By: Tamara B. Pow, Esq.
The purchase and sale agreement (the “PSA”) is the central document for the sale of commercial real property and one of the most important. The terms of the agreement are negotiated between buyer and seller often after a letter of intent (“LOI”) has been signed, although sometimes the parties may forego an LOI and jump straight to the PSA. For best practices, an LOI should be used to ensure the parties agree on the basic terms of the sale before investing time and energy into negotiating the PSA, which is often a lengthy and time consuming process involving multiple rounds of revisions before an agreement acceptable to both sides is reached.
The party providing the initial agreement has the benefit of being familiar with the terms and structure of the document while the other side must read and analyze the entire agreement to understand the agreement and any revisions that need to be made. A custom agreement can be 50-60 pages as opposed to a form agreement such as one provided by the California Association of Realtors or AIR CRE which are typically less than 20 pages.
Initial items to note are the sale price, deposit timing and amount, accurate identification of the parties and the subject property, time permitted for due diligence (including title review and objections), length of the escrow period, the representations and warranties provided by each of buyer and seller, buyer and seller documents that must be delivered to the escrow holder before the close of escrow, and any special clauses that either buyer or seller want incorporated into the PSA.
The party reviewing the PSA should make sure the pre-negotiated terms of the LOI have been incorporated into the agreement and the PSA should be revised if it deviates from the LOI. The sale price, deposit, identification of the subject property, length of due diligence and escrow periods are typically negotiated in the LOI, therefore a simple comparison against the LOI will confirm if these items are correctly stated in the PSA.
During the due diligence period, a buyer should obtain a preliminary title report as soon as possible since it provides access to documents recorded in the title record which impact the property. These documents are typically listed as exceptions to the title insurance policy and it is up to buyer’s counsel to identify which exceptions should be removed as well as explain the responsibilities the buyer is taking on in regards to exceptions that will remain (these are often agreements that run with the land such as CC&Rs, easements, and use restrictions). The PSA should provide a buyer with the opportunity request that the seller remove or modify items identified in the title report, allow the seller time to respond to these requests, and finally give the buyer a right to terminate the PSA without losing its deposit if it is not satisfied with the seller’s response.
Other due diligence items will vary depending on the goals of the buyer with respect to the property, and include items such as obtaining a survey, testing of soil and inspection of existing improvements for hazardous problems, as well as contacting the city in regards to development plans and potential changes to zoning. Experienced buyers with plans to re-develop the property will often negotiate a lengthy due diligence period to be sure they are able to obtain all permits and approvals required to achieve their goals. A buyer that does not plan to redevelop the land is typically receptive to a shorter diligence period.
Before expiration of the due diligence period, the buyer should be able to terminate the PSA without penalty and receive essentially the entire deposit back (but will often be required to pay for escrow and title costs incurred). If the diligence period has ended and the buyer has not terminated the PSA, the deposit becomes non-refundable. California PSAs typically include a liquidated damages clause which state that if a buyer breaches the PSA then the deposit shall be relinquished to the seller as liquidated damages. A buyer breach, if it happens, will typically occur after the diligence period because the buyer may no longer terminate the agreement without penalty unless the seller violates the terms of the agreement.
From a buyer’s perspective, representations and warranties (often referred to as “reps and warranties”) cover issues such as authority of the seller to enter into the agreement and sell the property, whether there are any lawsuits filed or threatened against the property, if there are any environmental or statutory violations. They will also include the statements that seller has not filed for bankruptcy and is not a foreign person/entity or prohibited person under applicable statutes, the property is not subject to condemnation, and that all third-party interests in the property have been disclosed (such as a tenant interest under a lease).
If the property is occupied by a third-party tenant the buyer should request a tenant estoppel be provided as a closing condition, and should know if the lease contains a right of first refusal (“ROFR”) permitting the tenant a right to purchase the property before anyone else. If the lease contains an ROFR, the buyer want confirmation that the tenant is waiving the ROFR before expending resources on diligence and will want the PSA to state that the diligence period does not begin until after waiver of the ROFR is received.
Commercial real property in California is often sold on an As-Is basis, meaning a buyer accepts the property in its current condition without any warranties from the seller regarding the condition or use of the property. A buyer should confirm the As-Is clause makes an exception for the Seller reps and warranties specifically stated in the PSA to hold Seller accountable for these specific items.
As the parties make their way towards the close of escrow, buyer’s counsel should prepare closing instructions setting forth the documents a seller must place into escrow before the remaining purchase money may be transferred to seller. Some buyers want a right to extend the close of escrow and sellers are more receptive to this option if the extension right requires the buyer to place an additional deposit into escrow. It is best to obtain an extension option during the LOI or PSA negotiations because a seller has no obligation to agree to a closing extension if it is not part of the agreement. A seller refusing to amend the PSA for a closing extension can press the buyer to close on time or hold buyer in default of the agreement, thereby placing the buyer’s deposit at risk. A final note on the close of escrow is closing costs, which are typically allocated according to county custom but sometimes the parties will agree to allocate them otherwise. In either event, a buyer should make sure the PSA accurately reflects which party is responsible for such costs, and that the settlement statement is consistent with the PSA.
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