Gap Closings: A Commercial Real Estate Necessity
Written by: Seth A. Malamut
Looking forward into 2013 and beyond, one element of commercial real estate transactions will undoubtedly be used with greater frequency: Behold, the gap closing. Though existing for some decades, and frequently called a “New York” style closing, the gap closing is a mechanism that allows real estate to be easily conveyed by parties who never leave the comfort of their own desks. As business becomes more globalized, as Registries of Deeds suffer greater filing backlogs, as attorneys and clients close deals from across the country, the “traditional” commercial real estate closing may be going the way of the dodo. In the face of changing conditions it is vital that commercial real estate attorneys, and their clients, understand the gap closing -- its virtues as well as the issues it may entail.
Gap closings are those transactions where, after documents and funds are delivered, there remains an interval of time before recording of documents. As with traditional closings, a title policy is issued insuring title typically from the date of the most recent title commitment. The title insurance company insures the “gap” in time between the closing table and recording of documents. The risk in any such scenario, and which party bears that risk, is that an intervening matter of record, or title, such as a tax lien or a judgment against the seller, may be recorded between the time of closing and when closing documents are recorded; the result being that the buyer may not receive the quality of title that it has negotiated, after which it will look to its title insurer for coverage.
This “gap” may occur for any number of reasons. For instance, several states have a recording lag – meaning that even if documents are presented for recording on the day of closing they may not be processed for several weeks. More likely, the buyer is located in one state, the seller in another, and the property in yet another. In such scenarios closing is typically run through buyer’s designated title company in the state where the buyer is located. The title company is charged with shepherding all documents, receiving and disbursing funds, and putting closing documents to record. However, as nationwide transactions become more common, as portfolio transactions increase (buyers acquiring multiple properties, perhaps in multiple states, from the same seller), the likelihood of getting to record on “closing day” becomes increasingly unlikely. In the current climate of commercial real estate transactions the gap closing is not just an option -- it is a frequent necessity.
So, who bears the risk? In certain states it is merely customary for title companies to assume the risk. This risk may be mitigated, in part, by updating title immediately prior to closing – thereby shortening the gap, and by the title company over-nighting documents to a local agent who records upon receipt. In addition, title companies often seek to spread the risk by requiring a gap indemnity, whereby the seller indemnifies the title company for matters of record appearing between the date of the Commitment and recording.
With respect to gap indemnities, it is important that the indemnitor be a financially responsible party. Frequently the holder of commercial real estate is a single asset entity whose only asset is the underlying property. Once that property has passed to the hands of the buyer anyone looking for recourse against the (now asset-less) seller may find nothing but empty pockets. The better practice is to ask a seller’s parent company, or other financially viable party, to give the gap indemnity.
Lastly, it is important that buyer’s counsel carefully prepare their closing instruction letter to the title company. Among other key elements, the closing instruction letter in a gap closing should bind the title company to issue the policy in the form of the marked commitment or pro forma “with no additional exceptions.” Doing so will ensure that the title company is obligated to issue the same policy for which the buyer negotiated, regardless of intervening matters of record. Taking these steps, understanding the process, and using quality title insurance companies combine to ensure that the gap closing runs smoothly and the parties receive the benefits of their bargain.
Seth Malamut is an associate in the firm's Real Estate Department.
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