Pre-Possession Agreements

By Michael Denious

The Real Estate Commissioner’s Rules include the following warnings to real estate licensees concerning what are referred to as “pre-possession” and “post-possession” occupancy agreements:

J.  A salesperson or broker shall not:

1. Permit or facilitate occupancy in a person’s real property by a third party without prior written authorization from the person; or

2. Deliver possession prior to closing unless expressly authorized to do so by the owner of the property or property interest being transferred.

K. A salesperson or broker shall recommend to a client that the client seek appropriate counsel from insurance, legal, tax, and accounting professionals regarding the risks of pre-possession or post-possession of a property.

A.A.C. R4-28-1101(J &  K).

What are such agreements? A “pre-possession” agreement means an agreement by which the buyer is permitted to take possession of the property prior to (or “pre”) closing. A “post-possession” agreement means an agreement by which the seller is permitted to retain possession for a certain period after (or “post”) closing. They are somewhat awkwardly named; it would make more sense to refer to these agreements as “pre-closing possession” agreements and “post-closing possession agreements,” respectively.

In years past, pre-possession agreements carried some notoriety in the residential real estate industry, and for good reason. There are several potential dangers associated with such arrangements, and when they go bad, they do so badly. More than one residential real estate “horror story” can be attributed to a pre-possession arrangement gone awry. Hence, the reason for the Commissioner’s Rules on this issue.

Pre-possession arrangements (and post-possession agreements)¹ can serve a valid purpose for the buyer and seller, but must be done with great care. Following is a general discussion of pre-possession agreements and things one should consider.

The most substantial risk with regard to a pre-possession arrangement usually falls upon the Seller. If the Buyer cannot close, the Seller then is left with a tenant.  Because the Seller is trying to sell, not lease, he does not want a tenant, much less shoulder the obligations of landlordship. The Buyer may be either unable or unwilling to simply leave immediately after closing fails.  The Seller will naturally have a hard time finding another buyer until the tenant leaves.

Furthermore, while the Buyer is occupying the property prior to closing, he/she may get cold feet or “buyer’s remorse.” The property may no longer feel right or the Buyer become aware of various things that detract from the desirability of the deal he/she has agreed to in the first place. The Buyer may change its mind as to whether to purchase the property or attempt to rewrite the purchase contract.

There is also the possibility of damages to the property during the Buyer’s occupancy prior to closing.  Whether such damages are caused by the Buyer, the question will arise as to who assumes the risk.

The Seller’s best protection is to put the agreement in writing. The Seller can also gain protection somewhat by obtaining a sufficient security deposit to cover rent (both anticipated and unanticipated) and damage to the property. This agreement is a lease, plain and simple, despite its “pre-possession agreement” name.

The agreement should address all of the terms that one would expect to be contained in a normal residential lease. The parties should consider the application of the Arizona Residential Landlord Tenant Act, A.R.S. §§ 33-1301 et seq., which applies broadly to all residential leases, with certain exceptions. While the exceptions include occupancy under a contract of sale, this exemption does not apply, because a “contract for sale” (also called an agreement for sale) is legally very different from a purchase and sale agreement. There may be numerous reasons and arguments why the Act should not be applied to short-term pre-possession agreements, however, those reasons do not appear in the provisions of the Act. Therefore, the safe course is to assume that Act applies.

Various provisions in the Act that should be considered include the restrictions on advance rent, security deposits and refunds (A.R.S. § 33-1321), the landlord (Seller’s) obligation to maintain the premises (A.R.S. § 33-1324), and the landlord’s remedies for breach by the tenant (Buyer), A.R.S. §§ 33-1361, et seq.  The parties may consider referring to specific provisions of the Act as being not applicable, but only with great caution.  If the parties simply recite that the Act is waived, the waiver will be ineffective as against the Buyer (tenant), because the Act expressly prohibits any agreement under which the tenant waives or foregoes rights or remedies provided under the Act.

The parties should also consider and address the following issues:

1. Buyer’s right to continue to occupy the premises of the sale does not close as scheduled.

2. Amount of rent and security deposit to be paid by Buyer.

3. Buyer’s responsibilities to maintain the premises.

4. Responsibility for payment of utilities, and when utilities are to be transferred into Buyer’s name.

5. Seller’s obligation if the premises are damaged or something breaks prior to closing.

6. Insurance on the premises; Seller’s insurance may no longer be effective upon Buyer’s occupancy.

Following are suggested provisions that address the above concerns.

Termination Date. From the Seller’s perspective, the agreement should state that if the sale does not close on the scheduled closing date, the Buyer’s right to occupy the premises terminates on that date.  The Seller may want the agreement to state that the cancellation provision (if one is in the purchase contract) shall not extend the termination date (and in fact, the Seller may want the Buyer to remove the cancellation provision altogether). The agreement should state that if the Buyer has not closed by the scheduled date, the Seller may immediately file an action in court for recovery of the premises, without the necessity of any prior notice. The parties should also address what happens if the sale doesn’t close in time by reason of the Seller’s default.

Rent and Security. If the Buyer will pay rent for the use of the premises prior to closing, the exact amount should be specified in the agreement (either as a daily, weekly or monthly basis, or a flat rate). The Sellers should obtain a security deposit just as with any other type of rental situation.

Risk of Loss or Damages. Generally, the risk of loss or damages to the premises should be borne by the Buyer, though this is negotiable. The Seller should require the Buyer to pay for both casualty and liability insurance during the interim occupancy period. In other words, the Seller should be insured against damage to the premises (e.g., theft, fire, storms, etc.) and against claims for accidents on the premises (e.g., slip and fall, etc.). The Seller should also require the Buyer to agree to a “hold harmless” provision, stating that Buyer will indemnify and not hold Seller responsible for such losses or claims. The best protection for the Seller against such matters; however, will be the insurance.

Condition of the Premises. Presumably, the Buyer will have had the opportunity to inspect the premises prior to occupying the property. From the Seller’s viewpoint, the agreement should state that the Buyer has inspected the premises and agrees to accept the property in its existing condition except that the Seller agrees to repair the specific items listed in the occupancy agreement, if any such exceptions exist. From the Buyer’s standpoint, the Buyer will not want to waive the Seller’s warranties in the purchase contract relating to the condition of the premises at closing (e.g., that the roof will be watertight, that appliances will be in working order, etc.). The parties must agree how to handle this issue before the Buyer is given the keys to the premises.