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Previously, we discussed key purchase agreement provisions and concepts, including purchase price, earnest money and payments terms. In this edition, we’ll take a closer look at the due diligence process. Here is what you need to know:
During the due diligence process, the Buyer will inspect and investigate the property to determine if the contingencies running in its favor can be waived, or lifted, to proceed to closing. A thorough and comprehensive discussion of the due diligence process would read like a treatise. In an effort to stabilize excitement levels, I’ll stick to the basics. The most common areas in which due diligence is conducted are the following:
This category covers a wide array of issues, focusing on environmental regulatory schemes that may affect the property. Environmental due diligence includes obtaining and reviewing Phase I and Phase II environmental assessments, which provide the Buyer with an overview of the environmental condition and history of a particular property, focusing on the possible presence of hazardous materials. The Phase II assessment will explore at greater length issues revealed by Phase I. Other environmental due diligence items include designating the locations of underground or aboveground storage tanks, the presence of asbestos, lead and mold, and determining whether or not there are any particular restrictions regarding the use of the property. The extent to which a Buyer conducts environmental due diligence depends in part on their intended use of the property, but also on factors like the age of the property and the historical uses of the property.
PHYSICAL CONDITION / CODE COMPLIANCE
A Buyer will want to conduct a physical inspection of the property, which will also include taking an inventory of the surrounding area. The most prudent Buyer will hire an engineer or qualified building inspector to determine the condition of the improvements on the property and design areas in need of maintenance or repair. The improvements on the property must also be reviewed for code compliance, which entails checking with the applicable jurisdictions (county and municipality) to determine the applicable requirements. The Buyer will also want to check the surrounding improvements, such as retaining walls, drainage systems, access, and the condition of surrounding roads and sidewalks. All of these items determine whether or not the Buyer can expect to pay special assessments in the near future following their purchase of the property. Issues revealed in this type of inspection are commonly resolved prior to closing as a result of the parties’ negotiations.
The title review process is used to determine the condition of the title to be transferred to the Buyer at closing, and also to identify title problems. In this day and age, Buyers and their attorneys work with a title company to have a title commitment issued and eventually to purchase an owner’s policy of title insurance. A title commitment sets forth the record ownership, legal description, and all encumbrances or memorials affecting the property which the title company uncovers. Based on the title commitment, the Buyer may object to certain aspects of title, and the Seller will proceed to have them resolved in accordance with the purchase agreement.
If the Buyer intends to develop the property, change the use of the property or make significant changes to the existing improvements, it is often useful to determine what approvals might be necessary to accomplish those intentions.
The Buyer should also inspect and review any items of personal property or fixtures sold with the property. Fixtures should be inspected for condition and UCC searches should be conducted to determine whether any third party has a security interest in any of the personal property being transferred to the Buyer at closing.
Now that we have the basics of due diligence covered, watch for The Purchase Agreement: Part III, in which we discuss common contingencies benefiting Buyers.