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New Terms and Clauses of the Multifamily Contract During a Pandemic

In an environment of a pandemic caused by COVID-19 (the “Novel Coronavirus”), buyers and sellers (collectively the “Parties”) are now implementing new terms and clauses in the multi-family contract to complete transactions.  I have been working with numerous buyers and sellers to navigate these uncharted waters to continue with current purchase and sale contracts (“Contract”) through amendments and creating new Contracts for buyers and sellers entering the market.  Upon several conversations and feedback with the Parties, I have concluded there are about six different topics that keep reappearing as new terms and clauses for the Contract: Extensions and Earnest Money, Financing Contingency, State of Emergency, Time, Reports and Material Adverse Conditions.  I will briefly explain and discuss these various hot-topics and how each party is reacting to these new terms and clauses.

Extensions and Earnest Money

The Parties are typically agreeable on providing an extension to the Contract because of the new status quo of the environment regarding the Novel Coronavirus.  Contracts and Contract amendments are typically extending the due diligence/inspection period 60-90 days between the Parties, so the buyer has enough or additional time to complete the due diligence/inspection period.  This provides comfort for the buyer to re-evaluate the market, obtain enough time for financing and complete the due diligence/inspection period because of unforeseen delays.  Sellers believe this additional time is not necessarily a delay and sometimes an opportunity to procure additional earnest money from the buyer to afford the additional time or extension of the due diligence/inspection period.  The additional earnest money is sometimes refundable, non-refundable or split depending on the negotiation between the Parties.  The earnest money may also be refundable, contingent upon additional provisions such as financing, reports and material adverse conditions, which will be discussed later in this article.

Financing Contingency

Financing has become a big concern for buyers and rightfully so because lenders are now requiring additional interest reserves and additional underwriting requirements because of the Novel Coronavirus. Buyers are asking sellers to be reasonable about the timeline and application process with the lender.  Buyers still need to be able to obtain loan terms that make financial sense and fit within their financial model.  Buyers are also asking for the financing contingency to continue up until closing.  Lenders are still figuring out this market and sometimes may drop a deal after the buyer has already been approved for financing.  Therefore, a return of the earnest money is a key component for the buyer because sometimes it is not the buyer’s fault that financing falls through.  Sellers are typically unsettled about this additional financing request.  Sellers can look at this financing clause as another negotiating deal point to procure a small amount of earnest money as non-refundable immediately and then also require a much larger amount of earnest money deposited as refundable.  This may add comfort to the seller that you have money in your pocket and the buyer is on the hook for additional money which will not be refundable after the financing period is over.

State of Emergency

At this point in time, there is an understanding that certain governmental rules and laws are being implemented that may cause a delay with the Contracts.  These delays impact the Buyer’s due diligence period, an inspection of the property and ability to have third-parties complete appraisals, zoning reports, and environmental studies.  The delays are unavoidable because of the governmental rules and the Parties must decide if this is a clause worth adding to have a smooth transaction.  Buyers believe the clause is reasonable for sellers to accept and accommodate and sellers are typically agreeable but want to be informed as to what is specifically causing a delay for the buyer.  Buyers need to provide consistent progress updates to the seller to keep transparency with the seller.  The seller typically doesn’t want long delays on critical dates in the Contract and wants to be fair and reasonable.  Buyers should anticipate providing the Seller with a list of items that need to be completed in the due diligence period and a specific timeline.  The Parties can then mutually keep track of where they are at all points in time during the Contract phase.  This transparency will then avoid unnecessary delays in a transaction and allow the seller to be aware of any specific delay so it can be promptly addressed.

Reports

Reporting has been brought up on several Contracts and amendments by buyers in order to have a better picture of the financial condition of the property, the current collections status and the occupancy status of the property.  Lenders are also asking for these reports to provide their underwriting department a better picture for structuring the buyer’s loan.  Sellers should be prepared to provide these reports for the buyer from the beginning of the Contract to the day of closing.  Buyers and lenders want a clear understanding of the financial condition of the property and whether there will be sufficient rent income for the buyer to make the mortgage payments, pay for management fees and pay for other third-party costs and expenses.  Typical reports that are being requested by the buyer and lender are financial statements, collection reports, delinquency reports, occupancy reports, and a rent roll.  Sometimes, buyers and lenders are asking for a threshold on some of these reports, such as a 90% occupancy requirement and/or a 85% collection requirement to justify the loan, cash flow and financial stability of the property.  Buyers are now tying these minimum reporting thresholds to the earnest money and as a contingency to the viability of the Contract.  Sellers will typically provide these reports, but sellers may need to provide more reports than usual in this environment because of the Novel Coronavirus.  Sellers are typically not arguing with these additional reporting requirements as long as the Buyer is diligently using the information to obtain their loan and approval from investors.  Buyers are also inquiring or requesting further details from sellers and property managers/landlords on how they are creating action plans with their tenants about rent payments, partial payments and non-payments because of the Novel Coronavirus.

Time

The section of “Time is of the Essence” in the Contract is now being reconfigured to add language about a “Force Majeure Event”.   The Parties need to be aware that delays may or may not occur based on unforeseen events which will cause a delay in the transaction closing, due diligence period or other critical dates in the Contract.  Buyers and sellers need to be cognizant of these additional events and incorporate these items into the Contract and specifically add the “Force Majeure Event” section.  Buyers are in favor of these additional clauses, but sellers are hesitant.  Sellers want to close as soon as possible without incurring any type of major delay and this “Force Majeure Event” clause creates that exact type of carve-out from the Contract.  Sellers should carefully review the specific types of events that are added to the “Force Majeure Event” section to make sure the events are reasonable for the delay.  In this current environment with the Novel Coronavirus, there has not been much pushback from the seller on adding this clause to the Contract.

Material Adverse Condition

Finally, a Material Adverse Condition section is being presented for the specific purpose of listing a pandemic or health crisis as an exit for the buyer to the Contract.  Buyers are also requesting a refund of the earnest money for these adverse conditions.  This clause would allow the buyer to terminate the Contract for the sole reason of the Novel Coronavirus because the Property or surrounding community would cause the transaction to be detrimental or impractical for the buyer.  The buyer would not be able to obtain any recoupment of out-of-pocket expenses.  Some sellers are not allowing for the recoupment of the earnest money as that would be liquidated damages for this sudden termination.  This clause is a catch-all provision and may only be used in extreme situations for the buyer.  Sellers may not mind the addition of this material adverse condition clause since the conditions are very extreme situations.  This clause may also be an area where earnest money may, may not or partially be refunded.

Conclusion

Sellers and Buyers will need to compromise on some of these additional terms and clauses to make a deal work.  This new world we live in may continue this way for the near future and beyond.  Buyers and sellers will need to adapt and expect these additional terms and clauses to be implemented into the Contract. There is still plenty of opportunity and value for buyers and sellers to make a deal work in this period of a pandemic.  Overall, collected rents for April were not affected that much and we don’t necessarily know how May will shake out at this point.  The worst may or may not be behind us at this point, but in any event, existing and new buyers and sellers will seize this time to complete existing and new transactions. The above clauses will be worked into those Contract amendments and new Contracts and inevitably change the way future multi-family transactions are completed.

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