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In certain instances, a party may want to acquire commercial property via purchase and utilize the same either for its own purposes, or perhaps to lease to others. While such transactions are common, they are certainly more complex than the purchase of residential property, and require careful planning to accomplish smoothly. The following are issues that a practitioner should keep in mind when negotiating a commercial purchase and sale transaction.
A letter of intent (also known as an LOI or term sheet) is a written expression of the important terms of a proposed transaction usually signed by both parties. The letter of intent forms the basis for negotiation of a final definitive agreement. It is not intended to include all of the terms of the purchase and sale transaction, but it should include enough material terms so that the parties have some assurance that they will ultimately be able to arrive at a deal to execute a definitive purchase and sale agreement. In the context of a purchase and sale of real estate, LOIs are typically nonbinding. However, even a nonbinding letter of intent may include an implied agreement to negotiate in good faith. With some nonbinding LOIs, there may be one or more provisions that the parties agree will be binding, such as a confidentiality agreement, an agreement of the seller to refrain from marketing the property for some period of time while the parties negotiate a definitive agreement, or an indemnity from the buyer for inspections that it may be permitted to conduct prior to signing a definitive agreement.
A purchaser will often want to inspect the property and perform other due diligence prior to purchasing a commercial property. To do this, a purchaser must be granted access to the property in question, and documents and/or financial records related to the same. In the case where the buyer is being given early access to the property, sellers often seek to limit the amount of time that a buyer can access the property. Often sellers will attempt to retain the right to cut off access to the property if the seller believes negotiations between the buyer and seller have not been, or no longer are, productive. Buyers will typically resist such attempts. For this reason, buyers will often push to incorporate exclusivity provisions into the access agreement.
Ultimately, the access agreement provisions should mirror the proposed due diligence covenants, terms, and restrictions that will be incorporated into the purchase agreement. It may also include indemnification for buyer’s acts or omissions, as well as those of its agents, consultants and/or contractors.
A purchase agreement for a real estate acquisition is exactly what it sounds like--it is an agreement to buy and sell real estate between two or more parties. It is not the actual conveyance document that transfers the real estate from the seller to the purchaser. All of the terms of a purchase agreement are negotiable, to some extent. If the parties executed a letter of intent, that will be the starting point from which to begin drafting a purchase agreement. However, standard purchase agreements often contain the following provisions:
The property description is one of the most important aspects of the agreement; it is the written description of what is and is not being conveyed. The legal description of the real estate is the written words that delineate the specific real estate being conveyed. It may consist of metes and bounds or a specified parcel identified in a recorded plat. It is typically included in the original agreement, though if an accurate legal description is not available when the purchase agreement is signed, it may be added after a title insurance company has produced the legal description as a result of its investigation as to the status of title. In that case, the agreement must otherwise identify the property (e.g., by street address) so that it is clear which property is being sold. Both parties’ counsel should make sure the property’s legal description is entirely accurate. In addition, personal property, if any, needs to be identified to be included or excluded in the agreement. Often commercial real estate has little tangible personal property, though some commercial buildings (e.g., a hotel) may have significant personal property. Whatever it is, the agreement should refer to it as part of the property to be purchased and, if there is personal property that is not being included in the sale, it should be expressly described and excluded from the definition of personal property.
With option contracts, a buyer is typically given the right to inspect the property (and to review financial and physical information concerning the property) during a specified period, usually called a “contingency period,” an “evaluation period,” an “inspection period,” or a “due diligence period.” The length of the inspection period is frequently negotiated and a key term in any letter of intent since the seller does not want to keep the property off the market for too long. At a minimum, the buyer needs a sufficient amount of time to undertake whatever due diligence investigation the buyer plans on taking in connection with his or her purchase. Usually the buyer is given fairly wide-ranging rights to access property records and to have its consultants enter the property to evaluate its condition.
Areas of investigation generally undertaken by a buyer can be broken down into (a) title and survey; (b) environmental, (c) property condition / structural, and (d) financial components. Different experts must be retained to perform each of these due diligence functions.
Representations and Warranties
The nature and scope of seller’s representations and warranties is one of the most heavily negotiated aspects of the commercial purchase agreement. Seller’s representations and warranties confirm to the buyer the existence (or nonexistence) of facts and circumstances regarding the seller, the property being acquired and its operations, all of which are relevant to the buyer’s analysis of the acquisition. Moreover, representations and warranties function to allocate risk between the buyer and the seller.
Seller’s representations and warranties can be broken down into three categories: (1) representations about the seller, including its existence and its authority to enter into and perform the contemplated transaction (for convenience, the representations in this category are referred to as “entity representations”); (2) representations about the property; (3) representations about the operations of the property. The buyer should also expect to make entity representations.
Great negotiation and expansion of the representations and warranties can be rendered meaningless if the buyer does not pay attention to what form of entity it is contracting with. In certain circumstances, such as when the counterparty is a special-purpose entity, a holdback or escrow agreement may be necessary to protect the buyer in the case of a future breach of a representation or warranty.
Damages and Remedies
Typically, damages awarded for a breach of contract are based on the actual economic losses suffered by the non-breaching party. In some cases, the amount of economic loss is readily ascertainable. In other cases, it can be difficult or impossible to determine the extent of the losses caused by the breach. In those cases, the parties may agree in advance on an appropriate level of liquidated damages. In the context of a sale of real property, damages are most often liquidated for a breach by the buyer prior to closing, and the liquidated amount is frequently (though not necessarily) the same amount as the deposit made by the buyer.
Parties to a purchase agreement often provide indemnification to the other party in instances where damage is caused that is ascertainable. In option contracts, it is customary for the buyer to indemnify the seller for any losses that occur as a result of the buyer’s entry onto, and inspection of, the property during the inspection period. The buyer might also be asked to indemnify the seller for losses that arise on account of acts or omissions that occur after the buyer takes ownership of the property. Depending upon the buyer’s negotiating power, the buyer may also be the recipient of certain indemnities. Liability for breaches of representations and warranties can be backed by indemnification obligations, and at times the seller will indemnify the buyer for acts and omissions that occurred in operating to the property during the seller’s period of ownership.
Other Important Provisions
Commercial real estate purchase and sale contracts often contain other important provisions. These may include provisions dealing with (1) assignment of the agreement, (2) amendments to the agreement, (3) governing law, (4) allocation of commission, (5) appropriate notice, (6) execution of the agreement in counterpart form, (7) attorneys’ fee allocation in case of dispute, (8) integration of the agreement, and (9) the waiver and release of any warranty outside of those provided by the representations and warranties.
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