Buying Residential Real Estate: The Negotiation Process – Part 1

In this post, I take a closer look at what you as a Buyer can expect when you start to negotiate the Real Estate Contract terms with the Seller’s side.

The Mortgage Contingency Provision

When buying a new piece of real estate, it’s easy to get caught up in the excitement of such a purchase and overlook certain factors that may not seem as important at the time. Unfortunately, I’ve seen this happen again and again with different clients. The result is that the sales contract neglects to fairly represent you as the buyer in key areas.

To avoid that scenario, you need to be aware of a variety of aspects in your contract before signing on the dotted line. One critical area centers on the mortgage contingency provision. In basic terms, this section of the contract should be consistent with the current interest rates for mortgages and permit at least forty-five days to get a home loan.  Some contracts are overly optimistic and only allow for a thirty-day window to obtain the mortgage. That can be a problem.

Although the seller obviously wants to wrap up the deal as soon as possible, thirty days is not always enough time to satisfy all of the requirements that the mortgage broker will need to secure an approval of your loan application by the bank. So make sure you specify forty-five days to attain a loan in the contract. If you are able to get one sooner, that’s fantastic. But the forty-five day time span is a much more realistic expectation.

Similarly, when filling in the blanks for the proposed interest rate or loan charges, choose conservative figures. For example, if interest rates for 30 year fixed mortgage loans are at 4.0 percent, insert “4.0 percent” rather than “market rate” or “4.5 percent.” In this way you preserve your right to reject a 4.5 percent loan (or higher) and to truthfully declare the mortgage contingency to be “unsatisfied.” Otherwise, the seller will compel you to close the sale because you received a loan approval at a rate that is within the “acceptable” terms specified in your contract (even though the rate is actually unacceptable to you as a borrower).

Coming Soon

Next time, I will discuss the Real Estate Tax Proration Phase – the challenge of predicting the future.

Buying Residential Real Estate: An Overview

Buying a new home can be an exciting experience. But it can also be very stressful because it is a “life event” (like getting married or having a baby) and it is  more complicated than it appears, and, when so much money is at stake, there isn’t a lot of room for error. So, you really need to have a clear idea of the steps involved in order to avoid any critical errors.

At the outset, however, it is comforting to know that based on statistics, almost every residential sale closes once the buyer’s mortgage loan is approved. And, equally comforting is the fact that almost every closing that occurs, is finalized despite the occurrence of a least one or more last-minute crisis. Indeed, like birthing a baby, the outcome is wonderful despite all the noise and discomfort that is predictably part of the process.

In general, the home buying process has three different stages:

·        The Negotiation Stage;

·        The Mortgage Loan Approval Stage; and

·        The Deal Closing Stage.

This particular post  will concentrate on the negotiating phase, which has three fundamental parts:

1. Negotiating contract terms;
2. Performing the inspection; and 
3. Attorney approval.

Negotiating Contract Terms

The Negotiating Stage begins once you find a house that you want to purchase. Usually, your realtor will play a key role in negotiating the contract terms with the seller’s agent. As an attorney, I don’t participate in this phase for the most part. However, I’ve found that it doesn’t hurt to consult a lawyer during this phase, especially if you have questions that your real estate agent hasn’t addressed.

But in the majority of cases, you and your realtor will work together to develop the terms and conditions that are realistic for the purchase of the home. A form contract then needs to be filled out. This can be done either by you or your real estate broker.

The contract identifies the home’s agreed upon price and all of the personal property that is included with the purchase. From light fixtures to appliances to lawnmowers, for example, every item must be specified in the contract. The contract also has other specific terms, such as real estate tax pro-rations, title exceptions and other legal issues that will be initially completed by you and your real estate broker but will alter be approved by your attorney as part of the Attorney Approval Phase.

Performing the Inspection

After you and the seller have agreed on the terms for the sale, it’s time to move to the next phase: “Property Inspection.” In most circumstances, you’re given a designated period of time to have a licensed, third party inspector examine the home in detail and to decide if you are willing to accept it. This time period is outlined in the contract that you and the seller previously signed. The procedure for accepting, rejecting or conditionally approving the home is also detailed in the contract.

Attorney Approval

Now that you’ve completed a contract and hired an inspector to look closely at the home you plan to purchase, it’s time for the attorneys to analyze the agreement between both parties. My role as your attorney is to make sure the contract represents your interests fairly and doesn’t expose you to any liability when you take possession of the home.

During the attorney modification stage, it is important to keep in mind that the lawyers from each side of the transaction often go back and forth to make any necessary changes to the contract. With the exception of the sale price, there are many areas of the contract that can be altered between the two attorneys.

When both attorneys reach an agreement, they then sign a letter outlining any additional terms or revisions. This letter agreement does not need to be signed by the buyer or the seller. But it is officially included in the real estate contract as an addendum. Therefore, the changes made by the attorneys are considered to be part of the contract for the purchase of the home.

Coming Soon

In this overview blog, I’ve provided you with the basics of the Negotiation Stage of a residential real estate transaction.  Next time, I will expand on this foundation and take you through the negotiation process in greater depth so that you better understand the procedure.

How To Choose an Attorney

In my prior posts, I have stressed the importance of mindfully creating a sound infrastructure for your business, to ensure that it is protected from predictable disasters. I discussed using Non-Disclosure Agreements, employee restrictive covenants, key man insurance, Shareholder agreements and Cost of Collection vendor provisions.

 

While it is essential that you thoroughly understand each functioning part of the infrastructure of your business, you will not be the person who actually creates all of the legal documents necessary to bring the infrastructure to life. That is the role of the attorney for your business, commonly referred to as Corporate Counsel.

 

But choosing a Corporate Counsel must be done with great care and caution. This attorney will be your first and last line of defense. He/she must be capable of effectively protecting your business and vigilantly keeping it out of harm’s way. In short, your Corporate Counsel must be a wise legal confidant and business strategist who understands your business and whose judgment is sound and keen.

 

So, in this post, I will discuss how to wisely choose an attorney to serve as the Corporate Counsel for your business.

 

The Qualifications

 

While every attorney has his/her own background, education and experience, I believe that those attorneys who are in the top ten percent (10%), all share three essential qualifications:

 

1)            Competence:  The attorney must have a thorough understanding of the important aspects of your unique business and must possess a complete command of those areas of the law that directly relate to your business. Nothing short of this high level of competence is acceptable, since it is this fundamental legal expertise that will serve as the basis for all strategic pre-emptive plans and tactical decisions.

2)            Honesty:  While seemingly obvious, this qualification is essential. Your attorney’s integrity must be non-negotiable and you must be able to trust both his advice and loyalty without hesitation.

3)            Care:  The attorney who acts as your Corporate Counsel must be committed to you and your business. He/she must truly care about vigilantly protecting your interests.

 

Now, most people blur these three credentials by choosing an attorney based on their “gut” feeling. For example, they might select their golfing buddy, who just happens to practice law, since there’s already a relationship between them. Or, a likable neighbor may seem like the perfect attorney to bring on board.

I’ve found some people assume if they have an attorney who has a couple of the above three qualifications, that this is sufficient.

 

But it’s not. I regularly explain to people that two out of three is a wicked marriage. If you hire an attorney who cares and is good at what she does, but isn’t honest, you’re in trouble. Similarly, if you hire an attorney who feels a responsibility to you and values honesty, but has no idea what he’s doing, your business is going to suffer. And the attorney who is competent and honest but is indifferent to the safety of your business will provide you with a false sense of security.

 

You need an attorney who embodies all three of the qualities I’ve described. Anything short of this complete list could spell disaster for the castle you’ve worked so hard to build.

Worker Classification: Part Two

In my last post, I explained the critical importance of properly classifying your workers as either employees or independent contractors. Indeed, I warned you that if you do not classify your workers in accordance with state and federal guidelines, your staff incorrectly, your business could be subject to hefty penalties and retroactive interest.
Since it is so important to understand how the State of Illinois and the federal government evaluate the status of a worker, I’d like to discuss this subject in greater detail. That way, you’ll become more familiar with the evaluation factors, so you can better protect your business.

Illinois’ Factors

As I’ve previously mentioned, the Illinois courts rely on a ten factor “right to control” test. This tool enables the state to conclude whether or not your workers are employees or independent contractors. The difference between the two types of workers matters from a governmental perspective for purposes of employment benefits and taxation.
These ten factors cover a wide range of circumstances. Most importantly, Illinois wants to know how closely you manage your worker. For instance, does this individual receive training, materials and direction from you? If so, it is likely that the state will conclude that you “control” the worker and therefore, this worker is properly classified as a “controlled” employee rather than an “uncontrolled” independent contractor.

Other aspects include:

·        Worker engagement – Illinois will look at whether or not the worker performs duties for other employers. If he is exclusively employed by your business and is not available for hire, then the state will see him as an employee.

·        Worker skill – The state evaluates the amount of skill needed to do the work in a particular company. In general, if more expertise is necessary, the state tends to classify the worker as an independent contractor.

·        Employment length – The period of time a worker has offered you services can make all the difference to the Illinois courts. If this individual has worked in your company for a short time, she’ll usually be viewed as an independent contractor. Conversely, a worker who has a longer history with your business will probably be recognized as an employee.

·        Payment method - If you pay your workers on a project-by-project basis, chances are that the state will see these individuals as independent contractors. On the other hand, salaried or hourly workers are more likely to be categorized as employees by Illinois.

·        Integral or ancillary – An integral worker is considered part of the company’s regular business. The fact that he performs a key function in the business, it’s probable the courts will look at him as an employee. At the other end of the spectrum is the ancillary worker, who is an occasional contributor to the company and not involved in its operations on a consistent basis. The ancillary worker will likely be viewed as an independent contractor.

In general, the underlying theme to remember is how much control the business exerts over its staff members.

Similar to the state’s court system, the Illinois Unemployment Insurance Act examines the amount of power you have over your workers in order to determine the correct categorization. But instead of ten factors, there are only three. Furthermore, all three of these circumstances must be met for a worker to be recognized as an independent contractor. Otherwise, the worker is deemed to be an employee.

Below are the factors this statute systematically applies:

·        The business does not control the worker’s performance.

·        The service cannot take place during the normal course of business or at the physical location of the company.

·        The worker has to offer an occupation or profession that’s separate from your business.

Again, control is the key. This means that the less supervision you have over a worker, the better the argument for classifying this individual as an independent contractor.

The Internal Revenue Service’s Factors

Like the state of Illinois, the Internal Revenue Service (IRS) also evaluates employment status based on the right to control. Therefore, if you direct, train and integrate workers’ services into your business operation, for example, it’s reasonable to expect the IRS to define your staff as employees rather than independent contractors. This means that you’ll be required to pay certain taxes and possible penalties, if you have misclassified your workers.

While the amount of regulation over your workers is a critical element of the federal government’s final judgment, other components are also involved to generate this decision. In total, the IRS relies on twenty different factors. These essential circumstances include:

·        Reports – If a business requires written or oral reports as part of the job, then the IRS could assume the worker is an employee. This consistent expectation suggests the worker is regularly supervised, which supports the government’s theory of permanent employment.

·        Payment of expenses – If a company covers workers’ travel or business expenses, the government may conclude they are employees. That’s because the payment is interpreted as control over the workers.

·        Realization of profit or loss – If workers can experience a profit or loss as a result of providing services to a business, they will be probably be viewed as independent contractors.

·        Working for numerous companies – If a worker provides products or services to several unrelated businesses, it’s likely the IRS will see him as an independent contractor.

·        Right to discharge – If a business has the right to discharge its workers, then the IRS might regard these individuals as employees. An independent contractor is protected from being fired unless he does not live up to contract specifications.

·        Right to terminate – If a worker can terminate her employment without any liability, then the federal government will generally look at this individual as an employee.

Need More Help?

Worker classification encompasses many detailed factors. So it’s understandable to feel overwhelmed by the numerous elements. But as a small business owner, you need to be aware that if you group your workers incorrectly, you could face harsh tax consequences.

However, my team and I at DregerLaw are well-versed in all of the factors the state and federal governments use to determine worker status. Let us make sure you’ve designated your staff correctly.

Worker Classification - An Overview

Every business needs workers. So as a small business owner, you must determine how you want to classify the people who work in your company. Basically, this means you have to choose between designating your workers as employees or as independent contractors.

However, I must stress that this decision must be made with great care and deliberation. Indeed, it is imperative that you categorize your workers correctly or you could face severe federal and/or state tax consequences.  So in this post, I’ll provide an overview to help you understand the best approach to take in making these worker classification decisions.

Circumstances for Worker Classification

There are a number of circumstances that can make worker classification an issue to business owners. These situations include:

• When a new business is looking to set up efficient management and accounting practices;
• When an existing business is downsizing to reduce operating expenses and payroll taxes; and
• When a flourishing business is expanding its staff to increase productivity.

In each one of these circumstances, proper labor classification is immensely important. Both state and federal taxing authorities monitor and regularly conduct audits of businesses, with the hope of being able to impose significant retroactive penalties and interest on a business that is determined to have improperly classified employees as independent contractors.

The “Right to Control”

To discover whether or not a business has accurately classified its workers, both the state and the federal government have devised lists of factors that can be applied to the company’s structure. The purpose of each point is to determine how much control you as the owner have over your workers. The more control you exercise, the more likely it is that your business is staffed by employees, not independent contractors.

This “right to control” essentially means that you actively supervise, provide tools and convey clear expectations of how your workers should use their time fulfilling certain roles within your company. In other words, if you inspect an individual’s output, give him set hours on work days and, overall, direct his performance for you, then you are subject to paying state and federal employment taxes, Workers’ Compensation and other fees that correspond with hiring permanent employees.

State and Federal Factors

Illinois common law examines ten different factors in its “right to control” test designed to distinguish between employees and independent contractors. Although the emphasis on these factors may fluctuate, control is still the key.

The Illinois Department of Employment Security (IDES) has devised its own strict test for evaluating the status of a worker. While the IDES only considers three (3) factors, its strict pro-employee consideration of these factors almost always results in a finding that the worker is an employee, not an independent contractor. Therefore, a business owner, who has mistakenly classified his workers as independent contractors, may be forced to pay harsh penalties and interest to IDES.

On a federal level, the IRS conducts its own evaluation of worker classification based on twenty factors. Like the IDES test described above, the federal test also tends to favor a finding of a worker as an employee rather than an independent contractor. As a result, an employer could be compelled to pay an exorbitant amount of taxes, penalties and interest to the IRS, retroactive to the date of hire of the improperly classified worker.

Defending Your Business

Now that you understand what’s at stake when it comes to classifying your workers, let’s discuss how you can prevent state and federal authorities from re-classifying the categorization of your staff in a way that makes you susceptible to enormous penalties.

First of all, you need to familiarize yourself with the different factors that the state of Illinois and the federal government apply to determine worker status. Secondly, you must structure your business so that you cannot be deemed to have a “right to control” your workers. You can achieve this outcome by making your workers truly independent from your company. For example, each independent contractor must be their own separate, incorporated business with company names and business cards.

Next, you should have each corporate worker sign an Independent Contractors’ Agreement with you which includes explicit language that declares each person as independent with no obligation to you. The agreement should specify that your independent contractors can and do work for other people. So they are not tied exclusively to your business. This move minimizes the “right to control” aspect that is such a core factor to both Illinois and the federal government.

It may seem uncomfortable at first to take such extraordinary steps. But you have to keep in mind that if you don’t protect your worker classification, you could be subject to a grueling audit that will be both costly and a serious threat to the future of your business.

In my next post, I will look more closely at some of the factors that the state and federal governments use. That way, you will better understand how these factors work as a whole.

The "Cost of Collection" Clause

In this post, I’ll explain the meaning of the “Cost of Collection ” clause and I will tell you why it’s so crucial that you integrate this provision into the agreements you create with customers.

When you own a business of any sort, the business must generate revenue. Without these funds, your company cannot stay afloat. That’s just the reality of running a company.
So after your business provides services or supplies products, you naturally expect to get paid. But if you send out all of your bills and find that nobody is paying you or a client decides he’s just going to pay you whenever he wants, your business can quickly slip into a financial crisis.
Therefore, to avoid this cash flow nightmare, you have to give your customers an incentive to pay your bills to them. This incentive comes in the form of a provision within your contract called the “Cost of Collection.” By including this specific provision, you’re spelling out very clearly that there are consequences if your clients or customers ignore their responsibility to pay you.

The Last Ten Percent
Sadly, I’ve seen many of my clients lose out on the last ten percent of money owed to them by their own customers on multiple occasions. It’s a helpless feeling when you’re unable to collect the full amount of a bill after you’ve done all of the work.

What these wily customers have figured out is that this last ten percent is just small enough that a business owner won’t take them to court. It’s not worth the legal fees. Therefore, the owner is forced to abandon the recovery of that ten percent (10%) balance of his Contract, even though the money was legitimately earned.

However, this entire scenario changes if the “Cost of Collection” clause is written into a signed contract with clients or customers. The tables are turned now because you as the business owner have the enforcement rights to defeat that nonpayment strategy.

How the Cost of Collection Clause Works

If you build the “Cost of Collection” clause into your agreement with a customer and this individual fails to timely pay for services rendered, you now have a legal recourse at your disposal. You can take this customer to court to secure a judgment for the full amount of the unpaid contract balance, plus all of your attorney’s fees incurred in enforcing your contract rights.

Illinois law says you can get reimbursed for legal costs under the following circumstances:

• If the recovery is written into a contract; or
• If the recovery is written into a statute such as Consumer Fraud, which is designed to be a disincentive for deceptive business practices.

In other words, this “Cost of Collection” clause gives you the power to force a non-paying customer to promptly pay your contract balance, since it will be the customer, not you, who pays for the attorneys fees incurred in enforcing your contract rights.

By making sure that every client or vendor agreement contains a “Cost of Collection” clause, you’ll find that the people you do business with will become far more cooperative when it comes time to pay you.

Understanding Restrictive Covenants

Trust, But Restrict

               Creation of a business requires a certain amount of trust. That’s because even if you’re the driving force behind your company, you still must rely on other­­s to assist you. The reality is you just can’t perform every role yourself.

               So, trust has to be part of the equation. But problems arise, however, when you trust the wrong people. Unfortunately, some individuals won’t hesitate to steal the confidential information behind your business and profit from it at your expense.

               For this reason, it is crucial to protect your company from being raided by those within your circle of trust, by using non-disclosure agreements (NDAs) and restrictive covenants. In a recent post, I provided an overview of NDAs and restrictive covenants and I explained that they are designed to ensure that the secrets of your business do not get shared without your knowledge and consent. Now, I want to discuss these agreements in greater detail, so that you understand how they can be applied to give you the power to guarantee that the confidential information of your small business is never compromised.

NDAs

               Typically, an NDA is a one-page document that you require be signed by anyone outside your company with whom you must reveal confidential information in order to explore how this individual can enhance your business. Once the document is signed, the person is bound by this contract and is prohibited from ever revealing the sensitive information that you’ve shared, even if you ultimately determine not to enter into a formal business relationship with this individual.

               If, for whatever reason, this individual violates or even attempts to violate the NDA, you have the right to take the individual to court to secure a restraining order to keep the individual from disclosing the secrets of your business. The NDA also will allow you to have this individual pay you for all of the attorney fees that you incur to enforce the NDA. As a good business practice, always make sure that you clearly explain this aspect of the NDA, so people are well aware from the start that there are dire consequences for ignoring the terms of the NDA.  

Restrictive Covenants (Clauses)

               In contrast to an NDA, a restrictive covenant is used with individuals that are already inside your company (i.e. employees) or non-employee individuals with whom you have decided to do business (i.e. independent contractors). But the idea behind a restrictive covenant is the same as the NDA, in that restrictive covenants are designed to protect the unauthorized disclosure of your business secrets without your knowledge. Restrictive covenants /clauses typically provide three separate protections:

·        The Confidentiality Clause is similar to the NDA. Its purpose is to make sure that confidential information, such as sensitive financial information, customer lists and other trade secrets of your business (sometimes referred to as “intellectual property”), stays private. This keeps your competitors from using this sacred information to unlawfully gain a competitive advantage over your business.

 

·        The Non-Conversion Clause is a natural follow-up to the non-disclosure. It states that once new employees or independent contractors have been given access to your intellectual property, they won’t attempt to steal your workers, suppliers or vendors. Basically, your staff is barred from trying to build a separate business for themselves of for one of your competitors, based on your ingenious ideas.

 

·        The Non-Compete Clause is the final of these three essential protective documents. It tells your staff members that they cannot go out and compete with you in any form whatsoever. You want to make sure, after you have revealed the secrets of your business to trusted individuals that they won’t apply this key information, to their own company on your territory.

               All three of the restrictive covenants can be easily embedded into an existing employment agreement. That way, every member of your staff, whether full-time or part-time, will fully understand that they have clear restrictions on what they can reveal to the outside world. Equally important, these employees or independent contractors will know that if they ignore these restrictions and instead, try to profit on the back of your business, the consequences of their violating the restrictive covenants will be severe. Just like with the NDA, their violations will expose them to serious court action and personal judgments, separate from being fired.

               When you give the restrictive covenants to an independent contractor or someone whose services you’ve hired from outside your company, the restrictions should be part of your Independent Contractor Service Agreement with this individual or theses restrictions may be contained in a free-standing separate two-page document.

Duration

               Non-compete clauses remain in effect for three to five years after the employee relationship ends. Consequently, the covenant serves as a meaningful deterrent, as it blocks this person from interfering with your business and stealing your clients for a significant period of time.

               Even harsher, is the duration of the confidentiality clause. This one is typically for life. That means that the people to whom you have revealed all of your trade secrets, can never share this information with anyone without your authorization, except under extreme circumstances (i.e. court order).