Author Archives: Christopher P. Finney

An issue that manifests itself in any number of scenarios is the seemingly odd question: Can a seller contract to sell something that he does not own.

Somewhat surprisingly, the answer can be “yes.”

Hypothetical sale of stock

Let’s take a theoretical situation in which a seller promises to sell to a buyer 1,000 shares of the Procter & Gamble Corporation for $100 per share on the 2nd of January, 2018 (a date that as of this writing has not yet come), but the seller does not own any Procter and Gamble at the time of making such agreement.  Is that contract enforceable against the buyer?  As against the seller?

Sure.  If the seller does not own 1,000 shares of Procter & Gamble Corporation at the time of the contract, he had better make arrangements to get that stock under his ownership or to find a party who does own those shares who will fulfill the seller’s promises.

OK, but what about real property?

But come on, that’s perfectly fine as to a publicly-traded stock, but what about property that is entirely unique, not replaceable with “equal or like-kind” property, and under the control of a third party?

Well, the same principle applies.  If the seller is going to make a binding promise to sell that asset, and he wants to avoid being sued for breach of contract, he had better figure out how to either get title to the property before the promised closing date, or otherwise arrange for the cooperation of the property owner.

The basis for fraud?

The story is as old as the bridge.  A gullible tourist goes to New York City and a local shyster sells them the Brooklyn Bridge.  The seller does not own the bridge at the time of the contract, so it’s an enforceable contract, right?

Well, in that classic case, and in the case of other instances of fraud, selling property that the seller does not own could well be a badge of fraud.  If he knew at the time of contracting that he did not have title, and could not obtain title to the property in question, then the promise to sell that asset clearly would be fraud.

What if the seller claims that he thought he would be able to obtain the asset before the promised closing date, but was just unsuccessful.  Depending on his intentions, and the affirmative representations made by seller in conjunction with the sale, the failure of performance could be simple breach of contract, or it could be actionable fraud.

The peril for the seller

The peril for the seller who does not own the asset he promises to sell is that in order to avoid claims both for breach of contract and fraud, he will need to “pay the price” to get that asset into his name before the date of his performance.  In the case of Procter and Gamble Stock, if the price on the NYSE rises of $150 per share before the first of the year, he may just need to take a loss at $50 per share to assure fulfillment of his contractual obligations.  In the case of unique property owned or controlled by a third party, the seller may be in great peril as he will be under the mercy of that seller to “name his price” and terms to transfer the asset to the seller who has promised it any a date certain to a certain buyer.

Conclusion

This concept comes into play in various scenarios.  And the first instinct of parties — and attorneys — is to think you can’t promise to sell that which you don’t own.  A seller can.  But he should carefully consider the consequences of that decision.

What due diligence steps should a tenant undertake with respect to a commercial property before signing a lease?

Due diligence customary in a commercial real property purchase

Step back and consider for a moment that when we buy a piece of real property — for our home or for our business — it is prudent and customary by both the buyer and the lender to conduct due diligence investigations of the property:

• title,
• survey,
• physical inspections of the structure and mechanical systems,
• environmental, and
• checks of governmental records for notices of liens for violations, zoning, traffic engineering, etc.

The list can seem endless.

Isn’t a commercial lease low-risk for the tenant?

But when simply signing a lease for a term of years, why should the tenant be concerned with these things?  After all, his upfront cash may not be significant (relative to a purchase) and if things don’t work out, the tenant can just leave, right?

Well, sometimes that is the case.  The cost and time needed for due diligence would outweigh the risk the tenant is undertaking by simply signing the lease and moving in.  If so, then by all means, proceed.

But, wait, consider this!

But consider these countervailing factors:

• Tenant is spending significant monies on tenant buildout costs.
• Tenant is spending significant monies to move, including moving of furniture, fixtures and equipment, the installation of computer and phone systems, and printing of letterhead, envelopes and business cards.
• The disruption of your business arising from a move (and if things don’t work out a second move).
• The image you are building at the new location.  What will be lost if a second move is necessary?  Think of a restaurant or bar, retail store,  or bank branch.  The location is intricately tied to a business’s identity in the mind of the consumer.  It may not be easy to just pick up and move.

The reality is that if the tenant does not undertake the kinds of due diligence implemented for a property purchase, he could “lose” the property in many of the same ways as in a purchase — i.e., he could lose the out-of-pocket costs associated with the activities noted above and have the inconvenience and loss to reputation by relocating to a second location.

The types of risk potentially borne by a tenant that due diligence could avoid

Indeed, in certain circumstances the tenant could be obligated to pay rent throughout the lease term, but the property cannot be occupied for its intended purpose.  (Consider a situation where the property cannot be occupied but where the landlord does not appear technically in default of his obligations under the lease.)

• When signing a significant lease for property, a title examination, possibly a survey, and assuring lender buy-in of the lease can be absolutely critical.
• If, for example, the landlord has a mortgage against the property, and the mortgage is in default, that lender legally can extinguish a later–signed lease concurrent with the foreclosure.
  • To avoid this risk, one asks a landlord to execute a subordination, non–disturbance and attornment agreement agreeing that so long as tenant makes prompt and full payment of rent (to the landlord or– when in default of the mortgage — to the lender), the lender or a successor buyer will honor the lease.
  • A tenant’s policy of title insurance can be issued, transferring that risk to a title insurer.
• If the property does not comply with the regulatory requirements, zoning for example, of the jurisdiction in which the property is located, the tenant could be required to make extensive property modifications or to move.
• If the property has environmental problems, the cost of compliance — in an unlimited manner — could be transferred to the tenant.
• If the property has structural problems or the HVAC system is old and inoperable, depending on the lease language (shifting repairs and replacement of the HVAC to the tenant), the burden of fixing the problem could fall to the tenant.

Conclusion

Many times tenants will assume these risks in smaller leases.  Negotiating with the landlord’s lender and conducting full-scale inspections and other due diligence may just not be practical.

But a tenant in a commercial setting should carefully consider the risk-benefit to foregoing certain due diligence steps to prudently protect their investment in their new premises.

Call Isaac Heintz (513-943-6654) or Eli Krafte-Jacobs (513-797-2853) to address your commercial leasing questions.