August 17, 2011

Firm News for August 2011: Best Practices: Executed Purchase-Sale Agreements

By: Ethan W. Smith, Esq.

Financing change of ownership transactions can present several unique challenges for lenders that are not present in loans for refinances or startups. From determining what searches are required to ensure the proper lien position, to dealing with the challenges posed by parties to the transaction whose timelines and expectations rarely align with those of the lender, the challenges presented by change of ownership loans can make the loan closing process both stressful and chaotic. One issue that presents itself from time to time is when parties refuse to execute the Purchase and Sale Agreement (or equivalent) until the closing. Most often this situation occurs when the parties have an executed Letter of Intent, but not always. Nevertheless, this situation presents several risks to both the Borrower and the lender that can disrupt the closing process at best, and risk the SBA guaranty at worst.

When the Purchase-Sale Agreement is not finalized at the outset of the transaction, material terms of the deal that can affect the eligibility of the loan may still be in flux. Terms such as the allocation of the purchase price, the terms of any employment or consulting agreements, or perhaps even the method of conveyance may still be changing as the parties negotiate. This can waste a great deal of time and money as the lender reacts to the ever-changing deal terms and attempts to ensure that the deal remains SBA eligible. Additionally, the lender risks the possibility of missing issues which could call the eligibility of the entire deal into question, thereby risking the SBA guaranty.

A more practical issue presented by the absence of an executed Purchase-Sale Agreement is the fact that without this executed contract, there is likely nothing to bind the seller to following through with the deal. Not only does the lender risk wasting its own time and money pursuing a transaction that the seller could walk away from at any time without penalty, but the lender also risks taking the borrower down the same path. Although it is uncertain whether the lender owes a duty to a borrower to avoid getting the borrower into this situation, it is not inconceivable that a lender could be subject to liability for encouraging a borrower to pursue a transaction that the seller is not obligated to follow through on. The most prudent course of action is to avoid these risks by requiring an executed purchase contract prior to working on the loan.

Regardless of the circumstances, the lack of an executed, enforceable Purchase and Sale Agreement presents unnecessary and unacceptable risks to both the purchaser/borrower and the lender. By requiring an executed Purchase and Sale Agreement early in the due diligence process, lenders can avoid the risks both to themselves and their borrowers.

For more information on this and other closing issues, contact Ethan at 267-470-1186 or at