When 2 parties sign a real estate contract, they generally do so with the expectation that the seller wants to sell and the buyer wants to buy. Basically, at the time that the contract is signed, both parties want to close. However, sometimes, things happen and one of the parties changes their mind and decides they don’t want to close. Now what?

There is no right or easy answer to this question. Who is attempting to terminate the contract and their reason for doing so are important factors in determining what to do. A common occurrence is when a buyer decides not to proceed at the end of the due diligence period. Most commercial real estate contracts and many residential contracts provide the buyer a time, following contract execution, to inspect the property and determine whether it is suitable for buyer’s use. Sometimes the inspection paragraph is broadly drafted and sometimes it is narrow in scope. At the end of the due diligence period, the buyer, if not satisfied, may provide notice of termination to the seller and the deposit is to be released to the buyer. Most of the time, this goes without a hitch.

But things don’t always go smoothly here, even though the provision has been negotiated and is clearly spelled out in the contract. Sellers have waited through the due diligence period patiently (or not) and want to proceed to closing and object to the termination. I had a case where my buyer client requested several extensions of the due diligence period, purportedly to complete zoning review. When the buyer ultimately terminated the contract, seller objected arguing fraud because the buyer had never made application for approval and failure to give timely notice of termination. The due diligence provision was broad and allowed the buyer to terminate for any reason. But, seller refused to consent to the release of the $50,000 deposit. When no agreement could be reached, my buyer client sued for release of the deposit. The escrow agent placed the deposit in the court registry. We prevailed at summary judgment with the court finding that the seller had voluntarily executed each amendment extending due diligence and buyer’s notice of termination was timely. Seller had to release the deposit and pay buyer’s attorney’s fees. Whether the buyer had made application for the zoning approval was not relevant.

A buyer might also attempt to terminate a contract because of a failure to satisfy other contingencies such as financing or government approvals. From the buyer’s perspective, it is important that, regardless of how the contract is drafted, the buyer document its efforts to timely satisfy the contingencies and keep the seller advised of all its efforts. If buyer does not keep the seller informed and then is unable to satisfy a contingency, seller could have grounds to object to buyer’s attempt to terminate the contract and recover the deposit. If not expressly stated, buyer has an implied covenant of good faith which means that the buyer must use its best efforts to satisfy the contingencies. If the seller isn’t in the loop, the seller can also allege that the buyer has not reasonably attempted or used best efforts to do so.

Sellers, likewise, fail to close from time to time. Buyers’ remedies are usually clearly spelled out – specific performance being the most common. To assure that a buyer can pursue specific performance as a remedy, buyer must demonstrate that it was “ready, willing and able” to close on the closing date and seller failed to perform.

This can be illustrated in another case I had a few years ago. My client was a tenant under a commercial lease. Under the lease, the client had an option to purchase after the 3rd lease year if exercised between 120 and 60 days before the end of the 3rd lease year. The terms of the purchase were set forth in the lease and the option was to be exercised in writing to landlord by tenant preparing a contract, signing the contract and sending it to landlord. Closing was to occur 60 days thereafter. We prepared the contract and timely exercised the option. The landlord’s attorney responded that the option was not valid for a myriad of reasons and if we wanted to purchase the property, the price would be 2.5 times the option price. The shake down was on.

Though we spent the next 60 days arguing with the landlord’s attorney as to why the landlord was wrong about the validity of the option, we also prepared for the inevitable lawsuit by getting ready for closing. We ordered title and survey. We prepared closing documents. The client sent me the required deposit and I notified the landlord and the attorney that the deposit was being held in my trust account. Upon receipt of the title commitment, I sent a title objection letter. We prepared a closing statement and requested seller documents. The day before the closing, the client wired the net closing proceeds to my trust account.

On the scheduled closing date, I sent the buyer signed closing documents to the landlord’s attorney and advised that all closing proceeds were in my trust account ready to be delivered to landlord/seller upon receipt of the deed and other closing documents. In effect, I “tendered” the closing proceeds. Of course, the seller/landlord rejected our tender and refused to close. We filed a lawsuit for specific performance and, because we took all of these steps, won on summary judgment. After concluding that the option was valid (rejecting all arguments of the landlord), the court cited each step we took to confirm that buyer was ready, willing and able to close and ordered landlord to convey the property to my client. Landlord was also ordered to pay all of my client’s legal fees.

Disputes over closings occur. Attention to detail on both buyer’s and seller’s side is necessary to enforce the contract or to resolve the dispute without litigation. Luckily, I have only had a handful of these cases go to court over the years. Not every deal will close. In fact, most won’t. But no one wants to litigate. Detail starts in the contract and continues as you work through due diligence and prepare to close. If the transaction is not going to close, this attention to detail will help avoid the costs of litigation.

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.

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