Want to Back Out of a Real Estate Deal? Consider This Structure

In the ever evolving state of the economy – including fluctuating interest rates, or even in a scenario where a purchaser has a property under contract that no longer makes sense for such purchaser to buy based on, for example, property condition, encumbrances, or zoning – a purchaser’s usual initial reaction is to simply terminate the purchase agreement prior to the expiration of the diligence period and walk away from the transaction. However, in the process of such unilateral termination, a purchaser is generally out all of its costs expended to such termination date, including the negotiation of the purchase agreement, conducting due diligence, attorneys’ fees, and working through any rezoning or plan approval. Alternatively, there are scenarios where a purchaser has secured a “deal” on a property with no intention to close, but such purchaser enters into a purchase agreement in hopes of turning a quick profit by locating a final purchaser.  In both of these scenarios, there are actions that can be taken by a purchaser to mitigate costs or even allow for a substantial gain to the original purchaser via an “assignment fee.”

The two most common transaction structures to obtain an assignment fee fall under the following scenarios.

Assignment

The original purchaser and the final purchaser enter into a true assignment of the purchase agreement; however, rather than simply assigning the purchase agreement, the original purchaser also assigns all of its due diligence materials (i.e. survey, environmental, plan approvals, etc.).  The original purchaser will also generally make some limited representations as to the nature of the purchase agreement and the accuracy of the due diligence materials being assigned.  As consideration for the purchase agreement and due diligence materials assignment, the final purchaser will pay an “assignment fee” directly to the original purchaser.  This assignment fee can be paid outside closing or as a closing cost shown on the settlement statement, which allows the assignment fee to potentially be a part of the final purchaser’s financing.

Separate Purchase Agreement

The original purchaser realizes it no longer desires to purchase the property, so it begins to “shop” the property to potential third-party purchasers.  If the original purchaser finds a new purchaser, the parties enter into a new purchase agreement that largely mirrors the original purchase agreement, with the caveats that (1) the purchase price will generally be higher in the new purchase agreement (representing the “assignment fee” in this scenario); and (2) unilateral termination under the new purchase agreement should terminate prior to the termination of diligence period under the original purchase agreement. Additionally, the new purchase agreement should build in a requirement that the new purchaser must close directly with the seller to avoid the original purchaser ever having to take title to the property, show up in the land records, or pay any transfer tax at closing.

Key Considerations When Negotiating Original Purchase Agreement

• Long (90 days or more) due diligence period to allow for the completion of due diligence with time remaining thereafter to find a subsequent purchaser prior to the expiration of the unilateral purchaser termination right.
• Limited confidentiality provisions that would restrict ownership or transfer of due diligence materials.
• No representations or covenants made on behalf of the original purchaser restricting or prohibiting subsequent purchase agreements prior to closing. 
• Broad purchaser unilateral assignment provisions. 
• Allocation of closing costs that will be acceptable to a subsequent purchaser, so that the new purchaser will agree to close directly with the seller. 

Key Consideration When Negotiating New Purchase Agreement

• Timing – which is likely the most important. The original purchaser will be at risk if it is required to act under the original purchase agreement prior to knowing whether (1) the new purchaser will move forward with the transaction; or (2) the new purchaser will require any special requirements (i.e., title, zoning, or approvals) in connection with closing under the new purchase agreement.
• Representations and warranties must be limited on behalf of the original purchaser, as it does not own the property and is not in a position to make standard representations.  The representations and warranties are often the most negotiated point under this structure. The new purchaser will seek to obtain a full list of representations, but the original purchaser is not in a position to provide such representations without a level of risk.
• As previously stated, having a clear election that can be invoked by the original purchaser that causes the new purchaser to close directly with the seller to avoid title passing through the original purchaser and double transfer tax. 

There are obviously numerous caveats to the above considerations, each of which must be thoroughly examined in combination with the property and the parties involved when contemplating or choosing an “assignment fee” structure.  However, if negotiated correctly, money can be made without ever closing on a property, or at a minimum, costs can be mitigated if a transaction is no longer desired.

Tommy Gossett is a member at Bass, Berry & Sims in Nashville, Tennessee. He can be reached at TGossett@bassberry.com.

McKeehanon Rue is an associate at Bass, Berry & Sims in Knoxville, Tennessee. He can be reached at McKeehanon.Rue@bassberry.com.