Willing But Un-Able: Exclusivity Periods in Letters of Intent Can Be Problematic
Jotham Sederstrom Sept. 5, 2012, 7:15 a.m.
With the intense competition today for “good deals,” choosing the right buyer can become increasingly more difficult. A new breed of suspiciously sketchy buyers has entered the market.
Traditionally, a prospective purchaser would make an offer, secured by a certain confidence that she would be able to obtain enough financing from a lender and had enough equity to cover the cost of the property and closing costs and enough reserves to get through a period of stabilization of the asset.
That buyer would then enter into a contract of sale, put up the customary 5 to 10 percent deposit in escrow and proceed to secure all the elements necessary to get through the typical 60- to 90-day closing. At which point, clean title would transfer and the new buyer would take ownership of the property while the seller left the table with the proceeds. Both sides then went their separate ways.
More recently, the playing field has changed. A new buyer profile has digitized, throwing a curveball of mayhem into what was normally a predictable course of transaction events. These buyers have the unrealistic expectation that they can jockey for position in a deal with no money down and no skin in the game. It takes the art of flipping to a very different level.
This behavior could be the result of greed and envy. No matter the cause, it must be anticipated, understood and eradicated.
It all begins with an unsuspecting letter of intent, or LOI. A standard LOI should contain an offer with price, terms, deposit amount, closing schedule and any conditions of the sale. When it begins to resemble a contract, the broker needs to be very diligent going forward.
One land mine to be wary of is any language that alludes to an “exclusivity period.” This clause can be used as a boomerang on an unsuspecting owner. The purchaser is positioning himself for an angle to keep the property off the market while a contract of sale is being negotiated. While this is usually not a problem if the purchaser has the wherewithal to close, a purchaser who does not have the funds to close may use this as a tool to tie up an owner.
An unsuspecting broker and owner may innocently agree to this until it comes back to haunt them in a way they never suspected.
A well-respected broker recalled one situation in which an owner agreed to an exclusivity period in dealing with a particular buyer. A new and higher offer came in from a competing buyer. The owner made the innocent mistake of mentioning it to the original buyer. That buyer had his attorney send the owner a letter stating he was in violation of his letter of intent and would pursue legal remedies.
What was really going on was that this buyer didn’t have the funds to secure a deposit and needed the extra time to execute the contract. Rather than continue to pursue sourcing funds, the buyer used the ploy to “shake down” the owner, who ended up paying the buyer $50,000 to go away. The owner was hit with an unexpected problem that resulted in a waste of time and money. The property was off the market during a critical time and he lost other opportunities to sell to more qualified buyers at higher pricing.
An experienced seller I spoke with got stuck in a similar trap. She accepted a letter of intent from a buyer no one had heard of before. They began contract negotiations, and then the seller got a substantially higher offer from another buyer. The seller went back to the first buyer and explained what had happened. The buyer chose to fight rather than negotiate, and when the seller ceased contract negotiations, the first buyer filed a lis pendens forcing the seller back to the table. The seller ended up negotiating a slightly higher price from the buyer rather than spending time and money litigating. However, it was not anywhere near the offer she lost.
The lesson here is to be vigilant when accepting letters of intent. Know who your buyers are. Track down anyone who has done business with them in any field. Get as many references as you can. Find out where their funding is coming from and who their investors are. There is no such thing as learning too much about the people you do business with.
A buyer is only ready, willing and able if he has the funds, ability and intent to finalize a deal. If his intentions are not honorable or in keeping with the spirit of the transaction, disable the deal before anyone gets hurt.
Adelaide Polsinelli is a veteran real estate professional with more than 25 years of real estate brokerage experience. She is senior director at Eastern Consolidated, an investment sales firm in New York.