Hard money deposits in purchasing an auto dealership

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The deposit is a standard and integral term in buy-sell agreements, whether in an asset purchase agreement (an “APA”) or stock purchase agreement. The focus here will be APAs, since they are used for the vast majority of automobile dealership buy-sells.

Generally, at the start of a buy-sell, the parties execute the APA, open escrow, and the buyer deposits the agreed-upon cash deposit. There is no standard amount of deposit, but it tends to be within 2% to 8% of the final purchase price, less flooring. The APA provides that the deposit is subject to a myriad of terms and conditions governing such things as selection of the escrow, whether interest is earned on the deposit, and what rights the buyer has to recover the deposit. Most APAs – and the kind discussed here – provide for the deposit to go to the seller as “liquidated damages” if the buyer fails to close the transaction in breach of the APA.

Most APAs also provide for a due diligence period. If the buyer elects to cancel the purchase prior to the end of due diligence, the buyer simply gives notice of termination to the seller, and the deposit goes right back to the buyer. However, it is after the end of due diligence when sellers ask “has the deposit gone hard?” Since a “hard deposit” is not exactly defined in the law, the question is more ambiguous than it seems.

After the end of the due diligence period the buyer no longer has an unrestricted right to terminate. As such, the deposit is no longer refundable to the buyer at will. The buyer is committed to closing the transaction or facing loss of the deposit for failing to close. But does that mean the deposit is now a hard deposit? That may not be enough in the minds of many sellers. This is because the APA contains a host of conditions to the buyer’s obligation to close, and if these conditions are not met, the deposit goes back to the buyer. Examples of such conditions include factory approval, DMV licensure, financing approval, and landlord consent to assignment and assumption of the lease. Experienced sellers try to keep the conditions to a minimum from the start, but that is often not possible resulting in a host of soft spots in an otherwise hard deposit.

Sellers frustrated by delays in closing, but asked to extend the closing date even further, often ask their attorneys to draft an amendment to the APA to grant the extension but to also provide for the deposit to be made a hard deposit. This is typically accomplished by providing for waives by the buyer of some or most of the conditions. For example, a financing contingency could be waived. Sellers often ask for waiver of all conditions except factory approval. But this is shorthand for deletion of all conditions except for those the seller is obligated to perform, such as transferring the assets free and clear of liens. Buyers will often balk at waiver of conditions they consider outside their control, such as timely receipt of the DMV and BAR licenses. The final version of the hard deposit amendment is highly negotiated and varies from deal to deal.

Sellers will always prefer eliminating as many conditions to the closing as possible. But a balancing of interests leads to consideration of the list of conditions in the APA, some of which are eliminated by the passage of time (like the due diligence), and others that might be negotiated, item by item – and even within individual items, right up until closing.

For instance, right up until closing, the buyer will require a condition for factory approval. However, even within this contingency, there is room for negotiation. The factory’s approval is usually paired with an addendum containing dealer-specific requirements that the buyer must agree to before factory approval is granted, such as facilities updates. The buyer may request that it has sole discretion in accepting any factory addendum, while the seller may demand that the buyer accept whatever form of dealer agreement the factory is willing to offer.

Thus, although the APA may be said to provide that the deposit goes hard after the due diligence period, the deposit will still be held subject to significant conditions and contingencies which give the buyer some assurance that outside factors will not confiscate its deposit. Buyers who request the seller to agree to extensions of the closing date, however, should be prepared to have many of these conditions peeled away or modified as part of the negotiated closing extension agreement.