Due diligence in commercial real estate contracts – how much is enough or too much?

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In purchase and sale contracts as well as some long-term leases, the scope and timing of due diligence is often a hotly negotiated topic.

From the seller/landlord’s perspective, the time for due diligence should be short and tie in neatly to closing. In addition, the scope of due diligence should be as narrow as possible.  Likewise, any representations and warranties related to items defined by the parties should be limited to the effective date of closing or as close to as possible to that time.

From the buyer/tenant’s standpoint, the timing should align with their financing goals for the property, coordination of operations, up fit as well as satisfaction as to what they are buying – i.e. clean title, no hazardous waste problems, proper zoning approval, building inspections, lease evaluation AND and that the seller/landlord stands behind its representations.

What to Look For

Let’s step back a bit and look at what items customarily fall within due diligence for commercial real estate contracts. Although there are differences depending on the type of property, the existing and intended use, age of buildings etc., generally most parties to these transactions should expect the following to be discussed and investigated:

  1. Title  (including  easements, encumbrances, restrictions and covenants, current title policy);
  2. Survey;
  3. Zoning and governmental restrictions, licenses and rules;
  4. Existing and Intended Use of the Property;
  5. Buyer Financing (if not a cash deal);
  6. Inspection of Improvements;
  7. Environmental Inspections and tests;
  8. Existing Leases or other Third Party Property Rights;
  9. Legal Status and Authority of the Parties; and
  10. Representations and Warranties.

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Key Factors

One could post 1500 words on any of these topics (maybe later), but let’s focus on the issues that could develop when the contract is in play.  As an Owner or Buyer what should you watch out for, prepare for, and deal with in these transactions?

  1. Is this  a 1031 Exchange? – if so, expect the  buyer to want to move quickly and thoroughly to avoid the tax consequences that come from not hitting the closing deadline.
  2. Is this a cash deal? – if so, expect the buyer to want to accelerate the due diligence period to get the $$ into the asset as soon as practicable.
  3. If not, is the sale/purchase subject to conventional or non-conventional financing? – As a seller, you will want to have a back-up plan if the contract is terminated either way, but especially if buyer is pulling funds from sources that may have challenges on closing day.
  4. Is this transaction a stand alone deal or tied to bundling properties for a portfolio? – if the latter, be sure as a seller you are aware of the buyer’s plan and contingencies relating to the other properties.
  5. Is this a long term investment for the buyer or a flip? – this could significantly increase or decrease the scope of due diligence and the importance of those terms in the contract.

 

Takeaways

When the parties negotiate due diligence terms and go through the investigation process, all should be aware of the particulars of the asset, the factors lying within and outside the transaction, the motivations of the buyer/tenant AND seller/landlord, and any other relevant factors relating to the property, process and parties. Perhaps “a little dab will do ya”, but sometimes the situation may require multiple rounds of review and analysis.

Confidentiality and Non-Disclosure Clauses in Commercial Contracts – Is it worth the Effort?

Let’s set the scene….

The parties to an active litigation case or in the case of a pre-filing settlement discussion or mediation have worked hard, given up more than they wanted to or not received as much as they desired, and are concerned collectively about how their attorneys fees are continuing to pile up. Throw in some bruised egos and negative past events that have been ruminated over and rehashed and you have folks who want to get something down in writing as to basic terms and be done. Details be damned! That’s what the lawyers are there for. Right?

This situation creates fertile ground for the parties, and perhaps even their attorneys, to not spend the time and effort that they should in crafting a solid, workable and individualized confidentiality agreement that captures the present and future concerns the litigants may have about anyone else discovering the details of their settlement. Many clients suggest lawyers use “boilerplate” clauses or the “usual verbiage” in order to avoid having to be involved with situations that they have gritted their teeth over and reached an agreement. A weary or inexperienced attorney might reflexively reach for form language that he or she used in previous settlements. Even worse, they may ask for the same type of generalized language from another attorney who has not been involved with the parties and the issues in dispute.

Here’s why that is a recipe for disaster in many situations.

Continue reading

Is this battle you should choose ? – Negotiating Commercial Lease Maintenance and Repair Terms

While negotiating a commercial lease, the inevitable issue of maintenance of the building, premises and building systems may prove to be one of the tougher issues facing landlords and tenants.  Although the LOI negotiations on basic terms such as rent, term , options, square footage and other rights and responsibilities of the parties are often sorted out early, maintenance and repair are often not specifically defined (carve out here for dynamite manufacturers and buildings that have significant deferred maintenance issues).  However, many well intentioned business people leave the issues of who maintains and repairs what in general terms even in the drafting of the lease agreement. In addition, tying in generic terms relating to casualties and indemnity can lead to uncertain results if not examined carefully for each transaction.

Concerns of Landlords and Tenants

For owners, the basic concern is protecting the asset while minimizing  cost. For tenants (except for their specific improvements) the chief concern is minimizing the scope and costs, specifically related to the structure, building systems common areas and even certain improvements which may be deemed fixtures that have to be surrendered at the expiration of the lease.  Costs are the common denominator, but there is often more at stake. Take the tenant who has injected thousands of dollars into upfits and permanent improvements or the landlord who has retrofitted the premises to fit tenant tenant needs. Then the issues get sticky….

 Less Sticky Situations

In  some lease scenarios, these issues may be more easily resolved and defined, such as:

  1. Ground Leases
  2. Build to Suit Transactions
  3. Single Tenant Occupancy
  4. Outparcel Leases
  5. Franchised Tenants
  6. Substantial or Complete Retrofit by Tenant
  7. Tenant with Extensive Renewal Options
  8. Tenant with an Option to Purchase

In these situations either landlord or or tenant will likely want to substantially control the protection of their asset or improvements. Landlords desire to protect the structure, building systems, fixtures and alteration approval. Tenants generally want landlords to pay for the maintenance and repair of as much as possible, except for tenant-specific or custom alterations and personal property.  Many LOIs in these situations come tailor made for the final lease and are  essentially non-negotiable on these issue. But what about the rest?

What’s in the the toolbox  to help?

Great question. But over time, real estate professionals have gathered and honed many methods to deal with the issues of maintenance and repairs. By no means a complete list, the items below can help guide the parties to a final agreement knowing that protections and securities have been built in to deal with the lease, such as:

1. Insurance – ideally both landlord and tenant should maintain separate policies that name the other other as additional insureds where appropriate.

2.  Maintenance Contracts – especially for building systems, a solid and reliable maintenance agreement obtained by one or both of the parties can prevent problems from arising. As for the structure (except in ground leases and other situations where the tenant is constructing and fully controlling the building), most tenants look to landlords to cover.

3. Indemnities – these animals can create a good umbrella to cover negligence,  third party damage and other unforeseen circumstances. Again, the party with more to protect will want want a stronger, tighter and broad scope clause included in the lease. Key to this discussion will be the financial status of the parties.

4. Casualty Responsibilities – Likewise, by dividing the risk, responsibilities and rights if there is unpredictable damage to the building and its contents, the parties should know what the consequences will be for themselves.

5.  Approval for Improvements – This is often a tug of war between landlords and tenants. Many times setting a requirement for approval of improvements costing above a certain dollar amount can allow the landlord to be assured the building is not substantially modified without their blessing, while allowing tenants the right to make routine changes and replacements without having to wait for the landlord to respond to their requests.

6. Guarantors – Often a tool to insure that landlords have additional security for unpaid rent, TICAM etc., personal or corporate guaranties can assuage concerns of how risk may be otherwise allocated in the lease agreement.

 

Takeaway

The touchstone for negotiation of maintenance and repair responsibilities should be what does each party want to protect or control and what are the costs and benefits of the physical items, fixtures or structure to be maintained.

 

 

 

 

 

 

 

 

Landlords Lose Remedies Or Do They? – The Lockbox

 

Most commercial landlords are familiar with the concept (or actually use) a bank “lockbox” for deposits of rent and other lease charges from tenants. The process is simple. Take for example a shopping center development. Instead of the landlord receiving checks by mail or other carrier, tenants deliver their payments directly (usually via via ACH) to a bank that holds all of the payments in a single account.

The advantages of this system are numerous:

  1. Landlords don’t have to spend the time or the $$ to collect and account for all of the monthly or periodic payments owed by the tenants;
  2. Although there is generally a fee charged by the bank for this service, it is usually far outweighed by the cost of employees or third party collectors doing the same job; and
  3. The bank provides a clear timely report of which tenants are making payments, short paying, or not paying at all.

So, assuming you are a landlord with multiple properties and/or numerous tenants, why would you not choose this method of gathering and accounting for rents, TICAM  and other payments?  Unfortunately in many states if a rent payment is deposited, it is considered to be accepted by the owner and constitutes a waiver of all defaults. In addition, most banks will not block individual tenant’s payments, short of closing the account entirely. Not a good solution for the landlord, especially when the anchor tenants are paying through the lockbox as well.

So what do you do if you don’t want to block your lockbox?

In many situations landlords and their attorneys have attempted to come up with creative solutions to this problem, including:

1. Attempting to reverse the payment through the bank;

2. Sending the tenant a replacement check in the same amount with a letter reiterating the default is not waived and landlord maintains its position that it can act on its remedies;

3. Changing the notice address for payments to a P.O. Box or even better, someone’s office; or

4. Reporting to the bank that any payments received by the defaulting tenant are potentially fraudulent.

Which of these have been successful?  Under the first scenario, most tenants have successfully argued that once the check is negotiated by virtue of deposit into the lockbox account, the receipt of the same and waiver cannot be undone.

In the second situation, tenants have either refused to accept the payment back from the landlord either by ignoring certified mail or hiding from the FedEx person!  Thus, the tenant can frustrate the attempt to avoid a waiver.

In the last scenario, even when there has been a history of bad checks issued by a tenant, most banks will not investigate checks sent by the offending tenant before they go directly into the lockbox deposit. This is also dangerous, as a savvy tenant could argue that the landlord is setting them up to default by creating a mechanism by which they can evict or collect additional monies per the remedies section of the lease.

For tenants who are concerned about getting their rent in on time and in full, the third situation may work. However, a canny tenant would continue to send the rent to the lockbox. Although that may be technically a default of the notice paragraph in the lease, courts have held that it does not undo the waiver of the default by the owner.

Is this the end of the story?

Maybe not.

Some courts have ruled that waiver must be a conscious choice regarding legal rights as to the tenant. In other words, the landlord must have actual knowledge that the payment is being made and intentionally not take action to allow the check to be accepted.  In the case of Manufacturing Co. v. Building Co., 97 S.E. 718, the North Carolina Supreme Court stated that “[w]aiver must be manifested in some unequivocal way, and to operate as such, it must in all cases be designed, must have so acted as to induce the other to believe that he intended to waive…”.  The case also cited Justice Holmes’ classic definition of the doctrine of “election” from Bierce v. Hutchins, 205 U.S.340, that “[e]lection is simply what its name imports; a choice shown by an overt act , between two inconsistent rights, either which may be asserted at the will of the chooser alone.”

In the lockbox situation, an affirmative election to not waive the tenant’s default (by returning the payment and stating in writing such election and intent not to waive the default), the landlord would arguably be able to maintain an action for eviction, collection and other damages despite the tenant’s position to the contrary.

Business Decision or Rely on the Courts?

One final point.  Aside from the legal outcome of accepting lockbox payments, landlords may want to consider shutting a lockbox account down temporarily in order to have rock solid grounds to oust a tenant. Consider the situation of a large tenant in a industrial park who has defaulted repeatedly and the presence of a more solid and attractive replacement tenant for the same space. Foregoing the rent payments for a month or two may make more long term business sense than accepting the rent from the defaulting tenant and potentially losing the replacement business in the process. Obviously this is not an easy decision to make in most cases and lender restrictions and other factors could easily complicate the decision.

Leases or Licenses – Careful What You Wish For!

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Just as we have previously reviewed and analyzed the differences between certain aspects of  sharing property rights, landlords and owners are often met with the challenge of whether to enter into lease or a license agreements when allowing businesses or individuals to use their real property. Although these contractual arrangements resemble each other in many structural ways, they have important legal and practical differences that should be considered before choosing one path or the other. Read on for five important differences… Continue reading

SPECIFICITY IN LEASES: When is too much detail a problem for the parties (or even in this article)?

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No one wants too much or too little. But where is the Goldilocks’ solution? Err on the side of too much rather than too little?  Stick to the amount determined by local business standards? Somewhere in the middle? Enough to get the deal the deal done?  Hmmmmmm….

In order to analyze this situation, let’s imagine subpoenas were issued for a representative of each of following players in a lease negotiation to given confidential testimony on this question, including their overriding goals. Each representative is given pure anonymity and the prompt to be as forthright and open as possible. The investigator interviews each person and then reviews his notes. A clear answer does not appear. Rubbing his eyes, he looks at the testimony again: Continue reading

You Mean I Cannot Evict A Tenant If It Is Unfair?

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Yes, this seems strange doesn’t it.

However, the North Carolina Supreme Court has determined this can be the result in certain circumstances.  In Eastern Carolina Regional Authority v. Lofton (No. COAA14-212), the N.C. Supreme Court found that in an eviction case based upon criminal activity of the tenant’s guest, the tenant could not be evicted because it was her involvement in the basis for the eviction would be “shockingly unfair of unjust” or “excessive” and “unreasonable.”  One could easily argue this was limited to the residential nature of the case (domicile), but the N.C. Supreme Court based its ruling on the basic four criteria that serve as a basis for ALL evictions, commercial or residential. Continue reading

Just Work With Me! – Best Intentions and “Waiver Creep”

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When is it a good idea to keep working with a defaulting tenant?

How many times (even during a robust market) have landlords considered and perhaps acted on a tenant’s request to grant them abatement, deferrals and other concessions in order to preserve the relationship, avoid vacancy, make their lender happy and keep the rent coming in? More often than you might imagine.

Although there is clearly self-interests on both sides in the decision to allow the tenant to pay partial rent or defer overdue amounts under the lease, often landlords and tenants enter into such discussions with the best intentions for all involved.

Yet, even the most benevolent agreements can lead to negative consequences down the road. Continue reading

Growing Pains – Issues Surrounding the Construction or Re-Devolopment of Commercial Properties

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Let’s face it.  In the post recession market, Developers and Owners are ready to look for opportunities to build, expand, alter and modify their properties.  Although likely not as robustly as to pre-2008, there is retail, office and industrial re-development and expansion happening as we  read these words.  And with this change in the market comes an inevitable challenge between Landlords and Tenants as to their rights and obligations as new development moves forward and existing product is modified, altered and expanded.  The focus of this post is to delve into the issues relating to what these parties should discuss, plan for,  and work through during the growing pains.  One of the struggles is to determine the rights and responsibilities of the owner and the tenant when a dormant or unimproved property experiences growth and (yikes!) prosperity. As reflected below, change may not ultimately be a problem for either party.  Although there is a lot of advice for tenants, landlords can certainly benefit from this discussion. Continue reading