Negotiating the Purchase and Sale Contract

By Douglas M. Bregman
Douglas M. Bregman is a member of the law firm of Bregman, Berbert, Schwartz & Gilday, LLC, and has maintained a general civil law practice for over 35 years focusing on transactional real estate and business representation; mediation and arbitration; and civil litigation. Since 1992, Mr. Bregman has been an Adjunct Professor of Law at Georgetown University Law Center and beginning in 2011 at Columbia Law School, teaching a course entitled: Drafting and Negotiating Commercial Real Estate Documents: Contracts, Loan Documents, and Leases. This article is adapted from a chapter in the Commercial Real Estate Transactions Handbook.

his article focuses on the acquisition of commercial real estate. Particular attention is paid to the provisions contained in the real estate contract. Also examined is the role of the attorney and how the attorney can advise and assist the client during the negotiation and drafting of a commercial real estate contract. Although not an exhaustive list, commercial real estate is commonly understood to include office buildings, shopping centers and malls, warehouses, industrial parks, apartment buildings, and raw land.

ROLE OF THE ATTORNEY

Every commercial real estate transaction has its own variables, and in writing the contract for each deal, the attorneys role may vary greatly. The attorneys participation will depend on which client is represented, the needs of the client, the complexity of the deal, and many other factors. However, the attorneys role will nearly always involve technical assistance in structuring the transaction and in drafting and negotiating the contract. Often the client will depend on the attorney for business advice as well as legal counsel. In some cases the attorneys role as legal advisor will have some friction with the clients business judgment. In the capacity of legal adviser, the attorney must counsel the client regarding both the risks and opportunities that are present in the specific transaction. An attorney should always ensure that the client has a thorough understanding of the deal and each of the contract terms strengths and weaknesses. If a transaction strikes the

attorney as particularly risky or weak, the attorney should not try to substitute his or her judgment for that of the client especially after the client has studied the deal and decided to move forward. It is the attorneys job to complete the deal with the best contract possible within the confines of the transaction and law. An attorneys personal views should not cause a deal to unravel. Once the strengths and weaknesses have been presented to the client and the attorney has made his or her concerns known, the client, not the attorney, will be in the best position to quantify the risks and rewards of a particular transaction and make the decision whether to move forward with the contract. An attorney who does not counsel the client about the potential problems does the client a disservice. It would not be a waste of time for an attorney to record any of his or her objections to a clients proposed course of action. Some transactions may be so risky that the attorney cannot in good conscience proceed. If the attorney is so opposed to the transaction and feels compromised in some way that the attorney cannot overcome, the attorney may resign.1 Negotiation by or through the attorneys often is at the heart of nearly every commercial real estate transaction. Few deals are accomplished without substantial negotiation. Complex deals often require extensive negotiation.The negotiator who refuses to concede even the smallest point risks losing the deal. On the other hand, if the negotiator becomes too accommodating, the negotiator risks giving up too much. Of course, any negotiation strategy depends on the respective bargaining positions of the parties and the economics of the deal.
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Negotiations often can be tedious and laborious. It is important that the attorney remains fully engaged to guarantee that the clients interests are protected. If the attorney loses focus and important details escape notice, the client and the attorney may later have to deal with unplanned adverse consequences. Negotiations also can become heated with both sides employing aggressive and emotional rhetoric and tactics. It is important that the attorney remains professional and clearheaded about his role. Negotiations can present an opportunity for the attorney and client to learn more about the deals issues and the other party. The attorney and client should work out a negotiation strategy before the actual back-and-forth process begins. Preparation for negotiations is critical. It will be important for both the attorney and the client to have a thorough understanding of what the preferred outcome of the negotiations will be. It is essential that the attorney and the client communicate about the negotiations beforehand so that they have the same understanding about what is essential in the contract terms and what concessions they may be willing to make. If the attorney and client work well together, they often can play off each others strengths to negotiate a much more effective deal together than either could alone. An often successful negotiating strategy is the classic good cop/bad cop routine. Depending on the deal and the client and attorneys strengths and comfort level, the attorney or the client may play either role. In fact, during the course of negotiation the attorney and client may swap roles if it seems advantageous. Often, the personalities of the attorney and client will dictate which role each assumes at a particular point in the negotiation. The closing date or specific conditions precedent after the satisfaction of which closing will occur; and The method of payment; e.g., cash, seller financing, or the assumption of existing debt.

Most commercial real estate contracts go far beyond the basic essentials.4

Basic Contract Organization

The organization of the body of a contract is a matter of personal style and preference. What follows is a description of thirteen basic contract sections: (1) Parties to the Contract, (2) Property Description, (3) Purchase Price, (4) Study/ Feasibility Period, (5) Conditions Precedent, (6) Title, (7)Costs and Adjustments, (8) Closing, (9) Representations and Warranties, (10) Defaults, Attorney Fees, and Dispute Resolution, (11) Additional Undertakings, (12) Casualty and Condemnation, (13) Indemnification. Each of these categories may have one or more subcategories.

Parties to the Contract

A contract generally begins with a simple formulation: Made [as of a particular date] by and between [Seller] and [Purchaser]. A fundamental question a seller or purchaser needs to know the answer to is: Does the party signing the contract have legal capacity to sell or buy this real estate? The parties, and by extension their attorneys, who fail to do their due diligence may suffer adverse consequences rising from their inattention to even this most basic question. The purchaser can determine whether the seller has the right to sell by ordering a title report as soon as possible. Even before the full title report is available, the title company often can advise in what name the title is vested. Another approach, until the title search is completed, is to ask the seller to produce its title policy or deed which lists the name of the rightful owner. Additionally, the contract should require that each party should supply copies of its organizational documents to the other. If either the seller or buyer is unable to produce these documents, copies may be available from the jurisdictions office of public records. These documents should be reviewed carefully to determine who is authorized to act on behalf of the seller and buyer. For example, a partnership agreement might provide that all general partners must approve of a decision to sell partnership assets. Or, a corporate charter might require that the sale of a major asset
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THE CONTRACT
The Basic Elements of a Contract
In most jurisdictions, contracts for the sale of real estate must be in writing to satisfy the statute of frauds. Generally, this requirement states that, at a bare minimum, a written contract: (1) discloses the names of the parties to the contract, (2) adequately describes the land or property to be sold, (3) provides the essential terms of the agreement, and (4) is signed by the party against whom the contract is to be enforced or by an agent authorized by that party.2 As a practical matter, these essential terms also include:3 The price or a formula that can be used in determining the price (for example, the appraised value);

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requires ratification of the corporations board of directors. In some instances the actions of one or the other party might need to be approved by a court, such as a sale of real estate from a bankruptcy proceeding. If an agent purports to act on behalf of a principal in a transaction, then that agent should be able to produce a written agency agreement or power of attorney that specifically authorizes it to bind the purchaser or seller. Any such agreement should be carefully inspected to ensure it permits the agent to bind the principal. Finally, there are times when a contract is signed before the purchasing entity has been formed. Persons signing on behalf of a yet to be formed entity may take on greater liability than they intended. In some cases, signatories have been held personally responsible for actions taken on behalf of an entity yet to be formed or formed but not yet capitalized.5 This potential liability can be mitigated substantially if the contract limits or eliminates the individuals liability.6

Purchase Price
The negotiated purchase price, normally payable in good funds by a wire transfer or by delivery of a cashiers check or certified check, should be clearly spelled out in the contract. If a portion of the purchase price is payable by the purchaser assuming existing financing or by the seller lending part of the purchase price, the contract should establish under what conditions (e.g., fees and loan modifications) that the debt is assumable or provided by the seller. If the purchaser cannot benefit from the assumption because of a due on sale clause or other restriction on assumption of the debt, the parties should address the consequences of this fact early in this contract provision. If a lenders consent to the loan assumption is necessary, this contingency should be reflected in the contract. If payments or fees to the lender may be required or if the interest rate on the loan may be adjusted, it is important to negotiate how the seller and purchaser will allocate these expenses in the contract. The earnest deposit securing the purchasers obligation to perform under the contract also is delineated in the contract. The deposit typically is in the form of either cash or a letter of credit and usually is held by an escrow agent or stakeholder. If the deposit is in cash, consideration should be given to placing it in an interest-bearing account. Any interest earned on the deposit should go to the party designated in the contract, usually the one who has beneficial title to the deposit while the interest is accruing. Prior to the release of the deposit, there is significant authority that the purchaser making the deposit owns the deposit until all conditions of the contract have been satisfied.9 Assuming conceptually that the deposit belongs to the purchaser until it is either forfeited at the purchasers default or paid to the seller as part of the purchase price, it is typical that the interest accrues to the benefit of the purchaser. A letter of credit is an undertaking by the issuing financial institution to make payment upon presentation consistent with the letters terms, before the letters expiration date, of certain amounts described in the letter. If the deposit takes the form of a letter of credit, it is important that the seller approve the issuing financial institution. If the issuing institution becomes insolvent, it is possible that the issuer will not honor the letter. Consequently, the letter is only as good as the issuers financial standing. The letter of credit can be issued under the Uniform Customs and Practices for Documentary Credits (UCP)10 and can be payable to the escrow agent as opposed to the seller under the contract.
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Property Description
The contract must accurately and completely describe the property to be conveyed. An attorney drafting a real estate contract should take great care to ensure that the property being transferred is described as accurately as possible. The two most common ways to describe the property are through either the use of a written, legal description of the property or through the attachment of a plat, a prior deed, or similar document to the contract. It would not be wrong to do both. Because the exact size (acreage or square feet) of the property may not be available, it should be described as [so many] acres (or square feet) more or less7 (or with an equivalent qualifier such as approximately).8 The property should include any related improvements, appurtenances, beneficial easements, and rights-of-way over adjacent land and rights in adjacent alleys and streets, as well as fixtures and personal property used in the operation and ownership of property, which the buyer and seller expect to convey with the property. Many technical words and terms employed in a property description may sound unfamiliar. While the language may be obscure and seem archaic, the words and terms have technical meanings. These unfamiliar words and terms mostly come from the science of land surveying.Terms that may sound unfamiliar include strips and gores. A strip, maybe unsurprisingly, is a long narrow piece of land, and a gore is an irregular triangular piece of land.
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An escrow agent is a person or entity that holds documents and funds in the transfer of real estate, pursuant to the instructions of both parties. If an escrow agent is to hold the deposit, the escrow agent should certify that it has received the deposit and that it agrees, by signing the contract or a separate escrow agreement, to hold the deposit in accordance with the terms of the contract. The purchaser or seller may prefer to have its own counsel retain the deposit. The attorney, who supposedly is acting as a neutral stakeholder, may have a conflict of interest if there is a dispute as to the deposit. If there is a dispute, the attorney may be forced to withdraw from representing either party. One way to avoid this result is to recite in the contract that both purchaser and seller waive any conflict and authorize the law firm to continue to represent its client in the event of a dispute. The contract also should provide that, in the event of a dispute, the escrow agent is entitled to deliver the deposit to the clerk of the local court or another escrow agent chosen by the stakeholder so that the attorney may continue to represent the client. Even with these protections, the attorney may face conflicts if it serves as escrow agent. may undertake a full physical inspection. Finally, the purchaser should negotiate the right to terminate the transaction, at any time during the study period at the purchasers sole discretion, by written notice to the seller. How, when, by, and to whom notice is to be given are important points to be negotiated carefully. The purchaser and its attorney should not delay in following through with obtaining all the desired due diligence information during the study period. What follows are some of the common studies.The purchasers attorney should obtain a title search and carefully review the title report. If a defect is found, the purchaser should immediately report it to the seller. The purchaser should hire the appropriate experts to perform physical inspections and tests of the property. The types of tests performed will vary depending on the type of property being acquired. The property should be environmentally inspected for the presence of hazardous materials. The purchaser and its attorney should review the propertys zoning and the status of any pending building permits or other approvals. The purchaser should study the leases and the contracts that apply to the property. The purchaser should conduct an economic study of the property to examine the financial assumptions regarding it. The propertys operating history, including existing leases, income, operating expenses, and capital expenditures, should be studied in detail. An important area for due diligence during the study period is zoning and land use. Nearly all commercial property is subject to some zoning and land use restrictions. The purchaser and its attorney should carefully review any applicable restrictions; this is especially true if the property in question is raw, undeveloped land or if the buyer wants to modify the propertys current use, after acquisition. The property also may be subject to land use ordinances that establish standards for such matters as parking, storm water management, grading, landscaping, green space, public space, and other physical development requirements. If the property has existing improvements, it is important to ascertain, during the study period, whether the improvements were built in accordance with existing zoning, site plan ordinances and building codes and whether proper certificates of occupancy were issued. Even if the property is in compliance with all applicable zoning and land use restrictions, any changes in the use of the property or even minor renovations may require approval from governmental authorities.
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Study/Feasibility Period
The feasibility period is the contractually designated time when the purchaser may study the property it is interested in purchasing.11 The length of the study period is usually negotiated by the purchaser and the seller. The seller typically wants a relatively short period because the property is tied up and cannot be sold to someone else while the property is under contract. On the other hand, the purchaser will desire a generous study period so that it can complete its study of the property before it is locked into the purchase. A typical study period for a commercial transaction is between 30 and 60 days. Longer periods may be negotiated if there are particular issues such as zoning or financing that must be clarified by the buyer. Shorter periods may be negotiated, especially if the seller has other offers pending. During the study period, the seller should be required to deliver all relevant property information, including leases, agreements regarding building operations, financial reports, its own title insurance policy, architectural renderings, surveys, plats, site plans, zoning documents, litigation information, studies such as environmental testing, and governmental certifications and citations. The seller should grant the purchaser access to the property so that the purchaser 6 REAL ESTATE FINANCE

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From the sellers standpoint, this section of the contract should clearly delineate the extent of the physical investigation of the property that the buyer will undertake. The seller should include a contractual provision that if invasive testing is required that the property will be returned to its prior state at the purchasers expense if the deal is terminated. The seller will ask that the buyer keep all the propertys information confidential and that all the due diligence materials should be turned over to the seller, if the buyer does not proceed with the transaction. may be long gone by the time title problems arise, the prudent purchaser will seriously consider obtaining title insurance from a reputable title insurance company with substantial assets. The title insurance policy pays the damage arising out of the loss covered by the policy and also pays for the cost of defending the title, up to the limits of the policy. Title insurance commitments must be carefully reviewed by the purchasers attorney. Also, the insured party often will be able to purchase endorsements for events not covered by the basic policy. Sometimes these endorsements may be required by the purchasers lender.13 The title insurance policy generally will be of little interest to the seller. Of greater importance to the seller, relating to the contract language in this context, is the type of title objections available to the buyer, the method by which they will be reported to the seller, and the sellers obligations to cure the objections. Sometimes the seller has a recent title report listing exceptions that can be reviewed by the purchasers attorney, attached to the contract, and excluded from the realm of purchase title exceptions. Additionally, the seller will want the purchaser to have a contractual obligation to promptly order a title report and to timely notify the seller of covenants, encumbrances, or other matters that are objected to by the purchaser. The seller is then given a period of time in which to either agree to cure the title objections, explain why they should not be an issue for the purchaser, or refuse to cure the title objections. If there is a title objection that the seller refuses to cure, the buyer will try to provide for itself in the contract that the purchaser should have the option of: Correcting the title objection if the title objection can be corrected by the payment of money and proceeding to closing, with a deduction from the purchase price in the amount required to cure the objection, Accepting the title as is (assuming that the objection cannot be cured with a payment), or Terminating the agreement

Conditions Precedent
A buyer may be interested in a property only if certain problems can be fixed or issues resolved. A seller may be able to go forward with the contract only if it is approved by its board of directors. A condition precedent is an event or process that a party to a contract may establish before it is obligated to carry out its duties or responsibilities. For example, a purchaser of raw land that the buyer intends to subdivide for development as a new subdivision may be unwilling to purchase the property until approval has been granted by the necessary governmental authorities. A purchaser of a shopping mall may be unwilling to commit to the acquisition until it learns whether an anchor tenant has extended the terms of its lease. The cost of resolving these issues may be built into the purchase price. In lieu of termination, the seller may be willing to sell the property at a lower price that reflects the propertys status, if the condition cannot be met. Typically, the purchaser or seller will have the right to terminate the contract if the conditions precedent are not met.

Title
It is common to provide in the contract that the seller shall convey at closing a fee simple title to the property that is marketable, good of record, and insurable as such at standard rates by a title insurance company acceptable to the buyer. Title must be free and clear of any liens, encumbrances, or restrictions except for the lien of real estate taxes that are not yet due and payable and title matters that have been approved in accordance with the language set forth in the contract. In most cases the purchaser will want to purchase title insurance.Title insurance is important because a purchasers title is only as good as the sellers title, in other words, the purchaser inherits all known, and most importantly, unknown title defects from the seller.12 Because the seller
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The purchaser should also try to obligate the seller to do whatever it must, including litigation, if necessary, to clear the title. The seller normally will object to giving the purchaser the right to use, in effect, the sellers money to correct title defects. The seller may not be willing to sell its property at the contract price if it must expend a significant amount of money and time to cure a title defect. The seller also
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may object to the purchasers requirement that the seller be obligated to litigate if necessary to cure objections. Because neither party can predict the cost and delay of prospective litigation, one solution is to include a contractual clause that sets a dollar and time limit for curing title objections. on an estimate that was too low) may be entitled to reimbursement for a proportionate share of these items once collected from the tenants, because the seller paid a share of the expenses that the reimbursement represents. Conversely, if the tenants overpaid, there needs to be a mechanism to retrieve the proportionate excess of funds from the seller so that the tenants can be properly credited from the money collected by their former landlord. Careful contract language consideration also should be given to the issue of tax apportionment. The attorneys must be familiar with the jurisdictions real estate tax assessment and levy procedures. If a tax bill for the year in which taxes are apportioned is available or ascertainable before the closing, then the apportionment between purchaser and seller should be relatively straight forward. If however, the tax bill cannot be ascertained prior to closing, then the contract must address the basis on which the estimate is to be made and whether the adjustment will be final or readjusted after the tax amount is known. Regardless of whether the adjustment is final, both parties should want the apportionment to be based on the most recent tax information available. In transactions in which the buyer is intending to assume the sellers financing, consideration should be given to the disposition of reserves that are being held by the lender.The lender could be holding the borrowers funds for such items as replacement reserves and leasing reserves. The contract should address the disposition of these sums. The parties should include in the contract language other categories for proration, such items as for the adjustment between the parties of utility costs in the building. Because the amounts may not be known until after settlement, a utility reserve may be established on the settlement sheet at closing.

Costs and Adjustments

At closing, also referred to as settlement, both the purchaser and seller incur various costs. These closing costs usually are paid at the settlement. Closing costs include: title insurance premiums, recordation and transfer taxes, recording fees, brokers fees, financing fees, and attorney fees, among other things. In different jurisdictions, customs vary regarding who pays what closing costs. Often the parties split transfer and recordation taxes and each party pays its own attorney fees. Nevertheless, unless mandated by statute, who pays what costs is subject to negotiations. The costs of such items as real estate taxes and prepaid costs that benefit the buyer usually are prorated or adjusted to the date of the closing. Also, any prepaid rent, including building operating expenses or common area maintenance fees, that the seller has collected in most transactions are adjusted to the date of the closing. The issue of who collects the tenant rental amounts not received by the time of closing also needs to be addressed in the contract. The purchaser will be reluctant to jeopardize its new relationship with tenants to collect rent owed to a previous owner. Often, the contract will permit the seller to sue the tenants for back rent, without giving the seller the right to terminate the leases. If the purchaser is to collect all rent, including accrued amounts under the sellers time of ownership, the purchaser should negotiate to have any rent collected be first applied to the current rent and any excess go to the seller (maybe after deducting a collection fee) for rent due prior to closing. Another possibility is to sell the tenant receivables to the buyer for a discounted amount. In negotiating the apportionment provisions of the contract, the parties may consider the tenants estimated payments of installments of the propertys operating expenses or common area maintenance charges, taxes, and insurance. In many commercial leases, the tenant will pay these items to the landlord in monthly or quarterly installments during the calendar year, based on an estimate of the years expenses, with a financial reconciliation at the beginning of the next year. To the extent the estimate is too low and the tenants have underpaid, the seller (now the former owner who had tenants who underpaid their obligations based 8 REAL ESTATE FINANCE

Closing Date
The closing date typically is negotiated to fit the needs of both the buyer and the seller. The settlement date may be adjusted based on certain events specified in the contract or by mutual agreement. In addition to the actual date, place, and other logistics of settlement, the closing provision typically includes language that the purchaser will require, such as the following: Title to the property will be as set forth in the title report that was accepted by the buyer, and title objections that seller agreed to cure will be cured.
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The property will be in substantially the same physical condition as it was on the date of the contract, ordinary wear and tear excepted. The purchaser may also be prepared to accept a certain amount of damage from injury to the property, with a price adjustment or an assignment of insurance proceeds. All of the representations and warranties made by the seller in the contract will be true at closing. For example, the seller might represent that, to the best of its knowledge, the property is properly zoned and all certificates of occupancy and other necessary permits have been obtained. Even though this representation was qualified to the best of the sellers knowledge, if the seller learns about a missing permit prior to the date of the closing or if the purchaser learns about a missing permit and notifies the seller, the purchaser will have a contractual right to either delay closing or terminate the contract because the conditions precedent to closing were not met. In particular circumstances, there may be conditions to closing. For example, a purchaser may make its obligation to close conditional on its ability to secure financing. The closing might also be conditional on such matters as rezoning of the property or, in the case of undeveloped land, upon the completion of certain improvements, such as roads, sewer lines, and access to public utilities. From the sellers standpoint, these contingencies need to have realistic timeframes and outside completion (or drop-dead) dates. The outcome of this negotiation depends on the relative bargaining position of each of the parties and on a number of other factors. For example, when the purchaser has the opportunity to make an in depth inquiry during the study period, the seller may reasonably argue that the representations about those things the purchaser should be able to ascertain for itself should be limited. Similarly, if the seller is offering to sell the property at a relatively low price, the purchaser should be prepared to assume more risk. Some or all of the representations, by the language of the contract, may survive settlement for a period of time established in the contract. In the following subsections specific representations and warranties that generally are included in commercial real estate contracts are reviewed. Specific representations and warranties will be important depending on the deal. For example, representations and warranties concerning lease income are important to deals involving office buildings or retail centers. Representations and warranties concerning the availability of sewer, water, utilities, and proper zoning would be important for real estate purchased for development. Operating History. In many commercial real estate purchases, the purchaser is paying for the stream of income generated by the real estate. Most commercial properties such as office buildings and shopping centers are operating businesses. When a party buys the underlying real estate of those enterprises, it also is buying into the income stream those enterprises produce. The income stream, or potential income stream, is one of the most important factors in valuing a particular property.When the income stream operating history is important to a particular transaction, the purchaser may require the seller to make certain representations regarding it; sometimes these representations are backed up by attaching exhibits to the contract that provide support to the representation and having the seller represent and warrant that such documentation is true, correct, and complete in all material respects. These exhibits may include: Copies of the rent roll and current leases; Financial statements for the property for a certain number of years; A list of deferred repairs and capital improvements needed by the property; and A list of contracts made by the seller and applicable to the property that, by their terms, will survive the closing.

Representations and Warranties

The representations and warranties section of the commercial real estate contract usually is heavily negotiated.The sellers objective is to try to provide as few representations and warranties as possible to the purchaser and to sell the real estate in As Is condition. The purchaser, on the other hand, will try to extract as many representations and warranties from the seller as possible. At a bare minimum, the purchaser should require the seller to disclose all known problems and defects of a property, even if the seller is unwilling to accept liability for the disclosures. If the purchaser is not familiar with the property and the seller knows the facts, the buyer will argue that fair dealing requires the seller to disclose all material information. Representations made to the best of the sellers knowledge generally accomplish this objective.

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This exhibit list is not comprehensive, but is typical of items included in the representations of operating history. Employment Agreements. The purchaser may request representations concerning the existence of any employment agreements, union contracts, bonuses, profit sharing, retirement, vacation benefits, or health insurance plans with respect to any past or present employees who are engaged with the building that may impact the buyer. Employee questions especially are important for a labor-intensive property, such as hotels and apartment houses. On occasion they may be important for less labor-intensive properties such as office buildings and shopping centers. If the purchaser is acquiring a business enterprise operating the real estate, as well as the underlying real estate, the purchaser may be liable for salary and benefit costs of the employees of the business enterprise. Occasionally, the purchaser may be interested in retaining the services of the key employees operating a particular piece of real estate. If the purchaser is interested in retaining key employees the purchaser may have to negotiate with the employees separately to keep them with the enterprise. The successful completion of this negotiation may be a condition of the purchase of the building. Property Condition. The most contested representation is likely to be the one concerning the condition of the property. As mentioned before, the sellers goal will be to convey the property with as few representations and warranties as possible (i.e., in an As Is condition). The purchaser will want to extract as many representations and warranties as possible, including asking the seller to disclose any deferred repairs or deferred capital improvements of which the seller has knowledge. If the seller has material information about the property and does not disclose it, it will be difficult for the purchaser to correctly price the building or plan a capital repairs program. The purchaser should also ask the seller to make disclosures about the age and condition of any major systems that are part of the property, such as HVAC equipment and elevators. The purchaser should be aware that if the property is bought in As Is condition the seller may be able to rely on the doctrine of caveat emptor, if problems with the property arise, to defend against contract rescission or recovery of damages from the seller if there are latent defects in the property. Although the caveat emptor doctrine provides the seller with some protection against liability against latent defects, it does not give the seller a wholesale license to withhold information from the purchaser.The seller should 10 REAL ESTATE FINANCE not hide material defects of a property. The sellers attorney should counsel the seller accordingly. Sellers who are willing to give representations as to the condition of the property often will qualify the representations made by the phrase to the best of their knowledge and then add without any duty on the sellers part to investigate. In addition, the sellers representations may include a clause that the actual knowledge representation includes only the actual knowledge of certain named individuals from the selling entity. From the purchasers standpoint, asking a seller to make representations requires the seller to disclose information that may have otherwise not been disclosed. Once material information about the property is supplied, the purchaser can digest it and then address it with the seller if necessary during the study period. Condition of the Title. The purchaser should always require the seller to represent that the seller has good and marketable title to the property. Before closing, the purchaser will likely obtain a title insurance policy specifically insuring that the purchaser is obtaining good and marketable title to the property. The sellers representation with respect to the title, therefore, essentially overlaps with the protection the purchaser obtains from title insurance. The sellers representation generally requires the seller to clear title as a condition of settlement if the title search uncovers defects, and may be useful after settlement because the seller may be required to take affirmative steps after closing to solve a defect which comes to light later. Commitments to Third Parties. It is important that a purchaser receives assurances that the seller has entered into no undisclosed contractual commitments with third parties. The purchaser should ask for a representation that no other contractual commitments exist involving the property, other than the ones already disclosed by the seller. Frequently, any such commitment will be listed as an exhibit to the contract. Authority to Enter into the Contract. The purchaser will want the seller to represent that the seller has authority to enter into the contract to sell the property, and vice versa. In certain situations, the seller may be legally prohibited by third-party agreements, court orders, or laws with respect to the execution of the agreement to sell the property. For example, an entity that is in bankruptcy proceedings often will need to seek permission from the bankruptcy court before selling major assets. Also, the seller may have granted an option to a third party to purchase the property, and the buyer needs to know that the third party has not exercised
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its right to purchase, thus providing the seller with full authority to sell. Threatened Assessment or Condemnation. Typically, the seller will be willing to represent that there are no proceedings or threatened assessments, condemnation, or eminent domain proceedings that would adversely affect the property, or at least that the seller knows of no such proceedings. As most proposed assessments, condemnations, or eminent domain proceedings are a matter of public record, the purchasers attorney should be able to confirm this representation with the appropriate due diligence. Fire and Building Code Violations. Fire and building code violations may not be an issue if the transaction involves the purchase of raw land or new construction where there are recently issued permits and certificates of occupancy available. However, when the property is an older building, the purchaser should be aware that building and fire codes may have changed since the building was constructed. While sometimes existing construction is grandfathered in under the new regulations, a change in ownership may require a new certificate of occupancy triggering a complete inspection of the building. In many cases, the inspector may determine that work needs to be done to the building so that it complies with the building and fire codes. Because compliance upon change of ownership may be an issue, the buyer needs to do all the necessary due diligence to determine what code upgrades may be required after it becomes the owner. The basic contractual negotiation will probably have the seller representing that it has not received any notices of violation, but, if it does prior to settlement it will agree to cure code violations, at least up to a particular dollar amount. Zoning. Zoning and land use ordinances are complex. The seller may have no clear knowledge as to whether the property is in full compliance or exactly what type of development is allowed on the property. If the purchasers attorney does not have experience with zoning and land use issues it may be necessary to obtain the assistance of an attorney who is an expert in this area to assist with due diligence. Even if the seller is willing to represent that the property complies with all applicable laws and ordinances, the purchaser should get independent confirmation. For example, if the property is raw land that the purchaser plans to develop, the purchaser and its attorney should do a thorough investigation to ensure that the purchasers intended development plan is permitted. If the purchasers intended development plan may be problematic relative to zoning
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and land use ordinances it may not be economically feasible for the purchaser to go through with the transaction. If the seller is not willing to make any representations about the zoning and land use ordinances, the purchasers attorney should draft language that makes the zoning and land use a condition of the closing. If the purchaser finds that the zoning and land use ordinances are not congruent with the propertys use or the buyers intended use, the purchaser should have language in the contract that permits it to back out of the deal or to get the price reduced based on what legal use is available to the buyer. Foreign Person Affidavit. The Foreign Investment in Real Property Tax Act (FIRPTA) requires property owners who are foreign persons to have withheld and paid to the Internal Revenue Service certain taxes on the sale of any real estate that they hold in the United States.14 Without FIRPTA, foreign persons could evade paying US taxes on the sale of property because they usually are outside the jurisdiction of US courts. Under FIRPTA a buyer can be required to withhold some of the purchase price to fulfill any tax liabilities if the seller is a foreign person. In a FIRPTA affidavit, required based on a contractual representation, the seller simply confirms to the purchaser, assuming it is the case, that the seller is not a foreign person as that term is defined by the Internal Revenue Code and furnishes a US taxpayer identification number. Unless a purchaser has actual knowledge that the seller is a foreign person, it can rely on the FIRPTA affidavit as a representation that the seller is, in fact, not a foreign person. The purchaser should require in the contract language that the seller produce a proper FIRPTA affidavit as a condition of the closing. The purchasers attorney should draft contractual language stating that if the seller fails to produce a proper FIRPTA affidavit that the closing agent may withhold a portion of the purchase price to satisfy any possible tax liability under FIRPTA. Complete Disclosure. The purchaser often tries to obtain a representation that the seller has disclosed all material information and that the representations and warranties of the seller are complete and accurate. From the purchasers perspective, the seller should be completely willing to make this concession because if the seller has been completely revealing, there will be no undisclosed issues that come back to haunt the seller. On the other hand, the seller may be concerned that it may know something that it did not even realize was material and that later could form the basis for a claim of some sort.
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Competency and Authorization. The purchaser and the seller typically represent that they are legally competent and authorized to enter into the contract, and, if the purchaser and the seller are legal entities, that they are a duly formed business organization.The purchaser and seller may want some sort of recourse if it later develops that the deal has fallen through because the purported purchaser or seller did not have the authority or capacity to enter into the contract. Brokers and Agents. It is important that the parties represent to one another that neither has dealt with any brokers or agents except those set forth in the contract. It is altogether too common that brokers or agents previously unknown by one or both parties will emerge to claim a brokers or agents fee. Such claims can represent a major headache to the parties and result in unanticipated litigation and substantial legal bills. It is typical that each party will indemnify each other from and against the claims of their respective brokers or agents. and enforceable through court order. Another option is to require that the parties attend mediation prior to court or arbitration.

Additional Undertakings
One source of conflict between the purchaser and seller may be who bears what responsibility for the property during the period between the contract and the closing. The purchaser will want to ensure that the seller continues to maintain the property once it is under contract. Typically, the contract will provide that the seller must continue to operate the property in the same manner as it operated the commercial enterprise prior to the date of the contract. The seller may have contracted with other firms, such as a management company, to provide services to the property. Many of these service agreements are terminable, with no penalty to the purchaser, with appropriate notice. It is important for the purchasers attorney to review these service agreements so that the attorney may advise his or her client about each. How the seller handles the continuation of its leasing efforts between the signing of the contract and closing is an important issue for contract negotiation. The purchaser probably will not be interested in allowing the seller a free hand to enter into leases. On the other hand, the seller will probably be unwilling to leave leasable space empty, and lose money while it still owns the property, if it believes it can find tenants. Also, the deal may fall apart and the seller does not want to turn away potential tenants if the seller is to remain the owner. A typical compromise is that the seller may lease space with the purchasers approval, which will not be unreasonably withheld. If the seller does not have confidence in the purchasers reasonableness, the seller may insist on a specific standard, such as minimum and maximum rent amount for any leases signed between the time of contract and closing. In any case the purchaser most likely will require that it have approval over the major terms of any leases, especially the length, as the purchaser will not want to be locked into long term leases with business terms unacceptable when it becomes the owner. The sellers repair and maintenance obligations can have significant impact on the purchaser. Contracts often include a provision that the seller will be responsible for ordinary repair and maintenance during the time between signing the contract and closing. However, who will pay if the roof needs to be replaced or the HVAC system fails? Thepurchaser expects to buy the property in substantially the same
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Defaults, Attorney Fees, and Dispute Resolution

When drafting the contract, the purchasers attorney should include a sellers default clause. If the seller does default, the purchaser needs, at the very least, to have the right to terminate the contract and get its deposit back (plus any accrued interest) or, alternatively, pursue any legal and equitable remedies, including a suit for specific performance. The purchaser may negotiate to have the seller pay it some amount of money that would compensate the purchaser for its expenses related to the negotiation of the documents, its due diligence costs, and other out-of-pocket expenditures. Typically, the seller is protected if the purchaser defaults by its access to the earnest money deposit (plus accrued interest). A seller, however, may want the right to pursue the buyer for its losses, if any, beyond the amount of the deposit. The contract also may contain provisions concerning dispute resolution. It is not unusual for a contract to include a provision that in the case of litigation between the parties, the loser will pay the prevailing party its attorney fees. Also, the contract may designate the proper court for the litigation as well as the applicable state law. One option in lieu of court for dispute resolution is a contractual clause that any disagreement between the parties will be arbitrated. Any arbitration should be handled by an accredited arbitrator who is mutually agreeable to both parties. The arbitration clause also may state that any arbitration is final, binding, 12 REAL ESTATE FINANCE

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condition it was in when it signed the contract. While a standard of repair and maintenance such as will be kept in good repair or maintained at sellers historic level of maintenance may provide some guidance, the contract language needs to be negotiated to determine whether the buyer or seller pays if there is a major building problem that involves a substantial cost of replacement or repair that is not covered by insurance or a replacement reserve. by the condemning authority. The purchaser and the purchasers attorney should do their due diligence on whether the property is threatened by any condemnation. Any proposed condemnation will usually be the object of considerable governmental study and there should be a public record that the purchaser may examine.

Indemnification
Indemnification is a contractual promise by one party to pay another party if certain events or losses occur. In many commercial real estate contracts the representations and warranties are backed by indemnifications. For example, a seller may provide a warranty that a property is free from asbestos contamination. If the purchaser later finds asbestos contamination at the property the seller may be obligated to pay the cleanup costs. Of course, any seller will be looking to provide as little indemnification as possible, while a buyer will look to maximize the sellers exposure if problems arise. An indemnification is only as good as the financial strength of the party making it, unless there is adequate insurance coverage. If the seller is a business entity that intends to distribute all or most of its assets following the sale of a property, the indemnification may be worth very little to the purchaser. If the purchaser is relying on the sellers indemnification, the purchaser should confirm that the seller has the financial strength to make good on the indemnification. If the seller is an entity without sufficient assets and if all the sale proceeds are distributed, the purchaser may negotiate for personal indemnification from individuals or ask to have some of the sale proceeds set aside as a fund to pay for after-sale issues for a period of time.

Casualty and Condemnation

While drafting the contract, the parties should decide who will bear responsibility for damage to or loss of the property between contract and closing. It is common for the seller to bear the risk of casualty until closing. It is typical to provide that closing will occur without reduction in the purchase price if the damage is less than a certain dollar amount and if the seller either repairs the damage prior to closing or both assigns the sellers insurance proceeds to the purchaser and reimburses the purchaser for any insurance policy deductible. If the damage is over a certain amount, the purchasers attorney may want to include a clause that gives the purchaser the right to terminate the agreement, or adjust the purchase price to reflect the casualty, or accept the insurance proceeds from the sellers insurer. If the purchaser does accept this provision, the purchasers attorney should thoroughly review the sellers insurance policy to ensure that it provides adequate coverage. Ideally, if there is a casualty, the parties should end up in the same position as if there had not been loss. Therefore, if there is a casualty loss, the purchaser would either like to see the purchase price reduced by the amount of the damage, receive insurance proceeds that cover the damage and any other associated losses, or the seller will repair the damage by closing. A potential problem is that the parties will be unable to agree on the reduction in price or the amount that it will cost to cover the damage. The parties may stipulate that any disagreement over damages relating to a casualty loss will be decided through some form of dispute resolution such as arbitration. Even within well written casualty provisions, the occurrence of a casualty may impact the purchasers ability to obtain financing, and this needs to be thought through when negotiating the language in this provision. The purchaser may insist on the right to terminate the transaction in the event of an actual, planned, or threatened condemnation. Alternatively, the purchaser may determine that it wants to accept the condemnation proceeds offered
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TAXES
Income Tax
The consideration of tax consequences based on the transfer of property may have major implications on the structure of a commercial real estate transaction. Failure to consider the tax implications of a transaction may lead to a poorly structured transaction with negative consequences for either or both the purchaser and seller. While a comprehensive overview of the tax implications of a commercial real estate deal is beyond the scope of this article, participants in a commercial real estate transaction should be aware of the effects they may have. It is not unusual for the parties involved in a commercial real estate transaction
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to work closely with tax professionals to best structure the impact of taxes on any deal. An attorney should suggest to his or her client the retention of a tax expert. The purchaser may conduct a final walk-through of the property as close to the closing date as possible. The final walk through will ensure that the property is in the condition bargained for and will allow the purchaser to make certain that the conditions specified in the contract have been met. Representatives from both parties, as well as any necessary professionals, may be on hand when the final walk through occurs. Any problems with the property that are not resolved by the final walk through can be listed on a punch list and these items may be resolved by the seller or priced and the amount to make the repairs may be deducted from the purchase price. The closing will go more smoothly if there is a closing checklist. The checklist will provide a roadmap for all the details that need to be dealt with at the closing as well as a listing of the documents that will be required. The closing conditions of the contract can provide a helpful starting point for the closing checklist.The closing checklist can also provide a point of reference for the attorneys document preparation. Among the documents that the attorneys may need to prepare for closing are the deed, corporate organizational and authority paperwork, powers of attorney, bill of sale, and financing documents. An essential document that should be prepared for the closing is a closing statement.15 The closing statement lists any crediting or debiting of funds that have already occurred or will take place at the closing.

Sales Tax
If the real estate being sold includes the sale of personal property such as furniture, inventory, or equipment, a sales tax may be owed.Who pays this tax may be negotiated into the contract.

Transfer and Recordation Taxes and Fees

In most jurisdictions there will be an assessment by the government of a transfer and recordation tax and potentially other fees when the property changes hands. Who pays these fees should be specified in the contract. There also may be inspection fees associated with the grant of a new occupancy certificate; responsibility for these too should be specified by contract

CLOSING A COMMERCIAL REAL ESTATE TRANSACTION

The closing is the final process through which the property is legally transferred from the seller to the purchaser. The closing allows the parties to ensure that all of the contract requirements for transferring the property from the seller to the buyer are met. The closing date is set during the negotiations phase and in a commercial real estate transaction is usually some time after the contract is signed, so as to allow a sufficient study period and time to marshal all the necessary requirements for settlement. The primary acts of the parties to close the transaction are that the seller will have to deliver the deed to the purchaser and the purchaser will have to pay the purchase price to the seller. For many closings the parties are assembled around a conference table to conduct the settlement, but a physical gathering is not necessary, as the documents can be signed in separate places at different times by the parties (this is frequently referred to as a New Yorkstyle settlement). There are three important aspects of closing a transaction: (1) preparing for closing, (2) the actual closing, and (3)post-closing wrap up.

The Closing
The closing provides an opportunity for each party, virtually simultaneously, to sign all the necessary documents and exchange with each other all that is required by the contract. The attorneys should explain to their clients each document that is signed and be prepared to answer any questions that may be raised. In some transactions an escrow closing takes place by the choice of the parties or the lender. In an escrow closing the escrow agent, often the title company, is the depository of the settlement money proceeds and the deed. The parties and the escrow agent will agree beforehand what each partys responsibilities will be. Once all parties have signed all the documents and all the money necessary to close the transaction has been received, the escrow agent effects the closing by recording the deed, paying all items called for on the closing statement, and transferring the balance of the purchase price to the seller.
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Preparing for Closing

Proper preparation for settlement will be essential to ensure there are no last-second surprises or hiccups. Even with excellent preparation some matters may have to be finally resolved at the time of closing or post-closing. 14 REAL ESTATE FINANCE

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Post-Closing
The closing may mark the official end of a commercial real estate transaction, but there may be some final details for which attention is necessary. The attorneys or closing agent should make certain that all parties have received copies of all the necessary documents, including those that have been recorded or issued post-closing. Frequently, a closing binder is prepared for all parties. At some point between contract and closing, or at closing, the parties may have made agreements to have some responsibilities taken care of post-closing, such as repairs to the property. The attorneys should stay on top of these matters, as appropriate.

NOTES 1. Model Code of Prof l Conduct R. 1.16.

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 72 Am. Jur. 2d Statute of Frauds 295 (1974). See Friedman, Contracts and Conveyances of Real Property 1.2(n)(1984); Restatement (Second) of Contracts 131 (1981). See Williston, A Treatise on the Law of Contracts 18 (3 ed. 1961). Three Bros. Towing Co. v. Louisiana Gulf Indus., 317 F. Supp. 814, 816 (E.D. La. 1969); Smith v. Manausa, 385 F. Supp. 443 (E.D. Ky. 1974) modified, 535 F.2d 353 (6th Cir. 1976). See Macy Corp. v. Ramey, 144 N.E.2d 698 (Ohio Com. Pl. 1957). Other descriptions, having a different meaning, could be used, such as in gross or "plus or minus." See Friedman, Contracts and Conveyances of Real Property 1.2(n) (explaining the use of "more or less" in the legal description of a property). Johnson v. Schultz, 195 N.C. App. 161, 671 S.E.2d 559 (N.C. Ct. App. 2009) aff'd and remanded, 364 N.C. 90, 691 S.E.2d 701 (2010), Lawyers Title Ins. Corp. v. Edmar Const.Co., Inc., 294 A.2d 865 (D.C. 1972), see also 15 A.L.R.2d 870 (1951). ICC Uniform Customs and Practice for Documentary Credits UCP 600 (2006). The study period can often take place even before a contract is signed, thus eliminating, at least in part, the need for a feasibility period while the contract is executory. See Talman v. Dixon, 253 N.C. 193, 116 S.E.2d 338 (1960). One example is to remove the survey exception to the title insurance coverage. I.R.C. 1445. This frequently is prepared on a modified HUD-1 settlement statement form.

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