Cancellation Clause: Everything You Need to Know
Cancellation clause in a contract allows one or both parties to end the contract before it is expired as long as certain terms or conditions can be met.3 min read
2. Strengthening a Purchase Agreement by Cancellation Clause
3. Failure of the Buyer to Perform
4. Buyer's Failure to Close Escrow
Updated November 11, 2020:
A cancellation clause is included in a contract or an agreement to allow one or both parties to terminate the contract before it is expired as long as certain terms or conditions can be met. For example, in an insurance agreement, a cancellation clause will allow you to cancel the health, casualty, or property insurance before the date the policy expires.
Typically, cancellation clauses will require that the party seeking the cancellation to provide written notice of cancellation. It is important to realize that life insurance policies will not contain this clause and even though these clauses are in the policy, it does not automatically allow the insurer to cancel the policy. Once the cancellation has been completed, the insurance company will then be obligated to refund premiums that have been prepaid on a pro-rata basis. For example, if a policyholder were to have prepaid a six-month premium and canceled after two months, the insurance company would be required to refund the four months back to the party that was insured.
A cancellation notice will often require 30-day advanced notice, as well as an explanation for why they are terminating the policy. If the policy is a non-renewable one, the insurer will often follow the same procedures of cancellation.
Cancellation Clause Language
A cancellation clause will include language that clearly defines the steps and procedures for the parties to cancel the agreement. It will often include:
- The process for cancellation
- The time frame that cancellation must be sent
- The procedure if the party creating the agreement chooses to cancel
- A disclaimer that if the cancellation policy procedure is not completed, parties will not be liable
Strengthening a Purchase Agreement by Cancellation Clause
One question that often comes up when discussing cancellation clauses is in the case of real estate. Some sellers want to know if they can put verbiage in their contract that would allow them to cancel the sale of their home even if they have accepted an offer.
In the state of California, a seller's Residential Purchase Agreement and Joint Escrow Instructions will set forth provisions that allow the seller the ability to cancel the contract in certain situations. Though a seller can cancel the agreement, they are required to provide written notice such as:
- A Notice to Buyer to Perform
- Demand to Close Escrow
Failure of the Buyer to Perform
A purchase contract can be canceled by a seller if they have failed to comply with the provisions outlined in the agreement. This would be considered a failure of the buyer to perform. In the Notice for the Buyer to Perform that the seller can send, they will need to include:
- A section that removes all contingencies
- A section where the seller requests that the buyer take specific actions that were required in the purchase order
In the first section, the buyer will be requested to remove contingencies. These can include removing:
- A loan contingency
- An appraisal contingency
- Approval of homeowners association documents
- Approval of investigations and inspections
The second section will be where the buyer is compelled to perform an action such as:
- Depositing earnest money into escrow
- Providing a letter of loan prequalification
- Verifying the down payment and closing costs
- Returning a signed copy of Real Estate Transfer Disclosure Statement, Natural Hazard Disclosure Statement, Federal Lead-Based Paint Disclosures
- Returning a signed copy of liquidated damages
Once a Notice for Buyer to Perform has been sent, the buyer will have at least two days to complete the actions. If the action is not met the seller can cancel the agreement. It will not automatically be canceled, and the escrow company will require both parties to sign a cancellation.
Buyer's Failure to Close Escrow
The seller also has the right to cancel the purchase agreement if the buyer fails to close escrow on time. The buyer must be provided with a Demand to Close Escrow letter before providing notice of the cancellation. Though, even if the buyer does not meet the demand for escrow, the agreement is not automatically canceled without an officially written cancellation as well as a deposit release.
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