Nine Dance Moves in Negotiating and Closing a Commercial Real Estate Transaction

By Tom Loonan | Commercial Real Estate

Engaging in the “dance” that is a commercial real estate transaction is much like any other dance one would participate in. If you know the right moves and can anticipate the moves of your party the result will likely be a success. Here, this article takes a look at nine common components of a commercial real estate deal and what each of those components contributes to the overall dance of the real estate transaction.

1. The Letter of Intent (LOI)

Also known as the term sheet or memorandum of understanding, an LOI is the initial document executed by seller and purchaser memorializing the key terms of the transaction. While terms set-forth in this document are generally nonbinding on the parties they are customarily treated as nonnegotiable starting points from which the rest of the transaction may grow from.

The standard terms generally set-forth in an LOI include: a) the basic description of the property, b) purchase price, c) escrow deposit instructions, d) transaction timeframe and anticipated deadlines, e) proration and apportionment of third-party items, f) a non-binding clause, and e) confidentiality and non-disclosure provisions.

2. Due Diligence

After setting forth the general terms in the LOI the parties begin negotiating more specific terms to govern the transaction. Often, one of the first specific elements of the transaction to be discussed relates to the Purchasers right to conduct due diligence on the property and the purchase in general. The due diligence period provides the Purchaser the opportunity to investigate various agreed upon aspects of the transaction and to terminate the purchase agreement without penalty if it determines the results of the investigation are unsatisfactory.

Primarily, the due diligence consists of investigation regarding all material aspects of the property and it may sometimes extend to a review of the Seller entity. At the outset, the parties will agree to both the scope of the due diligence and the duration and deadlines by which Purchaser is entitled to cancel the transaction. The due diligence period typically begins upon execution of the purchase agreement or delivery of certain due diligence documents from Seller to Purchaser such as property condition reports, title commitment and ALTA survey, financial disclosure documents, etc. In addition to the review of the documents provided by Seller, the due diligence also includes physical inspections of the property, analysis of any binding contracts pertaining to the property, and an environmental survey of the property.

3. Contingencies

A negotiated purchase agreement often contains several provisions specifically built into the contract upon which the close of the transaction will contingent. Any transaction will initially be contingent upon purchaser’s determination that each of its findings through the due diligence process demonstrate the transaction is one the purchaser wishes to complete. If a purchaser discovers an unsatisfactory item through due diligence it will generally be entitled to cancel the transaction or work with seller to mitigate the unsatisfactory element or renegotiate the terms of the deal. Aside from the due diligence contingences, the other most common contingency found in commercial transactions is the financing contingency. This contingency sets a deadline by which the purchaser must demonstrate to the seller that it has qualified for the financing necessary to close the transaction. The financing contingency may be general and broadly state that financing will be available or specific and set forth the parameters that the terms of the loan commitment must satisfy.

4. Land Use and Zoning

As an extension of contingencies impacting a transaction a purchaser will review the local ordinances and zoning laws to ensure the property is compliant. To assist in this review, seller is generally requested to supply a certificate of occupancy issued by the local government certifying the property as satisfactory to the local authorities. After determining there are no existing violations against the property, a purchaser will also ensure that any purposed use of the property complies with local code or if the proposed use is not compliant a purchaser may work with the local government to receive certain approvals and assurances prior to closing the transaction.

5. Representations and Warranties

In consideration of the transaction each party will make certain representations and warranties related to their own ability to complete the transaction and their knowledge of the property contemplated in the agreement. This is particularly important to a purchaser as the seller may have information not immediately available through due diligence which is relevant to the property that the seller must disclose. To properly protect seller, the parties must give specific consideration to the survival period during which seller’s representations and warranties remain in force so as to assure purchaser is protected from liability not discoverable prior to close.

In making the specific representation and warranties seller will generally attempt to limit its liability by qualifying that the disclosures are only the seller’s “actual” or “best” knowledge in all “material” respects. Seller will further represent that documents delivered in due diligence may be relied on by purchaser to the extent they contradict any statements of seller. Additionally, each party will represent and warrant that they are in good standing and have all requisite authority necessary to complete the transaction.

6. Covenants

The covenants and rights governing the transaction will appear throughout the purchase agreement. These are the promises or agreements between the parties that each is obligating themselves to. Of specific importance in a commercial real estate transaction are the covenants relating to the use and operation of the property during the contract period. Specifically, the agreement will commonly specify the seller’s promise to conduct business in ordinary course including the operation, management and maintenance of the property in the same manner as prior to execution of the contract. The seller should also agree to perform all of its obligations to any contracts affecting the property and promise to inform purchaser prior to completing any material contractual decision that will affect the property. Finally, it is common that seller agrees to settle outstanding liens, maintain insurance on the property prior, and satisfy all tax liability prior to close. Some of these costs may be apportioned at closing, but the parties should spell out the responsibilities during the contract term.

7. Remedies for Breach

The remedies for breach arising from a commercial real estate transaction are generally limited. A right to the seek remedies will normally only arise after the breaching party is provided an opportunity to cure and the non-breaching party can demonstrate that they were ready, willing and able to close the transaction but-for the breach. The most common remedy for a breach is either the retention or return of the earnest money to seller or buyer respectively. Sometimes, a non-breaching party may be entitle to recover costs arising from the breach and in very limited circumstances a purchaser may be entitled to specific performance which would necessitate the seller complete the transaction under the agreed upon terms.

8. Closing the Transaction

The purchase agreement will generally contain specific conditions that must be satisfied by each party prior obligation to close the transaction. The purchaser’s closing conditions will likely be longer than the seller’s list considering the purchaser will receive the property and the liability that comes with ownership. Common closing conditions required by a purchaser include that all contingencies have been satisfied, all third party consents have been executed, seller’s reps and warranties remain accurate, and seller’s delivery of physical possession. Conversely a seller’s condition to close are very limited and typically consist of purchaser’s the continued accuracy of purchaser’s reps and warranties, purchaser’s delivery of any necessary closing documentation, and most importantly purchaser’s delivery of the purchase price. Finally, in addition to the satisfaction of all closing conditions, seller will be required to deliver closing documentation to purchaser consisting of the deed to the property, assignment and assumption of any transferred contracts, bill of sale, the FIRPTA certificate, and any requested books or records relating to the property.

9. Escrow Procedures

Finally, the parties to a commercial real estate transaction must give special consideration to the terms dictating the handling, use, and disbursement of the escrow deposit. The terms of escrow can be included as a separate section of the purchase agreement or by memorialized in a separate contract specifically referenced in the purchase agreement. Either way, the parties must specify who will serve as the escrow agent, the procedures and deadlines for the escrow deposit, the manner in which the escrow agent may deposit the funds, and the procedures for disbursement under each specific circumstance that may arise such as close of the transaction, a breach by either party, or a termination of the agreement for any other reason. Often, the escrow agreement will also specify a dispute resolution mechanism to be used in the event there is disagreement regarding the disbursement of escrow funds.

Conclusion

Each of the nine elements set forth above demonstrates a different complex aspect of the commercial real estate transaction. Each aspect requires specific attention and consideration by the parties to the transaction to ensure that all pieces fit together and are fair and satisfactory to provide for a successful closing.


QUESTIONS ABOUT THIS TOPIC?

If you have any questions about the content of this article or are in need of commercial real estate attorney please contact Tom Loonan at 715-808-8842, or email at tloonan@eckberglammers.com.


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