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Lawletter No. 201 Seller should make sure escrow closes when giving up possession When selling a business, perhaps the biggest mistake you can make is to hand over possession of the business before escrow closes. We continue to see a substantial number of cases where the seller of an automotive service or service station business fails to follow this rule and gets into serious trouble. In Lawletter Nos. 183 ("10 questions service station franchise buyers should ask") and 185 ("10 questions that service station franchise sellers should ask") we provided a general checklist for both buyers and sellers to review. One of the issues on that checklist for sellers involves getting a clear understanding of how and escrow works and why you should use one. This month, we focus specifically on escrows. Key points for seller: We would bring the following points in particular to the seller's attention: (1) Once the buyer has possession of the premises, as a general rule you cannot regain possession without filing a lawsuit. Such a lawsuit can be protracted and costly. Even if you win, you will not recover your attorney fees unless the written contract so provides. (2) You cannot obtain money that the buyer has deposited in escrow until he signs a written escrow instruction authorizing the dispersal of the funds. If the buyer refuses to release the funds, you will have to file suit to obtain them. (3) Even if the buyer refuses to release the funds, you would still have to file (and win) a lawsuit to regain possession of the premises on which the business is located. (4) If you are selling an oil company service station franchise, you may not be able to retake possession of the station even if the buyer refuses to release any funds from the escrow. It is not at all clear whether a franchise can legally be subject to repossession. (5) If the funds remain in escrow after the scheduled closing date, the escrow company has the option of filing a lawsuit and depositing the money with the court. The buyer and seller must then sue each other to get the money released. The escrow company, however, will be able to deduct its legal fees from the funds deposited with it. (6) The seller invites trouble by allowing the buyer to take possession prior to the close of escrow and the release of funds. Our experience indicates that a buyer who goes out of his way to manipulate the seller into a premature transfer of possession is likely to raise some minor or bogus claim as an excuse for claiming the price is too high. These claims have included everything from minor physical defects to assertions that the business is not as profitable as the seller said it was. (7) Failure to comply with all escrow conditions prior to a transfer of possession can lead to all sorts of other problems. For example, in some cases, it will be necessary to obtain the landlord's prior written consent to the assignment of a lease. If the seller hands over possession before that consent has been obtained, the lease may be subject to termination. Recommended procedures: We therefore suggest the following: (1) Get legal advice: As the foregoing indicates, the sale of an ongoing business usually requires competent legal advice. There are simply too many potential problems and technicalities to risk handling these transactions without an attorney. Make sure that you and your attorney go over each of the potential problems discussed above. Your lawyer will be able to advise as to the appropriate time for transferring possession. (2) Don't rely on broker: Don't rely on a broker for legal advice. Brokers are not trained in this area. Their job is to put buyers and sellers together and make deals go through. They are not lawyers. (3) Evaluate security where note given: If you are taking a secured note as part of the purchase price, carefully evaluate the collateral. If the business itself is being pledged as collateral, have your lawyer determine whether you could really repossess the business and what the cost would be. |
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