Letters of Intent are often a good place to start negotiations for all types of transactions. I’ve written about this before (see post HERE). They can be very helpful in setting the parties’ expectations and helping to draft the contract.  They work well as checklists for the essential points to be discussed.  However, LOIs should never be considered to be the final contract document, nor should they be considered to be binding on the parties as they do not contain all of the essential terms of the contract.

Most LOIs contain language making it absolutely clear that the LOI is non-binding and is merely an expression or outline of the parties’ interest in entering into a more formal, binding agreement. Until such an agreement is executed, the parties have no formal obligation to each other except perhaps, confidentiality and exclusivity for a specific period of time.

When an LOI gets too specific and a contract is not ever signed, disputes can and do arise. One or both parties might look to the LOI to “enforce” some right or a provision.  But, because the LOI is not binding, there is nothing to enforce.

This situation recently came across my desk. The client signed a LOI to sell the stock of his business nearly 6 months ago.  There were at least 5 occasions in the LOI stating that the LOI was not binding on the parties.  The LOI provided that the parties would “promptly” negotiate and execute a Share Purchase Agreement containing the economic terms in the LOI and regular and customary terms for similar transactions.  It provided that the Share Purchase Agreement would contain a 90 day due diligence period.  And, the LOI stated that if the Buyer “waived Due Diligence” and the Seller thereafter “failed to close,” Seller would reimburse Buyer’s due diligence costs up to $150,000.

Prior to and after the execution of the LOI, the Buyer conducted extensive due diligence on Seller’s company. Negotiations for the SPA began in earnest but were difficult for many reasons.  Both sides felt that the other side changed the business terms.  At the end of about 4 1/2 months, the Buyer agreed to “waive Due Diligence” by amendment to the LOI, yet Seller continued to provide financial records of the company that Buyer requested.  About 2 1/2 weeks later, Buyer broker off negotiations and made demand for reimbursement of its due diligence expenses, the entire $150,000.

Seller retained me to address the due diligence reimbursement issue. What were Seller’s rights?  Seller’s obligation to reimburse the expenses arose under the LOI.  But, the LOI, by its terms was not binding.  Of course, the Buyer could easily argue that this was one of those provisions, like confidentiality, that is binding.  However, Seller’s obligation to reimburse had 2 conditions precedent:  1) Buyer waive Due Diligence and 2) Seller fails to close.

Buyer argued that it had waived due diligence per the 2nd Amendment to LOI. I’m not sure that it did because the parties never entered a contract.  The LOI said that the contract would have a 90-day due diligence period.  Did Buyer waive that provision of the LOI or was it the provisions of the LOI allowing it to conduct due diligence prior to signing the contract?

But, assuming, for argument’s sake, that Buyer did waive due diligence, the 2nd condition precedent was not satisfied. Seller could not have failed to close because Seller had no obligation to close.  There was no binding contract.  No one agreed to anything – not the price, not the terms, not the closing date – nothing.  Therefore, Seller had no obligation to reimburse Buyer.

LOIs can be great. But if you never get to contract, all you have is a piece of paper and no rights.  My client, in this case, looks like it will lose this deal, but it will not have an obligation to pay Buyer.  This is a good result.  The Buyer, who was the more sophisticated party in this transaction and a bit of a bully, blew it.  They should have pushed for the contract ASAP so the due diligence clock would start.  Their strategy, whatever it was, backfired.

The holiday season is supposed to be a joyful time. Beginning at the start of November, as thoughts turn towards Thanksgiving turkey, cooler temperatures, family gatherings, Christmas, Chanukah, New Years and shopping, a certain contentment begins to settle in all around.  Or does it?

Certainly not in offices where real estate closings take place. Holiday season brings panic.  As year end approaches, the calendar is the enemy.  Everybody wants to close and everything is a rush.  A feeding frenzy has begun.

Why does this happen? I remember when I first began practicing, we always had to get 1 or 2 last big deals finished before the end of the year.  My senior partners always told me we had to do this for “tax reasons”.  The first couple of years, I assumed that this was because the client had tax planning reasons for closing by December 31.  I then came to realize that it was really for the firm’s cash flow needs that December 31 was critical.  Close the deals, collect large fees, partners get bonuses, don’t close, no fee, partners don’t get bonus.  Simple economics!

Later, when I started practicing on my own and money in the bank on 12/31 vs. 1/1 made no difference to me, we still had surges in November and December. But, if deals weren’t closed by the middle of December, many clients began to close up shop for the holidays, deciding to carry over the gain or loss until the next tax year.  Thus, 12/31 became an artificial deadline.  Sometime before 12/20 was the new deadline only for my own peace of mind.

Today, the feeding frenzy is as real as ever. It is true for residential and commercial closings.  Some of it might have to do with Trump tax reform.  But there are other factors.  First, we continue to ride a long, strong economy.  The real estate market remains strong and interest rates remain low.  With so many deals out there, clients want to close quickly to take advantage of the economic climate and interest rates before this changes.

Second, contracts signed early in the year, after everything closed at year end, run their course and have year end closing dates. There are 2 factors driving this.   Commercial deals are longer term.  Once the due diligence period has run its course and approval and other contingencies have been satisfied, closing must occur.  In a typical commercial contract, this can take 6-12 months, sometimes longer.  But when the date comes up, there is a rush to close.  Though you can’t predict when a contract will be signed, it does seem that many projects start at the beginning of the year which often times out the closing date for the end of the year.  As to residential contracts, many people put their homes up for sale in the summer, after the school year.  Consequently, contracts are often signed at the end of summer and early fall.  Closings usually take 60-90 days, which puts the closing right in the middle of the holiday period.

Third, cash deals are very common in both residential and small commercial contracts. Take a lender out of the picture and the process to close gets shorter.  Sellers like to accept cash contracts as it takes a major contingency out of the picture, further shortening the closing.  Sellers will accept lower purchase prices to get to closing faster.  If the expectation is a faster closing, a closing scheduled for the holiday time period will not likely carry over to the new year.

How do we cope with the frenzy and avoid becoming shark chum? Clients, brokers and other attorneys can sense stress immediately and when they do, they do what they can to add to it.  It is important to remain organized and up to date on every transaction, no matter the size, so that you never let the sharks smell the blood in the water.  If we do this, we will make it from Thanksgiving to New Years in one piece.

A personal guaranty is often the last requirement to finalizing a lease deal. Most landlords will require guaranties from all of the principals of the tenant and their spouses for closely held businesses that are leasing space in a property.  Though the tenant is the occupant and generating income and paying rent, the tenant itself generally has no net worth.  It is usually the practice of small businesses for owners to draw out most, if not all of the income of a business so that if there is a lease default, a landlord will have no remedy.  Therefore, lease guaranties are essential components to making a lease deal.

Yet, novice tenants are reluctant to sign personally, arguing that they have formed the entity specifically to avoid personal liability. They are quick to ask for lease incentives like large tenant improvement allowances and free rent, but they don’t comprehend the credit risk a landlord takes in entering these leases and providing incentives.  I have come across this problem several times in the past few months with tenants refusing to provide financial statements or guaranties or having their spouses guaranty the lease.  They will argue that a corporate financial statement from the start-up entity or an affiliate company should suffice.  Or, they think that the wife should not sign since she isn’t involved in the business.  Some offer short term (1-year) limited guaranties for longer term (10-year) leases.  How is the landlord to amortize and protect its investment under those terms?

Without the non-shareholder/member spouse as a co-guarantor, the shareholder/member spouse could easily avoid liability under a guaranty and lease by transferring personal assets to the spouse. Without personal financial statements or by providing only financial statements of the startup or an affiliate company, a landlord has no idea whether the people behind the tenant have the financial ability to fund, open and operate the business and cover losses in the future and pay the debt on default.  A landlord’s due diligence of a tenant and its principals should be akin to a bank’s underwriting of a loan.  Rent and lease incentives are not different than a loan.

Recently, in arguing these points with potential tenants, I have had one tenant walk away from a lease and another tenant partnership split up, leaving the financially stronger partner to solely own the business and guaranty the lease with his wife. Because these potential tenants were unwilling to provide the guaranties and/or complete financial information, we knew these were not good risks and fortunately, we never got to the point of spending the time or money of preparing leases.

A landlord should raise the issue of the guaranty early in lease discussions. If the tenant’s principal won’t provide one or won’t provide adequate financial information, landlords should end discussions and move on.

Many real estate and lease transactions begin with a letter of intent (LOI). An LOI is supposed to be a non-binding expression of interest between a buyer and seller of real estate or a landlord and tenant.  In a perfect world, the LOI should outline, in as much detail as possible, the salient business terms of the proposed transaction.  These would include the parties, purchase price or rent, closing date or lease term, contingencies, due diligence period, financial accommodations such as tenant improvement and who is responsible for closing and other expenses.  However, LOIs often are bare bones and leave many business points to be negotiated with the final contract or lease.  In these cases, what was the purpose of the LOI in the first place?

Sometimes, clients and brokers ask my input on preparation of LOIs. When they do, I try to make them as detailed as possible to that when I prepare the contract or lease later, I don’t have to re-negotiate.  More often, I am given a signed LOI and asked to prepare the contract or lease or worse, negotiate someone else’s document.  These LOIs regularly have missing or incomplete essential terms or ambiguities.  Therefore, we have issues that will have to be negotiated at the contract stage that the client and perhaps the broker intended to have put to rest with the execution of the LOI.

Another pitfall to LOIs is a negotiating strategy some people like to use. When I include a term in a draft of a document that the other side might not like, a common response is “that wasn’t in the LOI”.  These “strict constructionists” can’t honestly believe that a non-binding LOI acts as list of exclusive terms of the deal.  Similarly, if a client wants to modify or even tweak a term, the obstructionist won’t allow it because “that’s what the LOI says”.  People get too hung up on the 4 corners of the LOI, they ignore the provision that says it is non-binding or they just don’t want to make a deal.  Circumstances change between the LOI stage and the final contract.  The parties have had an opportunity to do a bit more due diligence, to talk with their partners, attorneys, bankers and other experts.  They have a more complete understanding of what needs to go in the final, binding deal.  The LOI is designed only to be a road map.  If one party gets too stuck on every word in the LOI, the deal will not get signed.

LOIs can be valuable tools, but only if they are drafted with the appropriate detail and only if the parties understand that until the contract is signed, nothing is final. If they are used otherwise, they can be costly and an obstruction to completing potentially valuable deals.

00179570

        When entering into a contract to purchase commercial real estate, experienced investors and developers generally understand that dozens of things could go wrong before the closing date that would prevent the closing from happening or could make the acquisition less than attractive, giving the buyer pause as to whether to close at all. As such, these buyers make certain that their contracts are well drafted and spell out all relevant provisions in detail. Their contracts contain explicit due diligence provisions and contingencies tailored for the specific transaction. All too often, I am faced with clients who are less sophisticated, anxious to make a deal and afraid they are going to “lose the property”. They push hard for me to back off important contract protections that could and will save them money and prevent litigation at a later date.

             Contingencies and due diligence are the 2 most important sections of any commercial real estate contract for a buyer. Taken together, these provisions can help the buyer determine whether the property is suitable for buyer’s intended use and whether the deal is feasible. They allow the buyer to assure that timing is adequate, that permits can be and will be obtained and that resources are in place. Therefore, it is critical that adequate time for due diligence be negotiated to allow the buyer to complete all tests, exams and evaluations. Contingencies might include approvals such as zoning, land use, site plan, environmental and financing. Other contingencies could be executed leases by a major tenant or sale of an existing property. Certainly, sellers will push back to shorten due diligence time periods and limit contingencies and the important thing for the buyer to remember and consider during this stage of negotiations is that the deal is not always such a “great deal”. If there is time to do inspections, it is possible to find that the property doesn’t suit the buyer’s needs. A zoning application can be denied, so if the contingency is waived or the time period is shortened, the buyer could be stuck with a piece of property it can’t use as intended so the property will have a lower value to the buyer.

             Buyers should work to protect their rights to the deposit. If a contingency fails and the contract is going to be terminated, the deposit should be returned to the buyer. But what if the buyer wants to continue with the transaction? Efforts should be made to extend the time period to satisfy the contingency rather than waive it and move forward. This can be accomplished by payment of extension fees that are smaller than the deposit. Often the extension fees are non-refundable but applicable to the purchase price leaving the deposit refundable in the event that the contingency ultimately fails. Sometimes, sellers insist upon the release of the deposit, making it non-refundable to the buyer. Buyer should then make every effort to have the deposit applicable to the purchase price at the time of closing and avoid payment of other extension fees. These principles hold true when buyer requests an extension of time of the due diligence period. Less is always more for the buyer.

             Of course there are dozens of other provisions in every contract which garner lots of attention in every transaction (and likely the subject of future posts). Buyers’ evaluation of a particular transaction should start long before contract execution and with the proper leg work, buyers will be in position to draft and negotiate due diligence and contingency provisions that work to their benefit.

    Get Blog Updates

    Get news, insights, and commentary delivered straight to your inbox!
    Click Here

    About Us

    Welcome to Assouline & Berlowe’s Florida Real Estate Law and Investment Blog with news, insights, and commentary for investors, developers, and their advisors.

    Topics

    Recent Updates

    Archives

    Stay ConnectedLinkedIn

    STAY TUNED!
    Get Blog Updates
    We'll send you an email whenever we add a new post.
    Stay Updated
    Give it a try, you can unsubscribe anytime.
    close-link
    Get news, insights, and commentary delivered straight to your inbox!
    Click Here
    close-link