Today I’m going to delve deeper into the topic of cancellation culture. No, not stifling freedom of speech but the cancellation of a commercial real estate transaction. In other words, how to unwind a transaction.
As mentioned in this space over the years, commercial real estate agreements come in two forms – leases and sales. Unlike our residential counterparts, commercial leases can represent a significant portion of our practices, in some cases up to 100%.
Since many companies choose to rent the premises from which they practice their profession and the sales market is currently experiencing an acute shortage, more and more leases are being created. Obviously, canceling a sale or a lease has its nuances, so I’ll spend some time on both.
What precedes each direction is an identification of needs, a study of the market, tours of potential, negotiation and contracts. The departure occurs at the documentation stage.
When a lease is signed, the deal is done, notwithstanding the fit-up and move-in. When a purchase and sale contract is executed, the transaction begins. As you can see, relaxation depends on where you are in the process. Allow me to dissect.
Until you scratch your John Hancock on this 17-page tome, you can leave even if you’ve signed a letter of intent. In some cases, after you sign a lease and you don’t make the required deposits in a timely manner, the landlord may press eject. But typically, once you and the landlord sign, deposits and insurance are exchanged, a rental agreement is assigned.
Now, if circumstances result in “delay of possession” – meaning you can’t move in beyond what’s described – a cancellation can occur.
OK, you’re in and things are changing. Now what? Generally, you have three alternatives: buyout, sublease or default.
A buyout works like this: With the lease, you have committed to a certain dollar obligation which is calculated by multiplying your monthly rent by the years remaining on the term. Let’s say that figure is $1 million. In order to complete a buyout, you would approach the property owner and offer him a fraction of the remaining bond. She will then analyze whether taking a buyout is in her best interest. More specifically, with the money offered, can the costs of finding a new occupant be absorbed?
Then a sublease
You attract a surrogate to live out your lease and do all the things you’ve agreed to do, like pay the rent, repay the property taxes, mow the lawn, etc. Please note: subletting must be accepted by the landlord, but it may not be unreasonable.
Finally, you walk away and raid the owner. This is never recommended as all sorts of legal remedies will be triggered. But, it is an option.
Reminder: When a purchase and sale contract is signed, the timer starts running. Until a deed is recorded signaling that the race is over, there are escape routes.
The simplest happens during a period of due diligence. Completed within 15-60 days of fulfilling a contract, this includes a finance commitment, title review, inspection, forensic appraisal of leases (if applicable ), expenditures and revenues and a survey of environmental conditions. If one of them is unsuccessful and a compromise solution cannot be found, it’s over.
Once all the conditions described in an emergency period are lifted, part of the money is at risk. This means the buyer can lock out and the deposit is lost.
Some may wonder, hmmm, it looks like the buyer holds the key. When can a seller cancel? Simply, if the buyer performs, the seller cannot. My lawyer buddies are collective in saying, uh-huh! True.
Needless to say, however, a costly “specific performance” battle may ensue.
Probably the craziest example of this happened a few years ago with a vendor we represented. It seems that the seller – after committing to sell his property – and the buyer waiving the contingencies have discovered a costly prepayment penalty.
One day I received a call from the seller asking me to cancel the transaction. Astonished, I asked, “On what basis?”
“Because I can’t afford the prepayment,” he replied.
Luckily, we persuaded the buyer to walk away. But not without reimbursement of their expenses and payment of their agent.
Allen C. Buchanan, SIOR, is a principal at Lee & Associates Commercial Real Estate Services in Orange. He can be reached at [email protected] or 714.564.7104.