Clients know that a property deal is not binding until there is a completed, signed contract. However, they are still frustrated and disappointed if the opposite party withdraws from negotiations, wasting all the time and money both spent on getting towards exchange. To solve this, agents may suggest a “lock out” or “exclusivity” agreement, but beware; this is no panacea.
Exclusivity agreements do not, indeed cannot, lock the parties in to the deal. An agreement “to agree” is invalid. When the exclusivity period expires, both parties are free to walk away if they have not chosen to exchange contracts, but the exclusivity agreement may improve their incentives to exchange.
A simple exclusivity agreement prevents the seller (or landlord, if it is a lease deal) from dealing with other potential buyers (tenants) for a fixed time. It can be written or verbal. Its aim is to give the buyer a guaranteed window to do due diligence, tie up funding and hopefully achieve exchange with less risk of being gazumped by a competitor and consequent waste of the costs invested in that preparation. These can be quite substantial, eg on a development, the anchor tenant may be doing detailed, expensive planning assessment and environmental searches. The buyer knows the seller does not have to exchange contracts, but hopes that it will take the deal on the table rather than start again. If that hope proves wrong, the buyer gets no compensation.
Such an agreement is less attractive to the seller. It offers no guarantee of exchange, no compensation for wasted costs if the exclusivity period expires without exchange, and may prohibit the seller from doing anything during the exclusivity period to prepare a back up plan. It could find itself back at square one in what may be a falling market.
More complex exclusivity agreements try to address these failings. They are best done in writing. However, negotiating them takes time and incurs legal costs, with the early stages of the main transaction going on hold meanwhile. Such delay suits neither client, so they and their agents need to think hard before embarking on a sophisticated exclusivity agreement as its negotiation may, at worst, torpedo the whole deal.
Some of the potential “extra features” and their drawbacks are:
- Requiring compensation for wasted costs to be paid to the “innocent” party. This needs close definition of which costs qualify and how to identify whether a party who refuses to exchange is “innocent” or not. In Dandara Holdings v Co-Operative Retail Service Ltd2004 the seller had to pay £22,000 for wasted costs, because the contract obliged the seller, if it chose not to exchange contracts with the other party, to indemnify that disappointed buyer for all costs properly and reasonably incurred. The clause did not limit the indemnity to particular reasons for the seller exercising that choice, so the indemnity applied even though the other sale took place after the exclusivity period had expired.
- Requiring the buyer to pay consideration, often called a deposit (which is set off against the main deal deposit if exchange occurs). The deposit could be nominal or substantial. It could be non-refundable (in all circumstances) or returnable in certain situations. The larger the deposit, the less likely the buyer is to agree to it being non-refundable but drafting the conditions for the refund of the deposit can be a major sticking point. For example, what makes a search result bad enough to entitle the buyer to abandon the deal?
- Placing obligations on the buyer to progress promptly the pre-exchange processes and obtain funding. The seller might even prohibit the buyer from making “unreasonable” amendments to the main contract. Enforcing these will be a challenge, and the restriction on amendments is potentially very dangerous for the buyer, particularly if compensation is payable to the seller where the exclusivity agreement expires without exchange on the main transaction.
- Not only prohibiting the seller from negotiating with other buyers (ie active discussion), but also from marketing the property, responding to unsolicited enquiries or selling the shares (either in the seller, if this is its only property, or in the SPV which owns the target property).
- Allowing the buyer to signal an early end to the exclusivity agreement if its due diligence exposes something sufficiently detrimental (again, a tricky definition). This sounds good for the seller, who will no longer be locked into inactivity, but don’t forget that a similar early termination could always be achieved by mutual agreement.
Clients need to balance carefully the reduced risk of losing the main deal against the extra time, cost and potential loss of goodwill in negotiating an exclusivity agreement.