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Previously we took a look at the due diligence process of a commercial real estate transaction. In this edition, let’s discuss what a Buyer needs to know about contingencies.
In a typical CRE deal, there are various standard contingencies that work to benefit Buyers (provided that a Buyer is savvy enough to include such contingencies in the purchase agreement). Essentially, the Buyer is given a “free look” or a period of time during which they can conduct their due diligence and determine whether or not they want to go forward. The scope of the Buyer’s due diligence is essentially determined by the types of contingencies in the purchase agreement. Typically, the Buyer’s free look period ends on a contingency date. On the contingency date, the Buyer’s earnest money likely becomes non-refundable, unless the Buyer has objected to conditions on the property (or terminated the deal, if available). Contingencies are often very deal-specific, but there are a number of common contingency concepts that come up time and again and generally apply in any deal. They include:
THE INSPECTION CONTINGENCY
It is standard for a Buyer to be granted the right to inspect the physical condition of the property. This may include invasive testing of the soil surrounding a piece of property, among other things. Typically, a Buyer will pay the costs associated with this type of investigation.
THE TITLE CONTINGENCY
A Buyer is granted the right to review the status of title to the property, and to object to certain deficiencies or issues with the title prior to the contingency date. The Seller will usually have a period of time in which to cure any title defects (typically right up to the closing date), and in some instances, the Buyer may have the right to proceed despite certain objections but may escrow portions of the purchase price to remedy such title issues.
THE GOVERNMENT APPROVAL CONTINGENCY
In some cases, property needs to be platted, or subdivided, or the intended use of the Buyer must be approved via special use or conditional use permit. Or, the plans for the Buyer’s intended development of the property must be approved, among other things. Obtaining the requisite government approvals under these circumstances is a common contingency in commercial purchase agreements.
THE FINANCING CONTINGENCY
Financing contingencies are common, and like other provisions, vary substantially in complexity. Commonly, a Buyer must waive this contingency if they find “reasonably acceptable” financing options. In other cases, a Buyer may negotiate for a provision that allows them to cancel the purchase agreement in the event they do not get approved for financing at a particular interest rate. In connection with a financing contingency, a Buyer will typically covenant to use its best efforts to obtain approval for whatever type of financing is required under the purchase agreement.
There are a variety of other general contingencies which give the Buyer an “out” if the contingencies are not met by the specified contingency date. During the due diligence process, the Buyer will determine which contingencies can be waived, and what issues need to be resolved prior to closing. Well-drafted due diligence and contingency provisions in a purchase agreement will give the Buyer a leg up when it comes to managing the unforeseen costs and risks of acquiring a piece of commercial real estate.
Watch for The Purchase Agreement: Part IV, in which we discuss representations and warranties, pro-rations, and general provisions which allocate risk and liability between Seller and Buyer.