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© Practising Law Institute

REAL ESTATE LAW AND PRACTICECourse Handbook Series

Number N-620

16th Annual

Commercial Real Estate Institute

Volume One

Co-ChairsMichael T. Fishman

Elliot L. HurwitzRichard C. Mallory

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Purchases Sales and Closings

Jodi B. Fedor

SSL Law Firm LLP

Danna M. Kozerski

Coblentz, Patch, Duffy & Bass LLP

If you find this article helpful, you can learn more about the subject by going to www.pli.edu to view the on demand program or segment for which it was written.

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1. OVERVIEW OF THE PURCHASE AND SALE PROCESS

1.1 Letter of Intent or Term Sheet 1.2 Purchase and Sale Agreement

1.2.1 What is sold and economic terms of sale 1.2.2 Conditions to sale, including title review and due diligence 1.2.3 Obligations/liabilities of parties before and after sale 1.2.4 Sale process

1.3 Contingencies, including Due Diligence/Title Review 1.4 Closing

2. UNDERSTANDING THE PROPERTY AND THE DEAL

2.1 Property Characteristics 2.1.1 Land vs. Improved Property impacts:

2.1.1.1 Due diligence - focus on development potential/risks vs. prop-

erty condition/operations/returns - need to understand buyer’s development plans

to conduct appropriate due diligence 2.1.1.2 Casualty provisions 2.1.1.3 Possible contingencies related to entitlements

and/or development rights 2.1.2 If Improved Property, type of real estate (office, industrial,

retail, multi-family) primarily impacts lease due diligence and importance of estoppels: - If single tenant, lease/estoppel are critical - If multi-tenant office/industrial, importance of indi-

vidual leases depends on size, length of term, tenant, etc.

- If retail, anchor/main tenants, tenant mix, co-tenancy, relocation right.

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- If multi-family residential, market/property condition and vacancy rate more important that specific leases. No estoppels.

- If value add opportunity or if buyer intends to occupy may want leases to terminate soon or include relocation or termination rights

2.1.3 If bank owned/REO Property, impacts: - Seller motivation. - Availability of due diligence materials. - Seller willingness to make representations and warran-

ties and incur post-closing undertakings/liabilities. 2.2 Specific Deal Characteristics

2.2.1 If the Property is currently occupied by Buyer, this impacts: 2.2.1.1 Due diligence (Buyer has access, may know more

than Seller) 2.2.1.2 Prorations (if buyer currently pays certain expenses

as tenant) 2.2.1.3 Contracts (if buyer currently contracts directly for

some services) 2.2.1.4 Representations and warranties (Buyer may know

more about the property condition/compliance than Seller)

2.2.2 If the Property will be leased back to the Seller, this impacts: 2.2.2.1 Prorations (if seller will continue to pay certain

expenses as tenant) 2.2.2.2 Contracts (if Seller as tenant will continue con-

tracts in place) 2.2.2.3 Utilities (may continue to be held/direct paid by

Seller as tenant 2.2.2.4 Be careful to define interaction and conflicts with

lease document [preserve limited reps, nature of “as-is” purchase agreement, risk of loss]

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2.2.3 If a Portfolio Sale, consider: 2.2.3.1 All or nothing vs. ability to “opt out” of individual

properties 2.2.3.2 Allocation of purchase price for tax/title insurance/

financing purposes 2.2.3.3 Casualty/condemnation (individual properties/

thresholds or aggregate) 2.2.4 If an option agreement rather than purchase agreement,

consider: 2.2.4.1 Consideration/deposit (likely need separate con-

sideration that does not apply to purchase price), 2.2.4.2 Seller operating covenants (particularly if a long

option term) 2.2.4.3 Possible purchase price calculation or adjustment

based on formula or other factors 2.2.5 If a bid/auction:

2.2.5.1 There will likely be no or limited ability to negoti-ate the form agreement or conduct due diligence

2.2.5.2 If public entity is the seller, usually need to be careful to conform bid to seller requirements or may be disqualified.

2.3 Existing Loan 2.3.1 Paid off (typical) or assumed (if cannot be prepaid, or if on

attractive terms) 2.3.2 If assumed, PSA should include:

2.3.2.1 Loan Documents as due diligence deliveries 2.3.2.2 Representations from the Seller related to the

completeness of the documents, lack of default, outstanding balance.

2.3.2.3 A contingency period for review and approval of documents and terms (coterminous with due diligence period typically)

2.3.2.4 Separate time periods (consistent with loan docu-ments) to obtain lender approval of assumption.

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2.3.2.5 Lender approval of assumption and assumption documents as closing requirements.

2.4 Entity/Structuring Issues 2.4.1 Seller Entity

2.4.1.1 Confirm vesting is with party that enters PSA 2.4.1.2 If SPE, Buyer should consider backing of post-

closing obligations and liabilities 2.4.1.3 Withholding issues (Federal, possibly State) if

foreign entity. 2.4.2 Buyer Entity

2.4.2.1 If SPE will be set up to hold title (note: may be required by lender), be sure PSA allows assign-ment of contract.

2.4.2.2 Owner/occupier may have internal reasons to hold title directly or through affiliate.

2.4.3 1031 Exchange 2.4.4 ERISA Representations/Compliance

3. LETTER OF INTENT

3.1 Customary Terms 3.2 Binding vs. Non-Binding Provisions

3.2.1 Generally non-binding, but some provisions may be binding (confidentiality, exclusivity, access rights)

3.2.2 Good faith and fair dealing obligation may impact “non-binding” nature of letter of intent.

3.2.3 State law may allow tort claims (detrimental reliance, etc.) under certain circumstances based on LOI.

3.3 Due Diligence Deliveries (if due diligence will be commenced or completed prior to signing PSA)

3.4 Time Periods (for contingencies, closing)

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4. PURCHASE AND SALE AGREEMENTS

4.1 Description of Property to be Conveyed 4.2 Purchase Terms

4.2.1 Purchase Price 4.2.2 Deposit(s)

4.2.2.1 refundable vs. “hard” (related to timing of due diligence review and contingency, and whether some or all due diligence is completed prior to delivery of the Deposit)

4.2.2.2 typically held in escrow, sometimes released to seller when hard

4.2.2.3 accrued interest usually to Buyer, sometimes part of Deposit

4.2.3 Independent Consideration (required in some states) 4.2.4 New or Assumed Financing

4.3 Due Diligence 4.3.1 Title and Survey Review/Permitted Exceptions

4.3.1.1 May be separate time period and time for Seller to cure objectionable exceptions.

4.3.1.2 May be exceptions Seller is required to remove, such as mechanics’ liens, mortgages, exceptions voluntarily created. ((PSA Form §3(a))

4.3.2 General Property Due Diligence 4.3.3 Inspections/Access (PSA Form §4(c))

4.3.3.1 If before PSA is signed, pursuant to Access Agree-ment, PSA language should be consistent with separate Access Agreement (if any).

4.3.3.2 Typically Seller approves scope of work, time periods for notice/access, may be present during access/testing

4.3.3.3 Indemnification/insurance requirements (Buyer, consultants)

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4.3.4 Environmental Issues (particularly on-going remediation or discovered issues) 4.3.4.1 Phase I investigation (Typically Buyer obtains its

own; if Buyer will rely on existing, need reliance letter from consultant)

4.3.4.2 Possible Phase II investigation (timing and access issues)

4.3.4.3 CERCLA Defenses (also consider other environ-mental laws [federal, state, local]): – Innocent Landowner Defense (“all appro-

priate inquiries”) – Bona fide prospective purchaser defense

4.3.4.4 Contractual allocation of responsibility/liability if issues are discovered or known (undertaking by seller, holdback, indemnification, credit).

4.3.5 Entitlements 4.3.5.1 Zoning inquiry/title endorsement/PZR Report 4.3.5.2 If acquisition for development, further analysis,

possible meetings with government officials (need Seller consent and/or exclusion from confidenti-ality requirements in contract).

4.3.6 Leases/Estoppels (PSA Form §5(a)(v)) 4.3.6.1 Tenant Estoppels

- Review leases for approved forms or estoppel requirements, timing; check consistency with PSA

- Required estoppels (typically for “Major Tenants” and/or percentage of tenants)

- Timing: Before due diligence expiration or before closing? Will seller request prior to due diligence expiration (disclosure concerns if sale is confidential or sensitive).

- Seller estoppels may be used to “cure” lack of tenant estoppel; consider consistency with other Seller liability/survival limits

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4.3.6.2 Other estoppels (from Owner’s Association, other parties to easements/CCRs/REA)

4.3.7 “Going Business” Due Diligence 4.3.7.1 Employees 4.3.7.2 Management/Service Contracts 4.3.7.3 Operational Permits/Licenses 4.3.7.4 UCC/Litigation/Bankruptcy Searches

4.3.8 Assumed Financing 4.3.9 CC&Rs/Ownership Association Documents

4.4 Other Contingencies 4.4.1 Possible Contingencies in addition to Due Diligence:

4.4.1.1 Loan Assumption/Financing 4.4.1.2 Entitlements (buyer or seller pursues) 4.4.1.3 Hazardous Materials Remediation 4.4.1.4 Seller Work/Development

4.4.2 Satisfaction of contingencies: 4.4.2.1 Time Period 4.4.2.2 Notice Requirement 4.4.2.3 Deemed approved/disapproved

4.4.3 What if there is a failure of contingency? 4.4.3.1 Pre-negotiate resolution vs. “take it or leave it” 4.4.3.2 Possible resolution includes purchase price adjust-

ment, seller undertaking (pre-close with possible closing extension or post-close with possible escrow holdback)

4.4.3.3 Contract may include Built-in consultation period or “cure” right.

4.5 Representations and Warranties 4.5.1 What does “As-Is” Really Mean?

4.5.1.1 Nearly all deals are “as-is” and include as-is language and release (conform to state law)

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4.5.1.2 Seller’s express representations and indemnities should be excluded from “as-is” and release.

4.5.1.3 Other possible exclusions are Seller fraud, some pre-closing contract claims, sometimes other Seller bad acts or certain defense claims. (PSA Form §10(e))

4.5.2 There are not “typical” Seller Representations, they vary by market, deal characteristics, leverage and negotiation (PSA Form §7(a)). Types of representations include: 4.5.2.1 Representations related to the Property: no viola-

tions, leases/contracts, no litigation/condemnation (usually include knowledge qualifier)

4.5.2.2 Representations related to the Seller entity (status/authorization, ERISA, OFAC),

4.5.2.3 Representations related to disclosure/due diligence deliveries (usually include knowledge qualifier)

4.5.3 Deal Specific Representations 4.5.4 Defining “knowledge” – actual knowledge of named per-

sons, required inquiry 4.5.5 “Cure” of discovered misrepresentation – may distinguish

requirement/remedy based on “Seller fault” (PSA Form §7(b))

4.5.6 Buyer closing with knowledge of misrepresentation typically waives claim against Seller

4.5.7 Survival Period (typically limited to 6-12 months) 4.6 Operating Covenants

4.6.1 Generally, Seller agrees to continue to operate, maintain and insure the property as it has been operated.

4.6.2 New obligations (leases, contracts) that would bind the Buyer generally require Buyer consent (sometimes after contin-gencies are waived or subject to materiality).

4.6.3 Covenant vs. Contingency: Is there a practical difference? Not unless there a “remedy” for a Seller default short of not showing up at closing (other than Buyer termination/return of Deposit).

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4.7 Remedies 4.7.1 Seller Remedies

4.7.1.1 Liquidated Damages, usually the amount of the Deposit (typical)

4.7.1.2 Exclusion for indemnification obligations (access, brokers, attorneys’ fees), and deal specific under-takings

4.7.1.3 Specific performance (Practical/legal challenges to enforcement; often waived by sellers)

4.7.2 Buyer Remedies 4.7.2.1 Pre-Closing (including Seller failure to close)

(PSA Form §12(a)) - Return of Deposit (and possibly recovery of

costs) - Specific Performance (usually with

parameters – time period to file, etc.) - Damages (Seller’s will resist); possibly

subject to a cap. If available, usually only for “bad acts” by Seller and only with Seller cure right.

4.7.2.2 Post-Closing - Suit for damages based on misrepresentation

or breach of indemnity. - Typically, Seller’s damages are capped (and

sometimes there is a floor or “bucket”). Seller liability cap can typically be 1-5% of purchase price, depending on size of deal. (PSA Form §12(b))

- If obligations are significant and Seller is an SPE or otherwise not creditworthy, Buyer may require financial backing of through parent guaranty/joinder, holdback or net worth covenant (PSA Form §12(c))

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4.8 Closing Costs/Prorations/Adjustments 4.8.1 Custom 4.8.2 May vary based on negotiation 4.8.3 Prorations based on closing date 4.8.4 If tenants pay expense pass-throughs, address year-end

reconciliation 4.8.5 If single tenant/triple net leases consider need for proration

of expenses paid by Tenant (PSA Form §6(f)) 4.8.6 Leasing Costs (if recent leases or on-going build-out, may

allocate responsibility for costs) 4.8.7 “Make ready” credits for residential properties (Per unit

credit for units recently vacated or vacated during PSA term, sometimes only if over a threshold vacancy percentage).

4.9 Casualty/Condemnation (PSA Form §11) 4.9.1 Risk Threshold (Buyer and/or Seller right to terminate) 4.9.2 Three typical approaches:

4.9.2.1 Assignment of Insurance Proceeds (plus credit for deductible) OR

4.9.2.2 Credit estimated cost to rebuild OR 4.9.2.3 Seller obligation to rebuild (and related extension

of closing) 4.9.3 If multiple buildings, threshold on each? Termination right

for individual buildings? 4.10 Indemnities (PSA Form §9)

4.10.1 Consider whether specific indemnities are consistent with “as-is” nature of deal.

4.10.2 If indemnities are included, they are typically cross (pre-closing liabilities from Seller, post-closing from Buyer) and typically only cover contractual claims (under leases, con-tracts), liability/insured claims (slip & fall), sometimes breach of representations.

4.10.3 Sometimes in closing documents (assignment of leases, contracts, intangibles) only or in addition to PSA.

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5. CLOSING PROCESS

5.1 Escrow vs. Table Closing. 5.2 Importance of Closing Checklist. 5.3 Closing Conditions

5.3.1 Closing Statement/payments 5.3.2 Document deliveries (including third party documents

[estoppels, consents]) 5.3.3 Title Policy 5.3.4 Possession/Keys 5.3.5 Original documents/other deliveries 5.3.6 Notices (to tenants, contractors, regulators, etc.) – may be

through escrow or outside, consider timing.

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NOTES

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