the buyer is responsible for obtaining independent legal and tax advice. 

Next Article – Due Diligence:  Inspection Notice and Buyer Disapproval

K. Michelle Lind, Esq. is an attorney who currently serves Of Counsel to the Arizona REALTORS®.  She is also the author of the book – Arizona Real Estate: A Professional’s Guide to Law and Practice (3rd Ed.) . 

For more real estate related articles, visit Michelle’s Blog at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com) This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.  4/13/23