01 Jul When a Good Deal . . . Isn’t.
A very recent decision out of California’s Central District Bankruptcy Court highlights the boundaries of “commercial reason” and “diligence” where distressed asset sales are concerned.
In re 1617 Westcliff, LLC (Case No. 8:12-bk-19326-MW) involved the court-approved sale of the debtor’s real property under a purchase agreement in which the debtor and the purchaser agreed to use their “commercially reasonable and diligent efforts” to obtain the approval of the debtor’s mortgage lender for the assumption of the mortgage debt by the buyer. If the approval was not obtainable, the buyer had the right to terminate the transaction. The buyer also had the right to terminate the deal if the assumption required payment of more than a 1% assumption fee.
As is sometimes the case where due diligence remains while a deal is approved, things didn’t quite work out as planned. Unfortunately, the bank proved less cooperative than the parties had anticipated. More importantly, however, the buyer notified the debtor-seller 4 days prior to closing that it would not proceed with the transaction as structured, but might be willing to proceed if the transaction was framed as a tax deferred exchange.
The debtor was, understandably, somewhat less than receptive to restructuring the deal at the 11th hour. It insisted that the buyer proceed with the transaction as originally agreed and as approved by the court. In response, the buyer effectively walked away. The parties then made competing demands on the escrow company regarding the buyer’s $200,000 deposit, and filed cross-motions with Bankruptcy Judge Mark Wallace to enforce them.
In a brief, 11-page decision, Judge Wallace found that the buyer’s renunciation of the deal 4 days before closing was a material breach of the buyer’s obligation to use “commercially reasonable and diligent efforts” to obtain assumption consent:
The Purchase Agreement required [the buyer] to keep working in good faith for an assumption until the close of business on May 10, 2013, not to throw up its hands and to propose – at the eleventh hour – a wholesale restructuring of the purchase transaction in a manner completely foreign to the Purchase Agreement. On [the date of the proposal] there were still four days left to reach agreement with the Bank, but [the buyer] chose (five months into the deal) to abandon the assumption. It was not commercially reasonable nor was it diligent for [the buyer] to cease negotiations with the Bank relating to the assumption of the loan under these circumstances.
Judge Wallace found that due to this breach the debtor was entitled to retain the $200,000 deposit. He found further that the buyer, by offering to purchase the property in a restructured transaction, had failed to effectively terminate the deal. Instead, the buyer had indicated that it was “eager to keep the Purchase Agreement in force (on terms other than those agreed to).” Since the deal had not terminated, the buyer remained under a duty to continue to use reasonable efforts to obtain the bank’s consent. Its failure to do so caused the loss of its deposit.
The 1617 Westcliff decision (the unpublished slip copy is available here) serves as a reminder to buyer’s counsel of the unique nature of distressed asset purchases. The Bankruptcy Court which originally approved the purchase remains available and prepared to resolve any issues which may arise prior to closing, often at a fraction of what it would cost to get a Superior Court involved in connection with an unraveled private sale. And conditions and contingencies to the sale must be carefully drafted and observed. This applies even to common asset-purchase “boilerplate” such as “commercial reasonableness” and “diligence.”