Don't play fast and loose with real estate contracts.

In a booming real estate market, some owners who have gone to contract to sell or lease real property try to use technicalities to assert that buyers have defaulted on the terms of the contract and that the transaction should have been terminated.

Their hope and belief is that they will be able to find another buyer or tenant who, in the rising market, will be willing to pay more for the property. Buyers are prospective tenants, conversely, try to keep the deals together and bring them to closing.

In sharply declining markets, the roles reverse. Owners are motivated to get to the closing table, but some buyers and tenants will look to kill a deal on the assumption that they will find a better one or that they will be able to re-trade the same deal at a lower price. Today's commercial real estate markets in New York City--the acquisition and leasing markets alike--seem to be neither a sharply rising owners' market nor a sharply declining buyers' and tenants' market. Obviously, the current problems in the financial sector have made it more difficult to finance deals and have led to significant layoffs. While prices in most sectors have softened, the New York City commercial market has not seen the fire-sale transactions that have occurred in certain other parts of the country. Rather, the New York City commercial real estate market has softened.

A recent decision in the New York State Appellate Division, Second Department, sends a global, big-picture, cautionary message to sellers and buyers and lessors and lessees: Don't play fast and loose with real estate contracts to try to carve out a more advantageous deal.

The case involved the purchase of two Mitchell-Lama housing projects on Roosevelt Island, but the Court's decision clearly applies to the purchase, sale or lease of any commercial or residential property in New York State. The sellers in this case tried to claim that the buyer--a client of our firm--had defaulted on the purchase by failing to close on a designated closing date. The buyer claimed that it had all of the funds necessary to close and that it had been willing to close the transaction in timely fashion. The sellers sought not only to void the deal, but also to keep the deposit.

The appellate judges ruled that the sellers had failed to prove that they had done everything that they were required to do to close the transaction and that the lack of such proof prevented them from defaulting our client. Our client believed that the real story was that the sellers did not want to close and preferred to kill the deal. The market at the time--late 2005 and early 2006--was one in which property values were rising sharply. If the transaction was terminated, the buyer would likely seek a deal with another buyer for substantially more money than the sellers and the buyers had agreed upon.

The message the Court has sent is that when you enter into a valid contract, you should honor the terms of that contract. Obviously, there are times when a contracting party deserves to be defaulted and a contract should be terminated. However, bad faith attempts to re-trade a deal by asserting bogus claims of default ultimately tend to backfire. The consequences could include liability for damages, based on the diminution of property values between the time the deal was supposed to close and the time the deal actually closes, as well as issues of reputation. Expensive litigation is another likely by-product of asserting specious claims of default.

The decision whether to honor a contract as written or attempt to renegotiate it by accusing the other party of defaulting on their obligations, is often driven by business factors, coupled with legal risks. By all means, negotiate hard. But at the end of the day, when you have a deal, honor the deal. It generally makes the most business and economic sense and, as the Court tells us in this case, the law requires it.

By SCOTT E. MOLLEN, ESQ., PARTNER HERRICK, FEINSTEIN LLP