Real Estate Contracts Today
 
October 5, 2004
 
James M. "Jim" Norman- Ft Lauderdale

Pick up almost any real estate related trade periodical and you will read about potential buy/sell opportunities and a general feeling of optimism and promise of brighter days ahead. As we go forward, however, the real estate contracts of sale may have some new twists and turns to them as a result of some recent experiences in key markets with investment fund or other very careful and very sophisticated buyers and sellers. This article will provide you some insight about some things to look for in real estate contracts.

Who Is Making the Representations and Warranties?

Whether examined from the point of view of the seller or the buyer, the question that must be closely examined is the identity of the person or persons attributable with “knowledge” in the contract. The real estate world today is a world of special purpose bankruptcy remote entities, single purpose limited liability companies and other very large institutional owners. When the contract says “seller’s knowledge,” “buyer’s knowledge” or words having similar effect, what and who is being referenced? In the next cycle of dispositions and acquisitions, expect to spend more time giving attention to exactly who are the most appropriate “knowledge parties” and negotiating the standard of knowledge that will be applied. For example, the concept of “knowledge” might be limited to the actual present (and not the constructive) knowledge of a limited number of specifically identified individuals, and the provision might expressly provide that those individuals should not be presumed to have conducted any inspection, examination or other inquiry to determine the accuracy of any representation, warranty or other statement made to “seller’s knowledge” or “buyer’s knowledge.”

Funding or Securing Post-closing Obligations

Representations, warranties and many obligations of the contracting parties tend to survive closing and the recording of the deed of conveyance for some period of time. Consider these post-closing obligations in the context of a single purpose entity or a seller that usually immediately distributes all of the net sale proceeds to its investors, and you have a very different set of challenges from the buyer’s perspective. The result is negotiating contract provisions to support the continuing obligations, usually of a seller, but it could impact a buyer’s obligations as well, that seek to do any number of things, either alone or in combination. This includes any of the following:

• continue the existence of the entity
• require the entity to maintain a minimum capitalization level in cash (or sometimes cash equivalents)
• establish an escrow to fund post-closing obligations
• provide a guaranty of payment for post-closing obligations

If I am the seller in the next transaction cycle, I am going to work hard to carefully limit anything that inhibits my ability to distribute proceeds or dissolve my selling entity. On the other hand, if I am a careful and cautious buyer, I am going to insist that the seller cannot walk away from the post-closing obligations of the contract, and that these measures are not intended to increase the seller’s liability, but rather ensure that if that liability becomes actual, there is a mechanism and a fund to provide for payment.

The Tenant Interview

This may take a little getting used to, but watch for buyers negotiating into the contract the right to conduct one or more “interview meetings” with the local representatives of each tenant at the property. This will be in addition to, and not in lieu of, the more customary seller’s obligation to deliver tenant estoppel certificates. If it cannot be resisted, the interview meeting should at least be thoroughly thought out and carefully structured. For this meeting to have relevance and value it must be timed to occur during the buyer’s due diligence period. This means that a buyer who is not yet “at risk” in the deal is talking to your tenants. If the buyer does not proceed, they may have far more information than they should about the seller’s tenants, and, in addition, the tenants may be asked to have another meeting with the next potential buyer.

There is also the challenge of ensuring that the tenant representative being interviewed is the right person to interview. It should not be assumed that the local business manager of a national or international company has the requisite knowledge to qualify him or her as the right party to meet with a potential buyer. If the interview meeting is scheduled, then the seller should manage the process. There are many aspects to this, but a few to note are described as follows. The buyer should advise the seller of each tenant or subtenant at the property that the buyer wants to meet at an interview meeting relatively soon after the contract is signed. The seller might try, in the contract, to limit the pool of potential meetings by agreeing to let the buyer meet only with tenants occupying space over a minimum threshold size, perhaps tenants leasing 10,000 or more square feet. Make sure the contract states that the seller will try to set up the interview meeting, not guarantee that it will happen, and that the seller shall not be in default if any tenant or subtenant declines to participate in an interview meeting or cannot participate in an interview meeting prior to the end of the buyer’s inspection period.

Interview meetings should occur at the offices of each tenant or subtenant at the property or at another location at the property designated by the seller. The seller and the buyer should each have the right to have one or more representatives or employees attend each interview meeting. The contract should also specify that the buyer cannot have further direct communications with the tenant after the interview meeting without the seller’s consent. Should the buyer request any additional meetings, a legitimate business reason must be presented. Other than the interview meeting and any additional communications agreed to by the seller, the buyer should not communicate directly with any tenant or subtenant of the property without the prior written consent of the seller. From the seller’s perspective, the contract should also include a confidentiality covenant to cover the interview meeting.

And There Will Be More Work Ahead

This is just a sampling of how the contract, soon coming to an office near you, may not quite be what you saw a year or so ago. Best bet, assume nothing and read everything in any contract before you sign.

A version of this article first appeared in Real Estate Forum magazine earlier this year.

For more information, e-mail Jim Norman at jim.norman@hklaw.com or call toll free, 1-888-688-8500.