With the recent changes in the economy and lackluster financing options, sellers of commercial property, hotels in particular, are increasingly facing purchasers unable or unwilling to close on the property in accordance with the purchase agreement.
The question then arises as to what a seller is to do when concerns emerge about the viability of their deals?
In some cases, the transaction fails outright because the purchaser is unable to secure financing. In others, the seller may face an unfounded basis to terminate the contract in an attempt to save its down payment.
After putting so much time and resources into negotiating the purchase agreement, and recognizing that deposits for the sale of hotels can run in the millions of dollars, it is important to put significant effort into protecting the seller’s rights throughout the implementation of the agreement. Such steps are crucial to lessen exposure should the transaction fail.
These concerns are often exacerbated for the sellers of hotel properties. The demands of running a hotel, particularly where a third-party hotel manager is on the property, result in transactions far more complicated than the sale of traditional commercial real estate.
Unlike agreements for the sale of commercial property, these agreements often include requirements for brand termination or assignment of the hotel management agreement or franchise agreement, leading to significant negotiations with the third-party managers and the brands themselves. Often, they also provide the extent to which and in what form confidential (and often proprietary) guest data and reservation information will be turned over to ensure a smooth transition.
Given the variety of parties and issues at play under such circumstances, complications may arise that add to the ordinary challenges of closing on a hotel purchase agreement. Thus, it is important to protect the parties’ rights throughout the entire process.
The increasing frequency of failed commercial real estate transactions, and in particular failed hotel deals, has led in recent months to a significant rise in the amount of litigation over the retention of multi-million dollar down payments. This often occurs because the failed purchaser seeks to recover the funds it originally deposited, while the seller also tries to recover that very same amount as a consequence of the purchaser’s failure to close. This article examines the most defining issues involved in such disputes and provides a range of best practices to consider for general information purposes when transactions go awry. Readers should seek appropriate legal counsel if faced with similar circumstances.
Time of the Essence Closings
Even when closing a transaction on the purchase of a hotel property, many of the basics of real estate law still apply. In New York, it is blackletter law that where the contract provides that time is of the essence, the failure to close the transaction on the date specified in the contract is a material breach of the agreement. See Grace v. Nappa, 46 N.Y.2d 560, 565-66 (1979).
In these circumstances, the non-defaulting party is typically entitled to retain the down payment as its sole damages for the other party’s breach. Because such deposits can run in the millions of dollars, the determination of who is entitled to retain the down payment can become a hotly contested issue.
In an attempt to avoid certain complications in a potential litigation, the non-defaulting party should pay careful attention to the specific provisions of its purchase agreement to ensure the default and termination provisions are properly executed.
Even where an agreement does not contain a time is of the essence clause, it is possible to impose a time-is-of-the-essence requirement.
Under New York law, courts have held that issuing a notice of default that specifies a new closing date that explicitly includes a time-is-of-the-essence provision, creates an obligation on the parties to close the transaction on that date. See Guippone v. Gaias, 13 A.D.3d 339, 340 (2d Dep’t 2004).
Thus, New York courts have held the “notice setting a new date for the closing must (1) give clear, distinct, and unequivocal notice that time is of the essence, (2) give the other party a reasonable time in which to act, and (3) inform the other party that if it does not perform by the designated date, it will be considered in default.” See Decatur (2004) Realty v. Cruz, 73 A.D.3d 970 (2d Dep’t 2010) (quoting Nehmadi v. Davis, 63 A.D.3d 1125, 1127 (2d Dep’t 2009). If the defaulting party fails to close on that date, that failure will be a material breach of the purchase agreement, entitling the non-defaulting party to the remedies discussed above. Id.
In addition to the outright failure to close on a specific date, it is also important to recognize that the continued delay of the closing date could constitute breaches of the purchase agreement.
For example, it is typical for a buyer to attempt to renegotiate the purchase price based on purported defects, or to request an extension so that it can comply with demands from the hotel manager or brand to receive its consent to the transaction. As a matter of contract law, a party to an agreement is generally only required to perform its obligations under the contract, nothing more. Thus, if these contingencies are not provided for within the purchase agreement, then such demands may actually be breaches of the purchase agreement or an anticipatory repudiation of the agreement.
Anticipatory Repudiation and Wrongful Termination
Often, purchasers, recognizing their inability to close on the transaction and fearing losing their entire down payment as a result, will contrive a basis to allege the seller has breached the purchase agreement as a way to terminate the contract and create leverage in a negotiation over the retention of the down payment. Such a strategy is extremely risky. Where a party indicates that it is not going to comply with the terms of the agreement or attempts to terminate the agreement unless it receives certain concessions, or advances a bogus basis to terminate the agreement, such conduct will be deemed to be an anticipatory repudiation of the contract, giving the other party the right to “elect … to rescind the contract, rather than to treat the repudiation as a breach or to await the expiration of the time for … performance and bring suit thereafter.” Smith v. Tenshore Realty, Ltd., 31 A.D.3d 741, 742 (2d Dep’t 2006).
“In general, abandonment of a contract need not be express, but may be inferred from the conduct of the parties and the attendant circumstances.” Savitsky v. Sukenik, 240 A.D.2d 557, 559 (2d Dep’t 1997). Thus, “[p]ursuant to the doctrine of anticipatory breach, a wrongful repudiation of a contract by one party before the time for performance entitles the other party to immediately claim a total breach.” Peng v. Willets Point Asphalt, 2010 NY Slip Op. 50671 (Sup. Ct. Queens Co. 2010). “A wrongful repudiation by one party excuses the other from tendering performance, and the other party need not prove its ability do so.” Id.
In other words, the wrongful termination of the purchase agreement by the purchaser relieves the seller of its obligation to demonstrate it was ready, willing and able to close in a litigation over the down payment. That is, upon the wrongful termination of the purchase agreement, the non-defaulting party is automatically entitled to the entire down payment regardless of their own ability to perform. Id. The “refusal [and repudiation] ma[y] take the form of an unequivocal statement or act, but anticipatory breach can also be found if a repudiating party is seeking to avoid its obligations by advancing an untenable interpretation of the contract, or has communicated its intent to perform only upon the satisfaction of extracontractual conditions.” Id. (internal citations omitted).
Given the stakes, it is important to reserve your rights throughout the implementation of the transaction.
One way to make your position clear is to issue a default notice detailing the specific breaches you believe have occurred. As always, pay particular attention to any notice provisions in the purchase agreement.
Many purchase agreements have specific provisions concerning when such notices should be sent, what they should detail, and how they should be served. Therefore, you should always consult the purchase agreement to ensure you are strictly complying with its terms.
In general, a notice of default alerts the purchaser of having breached a material term of the purchase agreement, i.e., failing to close the transaction on the date specified in the agreement. You may also want to note in the notice that you are reserving your rights under the purchase agreement and that any accommodation should not be deemed a waiver of those rights.
Finally, recognizing that the best result for both parties is most often to provide an accommodation to successfully close the transaction, it is almost always a good idea to memorialize these agreements in writing. This is because many commercial purchase agreements contain non-modification clauses, which specify that the agreement cannot be modified unless it is in writing. In New York, courts regularly enforce these provisions. N.Y. G.O.L. §15-301; see Nassau Beekman v. Ann/Nassau Realty, 105 A.D.3d 33, 39-41 (1st Dep’t 2013). This means that informal oral agreements to extend the closing date or to provide certain information or consents that were not provided for in the original purchase agreement are usually considered to be unenforceable modifications of the purchase agreement.
Given the complicated nature of purchase transactions concerning commercial and hotel properties, combined with the potential of a purchaser losing millions of dollars if the deal does not close, there is a very real risk failed transactions could end up in litigation. To ensure your rights under the agreement are enforced, it is important to assert them through appropriate notices of default and reservations of rights.
Further, any purchaser should be wary of issuing a premature termination notice given that it will relieve the seller of its obligation to demonstrate it was ready, willing and able to close the transaction in a dispute over the down payment. Finally, when making accommodations to your counter-party and modifications of the purchase agreement that you may want to rely upon in any potential litigation, take care to memorialize such agreements with a signed writing.