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“Or nominee” and Its Problems

by / Thursday, 14 November 2013 / Published in Articles

“Or nominee” and Its Problems  

By Bryan Mashian, Esq.  

 

Real estate buyers and brokers routinely insert “or nominee” after the buyer’s name in purchase offers. They usually add these words because the buyer wants to have flexibility in taking title to the property, such as in a business entity that has not yet been formed, or to “flip” the property to a new buyer (presumably at a higher price). Adding “or nominee” as magic words may or may not accomplish these goals but can provide an argument to a seller looking to back out of a contract that the purchase contract is unenforceable.

The reported California court decisions are inconsistent and therefore may cast some doubt on the enforceability of a purchase contract with an “or nominee” provision. Some cases appear to hold that inserting “or nominee” in an offer renders unenforceable any contract formed by its acceptance, as well as any claim to a broker’s commission based on having procured that offer. Some of these cases have relied on the statute of frauds requirement of a writing that shows the identity of the purchaser.

Some cases have rationalized that there has to be mutuality of obligations to have an enforceable contract. So, if the named buyer can designate a nominee as a substitute and walk away with no liability, then there is no enforceable contract. But other cases ignore these difficulties altogether and enforce the resulting contract, but still vary widely as to the meaning or effect of “or nominee.” Consequently, buyers and brokers should avoid using “or nominee” and risk that if the seller changes his mind after accepting an offer, a court may let the seller out on the ground that the contract was unenforceable.

The buyer’s contractual rights can be freely assigned unless prohibited by statute or the parties’ contract. Depending on the buyer’s plan, the buyer should initially consider whether adding any language is required.

Often the buyer intends to take title in the name of a company that has not yet been formed, which is typical for real estate syndicators. Or, a parent company intends to vest title in an operating subsidiary or a related entity. If the contract does not restrict transfers, nothing specific needs to be added to accomplish these types of transfers. The buyer can freely assign the contract at the close of escrow to the newly formed or related entity. But most commercial purchase and sale contracts restrict the buyer’s right to assign. So, the buyer needs to provide the right to assign to such entities, which is usually acceptable to the seller.

But the analysis becomes more complicated with other transfers. The flip buyer wants to assign the contract to make a profit. A straw buyer initially signs the contract but intends to take title at the close of escrow in the name of the secret ultimate purchaser. A straw buyer contracts with the seller because the seller has some special or personal objection to a particular purchaser, or because the purchaser has another reason to keep its identity secret. The discovery of any of these circumstances may create remorse in a seller and who may then try to back out of the deal. So, the flip, the straw or the secret buyer has to make sure the contract allows sufficient flexibility to achiever their objectives.

In all cash deals, once the seller has either prequalified the buyer or verified the buyer’s funds, then arguably the seller will not (or should not) care about the identity of the ultimate grantee. If the purchase contract requires the seller to finance a part of the purchase price, in California the seller can only collect on a secured purchase money note by foreclosing the deed of trust. So, if the seller is accepting a purchase money note secured by a deed of trust for the unpaid balance of the price, it might seem logical that it does not matter who as buyer signs the note, since no one has any personal liability for this loan. Furthermore, because of California’s “one action” rule, the seller cannot simply give up the security and elect to proceed solely on the note.

Even though the identity of the ultimate buyer might not matter theoretically in either of these cases, most sellers will prefer (and some will insist) to have the right to approve an assignee to retain control, and to make sure the buyer is credit-worthy and generally pays his obligations in a timely manner.

A common misconception is that upon assigning the purchase contract the original buyer is released. But the law is than an assignor still remains liable to perform the purchase contract. If the purchase contract has a valid liquidated damages provision, and the assignor receives from the assignee the amount of the liquidated damages, then as a practical matter the assignor has little exposure if the assignee breaches and does not close escrow. But in a flip, the assignee rarely will pay assignor’s profit until the close of escrow occurs.

To properly set up a flip where the assignor can assign the purchase contract, take a profit, and then walk away from any liability, the purchase contract must explicitly provide for such release of liability. The release component makes this transfer a “novation,” which can be provided in advance in the purchase contract. Needless to say, most sellers will be alarmed by (and at least resist) an advance request to completely substitute one buyer for an unknown buyer.

Buyers and brokers must be aware of a buyer’s ultimate goal and make an offer that does not lead to an unenforceable contract. The parties cannot blithely count on the “or nominee” words to accomplish all objectives.

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