Summary and implications
Until a sale contract is exchanged, a seller can withdraw at no cost or consequence. A lock out or exclusivity agreement, which stops a seller negotiating with any other party during the lock out period, can give a potential buyer some short-term protection. It gives time to carry out investigations and due diligence and to negotiate documents, so that the potential buyer is ready to exchange ahead of other prospective buyers.
Where prime properties are in short supply, with a number of potential buyers chasing the same deal, lock out agreements may sound attractive. However, there are three key issues buyers and seller should consider:
- Lock out agreements have to meet certain requirements to be enforceable;
- If the seller breaches the agreement (selling the property to someone else during the lock out period) the disgruntled potential buyer will only be able to recover limited damages to cover his actual wasted expenses; and
- The potential buyer will not be able to force the seller to sell.
A well-drafted lock out agreement needs to address both the buyer’s and the seller’s concerns. It should set out their obligations clearly to avoid any disputes. In this article, we look at these issues in more detail and consider the role a lock out agreement can play in a transaction.
What is a lock out agreement?
Lock out or exclusivity agreements seek to stop a seller negotiating with any other party during the exclusivity or lock out period. However, it is important to stress that lock out agreements do not bind either the seller to sell or the buyer to buy. They do not stop the seller, at the end of the exclusivity or lock out period, selling the property to someone else.
Lock out agreements are more usual in the context of a sale and purchase but they can also be applied to the grant of a lease or an agreement for lease as well as to other real estate transactions.
Lock out agreements can, therefore, provide a potential buyer with a short protective period within which to proceed with its due diligence. If, however, a potential buyer is looking for longer-term protection while it decides if it wants to proceed then a lock out agreement is not the answer. The buyer should consider agreeing an “option to buy” with the seller instead.
Some protection under the professional conduct rules
The negotiation of lock out agreements can take time. They can therefore sometimes be seen as a distraction from the main transaction. A potential buyer will already have some protection under the professional conduct rules regarding contract races that prevent a seller’s solicitor sending out a sale contract to a second potential buyer without notifying the solicitor acting for the first potential buyer who has already been sent a draft contract.
Enforceability of the lock out
A lock out agreement will only be enforceable (and the parties liable for any breach of their obligations) if the following requirements are met:
- Negative in nature. The agreement must oblige the seller not to negotiate with others. A positive obligation on the seller to negotiate with the potential buyer is unlikely to be unenforceable.
- For a fixed or defined period. References in the agreement to a “reasonable time” will be void because they are uncertain.
- Payment (or “consideration”) must be made for the agreement or the agreement must be executed as a deed. However an obligation on the buyer to incur costs (for example, legal costs in instructing its solicitors to carry out due diligence or surveyors’ costs in carrying out a survey) can amount to “consideration”.
A lock out agreement need not be in writing to be enforceable and it does not have to comply with the technical requirements for land contracts in the Law of Property (Miscellaneous Provisions) Act 1989 as it is not an agreement to sell an interest in land. Clearly, it will be preferable for both parties if the agreement is in writing as otherwise there will be more scope for dispute as to the agreed terms.
Remedies for breach of the lock out agreement
If the seller breaches the agreement and sells to someone else during the lock out period, the potential buyer will only be able to recover its lost or wasted costs – for example legal fees or surveyor’s fees. The potential buyer is very unlikely to get an injunction to stop the seller selling to someone else during the exclusivity period because the buyer had no right in the first place to require a sale to the buyer.
An injunction is highly unlikely and the damages will be limited; so if a seller gets an increased offer from someone else during the exclusivity period it might decide to breach the lock out agreement, proceed with the other party and pay the minimal damages for breach.
Some lock out agreements therefore expressly provide for agreed damages at a specified higher level to make the seller think twice before breaching the agreement. Whether a seller agrees to such a damages provision will depend on the bargaining strength of the parties and the period of the exclusivity. The level of predetermined damages should be a reasonable pre-estimate of the loss. If they are too high, they could be deemed a “penalty”, which is not enforceable.
Usual terms:
Lock out agreements will usually cover:
- A timetable for the supply of title documentation and draft documents by the seller;
- A timetable for the buyer to raise enquiries and provide amendments to draft documents; and
- An obligation on both parties to instruct their lawyers.
Another important term of lock out agreements relates to the triggers for their termination before the end of the exclusivity period. Termination triggers might include the failure by the buyer to raise enquiries or to have approved or amended the draft contract within a certain timescale. If the lock out agreement is terminated early, both parties will be released from their obligations and the seller will then be free to negotiate with another buyer.
Issues for the buyer
The aim for the buyer is to place itself in a better position than any rival potential buyers. It will want the seller to ensure that its employees, agents etc. all abide by the provisions of the agreement and to instruct them to do so. The buyer will also want to make sure that the seller positively engages with the enquiries process and provides its lawyers with all the necessary information. The buyer should set out clearly exactly what it wants the seller to do and not to do.
Issues for the seller
The seller will of course want to keep the period of exclusivity as short as possible, as it will not want to be prevented from negotiating with another interested party for any longer than is necessary. A seller should make sure that it is still able to manage its property in the meantime. This might include granting a lease or a licence to assign so this should be allowed explicitly in the agreement. As above, the seller should ensure that the buyer has to make progress with negotiating and amending the documents and perhaps carry out a survey.
The seller will also be keen to list the triggers for early termination of the agreement if the buyer has not met these obligations.
Click here to see a table setting out the main issues in summary.
