Memorandum of understanding in real estate

What is a memorandum of understanding in real estate? Although it is not a detailed purchase agreement, a properly formulated memorandum has legal validity in Israel, and the signer can be required to either go through with purchasing the property or compensate the seller if he or she decides to back out of the deal.

One day an attorney of ours received an urgent phone call. On the other end of the line was Maya, who said that she had innocently signed a memorandum of understanding to purchase an apartment, but has since changed her mind and now wants to retract her signature. During the conversation, Maya found out that she had made a grave mistake — she had assumed that only a purchase agreement could legally obligate her to purchase the property, but now discovered that a real estate memorandum is a legally binding contract for all intents and purposes.

Maya’s story shows that people simply do not understand the significance of signing a “pre-transaction” memorandum of agreement, which is extremely problematic. Most people sign memorandums without giving them much thought and without having properly assessed the apartment for sale – “It is not yet the final contract, it is just a summary to show that I am serious”. In this article we provide a detailed explanation of when it is appropriate to sign a memorandum of understanding and what the requirements are for it to be legally valid. In addition, we offer advice on how to proceed if you have already signed a real estate memorandum but wish to back out of the deal.

What is a memorandum of understanding in real estate?

A memorandum of understanding is a document that is usually drafted and signed during negotiations on the sale and purchase of residential apartments, but sometimes it is used in other real estate transactions as well. The document usually includes a commitment by both parties to sign a contract within a few days, by a certain date agreed upon by both parties. The document is not drawn up by an attorney; it is formulated by the parties who wish to put into writing their initial agreement regarding the property for sale.

Another factor that distinguishes memorandums of understanding from purchase agreements is the relatively small number of details they contain. In most cases, the document consists of a single page containing only basic details, and it certainly does not include the buyer and seller’s commitments and declarations that are required to close this type of transaction.

Do memorandums have legal validity?

The answer is yes. Unequivocally yes. Many people think that if the document is “only” a summary of the preliminary details agreed upon between the two parties, then the injured party has no grounds to sue the violating party, but this is a major error that may cost a fortune.

According to Israeli real estate law, a commitment to carry out a real estate transaction requires a written document, and a signed memorandum of understanding meets this condition. Court rulings over the years have emphasized that the law does not define a required format for the agreement, but rather that it be a written document; therefore, memorandums of understanding have full legal validity.

Conditions for legal validity:

The law defines two conditions that must be met in conjunction for a document to be legally binding. If one of the conditions is not met, it may be enough to make the memorandum of understanding legally invalid, so if you have signed such a document, check whether it fulfills both these conditions:

Specificity – for the document to be legally valid, it must contain the full details of the parties involved and of the property, in addition to the details of the transaction. The required details: the identities of the parties, a description of the property, its price, and dates of payment and transfer of ownership.

If any of the above details is missing from the document, it is not legally valid!

Resolve – the court will evaluate the document signed by the parties and conclude from it whether the parties have resolved to enter into a binding legal transaction. In rulings, this is defined as the “coincidence of wants” of both parties in relation to the property in question.

If there was proven to be no resolve, the document is not legally valid!

An unsigned memorandum of understanding:

Over the years, the jurisprudence regarding memorandums of understanding has developed, due to the large number of cases in which such memorandums were written and signed and then one of the parties sought to back out of the deal (the large number of court cases serves as further evidence for why it is not always advisable to sign memorandums of understanding).

The most dramatic ruling on this subject is that of the Supreme Court in Butkovski v. Gat, where it was ruled that even an unsigned memorandum of understanding can be legally valid under certain circumstances.

This unprecedented ruling dealt with a company that offered a lot for sale. The buyers held several meetings with the company’s representatives and in one of the meetings they reached an agreement. The selling company’s representative took some pages from a notebook and wrote down the details of the transaction.

The seller wrote down the full details of the property, in accordance with the legal requirement, but she did not sign the document; she only concluded with the buyers that they would meet the next day at the attorney’s office to sign a purchase agreement.

The district court rejected the buyers’ claim, but the Supreme Court reversed the decision. It was ruled that, according to the circumstances, the meeting had specificity, because of the formulated document, and it also had resolve, since the seller had made up her mind to close the deal. Therefore, the document she wrote was legally binding even though the parties did not sign it.

The downsides of signing memorandums in real estate:

If you have made it this far, you have probably been convinced that you should be wary of signing or even “merely” drafting a memorandum of understanding. Instead, you should choose a professional real estate attorney and follow their instructions beginning from the negotiation stage.

Nevertheless, here are the main problems with memorandums of understanding, and why they should be avoided:

First and foremost, there are the legal rights to the property – picture yourself, a moment after signing the memorandum, during the routine preliminary inspections before signing a purchase agreement, discovering that there is a lien on the property, or construction violations or anything else that reduces the value of the property but that you could not have seen at the time of signing the memorandum.

Memorandums of understanding do not specify important details necessary for a safe transaction, such as conditions on taking out a mortgage, attestations to the fact that the apartment has no prior tax obligations and other matters that may prevent its legal registration, as well as many other problems that can arise after having signed a memorandum.

So, to sign or not to sign?

The initial answer is no. There is no legal benefit in signing a memorandum before a real estate transaction. If you find a property at a bargain price, do not be tempted to sign what the seller is asking you to, even if he tells you, “If you don’t sign, I’ll sell it to someone else.”

If the deal is too good to walk away from, it is worth consulting with a real estate attorney who will speak to the other party before you sign. Even if you do sign a memorandum of understanding, an attorney can ensure that you are not committing to something that you are not ready to commit to, and prevent future problems by inserting a few simple clauses.

We recommend adding a clause that sets a target date for signing a purchase agreement, so that if an agreement is not signed by the specified date for any reason, the memorandum will be voided and neither party will have a claim against the other. The second clause we recommend adding is one making the memorandum conditional on the results of preliminary inspections regarding the legal, structural and physical condition of the property. This clause will allow you to back out of the transaction if you discover a defect in one of these aspects.

Another clause that should be added is one that states that the buyer cannot register a caveat based on the memorandum of understanding, only on the purchase agreement, as is customary.