Founder and Managing Shareholder
This article was originally published in Automotive Buy Sell Report, on May 24, 2017.
Real estate buy sell transactions typically involve items of so-called due diligence, i.e., items which the buyer must investigate and either approve or disapprove by a stated deadline. Such items include financing, status of title, and condition of the property. This raises important questions for the buyer.
They include: Will the buyer be able to obtain acceptable financing? Are there any liens or other exceptions to title which are not acceptable to the buyer? Does the property contain any environmental hazards that could kill the deal?
Buy-Sell agreements should be drafted to give the buyer adequate time to investigate and resolve these items while still meeting the parties’ business needs for a timely closing. This article addresses these common due-diligence deadlines, and the serious consequences that buyers face if they fail to act by the stated deadlines.
The buy-sell agreement will usually contain a clause that allows the buyer to notify the seller, by a specific date before the closing, that the buyer has not obtained adequate financing, thus entitling the buyer to terminate the deal without liability and recover his or her deposit, including interest if the parties agreed to hold the deposit in an interest bearing account. That same clause will often times provide that if the buyer fails to timely notify the seller he or she has not obtained financing, the buyer will be deemed to have waived that contingency, in which event the buyer cannot terminate the agreement without being in default and forfeiting his deposit.
Accordingly, if it becomes apparent that a commitment for financing might not be obtained before the deadline, it is imperative that the buyer avoid waiting until the deadline and either decide to terminate the deal and recover the deposit, or seek an adequate extension of the financing contingency deadline in writing signed by both parties.
If seller is not willing to agree to an extension, the buyer then has a decision to make: gamble their deposit in hopes that financing will be secured after the deadline or timely terminate the deal and walk away with the deposit. A seller who is motivated to do the deal will usually agree to an extension if the buyer has been moving the deal forward in good faith. That said, consideration should be given to negotiating a provision up front entitling the buyer to a one-time right to an extension upon request. Such a provision could help the buyer avoid any timing problems with the financing contingency.
The starting point for investigating title is to promptly obtain a preliminary title report reflecting the matters of record (liens, easements, CC+R’s, etc.) which will be excepted from the buyer’s title coverage. The buy-sell agreement will have a deadline for the buyer to either accept the title report with all listed exceptions to coverage, or to notify the seller in writing of buyer’s disapproval of any particular title exception, which will compel the seller to resolve that issue so the deal can go forward.
Buyers should therefore review the preliminary title report with competent counsel as early as possible to determine before the deadline whether buyer does or does not approve of any title exceptions.
If the buyer fails to timely notify the seller that it disapproves of a title exception on or before the deadline, the buyer may be deemed to have approved that title exception and must either close the deal with that title exception, which could leave the buyer with property having impaired value or marketability, or terminate the deal and thus forfeit the deposit as liquidated damages for breaching the agreement. The buyer’s best protection, therefore, is to promptly obtain and review the title report so it can give any required notification before the deadline.
Environmental Due Diligence Deadline
In an “as-is” sale, the buyer will have a deadline to approve or disapprove the property’s condition, which largely will implicate the property’s environmental condition. The buyer should therefore conduct a prompt investigation to identify any environmental problems with the real estate. To that end, the buyer should conduct a Phase I Environmental Site Assessment on the property to identify any actual or potential environmental problems.
If the Phase I reveals a possible environmental issue, conducting a Phase II ESA could help determine whether or not the matter is material to the buyer (i.e., would require remediation at significant cost). If such is the case, the buyer can either: (i) terminate the deal before the deadline and recover the deposit, or, (ii) if the buyer desires to stay in the deal, the buyer should consider obtaining an extension of the due diligence deadline to further negotiate and resolve this issue with the seller, such as by negotiating a reduction in the purchase price or other concession, or extending the closing so the seller can remediate the problem.
It is important to remember, however, that failure to timely notify the seller of a disapproved environmental problem on or before the deadline can result in the buyer having to either purchase the property subject to the environmental problem or decide to terminate the deal which could result in breach of the buy-sell agreement and forfeiture of the deposit.
Buyers should carefully negotiate the interim due diligence deadlines of real estate purchase agreements to ensure that they will have adequate time to identify, analyze, and if necessary, cure any issues that are uncovered during the due diligence period.
Failure to adequately prepare for and act by the deadlines could result in the unhappy choice for the buyer of going forward with a deal containing an unfavorable feature (such as unacceptable title exceptions or environmental concerns), or breaching the agreement through early termination, which may result in the buyer’s forfeiture of the deposit. It is therefore recommended that a buyer always utilize experienced legal counsel to negotiate and document the due diligence deadlines and issues and to remain actively involved in their resolution.