If you haven't clouded the title, then you might want to do a title search to see if anyone else--other than the current lien holders--has placed a cloud on the title (as a double-check). If your title search comes back clean, then go and quickly place a cloud on the title. If otherwise, then you just learned the hard way that you should have recorded that contract. In that case, you could still contact a lawyer to pursue your legal options, but you'll be in a weaker position without the cloud on the title.
I am very sorry you are going through this. First of all, escrow cannot be opened until yours is cancelled. I would not sign anything to cancel until you have discussed this with your attorney. You may wish to talk to a real estate attorney about what you should do now. This makes no sense to me that now the seller will have to sell by doing a short sale for less that what is owed when you have a higher offer (I am assuming?)
My best advice to you is to talk to legal counsel to make sure this is taken care of correctly for you.
Joan Patterson, B.A., A.S.P., G.R.I., Realtor
Keller Williams Realty
8250 White Oak Avenue, Ste 102
Rancho Cucamonga, CA 91730