by Andrew Morgan - QTHB
03rd November, 2020
Contract conditions: due diligence
Any genuine seller who has ever had a contract of sale collapse on them will tell you it is no fun, especially the closer to settlement it gets.
Therefore, minimising the risk of a contract being terminated by the buyer is worth seeking professional advice on and doing whatever one can to protect themselves.
Conditional contracts of sale should always proceed to settlement if there is a willing buyer and a willing seller. There is no reason that a contract should be terminated because of a due diligence clause not being satisfied.
Responsibility for this falls on both parties. The seller in providing detailed and accurate information so as not to give a buyer reason to terminate, and the buyer to be genuine in their intent and not just use this clause as an excuse to terminate a contract if they get cold feet.
In the past, on some occasions, buyers have utilised the benefit of a due diligence clause as a ‘get out’ clause, meaning they wanted out for a reason and used that as their method, not necessarily that the due diligence investigations found issues. Many years ago, residential contracts were altered slightly to try to avoid this situation via a due diligence clause not being all encompassing and creating some responsibility on the buyer’s behalf regarding building and pest inspections. These two items gained their own clause within the contract rather than within the special conditions and placed a responsibility on the buyer to ‘show cause’ as to why they wished to terminate the contract on those grounds. In other words, to provide some sort of evidence that there is an issue with the building worthy of termination of the contract. The tightening up of wording within special conditions can assist this also.
Unfortunately, the ‘handshake’ arrangement seems to be a thing of the past for many, and the value of the contractual concept diminished. Therefore, sellers must endeavour to protect themselves as much as possible from undue cost and personal disappointment by taking away the opportunity to opt out of contracts via due diligence without valid reason. The way to do this is by controlling what they can within the situation. Making sure all financial and other data supplied is watertight and accurate. All questions can be answered to a satisfactory resolution without holes, gaps or creating further questions.
We are witnessing more sellers today telling buyers to do their due diligence before signing a contract of sale. This is a highly effective strategy from a seller’s point of view. It retains competitive tension in the market and puts the responsibility back on to the buyer. Buyers, however, generally wish to ‘tie up’ a seller by locking them into a conditional contract, thereby improving their position to the detriment of the seller. The buyer holds all the cards in this position and the seller very few, leaving them stuck in a wait and see position, as opposed to being able to control proceedings. Other potential buyers are eliminated from competing and terms can be dictated to the seller forcing them to ask, ‘how high?’ when told to jump.
Business and commercial contract special conditions can be exploited as a simple way to opt out of a contract if so desired. Another way to look at this is that if a buyer is not fully committed to the contract, they will use clauses such as due diligence to hedge their bets. Effectively entering the contract, taking the business or property off the market, and then deciding whether to proceed, most likely at the end of the conditions time frame. Again, sellers need to be aware of this and deal with it as best as possible, rather than leaving things to chance and hoping the buyer that they may have had question marks over, can get the business done.
This is more about sellers controlling what they can control and not providing the opportunity for a buyer who gets cold feet to opt out for no good reason. It is about accountability and making sure that every financial and physical detail is in order. Risk management essentially is what needs to be assessed at the time an agreement is reached, well before a contract of sale is entered into.
How strong is this prospective buyer? Are they proven enough to go to contract with, and ultimately will they be able to settle the matter to avoid wasted cost, lost time, and disappointment?