DEFINITION of 'Contingency Clause'

A contingency clause is a contract provision that requires a specific event or action to take place in order for the contract to be considered valid. If the party that is to fulfill the requirements of the contingency clause is unable to do so, the other party is released from its obligations. A contingency clause can be considered a type of escape clause for those involved in the contract. It allows one party to cancel a deal if certain requirements are not met, though the party benefiting from the clause has the right to waive it.

BREAKING DOWN 'Contingency Clause'

A contingency clause can be inserted into a contract to benefit either party. Courts often require a good faith effort in contracts that contain these clauses. For example, a contingency clause in a real estate transaction may require the buyer to obtain financing before the seller transfers the deed. If the buyer cannot bring together sufficient funds to complete the sale, then both parties may have the right to walk away from the deal.

Ways Contingency Clauses Can Change an Agreed Upon Deal

Contingency clauses for real estate transactions can also be based on other determinant factors such as the return of a satisfactory inspection report. There may be damage to the foundation of a property or other unseen issues that were not detected when the buyer first looked at a property. The presence of hidden problems such as termites, the tendency for the property to flood or the spread of black mold could trigger contingency clauses. The seller could be compelled to pay the expenses necessary to mitigate these issues. If they do not, the buyer may have the right to call off the transaction or demand a reduction in the sale price for the property.

The appraised value of the property could also set off contingency clauses as well. The lender who is providing the mortgage for the property will send an appraiser to assess its value, which could result in the mortgage being reduced. If the property is determined to be of lower value than the negotiated sale, the lender is not going to cover that difference. This could prompt a contingency clause that lets the buyer request a lower price or they can abandon the transaction.

Paying close attention to the wording of a contingency clause is an important step in contract review. A loosely worded clause may provide either party too much latitude in determining whether the terms of a contract are being properly executed. A contingency clause should clearly outline what the condition is, how the condition is to be fulfilled, and which party is responsible for fulfilling it. The clause should provide a timeframe and what happens if the condition is not met.

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