Closing Conditions: Everything You Need to Know
A closing condition is a requirement or list of tasks that each party involved must satisfy between the first acquisition agreement and the closing date.6 min read
2. What Are the Time Intervals for Closing Conditions?
3. Why Are Closing Conditions Important?
4. Frequently Asked Questions
What Are Closing Conditions?
A closing condition is a requirement each party involved must satisfy between the first acquisition agreement and the closing date. As such, most purchases are not completed (i.e., they do not "close") when everyone signs the Purchase Agreement. There are still some tasks left to do before finalizing the purchase. These tasks are called closing conditions.
Closing conditions are found in sale and Purchase Agreements. They state the conditions both the buyer and seller must meet. There can also be joint conditions.
Most people who have purchased a home are familiar with closing conditions. For instance, one closing condition might be that the seller agrees to fix the house's broken window before the buyer can close. It's the same concept in business acquisitions.
Closing conditions can include:
- Provisions that each party's warranties and representations are valid as of the closing date
- Provisions stating warranties and representations have been met by all parties involved
- If applicable, approval given by government authority for the transaction to occur
- Joint conditions recognizing the transaction is legal
- Buyer conditions that the seller gets third-party consent, such as from suppliers
- Joint conditions that no pending legal problems would prevent closing
- Deal-specific conditions by the buyer that certain issues are addressed before closing
Sample conditions before closing may include:
- The seller has complied with all covenants
- All the seller's warranties and representations remain true
- The buyer has been satisfied with his or her due diligence investigation
- The seller has received all required consents and authorizations
- There are no opposing changes in the seller's business
- The buyer has secured financing to fund the purchase
Failing to meet any of these closing conditions gives any party involved in the transaction the right to walk away from the deal.
What Are the Time Intervals for Closing Conditions?
The time interval for closing conditions happens between signing the agreement and the closing date. This interval is set aside to allow everyone to complete closing tasks. In most cases, this time interval lasts for 90 days unless regulatory approval requires an addition amount of time.
However, this time interval can add complications to a business when the business is still in operation and required to make changes. These changes could include staff, customer contracts, account payables and receivables, and even litigation issues.
If you're buying a business, unless the closing conditions are satisfied by the seller by the closing date, then you have the right to refuse to complete the purchase.
Why Are Closing Conditions Important?
Closing conditions are important to meet during the timeframe between the signing and closing date. All parties involved want to be sure the business' or home's value is maintained, and they want to protect the deal. There are several promised pre-closing behaviors everyone involved must stick to:
- The seller cannot negotiate with or seek other buyers
- The seller cannot create a competing company, ask customers to move to a different supplier, or hire employees from the business into another business. This agreement is good for a stated period even after closing.
- The seller must get the buyer's permission before taking actions that could change the business' value. This can include acquiring a major investment, limited normal capital investment, or signing a major contract. In the event that any of these occur and the seller needs to ask the buyer's permission, the buyer must respond in a reasonable, timely manner.
- The seller might have to take actions to allow the buyer to take advantage of post-sale opportunities.
- Neither party can announce the details of the transaction without the other party's consent. The one exception is when they are required by law to do so.
Naturally, a buyer wants to have some promise that the business value remains as high as it was at the time of signing. The seller needs to offer certain reassurances through warranties and representations as part of these closing conditions:
- All agreed-upon pre-closing behaviors have been met between the signing and closing date
- All warranties and representations agreed upon are correct at closing. There are exceptions to any updates to disclosure schedules
- No changes that could adversely affect the business have occurred since signing the Purchase Agreement
- No litigation has come up that could keep the transaction from happening
- The buyer guarantees to certain post-closing actions, such as offering an employee benefit plan for a set amount of time
Deliverables also come into play. These are documents required by the buyer that won't become available until after signing the Purchase Agreement. The seller must offer these documents on the closing date as part of the closing conditions.
Typical deliverables include:
- Regulatory licenses, approvals, permits, etc.
- Board of directors and stockholder consents to the transaction
- Agreements such as employee retention and financing agreements
- Certificate stating the accuracy of the company's formation
- Third-party consent forms, such as contracts and leases
- Release of litigation settlements and liens
- Standard deal documents, including the bill of sale for assets and escrow agreements
Another important part of closing conditions is termination rights. The parties agree that the transaction can be cancelled:
- If both parties agree on the termination
- By one party if the other has not completed the closing conditions on time
- By one party if the other party has breached a warranty or failed to perform according to an agree closing condition
- If a legal issue makes the transaction illegal
Finally, the "Bring-Down" of representations and warranties make sure the other party's reps and warranties are correct at the time of the closing date. All parties have complied with the pre-closing agreements or covenants. There may, however, be extra negotiation as to whether the bring-down of reps and warranties should occur on the closing date or on both the closing date and signing date.
Frequently Asked Questions
- What is the closing process?
The closing process is the most important part of any real estate transaction, but it's also the point where most things can go wrong. Closing is the completion or settlement of the transaction – the last step before turning over the keys to the new owner.
- What are covenants?
Pre-closing and post-closing agreements between a buyer and seller are called "covenants." When you make a covenant, you're making a promise to fulfill your part of the closing agreement.
- I'm in the process of buying a home. What conditions can delay escrow?
There are six main conditions that can happen before closing on a home that can delay escrow. These include:
- Updated income or asset documentation, including new financial statements and paystubs. The lender will want all updated documents closer to the closing date.
- Credit inquiries. Any recent inquiries to your credit report may affect your ability to qualify for the loan.
- Employment verification. The lender will make sure you're still employed in the position you stated on the loan application. Be sure to mention any life events, such as maternity leave or medical leaves, to the loan officer in advance.
- Closing funds. Lenders need to see where all the funds are coming from for the transaction.
- Title and judgment searches are usually performed well into the mortgage process, but these searches could show judgments against you or the sellers with liens against the property.
- Lenders also want to make sure you have obtained homeowners flood and insurance coverage before closing.
- What items should I bring to my mortgage closing appointment?
You will need to bring the required funds to close, such as a down payment or closing costs depending on what was agreed upon. This means having a certified check from your bank. You should also bring proof of identification, such as your official driver's license, state ID, or passport.
- I'm selling my startup. Should I be worried about any post-closing disputes?
There is only one adjustment that remains after the closing date: the working capital adjustment. This is the most common cause of post-closing disputes in business. When signing the Purchase Agreement, a figure for working capital is estimated and listed on the document. The estimated figure promises that the real figure will be determined 60 to 120 days after closing. Any difference is paid out of escrow to the seller or buyer, depending on if the different exceeds or is less than the estimate. This is called a "true-up."
Working capital includes inventory, cash, prepaid items, and accounts receivable minus any liabilities. Disputes can occur if these terms were never clearly defined in the Purchase Agreement.
If you're selling or buying a business, the closing process can seem overwhelming. Post your legal need here to receive free quotes from the top 5% of lawyers on UpCounsel to learn how you can make sure everything goes as smoothly as possible.