TOP 10 ISSUES IN COMMERCIAL REAL ESTATE
PURCHASE AND SALE AGREEMENTS
1. WHO ARE THE PARTIES?
A. For Seller, do not allow Buyer to use, “and/or assigns.”
B. Cover assignability specifically in the Purchase and Sale Agreement (the “Agreement”).
C. Possible scenarios:
(1) Buyer cannot assign without Seller’s consent, which consent shall not be unreasonably withheld or delayed.
(2) Buyer can assign only to a party controlled or owned by Buyer, or under common control with Buyer (an “Affiliate”).
(3) Buyer cannot assign without Seller’s consent, which consent may be withheld in Seller’s sole discretion.
(4) Buyer can assign only after all due diligence conditions are removed and the earnest money “goes hard.”
D. For Buyer, make sure Seller owns the property, or require Seller to explain how Seller can sell property it does not own.
2. EARNEST MONEY
A. Use of Terms; Earnest Money Concepts
iii. Released to Seller
B. For Buyer:
i. Try to make earnest money a promissory note that is not redeemable until at least the end of the due diligence period.
ii. Do not call the earnest money “non-refundable.” Generally, the parties will acknowledge that the earnest money, even when referred to as “non-refundable,” still typically remains refundable if Seller fails to perform its obligations, or in the event of condemnation, casualty, or failure of a closing condition.
C. For Seller:
i. Require cash earnest money and make the amount substantial (5%?) to make sure Buyer is serious and has resources.
ii. Consider requiring that earnest money (or part of it) be released prior to closing.
iii. Require Buyer to post additional earnest money for extensions of the due diligence period or closing, and make sure such additional earnest money is as “non-refundable” as possible, and maybe non-applicable.
3. TITLE & ESCROW
i. For Buyer, the Agreement should clearly provide for Buyer to obtain title to the Property with only title exceptions that are acceptable to Buyer. All exception documents in the preliminary title commitment/report should be carefully reviewed, including CC&R’s, easements, and the like. In Oregon, Washington and most California counties, Buyer should expect Seller to pay for a Standard Owner’s Policy of Title Insurance in favor of Buyer in the amount of the purchase price. Buyer should expect to pay for extended coverage and any additional endorsements Buyer chooses to obtain.
ii. Seller should generally agree with the above. The Agreement should provide that Seller is not obligated to remove any title exceptions, other than monetary encumbrances (loans and trust deeds) that Buyer is not assuming.
B. Escrow. Very Important: Escrow officer and company can have a substantial impact on closing, escrow and title issues, and problem-solving. Establish a relationship with a title company and escrow officer (or several).
4. DUE DILIGENCE AND CLOSING CONDITIONS
A. For Buyer:
i. Generally, due diligence period is a “free look.” The most typical due diligence conditions a Buyer will want are physical inspections, title, land use approvals, document review, and feasibility.
ii. The Agreement should set out clearly how due diligence conditions (and all other conditions) are to be waived or satisfied. For Buyer, waiver should be effective only if in writing.
iv. Estoppels and other closing conditions (condemnation, casualty, Seller performance, title commitment)
B. For Seller:
i. Possible Seller due diligence conditions;
(1) Buyer financial statements;
(2) Seller board/member approval;
ii. Ensure that upon waiver of due diligence, any earnest money or promissory note will be converted to cash and go “hard.”
iii. Get indemnity/hold harmless agreement from Buyer for all claims arising from Buyer’s entry onto Seller’s property during due diligence.
5. ENVIRONMENTAL ISSUES
Background: Under various state and federal laws, both “owners” and “operators” of real property contaminated by hazardous waste or hazardous substances are generally jointly and severally liable for the entire cost of remediation, regardless of fault. Although there are exceptions, the exceptions are construed narrowly, and it is therefore essential that adequate environmental investigation be undertaken.
Phase I environmental site assessment or ESA: This is a study conducted by the environmental consultant of all public records and background information concerning the use of the property, the adjacent properties, and any hazardous waste release that has occurred in the vicinity of the property. A report is typically prepared that will provide a recommendation as to whether further study is recommended by the consultant. By definition, a Phase I ESA does not include testing of soil, water or air samples.
ESA Phase II: This is a study that includes soil, ground water, and/or air samples. If contamination is found, a report on a Phase II ESA will typically provide recommendations for remediation. The cost of remediation in some circumstances can far exceed the value of the property.
The Agreement should allow the Buyer to complete whatever environmental investigation the Buyer chooses before purchasing the property, particularly for properties in industrial areas. The Seller will want to make sure the Buyer is required to provide a copy of any ESA report to the Seller.
A. For Buyer: Need the right to obtain a Phase I ESA, and possibly Phase II if Phase I recommends a Phase II.
B. For Seller: If willing to allow a Phase II, consider adding the following:
i. Scope of Phase II must be approved by Seller;
ii. Results of Phase II are confidential except if disclosure is required by law;
iii. Retain approval rights for environmental consultant;
iv. Require Buyer to indemnify and hold Seller harmless for any damage done as a result of the Phase II ESA.
6. WARRANTIES AND REPRESENTATIONS
A. For Buyer:
i. Obtain warranties and representations from Seller that Seller has the ability and authority to enter into the Agreement, that Seller is not aware of any material violation of law in connection with the Property, that entering into the Agreement will not violate any law or breach the terms of the Agreement and other such warranties.
ii. Generally, the broader the warranties obtained by the Buyer, the more comfortable Buyer will be that Seller is fully disclosing the Seller’s entire knowledge of the Property, or risking a lawsuit if any material fact is not disclosed.
B. For Seller:
i. Limit as much as possible.
ii. Qualify to Seller’s actual knowledge and define “knowledge” to include a specific individual.
iii. Limit duration of warranties and representations.
iv. Limit liability exposure for warranties and representations to a specific dollar amount (5% of purchase price?).
v. Damage floor and caps.
vi. AS IS except for express warranties and representations.
Generally. It is important that a broker understand and be able to explain to his or her client remedies and potential exposure if a breach of the Agreement occurs. The Agreement should provide what remedies are available to each party in case the other party breaches.
A. For Buyer: There are a number of remedies that can be provided to the Buyer. Some Sellers attempt to convince the Buyer to agree that the Buyer’s sole remedy would be the return of the Buyer’s earnest money. This is generally unacceptable to the Buyer, given that the Buyer has often incurred expenses before the agreement terminates and limiting the Buyer to the recovery of its earnest money would not give the Seller any incentive to fulfill the terms of the Agreement if a better offer came along. Other alternative remedies are as follows:
i. The Buyer could be entitled to recover its earnest money, and maybe some or all of its out of pocket expenses.
ii. The Buyer could be entitled to recover consequential damages, including any damages caused by the Seller’s refusal or failure to perform. This would include lost rent, lost profits, and any other damages that flow foreseeably from the Seller’s breach. Very unusual.
iii. Specific performance. The Buyer can be entitled to file a lawsuit or other legal proceeding to obtain specific performance. In such a proceeding, the court or tribunal would have the authority to compel the Seller to sell the property to the Buyer. This remedy is generally palatable to both parties.
B. For Seller: Generally, a Seller’s remedy in the event of a Buyer’s default or breach is limited to retention of the Buyer’s earnest money. Accordingly, from a Seller’s standpoint, it is important to get the Buyer to pledge as much earnest money as possible in a transaction.
C. Both parties should consider asking for written notice and opportunity to cure any breach or non-performance before the other party can seek any remedy.
D. Fraud generally falls outside of damage and remedy limitations.
8. NOTICE PROVISIONS
Buyer and Seller have the same interest with regard to the notice provision:
A. A clear and unambiguous notice provision should be included that tells the parties how notice is to be given, to whom it is to be given and when notice is effective. You should explain to your clients that once the agreement is signed, they should strictly comply with notice procedures contained in the agreement.
B. Fax obsolete?
C. Allow e-mail notice?
9. OPERATION OF PROPERTY PRIOR TO CLOSING
Should generally require Seller to operate the property in the same manner as prior to PSA execution.
A. Maintenance and repair, leasing, insurance, etc.
B. Should Buyer have input on leasing decisions?
C. Who pays leasing costs?
Generally: The Agreement should set out a clear road map as to how and when closing will occur.
A. For Buyer: Agreement should set out what conveyance documents are needed and the form of each as appropriate – deed, assignment of leases, bill of sale, assignment of contracts and warranties, loan documents, etc. Consider asking for the right to extend the closing date for estoppels, financing, or for other last-minute issues.
B. For Seller: Consider asking for a right to extend the closing date for estoppels or other last-minute issues.
C. Other closing issues to consider: transfer tax, escrow fees, prorates, rent delinquencies, post closing CAM reconciliation, etc.