When entering into a contract to purchase commercial real estate, experienced investors and developers generally understand that dozens of things could go wrong before the closing date that would prevent the closing from happening or could make the acquisition less than attractive, giving the buyer pause as to whether to close at all. As such, these buyers make certain that their contracts are well drafted and spell out all relevant provisions in detail. Their contracts contain explicit due diligence provisions and contingencies tailored for the specific transaction. All too often, I am faced with clients who are less sophisticated, anxious to make a deal and afraid they are going to “lose the property”. They push hard for me to back off important contract protections that could and will save them money and prevent litigation at a later date.
Contingencies and due diligence are the two most important sections of any commercial real estate contract for a buyer. Taken together, these provisions can help the buyer determine whether the property is suitable for buyer’s intended use and whether the deal is feasible. They allow the buyer to assure that timing is adequate, that permits can be and will be obtained and that resources are in place. Therefore, it is critical that adequate time for due diligence be negotiated to allow the buyer to complete all tests, exams and evaluations. Contingencies might include approvals such as zoning, land use, site plan, environmental and financing. Other contingencies could be executed leases by a major tenant or sale of an existing property. Certainly, sellers will push back to shorten due diligence time periods and limit contingencies and the important thing for the buyer to remember and consider during this stage of negotiations is that the deal is not always such a “great deal”. If there is time to do inspections, it is possible to find that the property doesn’t suit the buyer’s needs. A zoning application can be denied, so if the contingency is waived or the time period is shortened, the buyer could be stuck with a piece of property it can’t use as intended so the property will have a lower value to the buyer.
Buyers should work to protect their rights to the deposit. If a contingency fails and the contract is going to be terminated, the deposit should be returned to the buyer. But what if the buyer wants to continue with the transaction? Efforts should be made to extend the time period to satisfy the contingency rather than waive it and move forward. This can be accomplished by payment of extension fees that are smaller than the deposit. Often the extension fees are non-refundable but applicable to the purchase price leaving the deposit refundable in the event that the contingency ultimately fails. Sometimes, sellers insist upon the release of the deposit, making it non-refundable to the buyer. Buyer should then make every effort to have the deposit applicable to the purchase price at the time of closing and avoid payment of other extension fees. These principles hold true when buyer requests an extension of time of the due diligence period. Less is always more for the buyer.
Of course there are dozens of other provisions in every contract which garner lots of attention in every transaction (and likely the subject of future posts). Buyers’ evaluation of a particular transaction should start long before contract execution and with the proper leg work, buyers will be in position to draft and negotiate due diligence and contingency provisions that work to their benefit.