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Law360 (April 17, 2020, 5:30 PM EDT) --
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| David Alvarado |
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| Cheryl Brechlin |
With this in mind, it is advisable to carefully consider the following concepts and provisions.
Due Diligence, Deposit and Closing Date
As we face the realities of a government-induced economic coma for the sake of protecting lives, both buyers and sellers are approaching PSA transactions with even more trepidation than during the Great Recession.
In particular, to preserve capital, spread their bets and add flexibility, buyers are attempting to phase out the funding of deposits and expand the timeline for the key transaction milestones. Likewise, sellers are finding such requests more agreeable in comparison to adding financing contingencies and additional closing conditions (which introduce greater uncertainty into the transaction).
A typical timeline for a commercial transaction might include a 30-day, free look, due diligence period with closing to occur 30 days later and require that a good faith deposit be funded upon contract execution and then go "hard" (e.g., nonrefundable except in the event of a material seller default, the failure of a closing condition and/or a material casualty or condemnation) upon the expiration of the diligence period.
In today's environment, with stay-home, social distancing and similar orders in effect, parties desire greater flexibility than ever. One way to provide this flexibility is to allow additional time to maneuver, which can be accomplished by either (1) simply extending the traditional contractual milestone dates — e.g., by pushing out the due diligence period and closing period to, say, 45 days and 90 days, respectively — or, (2) permitting an extension to such critical dates on account of force majeure.
Note that force majeure provisions in PSAs for stabilized operating properties are atypical (they are more common in leases, for example). It is advisable for a clause permitting force majeure extension to be included, however, with a focus on which milestones should be subject to extension for force majeure.
In addition, any force majeure clause should be pandemic-focused and narrowly crafted so that time extensions are only granted for those obligations directly impacted by the outbreak — with appropriate caps and collars included.
In addition, the seller might agree to allow the buyer a contractual right to unilaterally extend the due diligence period and/or the closing date, exercisable by giving timely notice and payment of an extension fee.
Of course, sellers are inherently reluctant to give extensions. However, such an accommodation is preferable to a seller relative to simply extending or adding contingencies (assuming they extend beyond the traditional due diligence contingency period) and/or buyer closing conditions.
This is because the seller is compensated for the additional time and risk and the buyer's provision of such payment evidences its commitment to and belief in its ability to close.
And, of course, the buyer prefers having the certainty of knowing up front that it can procure a time extension, if needed, so it can continue to invest time and money pursing the transaction without the risk of the property being sold out from under it during the extension period.
Additionally, a buyer may seek to spread out the funding of its deposit by disbursing a portion of it upon contract execution and the remainder upon the waiver of contingencies. For example, supposing an overall 3% deposit, a buyer might seek to pay 1% upon execution and 2% upon the expiration of the due diligence period.
Or, if the buyer is successful in obtaining a financing contingency (discussed below) with a contingency date extending beyond the due diligence period, the buyer might seek to fund 1% of the deposit upon execution, 1% upon the expiration of the due diligence period and the remaining 1% upon the satisfaction or waiver of the financing contingency, with the entire deposit remaining fully refundable until the satisfaction or waiver of the financing contingency.
Of course, the seller would prefer to see the entire deposit funded up front but might allow the funding of same in phases to facilitate the transaction if there are no preferable buyers.
Closing Conditions, Representations and Warranties
Given the market's current uncertainty, capital partners and lenders are taking a more conservative approach or simply sitting on the sidelines and waiting for things to normalize. While all transaction types are affected to some degree, it has become almost impossible to find capital for retail and hospitality transactions in this environment.
Accordingly, buyers — if they're showing up at all — often request a financing contingency and even a funding closing condition to mitigate uncertainty as to what the loan terms might look like, if the funds will be available at all (as the amount of the loan will impact the equity that needs to be raised and the loan-to-value ratio, interest rate and payment terms will affect the overall investment return).
If the financing contingency date does not run substantially beyond the due diligence contingency date, other than confirming the language regarding the satisfaction or waiver of such contingency, the seller will not likely be incredibly focused on the provision.
However, if the financing contingency date extends meaningfully beyond the due diligence date and, in particular, if there is also a funding condition (i.e., a condition allowing the buyer to terminate if its lender does not fund), the seller will be very focused on the language.
In those cases, the contingency should include, without limitation, the following: (1) the minimum loan amount, (2) maximum interest rate, (3) interest and principal payment terms, (4) recourse structure, (5) the contingency expiration date and (6) the exact nature of the contingency, which is often the receipt of a term sheet from a reputable lender.
The clause should require that the buyer use commercially reasonable, good faith efforts to satisfy the contingency. Additionally, it should set forth a timeline for the buyer to (1) submit a loan application and information required by the lender, and (2) obtain a term sheet from the lender.
The clause should further provide that if the buyer fails to submit the loan application on time and use good faith efforts to obtain a term sheet, that the seller can terminate the PSA unless the buyer waives its financing contingency. Moreover, if the buyer fails to obtain a term sheet on time but does not elect to terminate the PSA pursuant to the financing contingency, then the funding condition should be null and void.
If the buyer satisfied the requirements for the financing contingency, including obtaining a term sheet, the buyer should only be able to terminate the purchase agreement if the lender refuses to fund the buyer's loan consistent with the term sheet furnished to the seller upon the waiver of the financing contingency.
If possible, the seller should also require that the buyer's lender deliver a written notice directed to the seller advising as to its specific reasons for refusing to fund — refusal may be for any reason other than the buyer's failure to use commercially reasonable, good faith efforts to obtain the loan, including any breach of the provisions of the term sheet.
Buyers should also consider demanding closing conditions related to material adverse impacts of a pandemic and/or material adverse changes to the property. Obviously, this introduces even greater uncertainty into the transaction from the seller's perspective.
Accordingly, if the seller agrees to this at all, they should (1) consider requiring a termination fee, (2) carefully define material adverse change and (3) consider and corollate the provision with any representations and warranties in the PSA.
If the buyer has been successful in expanding the gamut of representations and warranties beyond what is typical and the veracity of same is a condition to closing, seller would argue that buyer's concerns have been specifically negotiated and, to the extent acceptable, addressed; leaving no need for a generic material adverse change termination right.
From a seller's perspective, an additional material adverse change type closing condition layered on top of everything else would shift the structure of the transaction akin to a purchase option (which often requires the payment of up front and periodic consideration during the pendency of the option).
Operating in the Ordinary Course
Generally, purchase and sale agreements include covenants requiring a seller to operate the property in the ordinary course — consistent with past practices — subject to casualties and ordinary wear and tear. However, even this low standard can be difficult to meet at this time due to closures of on-site leasing offices and routine building services delayed or curtailed — either due to government mandate or otherwise at the discretion of the seller or service provider.
Sellers should consider modifying this standard to address the unique issues of the COVID-19 pandemic (e.g., by making the standard subject to force majeure). Of course, the buyer will likely then insist that it has the right to terminate if the seller's failure of performance, even if excused, has a defined material adverse impact on the property.
In the end, the buyer may still have the right to terminate and receive a return of its deposit, but the termination will not be for seller's default and, hence, seller will not be liable for damages.
Conversely, buyers should incorporate requirements intended to mitigate potential contamination from the pandemic, such as enhanced maintenance and operating controls in line with Centers for Disease Control and Prevention recommendations cleaning and disinfecting procedures.
Access Issues
With stay at home and social distancing guidelines now in effect in most states, it can be complicated to access a property. This is particularly true with multifamily properties. Equally challenging will be the overall coordination of personnel for various property inspections.
A seller may want greater approval rights over whether, and to what extent, the buyer can gain access to the property, especially tenant-occupied areas. Accordingly, sellers should consider imposing new access protocols to protect against COVID-19 transmission as well as require appropriate insurance coverage to the extent available.
In exchange for accepting more curtailed access rights, buyers should consider demanding more extensive representations regarding the physical state of the property (and possibly a holdback or other means of securing such representation).
A Final Note: Title Insurance and Closing Issues
As the situation is rapidly changing, both buyers and sellers should consult with their title companies regarding any potential delays in conducting searches (i.e., title searches, Uniform Commercial Code searches, etc.) and also address local rules governing electronic signatures, electronic filing, electronic notarizing and insuring during the gap period between closing and recording — especially when a recording office is not operating at full capacity.
If the gap period in a particular county has been expanded due to the inability of a recorder to fully post documents so that the title company can update title before closing, title insurers may require a gap indemnity which covers the entire period between the last effective date searched in the public records and the date of recording.
Currently, closings in counties where a county recorder is fully shut down are being handled on a case-by-case basis. Obviously, a seller or buyer may be unwilling to close a transaction where documents cannot be recorded. Similarly, title companies may be unwilling to insure these transactions until the recorder's office is open for business.
In any event, we are in unchartered territory — the legal and commercial real estate landscape will undoubtedly continue to evolve during this unprecedented pandemic.
David Alvarado is a partner and Cheryl Nieman Brechlin is an associate at Crosbie Gliner Schiffman Southard & Swanson LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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