The term holdback is often used by Buyers, Sellers, Realtors and Lawyers. A holdback is often suggested as a solution to a problem which cannot be resolved prior to closing. Holdbacks arise in several different scenarios, the most common of which is where a Buyer attends at a property just prior to closing and discovers that an item is broken or damaged and wants the Seller to repair or replace it. In many cases, the item cannot be repaired prior to closing. To resolve the problem, the parties may agree to holdback an amount of funds from the sale until the issue is rectified, following which the holdback funds can be released. A holdback can be an effective way to resolve a problem to ensure that the transaction closes as scheduled. However, as this column will demonstrate, holdbacks are not as simple as they appear and can often be very problematic and lead to unintended consequences and costs.
The first misconception about holdbacks is that the party insisting on a holdback is entitled to the holdback. Unless there is a holdback provision in the Agreement of Purchase and Sale, neither a Buyer nor Seller has an automatic right to a holdback. I have encountered many situations where a Buyer or realtor has incorrectly assumed that a Seller’s lawyer must holdback funds from the proceeds of sale to deal with a problem. If the Agreement does not contain a holdback provision, then the right to a holdback does not exist. However, this does not mean that a holdback cannot be fairly negotiated between the parties.
In some circumstances, a holdback is the only real solution to resolve a problem in order for a transaction to close. Consider the situation where there has been significant damage to a property which cannot be rectified prior to the closing date. Assuming that the parties still wish to complete the transaction, the parties need a solution that will satisfy everyone. The Buyer will want assurances that the repairs to the property are properly done after closing. The only practical solution in this case is to extend the closing date of the transaction or to close the transaction with the Seller’s solicitor holding back funds which can only be released only when the repairs are done. It sounds simple enough, however, the details and the terms of the holdback need to be clear in order to avoid disputes.
In the example above, the first hurdle will be to determine the amount of the holdback. The Buyer will want a significant holdback to ensure that there are sufficient funds to cover the cost of the repairs and that the repairs are done properly. Based on my experience, it is likely that the parties will initially disagree over the amount of the holdback. Each party will need to support its position based on information to be provided by third parties. Other issues include determining what the holdback funds are to be used for and to set out how and when the holdback can be released. These terms will need to be negotiated and clearly specified in the terms of the holdback agreement. However, uncertainties may still arise once the repairs are done such as, who determines if the repairs are done, the Seller or the Buyer? What if the Buyer is not happy with the quality of the work? How will this be resolved? What if the parties cannot agree on this point? Disputes over this can escalate and lead to a stalemate. In situations where the parties cannot come to an agreement, the only way to settle the dispute may be to hire a litigation lawyer. Given the costs of litigation, the delay in going to court, and the uncertainty of the outcome, it may not make sense to proceed to litigation, however, if the parties cannot settle the dispute, this may be the only solution.
As you can see, holdbacks may can cause more problems than they solve. For minor issues, such as an appliance that isn’t working prior to closing, I will typically recommend that the parties resolve the issue on closing with a reasonable credit to the Buyer to cover the cost to fix the appliance. This settles the problem and eliminates the uncertainty of a holdback and problems such as disagreements over the wording of the terms of the holdback and/or disagreements over the release of the holdback. For more serious problems that cannot be resolved before closing, a holdback may be necessary. As you can see, it is important that the wording of the holdback agreement is carefully drafted. When dealing with a holdback clause in an Agreement of Purchase and Sale during the heat of negotiations, realtors should be aware of the dangers that a poorly drafted holdback clause can create. I recommend that in these situations, realtors should engage an experienced real estate lawyer for advice.