The Basics of Commercial Real Estate Transactions: Important Contract Contingencies

Prior posts have discussed initial considerations in the purchase of commercial real estate and conducting due diligence prior to closing the deal. Today’s focus will now turn to contingencies often found in commercial real estate contracts.

Macro image of a commercial real estate sign with shallow depth of field. ** Note: Shallow depth of fieldThere are several key buyer’s contingencies that find their way into offers and contracts for commercial real estate, and like every contract provision, the terms of these contingencies can be written in such a way as to favor either the buyer or the seller. These terms predicate the sale on the fulfillment of certain conditions with plenty of strings attached, giving a party an escape from the deal if expectations aren’t met. The following are some of the most common contingencies and a brief discussion of each.

Financing

Maybe the most common contingency clause in a real estate agreement concerns financing. This provision will state that the offer to purchase a property is contingent upon the buyer’s ability to procure financing for the property. Often, this contingency will spell out the terms of the required financing to keep the buyer from getting locked into a deal even if financing only comes at unreasonable rates. Sellers, however, prefer and should request more broad terms, such as financing under “commercially reasonable terms.” Buyers should always include a financing contingency unless they plan on paying cash for the property, and even when a loan has already been acquired.

Zoning/Land Use

Commercial real estate is only as valuable to a purchaser as it fulfills the intended uses of that purchaser, so zoning or land use contingencies play a valuable role. Commercial real estate may require changes in zoning or a variance, and these can be uncertain acquisitions at best. Any change in the intended use of the property from the current use should come with a zoning/land use contingency to preserve the buyer’s ability to use the property in the manner expected. Any special permits or approvals should be included in a buyer’s zoning/land use contingency, but sellers should demand that such approvals be requested in a timely fashion, setting specific limits for doing so.

Environmental

Environmental contingencies condition the closing of the sale on a satisfactory report on the environmental conditions affecting the property. These provisions are generally important, but become increasingly so when there are potential environmental hazards from prior uses or if the future use of the property may be environmentally sensitive. A buyer’s contingency should remain as broad as possible and require the seller to furnish other environmental reports related to the property. A seller, on the other hand, should limit as much as possible the buyer’s discretion in deciding what a “satisfactory” environmental report is, including specificity as to the terms of such a report whenever possible.

Inspection

A buyer can include a contingency that makes the deal subject to an inspection period of the property. During this time, the buyer can bring in experts to assess the property and determine its fitness for the intended use as well as any necessary repairs or upgrades. This contingency is usually open-ended, allowing the buyer to back out of the deal for any reason during this time.

Title and Survey

Finally, a buyer has a right to know that what he or she is receiving in the purchase is what the seller is actually providing. Buyers should include a contingency that conditions the sale on a thorough title and survey report that provides the buyer with complete knowledge of the extent of the property and the ownership interest being conveyed in the deal. A buyer should want this language to be detailed and thorough to protect against a host of potential issues. A seller, however, can prevent the buyer from having an absolute right to terminate the agreement, limiting the contingency to a reasonableness standard and giving the seller an opportunity to cure problems before termination.

For more information on commercial real estate contract provisions, contact the attorneys at McBrayer, McGinnis, Leslie & Kirkland, PLLC.

BMacGregorBrittany MacGregor is an associate attorney practicing in the Lexington office of McBrayer, McGinnis, Leslie & Kirkland, PLLC. She is a graduate of Transylvania University and the University of Kentucky College of Law. Ms. MacGregor’s practice focuses on real estate law, including title examination, title insurance, clearing title issues, deeds, settlement statements, preparation of loan documentation, contract negotiation and preparation, and lease negotiation and preparation. She may be reached at bmacgregor@mmlk.com or at (859) 231-8780.

This article is intended as a summary of federal and state law activities and does not constitute legal advice.

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The Basics of Commercial Real Estate Transactions: Due Diligence

The most enduring maxim of any transaction is “caveat emptor,” therefore a key element of any commercial real estate transaction is due diligence on the part of the purchaser. A thorough investigation into the fundamentals of the property, the seller, the financing and the deal itself is the most crucial form of protection a purchaser has. Such an investigation exists to prevent surprises that might arise post-transaction. This post will briefly cover some essential elements of due diligence in the commercial real estate transaction.

First of all, the necessary scope of the due diligence will arise from the goals of the acquiring party. The goals of a developer seeking to improve property will vary from those of a mere investor looking to maximize a revenue stream. The purchaser should begin due diligence by determining the property’s expected uses after the transaction and using that as a framework for the investigation.

Due diligence then seeks to answer several questions, starting with the property itself. What is the full extent of the property the purchaser is acquiring? What rights are inherent in the sale? What assumptions are made as to the future use of the property? The investigation should cover every aspect of the property, from the very rights conveyed by the fee title to development rights. The investigation should look for restrictions that might inhibit the purchasers planned use of the property, such as zoning restrictions, licensing requirements and legal compliance issues with laws such as the Americans with Disabilities Act. Investigate all current uses of the property for the terms of any leases involving the land or any obligations to lessees that transfer with the property. It may seem just like common sense, but a thorough review of the property survey may yield new questions. The purchaser should ask for, receive, and scrutinize every single document related to the property. An insurance policy, for instance, can be a wealth of information on the property, and any claims history can provide clues as to the property’s past. A title insurance policy should provide information on easements and encumbrances that might affect the property’s future use.A yellow folder with the label Due Diligence

The next step is to look to the seller itself. The purchaser should determine the full extent of the seller’s interest in the property. If the seller is an entity, the purchaser should verify the standing of that entity with the appropriate agencies. Due diligence should determine definitively that the seller possesses both the interest being sold as well as the authority to sell. The financial standing of the seller is also important, as a bankruptcy can affect multiple aspects of the transaction. Ask the seller for tax returns, service contracts, loan documents, balance sheets, profit and loss statements, bank statements, utility bills and any other documents that may relate to the seller’s financial status and use of the property. The seller may balk at such extensive requests, but a seller should understand that a sale requires as much scrutiny of the seller as of the property being sold.

The remainder of the investigation should thoroughly analyze all details of the financing and the deal itself, assessing any potential hidden or future costs, revenue streams, potential liabilities, etc. Fully understand the entirety of the transaction and confirm any assumptions. Evaluate all conditions precedent to the sale for completion.

The contract for sale should include ample time for due diligence. This time should be a date reasonably past the delivery of the last documents required by the purchaser to complete due diligence; this will both ensure sufficient time for review as well as give an incentive for the seller to deliver the documents quickly and effectuate the sale. The sale should be contingent upon written acceptance of the due diligence provisions, and that this acceptance is solely at the discretion of the purchaser.

This post is not meant to be an exhaustive list of due diligence items, but merely an initial starting point. Due diligence requires a thorough understanding and evaluation of the details of the transaction to a point where the purchaser believes that she or he is fully aware of all the costs, uses, interests and potential liabilities inherent in the purchase. The purchaser should have peace of mind that the property will provide all expected uses post-transaction with no restraints. If you need assistance with due diligence on a commercial real estate transaction, the attorneys of McBrayer can guide you through the process.

BMacGregorBrittany MacGregor is an associate attorney practicing in the Lexington office of McBrayer, McGinnis, Leslie & Kirkland, PLLC. She is a graduate of Transylvania University and the University of Kentucky College of Law. Ms. MacGregor’s practice focuses on real estate law, including title examination, title insurance, clearing title issues, deeds, settlement statements, preparation of loan documentation, contract negotiation and preparation, and lease negotiation and preparation. She may be reached at bmacgregor@mmlk.com or at (859) 231-8780.

This article is intended as a summary of federal and state law activities and does not constitute legal advice.

The Consequences of Walking Away: Breach of Contract in Commercial Real Estate

The temptation happens often: the deal is done, the ink is dry, the contract is finalized…then someone gets cold feet. Buyers don’t want to buy, sellers don’t want to sell, money gets tight, titles can’t be delivered, etc. What makes breach of commercial real estate contracts unique as opposed to most non-real estate contracts is that every single property is unique. No two properties can share the same physical location, but most also won’t share the same size, improvements, buildings, access, resources…the list is endless. It’s not as though the buyer can just buy the same property from another seller, and the seller who loses a buyer also loses expected capital. When one party breaches its duties in a commercial real estate contract, it’s important for the non-breaching party to understand what remedies are available. We’ll explore the most common remedies and what provisions should be in commercial real estate contracts to mitigate the effects of breach.

Specific PerformanceAngry Businessman Tearing Contract Paper

There are two main categories of remedies – legal remedies, which provide monetary remedies and equitable remedies, which do not. The main type of equitable remedy applicable in a real estate contract context is specific performance. Since each property is unique, the argument goes, the only way to make a party whole is to fulfill the terms of the contract. This is done by asking for specific performance, a court-ordered fulfillment of the terms of the contract. It is as simple as the name implies; the court orders the party in breach to perform a specific act: for example, the act of signing or delivering a deed. This remedy generally only applies as against a seller in breach, and this makes sense: there is exactly one property with these characteristics in existence in the known universe, so the buyer has a strong argument that he or she cannot be made whole by mere monetary damages. Courts are generally loathe to force a party to perform an action unless monetary damages are incapable of providing relief. Sellers really only receive money in the transaction, so money is an appropriate remedy.

Damages

Damages, on the other hand, are monetary remedies available to both the buyer and the seller. Actual damages for both parties are usually given as the difference between the value of the property and the agreed-upon purchase price. The seller opposing a buyer in breach will want to argue the purchase price was more than the value of the property, while the buyer opposing the seller in breach will argue the opposite. These damages are often highly dependent on the commercial real estate market at the time, giving one party an advantage. The buyer is also generally able to terminate the contract if the seller is in breach and recover any payments made. Other types of damages may be available to a buyer in a commercial real estate transaction – courts in other states have found lost profit damages for a seller’s breach of a commercial real estate purchase contract.

Contract Provisions

As seen above, buyers tend to have more remedies than sellers, so savvy sellers should include contract provisions that deter breach on the buyer’s part. One of those provisions provide for liquidated damages. Liquidated damages are a fixed sum of money available to a seller in the event of a buyer’s breach. As mentioned earlier, actual damages can be dependent on the market and other factors, so a contract clause awarding liquidated damages in the event of a breach gives a seller some firepower in holding a buyer to the deal.

One other contract provision to consider is the award of attorneys’ fees in case of breach. Both parties should watch the language of any attorneys’ fees provisions inserted into the contract, making sure that the clause includes the word “reasonable.” Otherwise, the other side could run up extensive attorneys’ fees that wind up being almost punitive.

For commercial real estate contract concerns and other issues involving contract breach, contact the attorneys at McBrayer.

J. MarkhamJoshua J. Markham is a member at McBrayer, McGinnis, Leslie & Kirkland, PLLC in the Lexington, KY office. Mr. Markham practices in virtually every aspect of real estate law, including title examination, title insurance, clearing title issues, deeds, settlement statements, preparation of loan documentation, contract negotiation and preparation, lease negotiation and preparation, and any and all other needs related to residential and commercial real estate matters. He can be reached at jmarkham@mmlk.com or (859) 231-8780, ext. 149.

This article is intended as a summary of federal and state law and does not constitute legal advice.

Commercial Real Estate Sales: Initial Considerations in the Purchase of Commercial Real Estate

The decision to purchase, lease, or sell commercial real estate is fraught with multiple challenges for both buyers and sellers. This series of posts will provide a basic understanding of the various aspects of transactions involving commercial real estate. This post will focus on initial considerations for buyers in purchasing commercial real estate.

Buy v. Lease

Real Estate CrisisThe first step in making a decision to acquire commercial real estate is to decide whether buying the property or leasing the property is more beneficial. Both transactions come with various risks and rewards, and both require a thorough understanding of the buyer’s needs, expectations and financial picture. Buying has drawbacks in that it tends to lock up liquidity, may compromise cash flows and ultimately subjects the buyer to the whim of various market forces. At the same time, buying has advantages over leasing if the buyer wants control of the property, wants specific tax benefits, or if land values are appreciating and property would be a suitable investment. Those who wish to forego maintenance issues, stay mobile and keep initial cash flow strong might consider a lease to be more beneficial. A way to make a determination in this area is to conduct a study of future net cash flows as a result of taking either option. Proper economic planning is essential to this determination.

Assembling the Team

A team of various experts is crucial to your decision to lease or purchase commercial real estate to ensure a smooth and beneficial transaction that best protects the buyer’s interests. These professionals operate in conjunction with each other to effectuate the transaction: a commercial realtor will work to identify potential properties; a lawyer will assist in determining whether legally the property is suited for the buyer’s intended use, as well as negotiate the sale and draft necessary documents; an accountant will analyze expenses and provide necessary financial guidance; and a mortgage broker will help secure financing.

It is especially important to consider what research needs to be done before a contract itself is actually drafted. Namely, it is essential to investigate or work with an attorney to investigate aspects of the property such as zoning, permissible uses, and existing restrictions, and then negotiate or draft a contract accordingly to make sure that the buyer gets or can get exactly what she or he wants and needs from the lease or the sale. An attorney will consider these existing factors to evaluate the short term and long term benefits and effects of a contract to lease or purchase to make sure the buyer is protected before he or she signs on the dotted line. Bringing an attorney in on the process earlier rather than later helps to ensure the buyer can maximize the benefits he or she will receive from the lease or purchase of their commercial property.

Start Shopping

There is plenty of work to be done in the actual consideration of specific properties for purchase. Thorough investigation and consideration of each potential site is key. Purchasers should visit multiple properties of varying types and create an ongoing list of the various pros and cons of each. The first consideration of any property is the old adage about the three most important aspects of real estate being “location, location, location.” Further, keep in mind the considerations mentioned above while you embark on your search and be sure to contact the attorneys at McBrayer when you need someone on your team.

Be sure to come back for the next post as this series continues to explore the elements of a commercial real estate sale.

BMacGregorBrittany MacGregor is an associate attorney practicing in the Lexington office of McBrayer, McGinnis, Leslie & Kirkland, PLLC. She is a graduate of Transylvania University and the University of Kentucky College of Law. Ms. MacGregor’s practice focuses on real estate law, including title examination, title insurance, clearing title issues, deeds, settlement statements, preparation of loan documentation, contract negotiation and preparation, and lease negotiation and preparation. She may be reached at bmacgregor@mmlk.com or at (859) 231-8780.

This article is intended as a summary of federal and state law activities and does not constitute legal advice.