Looking for risk in the real estate portion of your buy/sell agreement

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This article was originally published in Automotive Buy Sell Report, on October 21, 2015

Real estate is generally a major portion of any buy/sell agreement. Our previous article gave a brief overview of drafting typical title provisions in real estate purchase agreements (“REPAs”). Today, we will focus on the narrower topic of items of record a buyer should look for in the preliminary title report once it is issued. For each of the items of record below, a title report will typically provide only a brief description (for legal notification purposes) and a document recording number. After reviewing the preliminary report, buyers should determine which items of record pose unacceptable title risks and then examine the underlying recorded document to determine whether or not that item needs to be removed from the record or otherwise resolved.

Five categories of items deserve particular scrutiny:

1. Easements

An easement is essentially a right to use the property of another without owning it. Public easements are not usually problematic: they tend to give property access for the maintenance or improvement of utility services. For example, power companies can often access properties to repair and maintain electrical services. Some properties also have private easements that, for example, give neighboring landowners access over a particular portion of the property. Such an easement could be problematic for a dealer who wishes to park vehicles on, or otherwise use, that portion of the property. Buyers should carefully review the underlying easement document to determine if the location and scope of permitted access would interfere with their intended use of the property.

2. Leases and Options

Buyers should also carefully examine any recorded leases or options to purchase. Such agreements can give other parties superior rights to possession or future ownership of the property. They can also affect a property’s marketability, depending on whether their terms are favorable to the new buyer or not. Buyers should not rely solely on a title report’s memorandum of lease or short summary of an option (and some options are simply a provision in a recorded lease). The lease or option itself should be carefully reviewed so that buyers can understand the potential risks, if any, posed by those documents.

3. Liens

Nearly all title reports begin with a lien on property taxes “not yet due and payable,” which does not pose any title risks. But buyers should be concerned if a title report includes a lien for delinquent taxes. Other liens to watch out for include deeds of trust in favor of a lender and mechanic’s liens for work done on the premises. Buyers should demand resolution by the seller of any such liens before closing, including proof that the lien has been paid and released of record.

4. Disposition and Development Agreements (“DD&As”)

DD&As are recorded agreements between the seller and a redevelopment agency evidencing the seller’s borrowing of funds to acquire and/or improve the property, and the seller’s promises to (i) finish specified improvements by a particular date, (ii) use the property only for a specified purpose (e.g. operate a franchised dealership), and (iii) make scheduled payments. Buyers should examine DD&As carefully since the agency typically retains a right of reverter, i.e. the right to retake possession of the property, if any promise is not timely performed. Sometimes a buyer can work with the agency to obtain a recordable subordination (i.e., obtain superior rights to the property), but it is preferable to verify that the improvements and payments have been completed in a timely fashion. The buyer then only needs to be concerned about continuing to use the property as specified in the agreement, if it is still applicable.

5. Covenants, Conditions and Restrictions (“CC&Rs”)

Although CC&Rs more commonly limit an owner’s use of residential property, they can severely limit the value and use of commercial properties. For example, a property could be subject to CC&Rs that limit the size and appearance of lights, signage or landscaping and even where customers can park (although outside the scope of this article, buyers should also carefully review the relevant zoning laws since zoning can similarly limit the use of, and improvements to, commercial property).

A buyer’s response to any of these items of record is largely fact-specific. However, buyers should make sure they raise any objections to such issues before their due diligence deadline under the REPA has expired. Buyers should obtain a title report before the due diligence period expires, and should review the recorded documents underlying its items of record to make informed decisions as to which items will be problematic and how they can be resolved. Because these real estate issues are complex and can have serious legal consequences, we strongly recommend utilizing experienced real estate counsel when purchasing or selling commercial property.