Purchase and Sale: Flipping the Contract

By Alvin Arnold

In a strong real estate market, the value of a property can move up sharply upon the announcement of good news. This can be fertile ground for speculators who seek quick gains by trading properties. A popular technique for doing so is the flip contract—that is, entering into a purchase contract with the seller and then flipping it (assigning the right to buy) to a third party at a higher price. Although on the surface this process seems simple enough, complications could arise that leave the assignor facing an undesirable choice; either closing the purchase contract or walking away with a significant loss.

Assume that Mr. Speculator learns through private sources that a large company is considering the lease of a substantial amount of space in a largely vacant office building. He approaches the owner of the building and negotiates a contract to buy it for $1 million, $400,000 cash over an existing $600,000 first mortgage. Mr. Speculator puts down $40,000 at contract, agreeing to pay the balance of $360,000 at a closing in 120 days. The contract has a liquidated damages clause, permitting Mr. Speculator to walk away from the deal upon the loss of the down payment without further liability. The contract permits assignment to a third party.

After several weeks, the anticipated good news is announced. Mr. Speculator finds a local syndicate willing to buy the contract, provided that Mr. Speculator is able to obtain second mortgage financing for the $360,000 cash due at closing. A flip contract (assignment agreement) is entered into between Mr. Speculator and the syndicate. It calls for the syndicate to pay a cash purchase price of $90,000 to Mr. Speculator simultaneously with the closing of the underlying purchase contract. This amount represents the $40,000 reimbursement for the down payment plus a $50,000 profit to Mr. Speculator.

Mr. Speculator is able to obtain from a non-institutional lender a commitment for a discounted second mortgage with a face amount of $360,000 but to be funded at only $345,000. Because Mr. Speculator must put up the additional $15,000 to provide the necessary cash at the closing of the underlying contract, his gross profit is $35,000 ($50,000 minus $15,000 for the mortgage discount).

In drafting the flip contract under the facts described above, Mr. Speculator and the syndicate should consider a number of issues that fall into two categories: those related to the underlying contract of sale with the property owner and those relating to the flip contract itself. First, the flip contract must have attached to it as an exhibit the original or a true copy of the underlying sales contract, and the assignor must warrant that no changes have been made to the contract and none will be made without the consent of the assignee.

The parties must then specify who will deal with the seller following the assignment. For example, the underlying contract may give the buyer the right to require that any vacant space not be leased (so that the buyer can later negotiate its own leases), provided the buyer agrees to make good any lost rent.

The seller also must be notified of objections to title, any legal violations, or other unfulfilled conditions under the contract. Because the assignee is the true party-ininterest, the right and duty to make decisions on these matters should be the assignee’s. However, the assignor should have the right to step in if the assignee fails to act, to protect the assignor’s rights in the event the assignee eventually fails to complete the purchase.

The seller of property normally is not obligated to acknowledge notices from any party other than the assignor unless the seller consented to the assignment. Consequently, the assignor and assignee should agree on a procedure for giving notice; one solution is to have both join in notices to the seller.

The underlying contract may give the buyer the right to terminate the contract under certain conditions (e.g., if the title report contains exceptions not acceptable to the buyer). The flip contract should make clear what will happen if the assignee wishes to exercise the right to terminate the underlying contact and the assignor does not. One solution is to permit the assignee to cancel the flip contract but not the underlying contract. Suppose the seller has the right to cancel if the cost of curing certain violations exceeds a dollar limit and the buyer will not pay the excess. The assignor may insist on having the right to pay in order to keep the flip contract in force.

Several negotiating issues arise with regard to the flip contract (assignment agreement) itself. First, if the assignor has certain obligations under the flip contract (e.g., to obtain additional financing, as in the above case study), the consequences should be clear if the obligation cannot be fulfilled. For example, the assignor may be entitled to terminate the flip contract upon returning any down payment; or may be liable for a liquidated damages payment; or may be liable for actual damages suffered by the assignee (e.g., loss of his bargain).

Second, the flip contract should specify the consequences if the assignee fails to close the underlying contract and the assignor also is unwilling to do so. Normally, the seller of real estate agrees to accept the down payment as liquidated damages. This should be the liability of the assignee. If the seller has the right to any other remedy, the assignor will insist that the assignee be liable for that also. Finally, the assignor should be entitled to all or a portion of his lost profit on the Finally, the flip contract should specify the assignor’s remedy if the assignee defaults and the assignor decides to close the underlying contract himself

Alvin Arnold is editor of the Monitor

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Inquiries about material in the Monitor should be directed to
Alvin L. Arnold at (212) 885-8235.