Purchasing Property with Driveway Encroaching on Neighbor's Land

[Brent Seehusen]

I have a duplex under contract that is scheduled to close in 5 days.  Everything was going along smoothly until this morning when I received the sellers' disclosures which noted that the land owner next door believes one of the driveways is encroaching on his raw land.  

In looking at the Zillow aerial view it appears that the neighbor has a case:

The current owner didn't install the driveway and it wasn't disclosed to him that this might be an encroachment issue when he bought.  He found out when the owner of the raw land to the South sent him a letter and asked for $8-9k for an easement or title, not sure which.  

They never reached an agreement and the issue is still floating out there.

Here's an added complication... I signed on off on all contingencies yesterday afternoon and this seller disclosure magically appears in my inbox this morning.  It might have been my own realtors fault for not forwarding it to me but she's being a little vague about it.  So if I decide to back out of this deal the seller might try to keep my $2k deposit and we might end up in arbitration.

The way I see it, it might cost $4-5k to demolish the driveway and that's also the fair market value of the entire vacant lot to the South, not just the strip that the driveway sits on. If I proceed with this deal, does anybody see other costs/liabilities or risks that might go beyond being required to demolish the driveway?

It sure feels like the seller was trying to offload this problem and sneak it past me.  Just for additional context, here are some other facts:

1. The seller bought 6 months ago.  Now wants to sell claiming it was too hard to manage long distance.

2. The seller originally wanted all contingencies signed off in 10 days, but we got it pushed back to 15 days.

3. The seller wanted a 3% deposit instead of the customary $500 or $1,000 for this area.

4. They have generally dragged their feet throughout this transaction, but now that I signed off on all contingencies, I get this surprise in my inbox one day later.

What do you think?  Move forward with additional price negotiation?  Pull out?  What additional risks would I be taking on if I bought this place?