A Cure for Ailing Contracts: Don’t Leave Remedies Out of CRE Deals
When buyers and sellers of commercial real estate property come together, their interests are often aligned: seller wants to sell and buyer wants to buy. They negotiate the purchase price, the deposit, a study period, and other terms to put into a contract.
By the time they get to the remedy section of the contract, so much has been agreed to that the parties often feel there is no need to negotiate for remedies because the risk of a party defaulting is small. But hang around with some commercial real estate professionals and you will hear horror stories of how deals went bad and how remedies in the contract do matter.
A Seller’s Remedies
A seller’s remedy for a buyer’s breach of a contract is straightforward. If the buyer defaults and does not close, the seller’s remedy is to keep the deposit, even if the monetary damages the seller suffered were not as much as the deposit. The deposit acts as liquidated damages: no matter what the seller’s actual damages are, the parties agree that the amount of the deposit will fairly compensate the seller. The seller does not have to prove its damages.
Consequently, negotiating the deposit amount is important for the seller. A deposit not only establishes buyer’s good faith in going forward with the purchase but also is seller’s remedy if buyer fails to close. A seller must negotiate a deposit amount that is significant enough to fairly compensate the seller for a buyer’s default.
A Buyer’s Remedies
A buyer’s remedies are a bit more complicated and seasoned professionals will negotiate these provisions in a contract.
Standard remedies for buyers are either to get the deposit back and terminate the contract or sue the seller for specific performance where a court orders a seller to sell the buyer the property. But receiving the deposit back does not compensate the buyer for the time and money buyer spent to investigate the property and prepare for closing.
Furthermore, specific performance may not always be available. The seller could have sold the property to a third party or misrepresented that they had the power to sell the property. A buyer needs the right, in addition to the above remedies, to recover damages from the seller.
There are two types of damages a buyer will seek if a seller defaults under contract.
- If the buyer chooses not to sue for specific performance but rather to get the deposit back, the buyer will also want to be compensated for its transaction costs – costs the buyer incurred to negotiate the contract and perform due diligence on the property.
- If the buyer wants to sue for specific performance, but that remedy is unavailable, the buyer will want to be able to sue the seller for damages the buyer incurred because it was not able to purchase the property. The seller must be careful not to agree to open itself up an unknown amount of damages.
With both types of damage remedies, the seller must be careful not to agree to an unforeseen amount of damages. In the case of damages for transaction costs, the seller should not only require that such costs be the buyer’s actual and reasonable costs, but also that the amount of such damages be subject to a cap on the amount the buyer can recover.
For damages due to the unavailability of specific performance, the seller should try to ensure that such damages cannot include the buyer’s consequential or unforeseen damages, which could include a buyer’s lost profits or business opportunities and, again, the seller should try to negotiate a cap on those damages.
In one contract we recently negotiated, after going back and forth several times on whether consequential damages should be included, the parties finally agreed that specific performance would only be unavailable if the seller decided to sell to another buyer for a higher price. Therefore, the original buyer’s damages would be the difference between what the seller received from a third party purchaser and the purchase price of buyer’s contract.
Although that amount may not have compensated buyer for its damages, buyer did feel that it decreased the risk that the seller would sell to a third party.
One last thought on remedies. Almost every real estate professional at one time buys a home and often will use a standard form residential real estate contract, most likely prepared by a residential real estate broker. As a buyer you should carefully look at the remedies provision. Most of these contracts permit the seller, in the event buyer defaults to either retain the deposit, as liquidated damages or sue the buyer for damages, with nor cap or limitation on the damages. Such a provision opens the buyer up to an unknown amount of damages that could be many more times than the amount of the deposit. Cross out the right to sue for damages (yes, you can cross out provisions in a “standard pre-printed contract”). A seller’s sole remedy should be to retain the deposit.
Ann Marie Mehlert is a real estate attorney who helps real estate developers, investors, and owners to acquire, develop, lease, and sell commercial real estate throughout the Washington, DC area. For more information on remedies in CRE contracts, contact Ann Marie at [email protected] or 301-907-2803.