The Picture of Risks Due From COVID-19 Impact on Real Estate Closings In Florida, New York and New Jersey
We have surveyed numerous real estate agents and brokers related to the impacts they are seeing on closing transactions given that we are now nearly 12 weeks post shelter-in-place. While states are slowly phasing into “reopening” others are seeing an increase in the number of COVID case, including Florida. Agents and brokers are being forced to address and circumvent the multiple roadblocks that have developed due to this crisis including: showing properties, closing risks, legal risks arising from contract language, buyer’s access to financing, logistics of inspections and repair work given the sensitivities to exposing the residence or offices to strangers.
I. Closing Risks
In the current environment, with recorder’s offices either closed or capacity to process deeds being materially reduced, if the closing is contingent on recording, a buyer may be hesitant to fund the purchase price into escrow without any assurance of when the deed will be recorded due to the costs inherent in having funds remain in escrow for a prolonged period of time. Additionally, there may be an unwillingness on the part of the buyer’s lender to provide funding or to leave funds in escrow for an extended period of time. In a gap closing, title insurance companies may be wary of accepting gap indemnities and issuing title insurance when the date of recordation is a moving target as there is a greater risk of intervening liens as the gap period lengthens. Even if the title insurance company accepts the gap indemnity and is willing to issue title insurance to the buyer, there is a question as to the buyer’s willingness to close when it may have to pursue claims against its title insurance company to clear title of liens or defects following closing. Similarly, the buyer’s lender may consider the title company’s gap coverage insufficient given the possibility of needing to pursue claims against the title company to defend the lender’s lien priority.
Regardless, the seller typically bears the risk that the title insurance company will fail to issue title insurance and that this condition precedent remains unsatisfied. While failure of the title insurance company to remain committed to issue the title policy is not a default by the seller, the buyer will likely have the right to terminate the contract in the event that: (i) in a deed-recordation closing, the recording cessations or uncertainties mean the title company is not timely committed to issue title insurance as of the scheduled closing date; and (ii) in a gap closing, the title company will not insure the gap as noted above.
Buyers, on the other hand, risk default under the purchase contract. A buyer will not be in default if it deposits its funds and closing documents in escrow and authorizes closing. As noted above, however, a buyer may be unwilling or, because of its lender, unable to do so in either type of closing. Thus, a buyer’s potentially substantial deposit may be now at risk.
II. When Time Is of the Essence
The timing of closings has also been impacted due to the COVID-19 crisis. Accordingly, parties should consider the concept of “time of the essence” clauses and notices.
Where time is of the essence in connection with a party’s obligation, failure to perform by such party by a specific date will constitute an incurable breach. Failure to include such limiting language will be construed to permit a “reasonable time” to perform, including reasonable adjournments of the closing date unless there is bad faith or inexcusable delay.
In New York, for example, a party can unilaterally create such an obligation by sending a “time of the essence” notice whereby one party must give clear, distinct, and unequivocal notice to the other party setting a closing date that provides a reasonable time for that other party to act. The notice must also state that the other party will be considered in default should it fail to perform on the date designated in the notice.
What is a “reasonable” amount of time may be subject to change given a prolonged national emergency that results in the periodic extended closure of county recorder’s offices, local governments, courts and businesses. While a question of fact, courts may consider the following as probative of what is “reasonable”: (i) the nature of the contract, (ii) the parties’ previous conduct, (iii) whether the parties acted in good faith, (iv) the experience of the parties, (v) the potential for prejudice or hardship for one of the parties, and (vi) the amount of time provided for performance.
Parties need to be aware that using “time of the essence” notices during the COVID-19 crisis may not have the same teeth as previously and that it may be viewed as acting in bad faith.
The COVID-19 crisis may result in clauses inserted into sales contracts permitting delays due to pandemic, government closures and other causes not heretofore deemed to excuse performance by either a seller or a buyer.
III. Potential Defenses for Breaching Parties
If a non-breaching party is able to establish that it was ready, willing and able to close, but the non-performing party is in default for failing to close — whether due to strict enforcement of timing or a general unwillingness to close — the non-performing party may be able to assert some of the potential defenses below.
A. Impossibility of Performance
The common law doctrine of impossibility of performance is available generally “when the destruction of the subject matter of the contract or the means of performance makes performance objectively impossible” and the “impossibility” was produced by an unanticipated event that could not have been foreseen or guarded against in the contract. When performance of a contract becomes impossible, performance may be excused, but mere difficulty or inconvenience is insufficient to excuse performance. Arguments that a contract was impossible to perform, even in the face of a government moratorium, will not succeed where the intervening government action was foreseeable.
B. Frustration of Purpose
A party may be able to invoke the “frustration of purpose” doctrine where the purpose or “essence” of a contract is frustrated, rather than rendered impossible, by an unforeseeable event. This defense may be available even where performance of the contract is not impossible. To invoke the defense, the frustrated purpose “must be so completely the basis of the contract that, as both parties understood, without it, the transaction would have made little sense.” As with impossibility, the frustrating event must not have been foreseeable by the parties. Note that “changes in market conditions or economic hardship do not excuse performance.” A party is not excused from a contract simply because it becomes more economically difficult to perform.
C. Good Faith and Fair Dealing
The law of most states includes an implied covenant of good faith and fair dealing to all contracts such that neither party will act in a way that destroys or damages the right of the other to receive the benefits of its contract. It is unclear, however, whether a court would elevate in importance an implied covenant over an express “time of the essence” clause.
D. Force Majeure
Many non-performing parties to all types of contracts have begun advancing arguments based on force majeure clauses in connection with the effects of COVID-19. Force majeure, or superior force, is a defense that, under certain circumstances, may excuse performance of a contract when a party has been prevented by a force beyond its control. This is a bargained-for contractual right where the defense will depend on the language of the clause and whether it is broad enough to include the effects of the COVID-19 crisis. Since most purchase and sale agreements do not include force majeure clauses and courts are not likely to read a force majeure clause into a contract absent the express language, claims of force majeure are unlikely to excuse a missed closing unless explicitly contained in the contract.
In light of the COVID-19 pandemic, most recorder’s office closings have been resolved through Recording programs and local governments have demonstrated their commitment to maintaining the functions of the property records systems they administer.
If both parties to a sale transaction desire to consummate a deal, they will need to proactively and collaboratively seek creative solutions. Parties may mutually agree to waive claims for failure of a condition to closing, including for title, or claims for default due to timing issues related to recordings. Parties contracting for future deals will want to account for the possibility of government shutdowns impacting their transactions. However, if one party determines not to move forward with a transaction, the parties will likely face a protracted battle over the deposit, asserting many of the claims and defenses discussed above. These legal battles may be similarly impacted by delays and face protracted schedules as courts are forced to shut down, statutes of limitations are tolled as a result of the very same national crisis that produced the underlying legal dispute.
At Shendell & Pollock we remain available to answer all of your COVID-19 related concerns, questions and claims. Please contact Gary Shendell at email@example.com and Ilana Hanau at firstname.lastname@example.org to discuss this alert further.