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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   May 2016

Avoid ‘Dead Deal’ Lawsuits

Originators can take steps to protect their clients — and themselves — from litigation when transactions implode

Avoid ‘Dead Deal’ Lawsuits

The white-hot commercial real estate market may be showing signs of slowing down. Impending interest rate hikes, a volatile stock market, China’s economic slowdown and plunging oil prices all have implications for the U.S. commercial real estate market.

The decline in the number of commercial real estate transactions early this year affects not only the finances of mortgage originators and their clients, but also the likelihood of originators and borrowers end- ing up in court arguing about deals that went bad.

Ultimately, a commercial-market slowdown means real estate deals that were quick to close a few months ago could now encounter significant challenges. The ones that do not close trigger fears of litigation. Mortgage originators are wise to learn how to avoid legal action when buyers or sellers back out of deals — and to be able to explain what they have learned to their clients.

The reality is that dead deals rarely end up in court, and when they do, something has gone terribly awry. There is no silver bullet that will prevent a real estate transaction from going sideways when one party is determined to back out. Some careful preparation, however, can put all parties in a better litigation position if that happens — or better yet, enable them to avoid litigation completely.

Which areas commonly lead to dispute? Like commercial real estate in general, the types of cases tend to be cyclical. When the industry was emerging from the last economic meltdown, for example, there were a lot of guaranty-enforcement issues.

More recently, there has been a surge in alter-ego cases — parties seeking to nullify the limited-liability protections extended to corporate entities in order to hold individuals or companies liable for the obligations of others. Problems often arise when people fail to set up limited liability companies (LLCs) properly, or neglect to operate and manage them appropriately. When misused, instead of protecting individuals, LLCs can increase their exposure to liabilities — including opening the door to personal liability for company principals.

If the commercial real estate market slows, an increased number of buyers are likely to back out of deals. If it remains hot, sellers will continue to seek ever-higher prices for their properties. In transactions that have gone south, buyers frequently accuse sellers of fraud and failure to disclose as a basis for backing out of deals and recovering their deposits. Sellers will look to take advantage of every technical default and will “disclose” all sorts of issues, regardless of whether they are important.

Avoiding disputes

Whether your client is a buyer or seller, there are ways that you can help them circumnavigate disputes. One easy way to minimize risk on both sides is to take the small amount of extra time necessary to correctly document deals, as well as any changes to deals.

When things are moving quickly, there is a temptation for parties to gloss over changes. For example, parties will sometimes neglect to document that the seller has orally granted additional time for the buyer to conduct due diligence. That failure to document can come back to bite the buyer, if the seller later decides to back out of the deal. The bottom line is to avoid any deal, or change to a deal, that is not confirmed in writing.

Disclosures are a perennial source of litigation. Buyers who want to back out of a deal will often point to the seller’s failure to disclose what the buyer characterizes as “material”, or important, information. For sellers, a good rule of thumb for avoiding problems is to ask themselves whether they want to disclose a particular fact to a buyer. If the answer is no, then it is a good practice to disclose it.

When a seller wants to back out of a deal, they may go overboard by disclosing things they hope will scare off the buyer. Sophisticated buyers are skeptical of some of these disclosures. Sellers looking to avoid transactions also will focus on strict compliance with contractual conditions and deadlines, and they may even claim that their compliance is impossible because of some event or third-party action. These issues can be minimized by taking contractual deadlines seriously, regardless of how unimportant they may seem.

Avoiding the courtroom

When deals do end up in dispute, the best resolution is to reach an agreement outside of the judicial process. Mutual agreement eliminates risk by correctly taking the decision and strategy-making powers out of the hands of lawyers and putting them, instead, under the control of businesspeople.

Arbitration — private dispute resolution by an independent third party — also can be effective in saving time and money. If the opposing party is difficult, or if a good arbitrator is not selected, however, then arbitrations can be just as expensive and lengthy as ordinary litigation, but without the right to appeal. 

Similarly, mediation — or brokered settlement discussions — can break a communications logjam and get matters settled, but the timing needs to be right for the approach to really be effective. Parties need sufficient information to understand the strengths and weaknesses of their respective cases before they can be in the right frame of mind to settle.

Of course, sometimes an agreement to settle cannot be achieved, in which case a cost-sensitive yet aggressive handling of the matter is a must for an aggrieved party. Most important, parties need to understand that litigation (or the threat of it) is ultimately a business tool and, like any tool, it may get the job done, or it may be the wrong approach entirely.

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Good mortgage originators and their litigation attorneys will use the right resolution tool — be it arbitration, meditation or litigation — paying careful attention to the risks and rewards of each method, the timing of the action, and how well the parties are informed and how interested they are in settling.


 


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