New “shadow flipping” rules disruptive to commercial sector

This article was originally published in the July 2016 issue of Western Investor, a trusted source for commercial real estate, franchising and business opportunities in Western Canada.

There have been many discussions in recent months about “shadow flipping” and how this practice may have contributed to the high price of residential real estate in greater Vancouver. As a response to these discussions, the BC government has introduced regulations to limit shadow flipping in hopes of addressing the sky rocketing home prices.  For many business owners in the city, these new regulations beg the question – do these regulations also impact commercial real estate?

The short answer is yes, but it doesn’t look like the “crackdown” some believe it to be. This is due to the fact there have long been mechanisms in place to address assignments in the commercial real estate sector, and there is a simple way to minimize the impact that has resulted from the changes.  Before looking at the solution, let’s first have a look at what the new regulations are targeting.

“Shadow flipping” is the process by which a person – usually a real estate broker – negotiates one or more resales of the same purchase and sale agreement (“PSA”) at increasingly higher prices before the actual completion of the sale of the property.  The original seller receives what was originally contracted for, but the ultimate purchaser pays more than the original selling price.  Part of the increase goes to the intermediate “buyers”, and part goes to the real estate broker who negotiated the resales as commission on the resales.  This process was, and still is, completely legal.  Unless there is something in the PSA preventing it from being assigned, PSAs are freely transferrable.  However, there is a sense that shadow flipping is unfair to the original seller, and may be contributing to the already overheated real estate market in Metro Vancouver.

The BC Government has decided to impose new regulations on licensed real estate brokers.  These regulations prevent a PSA from being assigned without the seller’s consent, and further require that any profit resulting from assignment of a PSA will belong to the seller.  These provisions will be incorporated into the standard PSAs used by BC realtors.  At the time of writing, neither the new regulations nor the proposed changes to the standard PSAs have been released.

How does this apply to commercial real estate PSAs?  The ability to transfer a PSA to a newly created nominee company can be critical to a purchaser of commercial property.  The ability of the seller to prevent this could complicate the purchase, or worse, prevent the transaction from completing.

In addition, the purchaser may in fact be adding value to the property through various activities it performs prior to transferring the contract to a third party.  In this case, the profit properly belongs to the purchaser, as it was the purchaser’s efforts which added value to the property.  If the seller is able to capture the profit, there is little incentive for the purchaser to perform the value enhancing work.

So, what does this mean for a commercial purchaser?

First, keep in mind that the new regulations only apply to licensed real estate brokers.  There is nothing requiring a purchaser to include the new provisions in its PSA.  Lawyers often prepare commercial PSAs for the seller or purchaser, and as such, unless a brokerage form is used, the new provisions need not be included.

Second, even if a broker prepares the PSA, the purchaser can request in writing that the new provisions be removed.  The purchaser’s broker will then be under an obligation to provide written notice to the seller that the new provisions are not in the PSA, and the seller then has the option of accepting the PSA without the new terms.

Overall, the new regulations and the new provisions contained in standard form PSAs may create challenges for real estate brokers. However there is a fairly simple solution for purchasers of commercial property – hire a commercial real estate lawyer.

The impacts of these new rules may have been overstated when it comes to the commercial real estate sector, but it is always a good practice to have a commercial real estate lawyer review your PSA before you sign it – the new “shadow flipping” provisions are only one of many provisions that need to be skillfully navigated in a PSA.

Peter J. Anderson is a partner at Boughton Law, and has a solicitor’s practice focused on commercial real estate.