The Essentials of Commercial Real Estate Sale and Purchase Agreements

A commercial real estate sales contract can be one page or one hundred pages. There are no rules, and every term, every word, is up for negotiation. Nonetheless, there are provisions that are typically included in most CRE purchase agreements, and understanding these provisions is essential for both buyer and seller to protect their interests.

Let’s begin with a quick story.

Quick Contract Story No. 1

An attorney friend was suffering through the longest of purchase contract negotiations. There had been dozens of revisions by each side, and the agreement had grown to almost 200 pages. In a meeting with the other side’s lawyer, when it appeared they were close to a deal, but the other side started to waver again on the language, my friend said:

“I’ll agree to the contract as it is right now, and we can be done, if I can insert just one word.”

Opposing counsel, said “Sure. What’s the word?”

And my friend answered, “Not.”

Ahhhhh, the joyous free-for-all of commercial real estate negotiations.

That being said, this article discusses contract common provisions, their purposes, modifications that sellers and buyers may request to them, and their reasons for those requests. Let’s start with the purpose of contracts.

Purpose of CRE Purchase and Sale Agreement

A contract has several purposes: it specifies each party’s rights, obligations, and liabilities; it details the steps that must happen in order to close the transaction; and, naturally, it defines exactly what property, real and otherwise, is being conveyed.

While there is sometimes the inclination to keep a contract “short and simple,” a well-drafted contract will clearly address and define the purposes above, regardless of the document’s length or complexity. The time and money spent to create a thorough and complete contract will be returned ten-fold if conflicts arise.

Contract Form, Negotiation and Drafting

The first draft of agreements is typically done by the seller’s attorney, and then sent to the buyer for their input. The two parties exchange revisions until both accept a final document. The agreement will likely contain the common provisions discussed below, but it will be tailored to address the specific deal, including the specific type of property. For example, the sale of an unoccupied industrial property will have different issues than undeveloped land or a retail complex with multiple tenants.

Depending on the complexity of the transaction and value of the property, contract negotiations can be extensive. Who gets to choose what provisions are included? A quick story…

Quick Contract Story No. 2

A real estate attorney with 40+ in practice was asked why he refused to negotiate, or even discuss, a contract term that the opposing side colored as a “deal-breaker.” Noting first that they eventually accepted the term just as he wanted it, he then answered, “Because my client had the bigger stick.”

While not all parties and their attorneys negotiate with that attitude, the tale does highlight one truth: no party is entitled to a specific term. Everything is up for negotiation (including the decision, when one side is in a position of power, to not negotiate at all!).

Okay. Let’s dive into some common commercial real estate contract provisions…

Common CRE Sale and Purchase Contract Provisions

After identifying the parties and the effective date of the contract, the next words you’re likely to see in a commercial real estate sale agreement are “Whereas…”

1. “Whereas” Clauses

Often sale contracts start with a series of “whereas” clauses, also referred to as “recitals.” “Whereas” means literally “given the fact that,” and are a sort of introduction to the transaction, explaining the facts that led up to the contract. It’s generally accepted that recitals aren’t a part of a contract’s operative provisions. Accordingly, if a party views the language in a “whereas” clause to be a binding right or duty, it has to be taken out of the contract’s recitals, and included in the body.

2. Description of Property & “As-Is” Term

Depending on what is being conveyed, a contract will describe three types of property: real, personal and other. Real property descriptions detail the land and improvements to be transferred with as much specificity as possible. If a legal description exists, it should be used, and if not, the contract should provide that the description will be amended following a survey.

If personal property will be conveyed, the contract spells out those particular items. Because seller may intend to keep some of the personal property, an exhaustive list of the items to remain is ideal to avoid confusion.

Other property interests can include such things as lease and contract rights, licenses, intellectual property and warranties. Another quick tale…

Quick Contract Story No. 3

A party was purchasing a group of ski resorts. The sales contract correctly identified legal descriptions for all of the resorts’ land, a thorough list of all personal property to be transferred, and multiple leases, contracts and licenses relating to the operation of the resorts.

But, it didn’t address one important item: water rights. In performing its title review the buyer discovered that the rights to the water necessary to feed the ski resorts’ snow-making machines were granted to the seller personally, and not attached to the land.

While the parties argued about whether water rights were covered under the contract’s language, and eventually resolved the matter, the issue could have been avoided at the outset with better understanding of the needs of the property and a more complete description of property rights to be conveyed.

Lastly, where an agreement states that the property will be transferred “as-is,” this means the seller is making no representations as to the condition of the property. This limitation should be consistent with seller representations or warranties under the agreement, but in all cases an “as-is” disclaimer won’t shield a seller from fraud claims if it misrepresents conceals material aspects of the property.

3. Transfer Documents (Deeds, Assignments, and Bills of Sale)

Real, personal and other property are transferred by different instruments, so let’s take a look at possible issues with each.

a. Deeds

Because there is more than one type of deed, and they differ in the amount of protection given to the buyer, the contract must describe the type of deed to be used. The types, in order of the most protective of buyers to the least, are:

A general warranty deed, which “not only conveys to the grantee all of the grantor’s interest in and title to the property but also guarantees that if the title is defective or has a ‘cloud’ on it, such as a mortgage claim, tax lien, title claim, judgment, or mechanic’s lien, the grantee may hold the grantor liable.”

A special warranty deed (also called a limited warranty deed), which “conveys the grantor’s title to the grantee and promises to protect the grantee against title defects or claims asserted by the grantor and any persons whose right to assert a claim against the title arose during the period in which the grantor held title to the property. In a special warranty deed, the grantor guarantees to the grantee that the grantor has done nothing during the time he held title to the property that might in the future impair the grantee’s title.”

A fiduciary deed, “used to transfer property when the grantor is acting in his official capacity as a trustee, guardian, conservator, or executor, etc. A fiduciary deed typically only warrants that the fiduciary is acting in his appointed capacity and in the scope of his/her authority and doesn’t guarantee the title of the property.”

And lastly, a quitclaim deed, which is a “release by the grantor, or conveyor of the deed, of any interest the grantor may have in the property described in the deed. Generally a quitclaim deed relieves the grantor of liability regarding the ownership of the property. … The holder of a quitclaim deed receives only the interest owned by the person conveying the deed. If the grantee of a quitclaim deed learns after accepting the deed that the grantor did not own the property, the grantee may lose the property to the true owner. If it turns out that the grantor had only a partial interest in the property, the quitclaim deedholder holds only that partial interest.”

b. Assignments

As discussed below, a seller may be conveying its interests in leases, property-related contracts, licenses, permits, intellectual property and other items. Generally, buyer must determine whether the specific items to be conveyed are assignable, and if it wants to assume them. If they can, and it does, seller will transfer its interest in each my assignments delivered at closing.

c. Bills of Sale

A bill of sale is the usual method to convey personal property, and, like the contract itself, should identify the items transferred with as much specificity as possible.

4. Purchase Price, Adjustments, and Earnest Deposit

The purchase price is typically a set amount, subject to adjustments at closing. However, sometimes the amount will be based on square footage where the property’s actual size won’t be determined until a survey has been done. If personal or other property is included in the sale, the parties may, generally for tax purposes, allocate what portions of the purchase price are attributable to the land, the personal property, and the other property interests conveyed.

Additionally, the contract should detail what adjustments to the purchase price will be made at closing. Generally these relate to apportioning property expenses to each party for items such as closing expenses, real and personal property taxes, assessments, rents and security deposits.

Further, the contract will dictate who holds the deposit (typically a title insurance company or other neutral third party) and what happens to the deposit if the deal closes or not. Typically, if (i) the transaction closes, the deposit is credited towards purchase price, (ii) the deal didn’t close because buyer exercised one of its rights to terminated (e.g., one or more of buyer’s contingencies weren’t satisfied or waived), the deposit is returned to buyer, (iii) the sale didn’t close because the buyer defaulted, the deposit is kept by seller, and (iv) if the sale didn’t close because seller defaulted, the deposit returned to buyer.

Additionally, the contract should state whether the return or retention of the deposit resulting from a default will prevent the non-defaulting party from seeking damages under a breach of contract action.

5. Buyer’s Contingencies

Because a buyer won’t know everything it needs to know about the property at the time the contract is signed, it will be given a certain amount of time to review those aspects of the property it believes important. If following buyer’s review it determines that any one of these items is not satisfactory (as defined for each contingency), it may (i) give seller the opportunity to act to make the item satisfactory, (ii) accept the item as it is and waive its right to terminate the contract, or (iii) terminate the contract.

In order to determine if contingency items are satisfactory, it needs access to certain information in seller’s possession, including, for example, leases, property related contracts, permits, licenses, notices of land use or environmental violations or issues, and financial information such as income and expense statements and tax returns. Accordingly, the contract will require seller to provide all such property-related documents, as well as the obligation to provide any updates or new documents through closing.

The contingencies in a contract will differ depending on the purchase, but the following common ones are discussed below:

• the buyer’s ability to secure satisfactory financing
• satisfactory title
• satisfactory survey of property
• accepted building and property condition following inspections
• review of leases
• property income and expenses
• property-related contracts
• land use approvals, and
• satisfactory environmental condition

For a comprehensive checklist for commercial property due diligence items, check out our due diligence checklist

a. Buyer Financing

Central to the success of a sale is whether a buyer has the funds to purchase. If they don’t have cash (meaning readily available funds), and the seller isn’t providing financing, then buyers will look to third party lenders. If they can’t find satisfactory loan terms, this contingency will allow the buyer to terminate the contract. The seller will generally define the satisfactory loan terms (e.g., minimum loan amount, maximum interest rate and minimum term) so that buyer can’t opt-out under this contingency for a nebulous “we didn’t like the financing” reason.

b. Title Review

The agreed-upon title insurance company will review the chain of title and all other documents in the public record relating to the property to prepare a title commitment for buyer’s review. The commitment should establish that the seller owns the property, set forth any interests attached to the property (e.g., liens, easements, recorded leases, reversions, options to purchase, and covenants, conditions and restrictions (CCRs)), and then detail the conditions that have to be satisfied at or before closing so the company can insure the title required under the contract.

The buyer’s title contingency will generally provide that if the buyer objects to any title conditions, it can give seller the opportunity to cure or insure over buyer’s title objections. Where the seller can’t or won’t cure or insure, the buyer has the option of terminating the contract or waiving its objection.

Contracts may also provide that the seller must give the title company any items needed to remove the standard title exceptions. The American Land Title Association (ALTA) standard exceptions are:

• undisclosed parties in possession
• accurate survey or inspection
• adverse possession or prescriptive easements
• easements not shown by public record
• construction liens, and
• taxes not yet due and payable

Once the parties have agreed to the commitment, including what exceptions have been removed or insured over, the title company provides a title insurance policy to the buyer (and its lender, if any) at closing.

The importance of title review cannot be overstated. It can mean the difference between being able to use the land or not.

Quick Contract Story No. 4

In an article by PropertyMetrics about CRE deals gone bad, a seasoned real estate attorney described the following title review tale, “The Italian Villas:”

A client was buying property around [a high-end retail corridor] to build some Italian looking villas. He engaged us to get the property’s land use approved.

He had a big model made up of the villas to show city council. Must have weighed 60 lbs. We got the zoning approved, and I asked him “What are you going to do about the restrictive covenants?” He said, “What are those? How do I get rid of them?”

We weren’t hired to do any of his acquisition or title work, but figured out he had to get 51% of the property owners to waive the covenant. So he took this big model around to all of them, but couldn’t get more than 49%. Long story short, he had to sell. Didn’t lose his shirt, but had to sell.

Moral of the story, review title early on…

c. Survey

Obtaining a survey is important to verify the property’s size and location, that it has access to public roadways, access to sufficient utilities, locate easements and their potential impact on any proposed land use, and identify any boundary issues (e.g., unlawful encroachments). Additionally, a survey can reveal a potential prescriptive easement: a property use right given without the landowner’s knowledge or consent to a third party. Prescriptive easements, if enforced, can severely impact the property’s use and value.

The contract establishes which party pays for the survey, how long the buyer has to make objections to the completed survey, and how long seller has to cure them. Of course, seller can refuse any cures, and the buyer then decides whether to waive its objection or terminate the contract.

The agreement should specify the required standard of survey. Most lenders require the survey to meet the standards of the American Land Title Association (ALTA) and National Society of Professional Surveyors (NSPS): the “ALTA/NSPS Land Title Survey.” As explained by a due diligence consulting firm, the origin of the ALTA/NSPS survey was designed to give the title insurer all the information it needed “to delete the standard survey exceptions from their title policy[, answering] relevant questions, such as: 1) the surveyor’s findings about property boundaries, 2) any observed easements and exceptions to coverage in the title commitment and 3) the improvements, utilities, public access and significant observations on the property.”

The contract will generally specify that seller gives the buyer and its surveyor access to the property (though they may limit the times when surveying can happen), and that buyer indemnify seller against any injury or damage claims resulting from the surveying.

d. Inspections

Inspections generally will look at the state of improvements, personal property, and building code and other land use violations. As with surveying, seller will grant a right of access during a specified time, and require buyer to indemnify seller from injury or property damage claims arising from the inspections.

e. Commercial Tenant Leases

If the subject property includes existing tenants, verifying these tenants, their rental rights obligations (including options to purchase), the lease terms (e.g., can they be assigned to buyer), leased premises, and whether the leases are in default, are necessary to understand the obligations a buyer will be taking on, and the income and expenses generated from the leases.

Accordingly, buyers typically will ask the seller to provide:

• copies of all leases
• rent rolls, including past due rent payments
• notices given tenants
• estoppel certificates from tenants (here is a sample certificate form), and
• seller’s tax returns to verify rental income

Additionally, buyers will want sellers to indemnify them against tenant claims arising before closing, and may ask seller to notify all tenants of the pending sale.

For a detailed look at tenant estoppel certificates, take a look at our  article on tenant estoppels

f. Property-Related Contracts and Expenses

Similar to lease review contract provisions, a buyer will want to know its rights and obligations under property-related contracts currently in force with the seller, including the costs associated with each contract and whether they can be assigned to buyer. Such agreements can be for services like property maintenance, management, repairs, and others.

As with leases, the sale agreement may require seller to (i) assign at closing the contracts buyer wishes to assume, (ii) terminate those contracts buyer doesn’t want (to the extent it can under each contract’s terms), (iii) indemnify buyer against claims under the contracts for actions occurring before closing, and (iv) obtain estoppel certificates from the contract parties.

g. Land Use Approvals

If the buyer won’t be changing the current use of the property, it will want to confirm that the existing uses are lawful. This means reviewing compliance with zoning approvals, variances, conditional use permits, building permits, occupancy permits, signage permits and other similar approvals.

If the buyer will be changing the use, the contract will include a contingency that the buyer has a certain period of time to get approval from the appropriate governing body for its proposed uses. If the buyer diligently pursues the approvals, but isn’t successful, it may terminate the contract.

h. Environmental Review

A buyer will want to ensure that either the property has no environmental issues, or if it does, that it has an accurate understanding of the issues, and who must cure them.

To determine a property’s environmental health, a buyer often asks the seller to provide existing environmental assessments and agreements, as well as permits relating to environmental obligations. Buyers will also ask for the right to perform their own assessments, and terminate the contract if the assessment results are unsatisfactory. Typically these assessments are Phase I and II environmental site assessments.

A Phase I assessment involves a review of records, a site inspection, and interviews with owners, occupants, neighbors and local government officials. Even if the buyer doesn’t think such a review is necessary, its lender may require one. If the Phase I reveals potential contamination, a Phase II may be done to determine if hazardous materials are present. Phase IIs include site sampling and analysis with tests such as surface and subsurface soil samples, geophysical testing for buried tanks and drums, and sampling for Polychlorinated Biphenyls (PCBs).

The agreement should: (i) state who performs the assessments, and within what time frame; (ii) if items are revealed, who must remediate them, and how long they have to do so; (iii) provide that buyer can terminate the contract if it’s not satisfied with the reports’ conclusions; and (iv) require buyer to provide all reports to the seller.

Lastly, where potential environmental issues arise, a seller may want to require that all communications with any governing bodies relating to the potential issues be done either by the seller, or by the buyer only with seller’s consent. Sellers want this provision because while the buyer may walk away from the deal if the assessments reveal problems, any discussions with governmental agencies, and the results of such discussions, could create significant and long-lasting obligations for the seller.

6. Default Provisions

The agreement should clearly define what constitutes a default, how parties must be notified of the default, whether they are permitted to attempt to cure, how long they have to cure, and what happens upon an uncured default and termination of the contract. For example, the contract may require the buyer to return to seller all materials provided as a part of the buyer’s due diligence.

Additionally, the contract should describe a conflict resolution process to deal with any claims of breach.

For a discussion of conflict resolution processes, see our article on boilerplate lease clauses

7. Seller Representations and Warranties

A seller will make certain representations and warranties relating to the property. They should be spelled out explicitly, note whether some or all are limited to seller’s knowledge, and state whether each survives closing, and if so, for how long. Some of the more common representations and warranties include:

• the property is free and clear of all encumbrances
• there aren’t any land use violations (e.g., zoning, building codes)
• all permits necessary for the operation of the property are in place
• there are no environmental contaminations or violations
• seller has disclosed all claims against the property
• no parties have a right to occupy the property other than the identified tenants
• the leases, contracts, and financial documents provided to buyer are complete and accurate
• seller has the proper authority to sign the contract, and
• the improvements are free of any material defects and suitable for their intended uses

8. Other Seller Duties – Continuing Management, Insurance, Damage to Property

Buyers want to ensure that the property at closing is in virtually the same condition as when they entered into the contract. To ensure this happens, a buyer will obligate the seller to continue (i) to operate and maintain the property in a reasonable manner, (ii) lease the property in a reasonable manner (if there is an important tenant, buyer may want to limit seller’s ability to modify or terminate that lease without the buyer’s prior approval), (iii) keep the property insured, and (iv) not encumber the property without the buyer’s consent.

If notwithstanding seller’s efforts to maintain the property, it is damaged prior to closing, most purchase agreements describe the parties’ rights following damage. Generally contracts deal with the issue based on the extent of the damage. If the property can be fixed prior to closing, then seller will do so. If it can’t, then seller’s insurance proceeds will go to the buyer at closing so buyer can make post-closing repairs. However, if (i) the cost to repair the damage exceeds a certain amount, or (ii) the damage to improvements exceeds a certain percentage of the improvements’ total area, the contract will typically give buyer the option to terminate the contract.

9. Broker Involvement

Where one or more brokers are involved in the sale, the contract should identify those brokers and which party is responsible for their fees. It should also note that no other brokers were used, but if any unnamed brokers make a claim for fees, the party that dealt with them is responsible for their fees. Where there were no brokers, the contract should state this.

10. Assignment

Assignment provisions determine whether the buyer can assign its rights under the purchase agreement to another party. While the parties may disagree on whether assignment should be permitted, a compromise may allow for limited assignments to (i) specifically identified assignees, or (ii) any other party if the seller first consents.

11. Boilerplate Provisions

At the end of almost every CRE purchase contract are several pages of so-called “boilerplate clauses,” or clauses which supposedly are near-identical for all contracts, and thus less important. This is of course not true. Not only is every commercial real estate sale agreement different, but also these clauses can significantly impact the parties’ rights and obligations.

“Boilerplate clauses” include such items as:

• notice provisions
• attorneys’ fees
• merger/entire agreement clauses
• choice of law/governing law
• jurisdiction/forum selection
• force majeure
• the definition of the property
• dispute resolution
• parties, signature blocks, and others

For a discussion of each of these, examples, and pitfalls to look out for, see this PropertyMetrics article, “10 Boring Boilerplate Commercial Lease Clauses You Should Understand”

12. Closing

The contract should detail when and where closing will occur, and who will conduct it. Often parties will include the clause that “time is of the essence” as to the closing date, meaning there is no flexibility in the date. If closing doesn’t occur on that date the buyer can terminate the contract.

The documents to be provided at closing are described in the agreement, but generally consist of: (i) transfer deed, (ii) bills of sale, (iii) assignments and assumptions of leases and property-related seller contracts, (iv) title insurance policies, and (v) any other documents required by the title insurance company.

13. Pre-Contract Documents – Letter of Intent and Confidentially Agreements

Because the drafting of a purchase agreement can be time consuming and expensive, parties often chose to first draft a letter of intent (LOI) outlining the transaction’s principal “deal points,” e.g., property description, parties, price, significant contingencies such as the need to get proper zoning approval for a new use, etc. These will then be incorporated into the draft contract.

Depending on the circumstances, the parties may want the LOI to be binding or not. However, if they don’t want it to be binding, it’s critical that the letter include a clear statement that it’s not enforceable. If they fail to do this, and the LOI includes the material terms of the sale, a court may enforce it as a binding agreement. Nonetheless, binding or not, courts will typically impose on the parties the duty to use their best efforts to negotiate in good faith towards the terms of the LOI.

The second agreement sometimes used before the contract is signed, though often as a part of the contract, is a confidentiality agreement. To allow for the buyer’s due diligence the seller will be providing a substantial amount of information about the property, its environmental status, claims against the property, the seller’s management of the property and leases, etc. While the seller accepts that this information is necessary for buyer to determine if the purchase is worth pursuing, it doesn’t want this information shared with the world.

Hence, buyer will be required sign a confidentiality agreement (attached as an exhibit to the contract) providing that the buyer can’t disclose any of such information to parties other than those needed to interpret them, e.g., buyer’s lawyers, engineers, architects, accountants, environmental experts, surveyors, etc. (“consultants”) Additionally, in some cases the seller may require that buyer’s consultants also agree to be bound by the confidentiality agreement.

Sample Agreements

With the substantial caveat we’re not endorsing these agreements, and that any form or sample agreement must be modified for each specific deal, and should be drafted by a licensed real estate attorney, here are a few examples of CRE sale contracts:

• American Bar Association sample Purchase and Sale Agreement
• Northern Illinois Commercial Association of Realtors’ Commercial Real Estate Purchase and Sale Agreement
• New York City Bar Association’s Contract of Sale – Office, Commercial and Multi-Family Residential Premises
• DIRT’s Contract for Sale of Commercial Real Estate

Conclusion

Get ready to negotiate! Each property is unique. Each buyer and seller has different needs. And each CRE sale contract will be unique. But with an understanding of the above items, those common and essential items, you’ll have a little advantage at the negotiating table. That is unless the other side has a bigger stick…

In any case, because this article is given for informational purposes only, and not legal advice, if you have any specific issues regarding a real estate sale, please contact an experience real estate attorney.

If you have any comments or questions, or would like to share contract provisions that have served you well, please let us know in the comments section below.

 

Source: The Essentials of Commercial Real Estate Sale and Purchase Agreements

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