Lock-Out Agreements - What are the risks for Sellers?

An investor owns a prime investment which it is looking to sell. The seller receives a number of bids. One bidder is a long way ahead of the others but the seller is uncertain as to whether the bidder really has the money to proceed.

In addition, this highest bidder requires a lock-out agreement as a precondition to starting its due diligence. What is the potential downside for the seller of entering into such an arrangement? What sort of provisions should the seller include to protect itself against a buyer who he believes may not perform?

Nature of seller’s obligations

By entering into a lock-out agreement a seller is not actually committing to the proposed sale (just as the buyer is not committed to purchase). What the seller is giving up is its ability to sell the property to a third party during the lock-out period. The wording of each lock-out agreement will vary but basically the seller will be agreeing during the lockout period not to enter into negotiations with third parties, not to allow third parties to view the property and not to enter into any contractual arrangements with any third party.

In effect the site is sterilized. It is fundamental to any seller that any such arrangement is relatively short term. A seller does not want to find itself tied into a long lock-out arrangement particularly with a buyer who may not perform. No seller wants to be in the embarrassing position of having to explain to its shareholders that it is not in a position to accept a higher offer for site because it has entered into a long term lockout arrangement (unless of course the seller is receiving payment in itself for the lockout arrangement). After all, the purpose of a lock-out agreement should simply be to enable the buyer to carry out its initial due diligence whilst the parties agree the more detailed terms or the relevant legal documents.

Obviously the seller needs to give thought as to whether there are any specific arrangements (for example proposed lettings) which the seller is proposing to put in place during the lock-out period and which need to be excluded from the arrangements.

It is also essential that any lock-out agreement precisely defines a lock-out period. When does it start? When does it finish? If a trigger date is to be the date upon which information is supplied the type of information to be supplied should be specified so a to avoid any misunderstanding.

Good Faith Deposit

The seller might like to insist upon a non returnable deposit being paid by the buyer as the consideration for the lock-out agreement. This would not only compensate the seller for the sterilizing of the site for a short period but also, depending, on the amount provide some incentive for the buyer to proceed.

As a matter of law, a lock-out agreement does not have to be a written and properly signed agreement in the way a formal agreement for sale needs to be. It can be recorded in correspondence or even agreed verbally and in either case is legally enforceable. Sellers should however be very wary of entering into lock-out arrangements other than in a formal written form particularly where some form of non-refundable deposit is paid by the buyer.

The recent case of Gribbon –v- Lutton [2001] EWCA CW1956 illustrates the danger of a seller not having a written agreement. – In this case there was no written lock-out agreement and there were disputes as to the extent to which there had been a verbal lock-out agreement entered into by the parties. If the seller wants to be able to claim a non-refundable deposit at the end of the lock-out period if a buyer does not proceed, it is essential that the seller can show some form of consideration on its part for the payment of the non refundable deposit. Without “consideration” the deposit will have to be repaid. Obligations on the part of the seller of the type described above would be sufficient and a written agreement is the best evidence of those obligations.

Buyer’s Obligations

What sort of obligations should the seller impose on the buyer? At the very least, the seller will want the buyer to start carrying out its due diligence (for example submit searches, carry out environmental investigations and measured surveys within specific time limits). It may even be appropriate to specify that if those time limits are not met, the seller should be entitled to a right to determine the agreement.

The seller will also want the buyer or its solicitors to comment promptly on draft documents submitted, raise preliminary enquiries on information supplied and carry out the usual due diligence searches.

Where the seller is carrying out environmental or survey tests, the seller should ask the buyer to provide copies at the end of the lock-out period if the buyer does not proceed with the transaction – although these will not be specifically addressed to the seller they may provide useful background information (in particular circumstances a seller may even want to insist that the reports are addressed to the seller as well as the proposed buyer).

The seller will also want the buyer to keep the terms of the lock-out arrangement to be kept confidential. The last thing a seller wants is the market thinking a site has been sterilized particularly if the market gets the wrong impression about the length of a lock-out period or arrangement.

What other type of obligations might the seller enter into?

The seller may agree to procure that its solicitors dispatch draft documentation within a specific time frame, deal promptly with the buyer’s proposed amendments to the documentation and make reasonable efforts to answer the buyer’s preliminary enquiries.

If the seller is going to commit to allowing the buyer to carry out surveys, the seller needs to ensure that any occupational tenant’s consent is obtained where necessary and also approve the proposed investigations (for example the seller may want to be notified of where boreholes may be sunk; approve the proposed reinstatement works and check the buyer’s public liability insurance).

Liability for breach

What is the seller’s position if during the lock-out agreement the seller becomes convinced that the buyer is not going to proceed and he wants to proceed with an alternative offer immediately (say in order to achieve a sale before the year end). This will involve the seller breaching the lock-out agreement. What are its potential liabilities?

Firstly, a buyer may be able to obtain an injunction to prevent the seller negotiating with another interested party. However the courts have made it clear on a number of occasions that only a short term injunction will be granted (to reflect the nature of the lock-out agreement itself). Any injunction would prevent the seller negotiating with a third party during a lock-out period but would still not commit the seller to agree to any subsequent transaction with the original buyer.

Secondly a buyer will be entitled to damages for the breach. Historically, the Courts have focused on the buyer’s wasted costs when calculating the level of damages. However, there is an argument that the damages should be limited further. Even if the lock-out agreement has not been breached the transaction may not have proceeded and the buyer would have incurred irrecoverable costs. It could therefore be argued that the damages should be limited to the additional wasted costs which were incurred as a result of the seller’s breach.

With these potential limitations on a seller’s liability, a wary buyer may well ask the seller to pay a non-refundable deposit as well if the transaction does not proceed. This could then be used to compensate the buyer for its wasted expenditure and would also act as an incentive for the seller not to sell the site elsewhere. Obviously much will depend on the negotiating position of the parties but it is difficult to envisage that many sellers will want to put themselves in such a situation.

In any event an agreement to pay such a deposit or penalty does not in itself provide complete protection to a buyer. Such a deposit was paid or promised by Allied Domecq in exclusivity arrangements with Whitbread in respect of the well publicised sale of Allied’s pubs to Whitbread. Although there was a £25 Million payment which Allied Domecq would have had to make to Whitbread for breach, this did not stop Punch Taverns successfully bidding for (completely unsolicited and without any assistance from Allied) and acquiring these pubs.

So is there really any potential downside for the seller of a lock-out arrangement? The answer is a limited downside only. Provided the lock-out period is relatively short and the lock-out agreement incorporates the types of obligations on the buyer which are referred to above then a seller should not be unduly concerned – particularly if the seller can also persuade the interested buyer to pay a non refundable deposit.

For further information please contact Mark Heighton at [email protected] or on +44 (0)20 7367 2177