What is a Holdback?
An agreed upon dollar amount that is not released to the seller on the closing of a real estate transaction until a certain item is completed/provided. For example, the seller may agree to complete the landscaping, and agrees to hold back $5,000.00 until the landscaping is complete. The terms of the agreement to hold back these funds are usually agreed to in writing by the buyer and the seller, or agreed on between their respective real estate lawyers.
When is a holdback negotiated?
Sometimes a holdback is addressed at the time of negotiating the purchase and sale contract.
Other times, issues arise after the completion of the purchase contract and a holdback needs to be dealt with by either a written addendum to the purchase and sale contract, or between the lawyers. Outstanding items and holdbacks are often not anticipated during the negotiation stage and not addressed in the offer to purchase. This leaves the realtor or lawyer to negotiate a holdback once the purchase contract has already been signed. At this point, there is generally no obligation on the part of the seller to agree to a holdback of funds. They are entitled to insist on full payment of the purchase price and the buyer would have to rely on the breach of contract remedy against the seller following the closing.
Why a holdback?
Using a holdback, can allow the real estate closing to “close” as scheduled. For example, the seller gets paid for the property and the buyer receives possession of the property despite outstanding obligations of the seller.
The seller will receive payment for the property less the holdback amount, which acts as an incentive for the seller to complete their obligation and a comfort to the buyer that the work will be completed.
When negotiating a holdback, 5 questions should be answered:
- What must be completed or provided?
- What is the holdback amount?
- Consider and balance the following factors: the amount required to complete the work/task, the amount suitable to incentivize the seller, the amount the seller will reasonably agree to hold
- How do you decide whether the task has been completed or item has been provided?
- Examples: an inspector concludes the work is completed, a statutory declaration by the seller that the work has been completed, written notice by the seller, a receipt for the work, a municipal permit
- What is the timeline for completion of the undertaking?
- Consider setting a hard deadline for when the work must be completed by. Allow for season/weather changes and anticipate that there may be delays with trades or materials.
- What happens if the task is not completed?
- Decide to whom will the funds be releasable
IDEALLY, a holdback agreement should address the above 5 terms. I say ideally because a holdback agreement is still a negotiation between the parties and often the seller will not want to be limited by the terms of the agreement. For instance, there might be factors that they cannot control like weather or availability of trade people so they may not want to limit themselves to a timeline. It is however in the best interest of both parties to cover all 5 items. If not, there may be a problem later. See problems with holdbacks below.
Examples of good holdback clauses
- The seller’s lawyer shall holdback $5,000.00 dollars from the sale proceeds until such time as the Real Property Report with evidence of municipal compliance in the form of a compliance certificate report is provided to the Buyer. In the event the Real Property Report with evidence of municipal compliance (in the form of a compliance certificate report) is not provided to the Buyer by Jan 1, 2100, then the $5,000.00 shall be immediately releasable to the buyer.
- The seller’s lawyer shall holdback $10,000.00 until the basement is completed. The basement will be considered complete when an occupancy permit is issued by the City and provided to the buyer. If the basement is not completed by Jan 1, 2100, then the $10,000.00 shall be released to the buyer.
The problems with holdbacks
Holdbacks are a way to complete the closing but they are not perfect. This is what you need to know:
- If funds are released to the buyer because the work has not been completed/ items not provided, the buyer’s right to sue for further damages still exists.
- If no drop-dead date is provided in the agreement and the work is not completed, the lawyers cannot release the funds to either party unless both parties agree or a court orders that the funds can be released. Unless one of these methods are chosen, the holdback funds will not be released from the lawyer’s trust account.
- The cost required to complete the work might be greater than the amount held back and released to the buyer.
Holdbacks are there to offer some comfort to the buyer that the work will be completed but they are not a guarantee that the work will be completed promptly and to your satisfaction, or that you will receive the funds if the work is not completed. It may end up that there is a dispute about the work and the funds. Essentially, they are useful but cannot always be relied upon.
This article is provided for general information purposes only and does not constitute legal or other professional advice. You are advised to contact a Real Estate Lawyer regarding any specific legal issues. You may reach us at 780-473-7779.