Managing the Risks of Real Estate Auctions

The real estate business in New York is, to paraphrase the late Sen. Lloyd Bentsen's comment about Texas politics, a contact sport. That rough-and-tumble attitude extends to real estate auctions, where both buyers and sellers need to be aware of the potential risks and the possibility for manipulation.

While private auctions represent just a small slice of the real estate market, they have been growing in popularity as more homeowners and even builders turn to auctions for a quick sale in a soft market. In the soft New York City real estate market of the early 1990s, for example, buyers were able to purchase even desirable Manhattan properties for bargain prices at private auctions. As private auctions gain in popularity again, however, past experience at foreclosure auctions points out the scope for brazen manipulation ' even when the sales are conducted at a courthouse or by the sheriff.

A Bit of History

In 1998, a decade-long bid-rigging scheme by 25 real estate brokers and speculators at real-estate foreclosure auctions at the Queens County Courthouse was broken up by the Antitrust Division of the Department of Justice. The men pleaded guilty to rigging bids at the courthouse auctions between 1986 and 1997 in a scheme that involved an agreement not to bid against each other. Only one member of the group would bid at the auction, and afterwards, they would hold a second, private auction open only to the members of the group, the Justice Department charged.

A similar scheme played out in Long Island's Nassau and Suffolk counties. In the 2002 case of Shaw v. U.S., the government uncovered a 5-year-long bid-rigging conspiracy affecting auctions conducted by the Nassau and Suffolk County sheriffs' offices. In this scheme, the group set a pre-determined price at which one designated individual was to bid on the auctioned property on the group's behalf instead of each member of the group bidding competitively against each other. In cases where at least three bids were required, two other conspirators would first submit intentionally low bids, thus enabling the designated bidder to win the property with a subsequent bid. The final bid was less than that which would have resulted had there been legitimate competitive bidding.

The government's investigation further revealed that, when a third-party interested in bidding on an item appeared at the official auction, one of the co-conspirators would demand a cash payment in exchange for an agreement that the group would not bid against the outside party, and would threaten to bid up the property if they did not agree. The cash payment by the third party was then divided among the group members.

Clearly, if this kind of bid-rigging can take place at a sheriff's auction, similar abuses could occur at a small, private auction. That makes it imperative for all parties involved to be aware of the potential for a group of conspirators to attempt to 'fix' the sales; to protect themselves through contract negotiations; and by performing the necessary due diligence ahead of time.

The Risks

For sellers, the chief risk is that the property might sell for an unexpectedly low price if the auction fails to attract motivated bidders. Sellers could then seek to hold auctioneers liable for 'chilling' the bids or not maintaining the integrity of the auction.

Overanxious buyers, on the other hand, may find themselves bidding higher than they should and then risk losing the down payment when they cannot obtain adequate financing in the 30-day time frame for closing that is typical for private auctions.

Keeping Things Legal

Attorneys representing sellers should advise them, first of all, to ensure that the auctioneers are reputable and have the proper licenses. For instance, the New York City Department of Consumer Affairs maintains licensing requirements for both auctioneers and auction houses.

The attorney should then negotiate the auction contract and terms of sale to obtain the lowest fee, to cover advertising costs, to address the risks of a failed sale or a failure to close, and to prevent tactics that would exclude potential legitimate bidders. The terms of sale should cover whether the auction will be an 'absolute' auction with no minimum bid or if there will be a set minimum bid; the amount of the down payment; what constitutes acceptable financing; as well as the closing date and costs.

On the buy side, attorneys should make sure to perform adequate due diligence ahead of a sale to protect their clients. Those measures would include a title review, a tax search, an inspection of the property, a review of local zoning ordinances, a review of the terms of sale and establishing adequate financing ahead of the auction to ensure that the buyer doesn't jeopardize the down payment by being unable to close the deal.

For buyers, it is important to note that a private auction would result in a standard real estate contract between the seller and the highest bidder, which would afford the buyer contractual protection within the traditional domain of real estate law.

While any deceptive practices involving a private auction would likely be treated by the New York State Consumer Protection Law (General Business Law, Article 22-A, ” 349, 350), case law in this area is very light.

For their part, auctioneers may face costly legal disputes brought on by either unhappy buyers or sellers, or both. A key action to reduce potential disputes is to explain the auction process clearly to potential clients, including the substantial differences from a traditional real estate transaction. Auctioneers should have the detailed auction contract and terms of sale reviewed by an attorney, and avoid making any oral agreements with clients which could change the contract terms. Finally, auctioneers must be aware of their responsibility to hold an open and honest auction free of manipulation. That includes, of course, not withholding material information about the property from the bidders.

Conclusion

As private real estate auctions gain in popularity, legal disputes about the sales are certain to become more common. Lawsuits by sellers unhappy with the winning bid and false advertising claims filed on behalf of buyers may prove to be a growth industry along with private auctions. The legal risks to all parties, however, can be minimized ahead of time by taking the proper precautions to keep the aggressive play often seen in New York real estate within bounds.

Bruce F. Bronster is a partner in the Real Estate and Litigation Department at Dreier LLP, based in New York. Bronster, whose group handles general commercial and real estate-based litigation, foreclosures and transactional real estate matters, has participated in diverse land acquisition and development deals, financial restructurings, refinancings and mergers. He can be reached at 212-328-6138 or [email protected].

The real estate business in New York is, to paraphrase the late Sen. Lloyd Bentsen's comment about Texas politics, a contact sport. That rough-and-tumble attitude extends to real estate auctions, where both buyers and sellers need to be aware of the potential risks and the possibility for manipulation.

While private auctions represent just a small slice of the real estate market, they have been growing in popularity as more homeowners and even builders turn to auctions for a quick sale in a soft market. In the soft New York City real estate market of the early 1990s, for example, buyers were able to purchase even desirable Manhattan properties for bargain prices at private auctions. As private auctions gain in popularity again, however, past experience at foreclosure auctions points out the scope for brazen manipulation ' even when the sales are conducted at a courthouse or by the sheriff.

A Bit of History

In 1998, a decade-long bid-rigging scheme by 25 real estate brokers and speculators at real-estate foreclosure auctions at the Queens County Courthouse was broken up by the Antitrust Division of the Department of Justice. The men pleaded guilty to rigging bids at the courthouse auctions between 1986 and 1997 in a scheme that involved an agreement not to bid against each other. Only one member of the group would bid at the auction, and afterwards, they would hold a second, private auction open only to the members of the group, the Justice Department charged.

A similar scheme played out in Long Island's Nassau and Suffolk counties. In the 2002 case of Shaw v. U.S., the government uncovered a 5-year-long bid-rigging conspiracy affecting auctions conducted by the Nassau and Suffolk County sheriffs' offices. In this scheme, the group set a pre-determined price at which one designated individual was to bid on the auctioned property on the group's behalf instead of each member of the group bidding competitively against each other. In cases where at least three bids were required, two other conspirators would first submit intentionally low bids, thus enabling the designated bidder to win the property with a subsequent bid. The final bid was less than that which would have resulted had there been legitimate competitive bidding.

The government's investigation further revealed that, when a third-party interested in bidding on an item appeared at the official auction, one of the co-conspirators would demand a cash payment in exchange for an agreement that the group would not bid against the outside party, and would threaten to bid up the property if they did not agree. The cash payment by the third party was then divided among the group members.

Clearly, if this kind of bid-rigging can take place at a sheriff's auction, similar abuses could occur at a small, private auction. That makes it imperative for all parties involved to be aware of the potential for a group of conspirators to attempt to 'fix' the sales; to protect themselves through contract negotiations; and by performing the necessary due diligence ahead of time.

The Risks

For sellers, the chief risk is that the property might sell for an unexpectedly low price if the auction fails to attract motivated bidders. Sellers could then seek to hold auctioneers liable for 'chilling' the bids or not maintaining the integrity of the auction.

Overanxious buyers, on the other hand, may find themselves bidding higher than they should and then risk losing the down payment when they cannot obtain adequate financing in the 30-day time frame for closing that is typical for private auctions.

Keeping Things Legal

Attorneys representing sellers should advise them, first of all, to ensure that the auctioneers are reputable and have the proper licenses. For instance, the New York City Department of Consumer Affairs maintains licensing requirements for both auctioneers and auction houses.

The attorney should then negotiate the auction contract and terms of sale to obtain the lowest fee, to cover advertising costs, to address the risks of a failed sale or a failure to close, and to prevent tactics that would exclude potential legitimate bidders. The terms of sale should cover whether the auction will be an 'absolute' auction with no minimum bid or if there will be a set minimum bid; the amount of the down payment; what constitutes acceptable financing; as well as the closing date and costs.

On the buy side, attorneys should make sure to perform adequate due diligence ahead of a sale to protect their clients. Those measures would include a title review, a tax search, an inspection of the property, a review of local zoning ordinances, a review of the terms of sale and establishing adequate financing ahead of the auction to ensure that the buyer doesn't jeopardize the down payment by being unable to close the deal.

For buyers, it is important to note that a private auction would result in a standard real estate contract between the seller and the highest bidder, which would afford the buyer contractual protection within the traditional domain of real estate law.

While any deceptive practices involving a private auction would likely be treated by the New York State Consumer Protection Law (General Business Law, Article 22-A, ” 349, 350), case law in this area is very light.

For their part, auctioneers may face costly legal disputes brought on by either unhappy buyers or sellers, or both. A key action to reduce potential disputes is to explain the auction process clearly to potential clients, including the substantial differences from a traditional real estate transaction. Auctioneers should have the detailed auction contract and terms of sale reviewed by an attorney, and avoid making any oral agreements with clients which could change the contract terms. Finally, auctioneers must be aware of their responsibility to hold an open and honest auction free of manipulation. That includes, of course, not withholding material information about the property from the bidders.

Conclusion

As private real estate auctions gain in popularity, legal disputes about the sales are certain to become more common. Lawsuits by sellers unhappy with the winning bid and false advertising claims filed on behalf of buyers may prove to be a growth industry along with private auctions. The legal risks to all parties, however, can be minimized ahead of time by taking the proper precautions to keep the aggressive play often seen in New York real estate within bounds.

Bruce F. Bronster is a partner in the Real Estate and Litigation Department at Dreier LLP, based in New York. Bronster, whose group handles general commercial and real estate-based litigation, foreclosures and transactional real estate matters, has participated in diverse land acquisition and development deals, financial restructurings, refinancings and mergers. He can be reached at 212-328-6138 or [email protected].