Gap Closings: A Commercial Real Estate Necessity, Especially Now
Despite their long tenure in commercial real estate transactions, the gap closing has been, and will likely continue to be, used with greater frequency. Gap closings allow real estate to be easily conveyed by parties without the necessity of leaving their desks (and in a COVID-19 world, their own homes). In light of the COVID-19 pandemic and the shift to working from home, 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 transactions where, after documents and funds are delivered, there remains an interval of time before recording of the 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” between the closing table and the recording of documents.
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. The impacts of the COVID-19 pandemic, and governmental orders restricting operations of registries of deeds and other service vendors, have increased recording lags since early 2020.
Typically, these gaps occur when the buyer is located in one state, the seller in another, and the property in yet another. In these scenarios, closing is generally run through the buyer’s designated title company in the state where the buyer is located. The title company is responsible for shepherding all documents, receiving and disbursing funds, and putting closing documents to record.
What’s the Risk?
The risk in any gap scenario is 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 buyer may not receive the quality of title that was negotiated. The parties will then look to their title insurer for coverage.
Depending on the jurisdiction, electronic recording may be an option. Many jurisdictions permit the e-filing of recordable documents, and it is likely that more will follow suit in the future. 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, gap closing is not just an option — it is a frequent necessity.
Who Bears the Risk?
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 overnighting documents to a local agent who records upon receipt. In addition, title companies typically seek to spread the risk by requiring a gap indemnity, whereby 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 essential that the indemnitor be financially capable. 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 only find empty pockets. The better practice is to ask a seller’s parent company, or other financially viable party, to give the gap indemnity.
It is also important that buyer’s counsel carefully prepare their closing instruction letter to the title company. Among other 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.