Understanding Real Estate Extension Agreements: What Buyers and Sellers Should Know

What is a Real Estate Extension?

In the world of commercial real estate, the phrase "extension agreement" has taken on specific meaning. A form interpretation is as follows: "A written agreement between a landlord and a tenant or lessee, the purpose of which is to extend the initial term of the lease." A "further term" can also be included by the parties agreeing to an additional period of time to the existing initial term of the lease.
Practically speaking , from the perspective of the seller – it is common for a transaction involving multiple properties that are leased to the same tenant to have one or more of the properties under an extension agreement for purposes of obtaining the consent of the tenant to a certain disposition of a property or properties (or, for changes in other material terms of agreements affecting the property). From the buyer’s perspective, it is common for a transaction involving multiple properties that are leased to the same tenant to have one or more of the properties under an extension agreement in order to prevent a transfer of the property to a potential competitor by having less than all of the properties exist under an extension agreement.

When Would an Extension Agreement be Useful?

Extending the closing date may be necessary for a variety of reasons. In many cases, there are unknown issues which arise prior to closing that may delay the transaction. The following are a few common examples of circumstances that necessitate a real estate extension:

1. Delayed Financing.

Buyer’s often times run into difficulty obtaining financing. This can be caused by a variety of issues for example, when a buyer was counting on receiving money from the sale of other real estate but the deal fell through resulting in an inability of the buyer funding his or her new purchase. Another common reason for delayed financing occurs when lenders own policy decisions change on the eve of closing resulting in a failure to secure financing.

2. Inspection Issues.

More times than not, closing cannot take place if the inspections have not been performed or reviewed and any issues addressed.

3. Pending Sale of Other Property.

People often times buy and sell more than one property at the same time. Delays may occur where one property is reliant on the closing of another property.
Useful Tip:
It is important as a seller or purchaser to be aware of closing date contingencies so that one is not in jeopardy of becoming in breach of its obligations.

Key Elements of an Extension Agreement

When drafting a real estate extension agreement, it is important to have clarity on critical elements that should be retained to avoid any confusion. Some examples of these components are:
New Closing Date
In most cases, the original transaction could not close due to reasons such as: 1) conditions not satisfied or waived by a party, 2) delays in obtaining a key regulatory permit or 3) inability to obtain satisfactory financing. Whatever the case, the reason for the delay in achieving closing should be set out in the extension agreement.
In some instances, the buyer’s condition regarding financing may not have been satisfied, thus compelling the parties to agree on a new closing date at a later time. The new closing date is critical in determining the rights and obligations of the parties.
If a buyer’s financing condition was not met, it may be preferred to grant an extension period in which the buyer must either withdraw its financing condition or show that it was satisfied. If the buyer subsequently shows that the financing condition was in fact satisfied within the extension period, the parties may then mutually agree on the subsequent dates of closing and possession.
In all cases, the parties must have a specific date by which the transaction is to close or fall thru (without incurring default, breach or otherwise).
Revised Conditions
Despite the best efforts of the parties, various conditions had to be placed into the original real estate transaction in order to accommodate the needs of both the buyer and seller. This critical information is the foundation of the transaction as it is what allowed the parties to agree on moving forward with the transaction in the first place. As such, the parties must consider whether the reasons that caused the original transaction to falter also impacted the satisfaction of the original conditions. For example, if the transaction failed to close due to a contingency that the property be appraised at or above a certain value, the purchase price may need to be reduced.
Once the original conditions (or parts thereof) are modified, the parties should clearly lay out the new conditions in the extension agreement.

Legal Effects of an Extension Agreement

The legal implications of extension agreements can be significant, with far-reaching consequences if not managed appropriately. Buyers and sellers must understand whether or not an extension agreement is permitted under their existing contract, and if so, what the applicable legal process is to properly execute the extension agreement. Failure to observe the requirements under the underlying contract kan result in significant delay and may prejudice the parties. A legal review of the underlying contract will advise the parties as to their obligations to comply with the formalities of executing an extension agreement, and any issues that may arise as a result of doing so.
Furthermore, tax considerations must also apply to extension agreements. A seller may be properly motivated to extend a contract on the hope that higher taxes will occur, which a purchaser may be properly motivated to close on the property if lower taxes are levied. In addition to the tax considerations, other legal issues can arise as a result of an extension agreement, not the least of which is the possibility of potential tort liability, estoppel issues, and damages claims. The law around extension agreements is complicated and is an issue that any buyer or seller should discuss with legal counsel before entering into an extension agreement or a remedy for breach of the extension agreement.

How to Negotiate an Extension Agreement

Buyers and sellers should consider whether to agree in advance on the extent, length, terms and conditions of future extensions, including termination rights. A number of strategies are available to negotiate such an agreement:
Buyers minimize the risk of delay by negotiating an extension to a sale agreement in advance. The seller’s willingness to negotiate an extension will depend, in part, on the stage of the negotiations, the condition of the economy and market, and the closing "clause" of the sale agreement. An extension of time to close on a deal struck in a strong market would generally require less incentive for the seller to agree than one struck when the economy is weak and the seller faces a great risk of falling out of a deal.
The parties would typically exchange copies of the extension before closing. An extension is likely to be entered into by the individual(s) who signed the sale agreement on behalf of the buyer(s) and seller(s) . However, it may also be prudent to execute the extension under seal. In such cases a witness would be advisable.
Secret Last Minute Extensions Are Invalid Parties sometimes fail to extend the sale agreement, preferring instead to agree verbally on a new closing date and then close without signing anything. For instance, even after a transaction has been formally terminated by a party prior to the closing date, if the parties proceed to close the deal and the seller accepts the purchase price, but they do not prepare any documentation of an extension, due diligence would show that "no one asked Joe for permission to shut the barn door." Caution is warranted, particularly in a real estate context. If a seller permits or encourages a purchase to close without a formal extension, knowing that this is not what was intended by both parties, the seller may have ratified the extension or waiver and deprived itself of a defence based on a signed termination.

Common Mistakes When Working with an Extension Agreement

It is important to ensure that extension agreements are entered into at the correct time and in the right circumstances. The most common pitfall is the failure to act quickly enough. Redevelopment transactions are often complex and time-consuming deals which can involve multiple levels of approvals, development plans and other consultations. Without due care, the buyer can find itself in a position where an extension is needed because the condition end date has passed. Developers sometimes get sucked into the progressive entitlements process and underestimate how much red tape is involved, and the time it will take to deal with. Not acting early enough can result in having to agree to less favourable conditions or even having to open negotiations again with a more concerned vendor. This can easily lead to paying full price for a site that cannot develop as desired.
It is also impossible to agree on too many conditions. Typically, an extension agreement is not the time to seek additional conditions as a buyer. The buyer has passed due diligence; it will be rare that a developer will re-negotiate economic or lease conditions, for example.
Failure to address the parameters of the extension agreement can create ‘unexpected’ costs, particularly where the change is fundamental to the agreement. For example, rezoning costs can be significant and can delay the project. Developers must be careful to budget and prepare for further costs and delays and account for those before entering into an extension agreement.

How to Create an Extension Agreement

The parties to an extension agreement must be careful to ensure that they clearly express their intent in writing. Consideration should be given to the following:
(a) if there are default provisions in the original contract of purchase and sale, it is common to also include those default provisions in the extension agreement. In the absence of such provisions, then the lender will have to determine whether it can take possession after the expiry of the extension period by way of relying on its rights under the original contract of purchase and sale;
(b) by expressly stating that the extension agreement is only for a definite period of time, the parties are more likely to avoid litigation about the sale of the property if the borrower is unable to complete the sale within the extension period;
(c) if the extension agreement requires the borrower to pay interest on the outstanding principal amount at a specified rate or to make interest payments to the lender, then that requirement should also be included in the extension agreement;
(d) if the borrower wants to obtain clear title to the property in order to refinance, subdivide, or further develop the property, then the extension agreement must state that the borrower is permitted to obtain clear title to the property; and
(e) consider whether the extension agreement should state that the borrower will not be able to effectively enjoy its rights during the extension period, without the lender’s consent. Adding such a provision will avoid the parties needing to address whether the extension agreement constitutes "an intervening contractual arrangement" and thereby voids the purchase and sale agreement and transfer.