Five Key Legal Issues in Wholesaling
Wholesaling is becoming a more and more popular way that investors do deals. Wholesaling, like any real estate investment, has positives and negatives aspects. As a lawyer who has handled a fair amount of wholesale deals, I made a list of five legal issues that every investor should be aware of before getting involved in a wholesale transaction.
- Make Sure the Contract is Assignable
Not every contract is assignable, which is the mechanism that wholesalers use to sell their interest in the contract for a fee. Every county in Connecticut has a slightly different purchase and sale agreement, and many have also been tinkered by real estate agents and attorneys. Moreover, I see more investors using forms they have downloaded from various websites. If you are going to wholesale a contract, you need to make sure the contract is clear that you, as the Buyer, have the right to assign the contract to anyone in your sole discretion. If there is no such clause, arguably you may have to perform and you cannot sell the contract. Make sure the contact has a clear provision that you have the right to assign your interest.
Any real estate transaction has risks. Wholesaling a deal is no different. Therefore, it benefits you and mitigates risk if you enter into the contract with a limited liability company instead of as an individual. In the event that something goes south and there is litigation, it is much better if your LLC is a party and not you, and hopefully your LLC does not own many assets.
- Due Diligence Items
Due diligence items in the contract are essential even in a wholesale deal where you ultimately will not close. You should include the same due diligence items in the contract as if you were planning on purchasing the property. These due diligence items at a minimum are an inspection contingency clause and a mortgage contingency clause. I always advise clients wholesaling that they should push the contingency dates out as far as possible to allow you time to find a new buyer and give the new buyer enough time to do an inspection and/or apply for a mortgage. Keep in mind that the new buyer who you wholesale to will essentially step into your shoes and will have the same due diligence rights as when you signed the contract, so think carefully about them with the help of an attorney.
- You may have to Perform
If you cannot find a new buyer by the closing date, you may have to close on the property depending on how you draft the contract. If the Seller will not allow an exit provision if you cannot wholesale the contract, you will have to close or breach. If this is unacceptable, make sure there is a contingency clause that addresses this.
- If you are the Seller, Make Sure Buyer #1 on the hook if Buyer #2 does not perform
The Seller may allow you to assign the contract to a new buyer but insist that if that new buyer does not close, you are then required to close. When I represent sellers in wholesaling deals, I insist on this provision to protect the seller. Be prepared for this type of negotiation. Putting more money down may make the Seller more comfortable and not insist on such a provision (then you can seek reimbursement for the deposit from your new buyer).