This article has been written by Richa Ray, pursuing the Diploma Programme in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.
Table of Contents
Introduction
To understand the enforceability of a Lock out agreement, it is first of all important to understand what is a lock out agreement. It can easily be understood by the following example.
Lock out agreements are used mostly in the cases of a sale and purchase and can also be used in the context of grant of a lease or an agreement for lease and to other real estate transactions as well.
Suppose an investor owns a prime investment that he wants to sell. The seller obtains a number of bids. One of the bidders is far ahead of the other bidders but the seller is in doubt about the buyer and is unsure that the bidder really has the money to proceed.
In addition, this highest bidder intends to enter into a lock-out agreement. The questions that arise are What are the disadvantages for the seller for entering into such an arrangement? What are the provisions that the seller should include to protect itself against a buyer who he believes may not be able to perform?
The intention of Lock out or exclusivity agreements is to stop a seller from entering in any kind of settlement with any other party during the exclusivity or lock out period. However, one cannot ignore to emphasize that lock out agreements do not bind either the seller from selling or the buyer from buying. This kind of agreement cannot stop the seller, at the end of the exclusivity or lock out period, from selling the property to someone else. It simply means that the seller cannot negotiate with the third party and cannot enter into any contractual obligation with the third party.
Good Faith Deposit
The seller might insist upon the buyer to deposit a nonreturnable deposit as a consideration for the lock out agreement. This would only act as a compensation to the seller and stop him from negotiating with the third party for a short time. If, however, in the case where a potential buyer wants to go ahead with the deal and is looking for a long-term protection then in such case lock out agreement cannot be considered. The buyer must contemplate an “option to buy” with the seller instead. There was an English contract law case of Pitt vs. PHH Asset Management Ltd. [1994] 1 WLR 327 wherein the Asset management company were the undisclosed agents of the mortgagees who wanted to sell their Cottage at Suffolk for 205,000 pounds. Mr Pitt and Miss Buckle were the two competing bidders. Mr Pitt had put in the bid of 200,000 pounds, which PHH accepted ‘subject to contract’. Miss Buckle later on increased her bid to 210,000 pounds. It resulted in PHH to withdraw its acceptance of Mr Pitt.
Mr Pitt threatened to sue for an injunction to compel transfer of the cottage to him but it was noted by the Court of Appeal that it would just cause a nuisance). So PHH agreed to sell to him and said they would consider no further offers. Mr Pitt sued. PHH argued in its defence, there was no consideration to not consider further offers (for the lock out agreement), because Mr Pitt had only promised to be ready, willing and able to proceed with exchange of contracts, and he was already obliged to do that.
Another important point that has to be taken into consideration is that a lock-out agreement is not, necessarily, a written and properly signed agreement the way a formal agreement is made. It can be made in correspondence or even entered verbally and in both the cases,it is legally enforceable. However, when a non-refundable deposit by the buyer is involved, the seller should avoid entering into lock-out arrangements other than in a formal written form as it might lead to disputes in future. I would like to mention here a case of Gribbon vs. Lutton [2001] EWCA CW1956 wherein there was no written lock out agreement and they entered only in verbal lock out agreement and wherein the Recorder found that Without “consideration” the deposit will have to be repaid. This case basically illustrates that the written agreement is the best evidence in cases of lock out agreements.
Enforceability of Lock Out Agreement
For a lock out agreement to be enforceable following requirements have to be met:
- Negative in nature. The agreement has to oblige the seller so that they do not enter in any settlement with other potential buyers.
- For a fixed or defined period. It is important that the time period for such an agreement should be fixed. It should be exact or well defined. It can be one month or four months but it should be expressed in the agreement.
- Payment. In clear words the payment must be made for the agreement or the agreement must be executed as a deed. However the burden 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”.
Liability for breach
A common question asked is What will be the seller’s position if during the lock-out agreement the seller becomes convinced that the buyer will not be able to proceed and he wants to proceed with an alternative offer immediately. This step will involve the seller breaching the lock-out agreement. What are its potential liabilities?
The first step a buyer may think is to obtain an injunction to prevent the seller from entering in any settlement with another interested party. However, getting an injunction against the seller to stop him from selling to someone else is highly unlikely because the buyer does not have any right to pressurise the sale to the buyer and even if the buyer obtains an injunction against the seller, it would only be a short-term injunction.
Secondly a buyer can claim damages for the breach but will only be entitled to recover its loss or wasted costs for example legal fees or surveyor’s fees. Historically, while calculating the level of damages the Courts have mostly concentrated on the buyer’s wasted costs.
To overcome the disputes regarding the agreement some lock out agreements therefore have added such provisions that expressly provide for agreed damages that may make the seller think twice before breaching the agreement. But in such cases the burden of convincing a seller to agree to such a damages provision will entirely depend on the parties and the period of the exclusivity. The level of predetermined damages should be reasonable enough because if they are too high, they will be termed as “penalty” that is not enforceable.
Usual terms
Now let’s discuss the terms that a Lock out agreement must 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.
Termination of the agreement is again an important term of a Lock out agreement that deals with the termination of the agreement before the end of exclusivity. The terms may include the failure on the part of the buyer to raise enquiries or to have approved or amended the draft contract within a certain timescale. Both the parties will be released from their obligations and the seller will be free to negotiate with the other party If the lock out agreement is terminated early.
Issue for the buyer
The job of the buyer is to place himself in a better position than any rival potential buyer and therefore it will want the seller and its employees or agents to abide by the agreement. So, it is important for the buyer to set out clearly and exactly what he wants the seller to do.
Issues for the seller
Seller would, obviously, want the period of exclusivity to be over as soon as possible so that it does not stop him from negotiating with other interested parties. So, the seller might want to manage his property for which he might want to put it for lease or a licence to assign and should be allowed in the agreement. The seller should also ensure that the buyer is making progress with negotiating and amending the documents and also carrying out a survey.
Another point a seller should keep in mind is to mention the list of the clauses that can trigger the seller from terminating the agreement early if the buyer does not meet these obligations.
Conclusion
I feel that the major concern in entering into lock out agreement is that it deviates from the main transaction itself which might, in most cases, lead to disputes because of its nature, and also the remedies available are very limited. So, instead of entering into such kind of agreements which usually takes a couple of weeks in arguing and drafting the clauses of the exclusivity agreement, more time should be spent on lining up the transaction and completing the conveyancing work.
References
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