Companies everywhere are working on ways to increase their capital base. In real estate, the use of various means of financing is, particularly in demand. The most common is what is known as contingent financing when drafting agreements for the sale of real estate. To learn what contingent financing is and how it can be used in real estate, please read this article.
Contingent financing: what is it and what is its role in real estate?
According to the common definition, contingent financing is a part of the contract that stipulates the need for the buyer to finance the property being purchased. Essentially, it represents an obligation that accrues to the purchaser of the property. At the same time, it is a prerequisite for the sale transaction – if the buyer does not agree to this clause or does not have the necessary capital, the transaction simply will not take place.
The main purpose of contingency financing is to protect the buyer’s interests in unexpected situations. For example, a public tender process was conducted and a winner was identified, but before the final stage of finalizing the transaction, the buyer was not financially able to follow through with the transaction. Therefore, in order to avoid possible penalties, a contingency financing clause must be included in the preliminary agreements. Contingency financing clauses must necessarily include:
- The final date of the transaction;
- Force majeure circumstances that may prevent its implementation and how they will be resolved;
- How conflicts between the parties will be resolved if the deal does not go through.
Since contingent financing is most often used to protect the buyer’s interests, the seller should use all possible means to protect his own interests. In particular, a due diligence assessment should be conducted prior to commencing negotiations to ensure that the buyer is capable of completing the transaction and that he intends to do so in good faith.
As mentioned above, a contingency financing clause is a mandatory part of a property purchase agreement. But they can only be invoked if certain conditions are met:
- The transaction has not been completed on time. If the buyer fails to complete the transaction before the deadline specified in the contract, he loses the entire amount of the contingency financing. If, however, the transaction is not completed on time through the seller, the entire amount of the deposit is refunded to the buyer.
- Unforeseen circumstances have arisen. If the transaction could not take place due to the influence of circumstances that were stipulated in the contract as contingencies, the entire amount of the deposit will be refunded to the buyer. This way the buyer’s interests can be safeguarded.
- A contingency assessment has been carried out. It is not always the case that force majeure has a decisive influence on the use of contingent financing, as they were not significant in nature. Therefore, contingent financing becomes available only after such circumstances have been assessed. The conclusions made by an inspectorate on the nature and strength of the contingency should also include a recommendation on whether the contingency funding should be triggered.
To ensure that the terms of contingency financing in real estate transactions do not come as a surprise to the parties, they should be made available by dataroom. Talking about it beforehand will help you work out the most suitable terms for contingency financing.