The Top Ten Points To Watch For In Commercial Real Estate Contracts #1 (cont’d)

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[author: David R Brittain]

“Will the party that comes to closing be the same as the party that signed the contract?”

Now for a look at the second part of Question #1 (click here for first part).  Let’s begin with a basic principle of Florida contract law: a contract for sale of real estate that does not forbid assignment is fully assignable (by either party).  If a party assigns its interest in the contract, the assigning party isn’t released of its obligations and remains liable for performing the contract if the party to which the contract was assigned (usually called the “assignee”) fails to perform.

These principles can have unpleasant consequences for commercial real estate buyers and sellers depending on the facts of a transaction.  For example, if the seller agrees to extend recourse purchase money financing to a buyer, the seller usually bargains for the creditworthiness and experience of the buyer in order to generate income from the property with which to make the mortgage payments.  If the party that shows up at closing holding an assignment of the contract and claiming the benefit of the purchase money financing isn’t the same as the party the seller thought would be its borrower, the prospects of repayment change entirely.  If the assignee is a business entity, the original borrower may not be involved at all.

Of course, under the same facts, the original buyer won’t be released from the contract and may still be liable for repayment, but here we encounter an ambiguity: is the original borrower to be a co-maker under the note or a guarantor?  The contract may be silent on this point.  The same kind of ambiguity may occur, even in the absence of purchase money financing, if the buyer has significant construction or development obligations to perform for the seller’s benefit after the closing under the contract.  Is the original buyer a guarantor of completion of the post-closing improvements?

There are several ways of dealing with such issues, rather than silence on the subject in the Contract (which is definitely NOT customary practice in Florida commercial real estate transactions).  However, many of the Florida standard commercial purchase and sale forms in circulation take a bare bones approach to the subject of assignment.  For example, the Florida Association of Realtors© Commercial Contract (12/2012 ed.) provides that “This Contract may be assigned to a related entity, and otherwise □ is not assignable □ is assignable.” The form invites the drafter to check the applicable box.  Is this provision sufficient without further modification?

Before answering the question, let’s consider a few common contract alternatives:

1. One approach is simply either to prohibit assignment of the contract entirely (which is one of the FAR form alternatives above) or to provide that there can be no assignment without the seller’s prior written consent, “in its sole, absolute, and unfettered discretion” (or similar terms).  This is the meat axe approach and ignores the fact that purchasers of commercial real estate usually do intend to assign their interest under the contract prior to closing to an entity such as a limited liability company or limited partnership.  The entity usually contains the original purchaser, its affiliate or subsidiary, and new investors providing the equity to acquire the property.  Such a provision is certain to invite extended negotiation and isn’t reasonable unless some aspect of the deal makes the particular buyer who signed the contract essential.

2. Another approach is to include the familiar clause that prohibits assignment “without the prior written consent of the seller, which shall not be unreasonably withheld.”   However, such clauses can be troublesome under Florida law, since a party’s good faith cooperation is an implied condition precedent to performance of every contract.  In a leading Florida case,  this principle led a Florida appellate court to conclude that a landlord under a commercial lease can’t arbitrarily refuse consent to an assignment of a commercial lease that provides that a lessee can’t assign or sublease the premises without the written consent of the lessor, even without limiting “reasonableness” language.  This holding has been applied to a number of different kinds of contracts governed by Florida law.  Thus, the tried and true “no assignment without prior written consent” clause immediately creates an inquiry concerning the reasonableness of a seller’s refusal to permit an assignment of contract.

3. Finally, there are various hybrid approaches that try to balance the seller’s and buyer’s respective interests.  The FAR standard form we mentioned above is one such hybrid, albeit with some problems.  Generally, a thorough hybrid paragraph (a) prohibits assignment of the contract except to specified business entities, in which the purchaser has a specified percentage ownership interest (often “a majority in interest and voting control”), (b) either forbids any other assignments, or defines the class of parties that are deemed acceptable assignees (by minimum net worth, for example), and (c) requires the assignee to assume and perform the original buyer’s obligations with written notice and a copy of the assignment to the seller not later than a specified period before the closing (to avoid missteps in preparing the closing document).

You’ll notice that the FAR Standard Commercial form is a hybrid that lacks sufficient clarity – that is, there is no definition of the term “related entity”; no mention of the fact that if a box is unchecked, the contract is fully assignable (without the seller’s consent), and no provision for release of the buyer from the contract if an assignment is made (if that’s the deal).  Thus, the form shouldn’t be used without some custom modification of these provisions to address these gaps in the text (depending on the facts).

4. Finally, whichever approach is used, keep in mind that under Florida law a provision that forbids assignment of the contract by the buyer doesn’t automatically prohibit transfer of the stock, membership, or partnership interests in the entity to third parties.  This, by the way, is another gap in the FAR standard commercial form.

Properly structured, an assignment provision in the contract can help insure that there are no regrets if and when a new party shows up to close deal.