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.