February 8, 2021
Even during a pandemic, the inability to obtain financing may not allow a buyer to walk away from a contract. An order for specific performance compelling the buyer to complete the deal may be the result. This is a cautionary tale about when you should decide to be a buyer, and about taking greater care to manage risks from the beginning, when agreements are drafted.
The doctrine of frustration relieves a party to a contract of the obligation to complete the contract “when a situation has arisen for which the parties made no provision in the contract and performance of the contract becomes a thing radically different from that which was undertaken by the contract” (The Supreme Court in Naylor Group Inc v Ellis-Don Construction Ltd. 2001 SCC 58).
The case of FSC (Annex) Limited Partnership v. ADI 64 Prince Arthur L.P, 2020 ONSC 5055 (CanLII), involved a “shotgun buy/sell” provision of the sort common in real estate joint ventures. ESC, the financial investor in a condominium project, triggered the clause after it apparently encountered difficulties working with ADI, the construction management partner. ADI chose to be the buyer of FSC’s interest.
Then it was unable to obtain financing and the deal did not close. ADI claimed that the pandemic frustrated the agreement, in that the unexpected event made it unable to borrow.
The judge did not agree with this argument because:
- ADI had three months before the pandemic emergency was declared to obtain financing
- ADI took a “somewhat relaxed” approach to obtaining financing. It did not have financing in place when it decided to be a buyer, not a seller, which was its choice
- before advising that they would not close, they had only contacted a “handful” of potential sources of financing – another deliberate choice
- while the pandemic might create restrictions on credit availability, this is not unique. Though no expert evidence was led, the judge noted that credit availability fluctuates as part of the ebb and flow of business cycles
- this is a normal risk a buyer faces
- a potential buyer can protect itself by making an offer conditional on financing
- though on the facts a conditional offer was not possible under this buy/sell clause, that simply suggests that ADI “did not have the financial wherewithal” to be the buyer, and should not have done so
- the risks inherent in committing to a buy/sell purchase are well known
- ADI had signed the agreement which did not contain any clauses covering financing conditions, material adverse changes or material adverse events though such clauses are common contractual provisions
- allowing ADI to exercise the buy option and then claim frustration would be unfair
- courts have previously held that economic downturns that create a lack of financing do not amount to frustration
Specific performance is an equitable remedy, and the equities here all favoured FSC – that is captured by the judge’s reference to fairness.
The final issue was whether damages would be an adequate remedy – in most cases where a seller tries for specific performance, the simple answer is that they can remarket the property and sue for any losses.
In this case, however, the judge:
- foresaw further disputes over the adequacy of the efforts to sell, and the price eventually obtained;
- considered the complexity of the development agreement, which would make finding another buyer complicated;
- decided that ADI, having decided to seek the benefits of purchasing, now must assume the risks.
There is no word on whether or not ADI actually was able to close the purchase, which is of course a primary reason why specific performance is seldom awarded in these circumstances. If ADI failed to comply, they might be found in contempt, and perhaps then damages might be sought, but that would be a frustrating result indeed.
For this reason, courts generally do not make orders that cannot be obeyed. But ADI, through its conduct, left this judge little choice. The result may be different in cases with other facts, but the same principles apply – especially the warning that deciding to be the buyer under a buy/sell clause is a risky proposition not to be taken lightly.
Also, as suggested by the judge, if you wish to protect yourself against risks such as an economic downturn or change in credit availability or other material changes in circumstances, provisions should be built into the buy/sell provision when the agreement is negotiated.