Purchase and sale agreements are the legal sales contracts involved in a commercial real estate transaction. They outline things such as the purchase price, the responsibilities of each party, and the conditions of sale. These kinds of contracts often take a considerable amount of time and effort to negotiate and are usually drafted and revised by knowledgeable commercial real estate attorneys.
The Letter of Intent
Before a purchase and sale agreement, a commercial real estate transaction will usually begin with a letter of intent (LOI) or a term sheet. Generally speaking, a letter of intent or term sheet will outline the basic terms of the transaction. They are shorter and less detailed than complete purchase and sale agreements and therefore are easier and less time-consuming to draft and negotiate. They also do not bind the parties to complete the transaction, although they might include other binding provisions, such as a non-disclosure agreement (NDA). If a buyer and seller cannot come to an agreement with a letter of intent or term sheet, they save a substantial amount of time and money by having avoided drafting a complete purchase and sale agreement.
Once the terms and conditions in the letter of intent or term sheet are agreed to, those terms are typically treated as non-negotiable. However, there will usually be many terms and conditions not included in the letter of intent or term sheet to negotiate during the purchase and sale agreement stage.
The Beginning of the Purchase and Sale Agreement
A purchase and sale agreement typically starts with the names and addresses of the parties and the date, followed by a summary of the reason for the contract, sometimes referred to as the recitals. Then it will describe the property, including things like the permanent index number (PIN) for the real estate parcel and any additional property included in the agreement, like machinery, equipment, fixtures, inventory, or furniture. It will also describe the condition of the property and any liens or contracts related to the property. Details, like the legal description of the property, are sometimes reserved for “Exhibits” referenced in the actual contract.
The agreement will also list the exact purchase price and state how the purchase price will be paid by the buyer. Typically, a portion of the purchase price — referred to as an “earnest money” or “good faith” deposit — will be due from the buyer upon signing the contract, with the balance due at closing. If using escrow, the contract will include escrow provisions and will likely state the expected escrow timeline and whether and under which conditions any deposit may be refunded. If the buyer or seller is hoping to complete a 1031 exchange, the contract will be sure to include those rights and requirements.
Finally, the intended closing date will usually be listed in the first section of the contract.
Explore the Justia Lawyer DirectoryCommercial real estate transactions often implicate local laws and customs. Buyers and sellers may wish to hire their own attorney to help draft and review the purchase and sale agreement, taking into account these specifics. Justia offers a lawyer directory to simplify researching, comparing, and contacting attorneys who fit your legal needs.
Title and Survey Provisions
Next, the contract will often outline the timeline under which the seller will provide the buyer with any existing surveys of the property and the seller or buyer will obtain a preliminary title report. It might also include details about obtaining surveys of the property from licensed surveyors or other professionals. This provision often gives the buyer the opportunity to object to any issues that arise during a review of these items and a timeline under which the buyer can ask the seller to address these issues or terminate the transaction.
Due Diligence Provisions
The purchase and sale agreement will include the timeframe of the due diligence period. The due diligence period is the time during which the buyer is permitted to investigate the property and the seller. It might also include timeframes for addressing zoning and financing concerns.
Investigations during the due diligence period might include investigations into the title, surveys, zoning and use issues, environmental and engineering concerns, leases, and other contracts. It will also often include physical inspections of the property, including things like evaluating the plumbing and electrical work. The contract will sometimes outline the specific investigations the buyer is entitled to undertake, such as environmental analyses, engineering studies, soil and water tests, appraisals, interviews with tenants, and more. The contract might also indicate the dates by which each inspection should be completed and how the seller will assist in completing the inspections. It might even address how long after final inspection reports are produced the buyer has to back out of the deal.
Buyers are often obligated to obtain insurance to cover damage and loss that might arise as a result of their actions on the property, like a fixture broken during a consultant’s inspection.
Buyers are generally permitted by the contract to back out of the transaction during the due diligence period for any reason so long as they provide proper notice. The contract also usually includes the buyer’s right to receive a refund of any deposit if they terminate the transaction during the due diligence period. A buyer usually wants the due diligence period to be longer, while a seller almost always wants the due diligence period to be shorter. The contract will outline how the buyer may give notice to the seller that they would like to continue or cancel the transaction during the due diligence period. Sometimes the contract will give a party the right to extend the due diligence period.
In some cases, a purchase and sale agreement will delineate different due diligence timeframes for inspections, zoning, and financing. For example, the contract may state that the period for inspection will run for 30 days, during which the buyer may terminate the contract for any reason and receive back their full deposit. It might then say that the timeframe for the buyer to rezone the property for a particular use will run for 60 days concurrently. Since government processes can be slow, the contract might include an option to extend the timeframe for rezoning for an additional non-refundable deposit. Buyers are often limited during this period to only terminating the contract if they cannot obtain their desired zoning approvals. Finally, the contract might include a third timeframe for financing, during which the buyer may only terminate the contract if they cannot obtain financing or financing that meets their enumerated requirements, such as a certain loan amount or interest rate.
Indemnity = a party’s obligation to assume responsibility for another party’s losses.
Throughout the contract, and especially in the due diligence provisions, the contract will often state who will be responsible for which costs. For example, the buyer is often responsible for paying the cost of most investigations and, if applicable, any repairs to the property for damage or alterations caused by the investigations. This part of the contract may contain an indemnity clause under which the buyer agrees to hold the seller and its agents harmless from damage arising out of these inspections. It might also mention that the buyer must purchase certain insurance coverage for possible damage and personal injury. If there are current contracts associated with the property, such as service contracts, the buyer may be given the right to choose to terminate those contracts at the seller’s expense.
Finally, the due diligence section of the contract may obligate the buyer to make an additional deposit if they intend to go through with the transaction.
Representations, Warranties, and Covenants
Representations and warranties outline the facts the buyer and seller relied on when entering into the contract. This means that a party can later be liable if a representation or warranty they made turns out to be false. Representations and warranties cover things such as the parties’ authority to enter into the contract, the leases and contracts associated with the property, defective, hazardous, or illegal property conditions, environmental and structural concerns, conditions that might affect the seller’s ability to sell the property or the buyer’s ability to buy it, and liens, judgments, and litigation or threatened litigation associated with the property. The representations and warranties provision will usually include a survival period and the remedies for misrepresentation, including liability limits. It will also often obligate one party to notify the other if there has been a material change in their representations and warranties prior to the closing date. If the property will be sold “as-is,” the contract should state that. The buyer is often permitted to terminate the contract and obtain a refund of their deposit if there is a material change in the facts related to the seller’s representations and warranties.
Required DisclosuresWhile it is common for laws to require that sellers of residential real estate make certain disclosures about the property’s condition, these laws do not always apply in commercial real estate transactions. Instead, the representations and warranties section of a commercial real estate purchase and sale agreement will impose those obligations.
Covenants, which are not limited to a certain contract provision, include things such as the seller’s right to enter into other contracts and the seller’s obligation to make certain repairs or undertake maintenance and maintain insurance for the property. They might obligate the seller to keep the property operating in its current state prior to the closing and cooperate with the buyer’s prospective lenders. A seller is often prohibited from encumbering the property with things such as new mortgages or changing the zoning of the property without prior consent from the buyer.
Closing Provisions
Closing provisions in a commercial real estate purchase and sale agreement will outline how exactly closing will occur, what will happen during the closing, whether an escrow agent will be involved, the closing date, and the conditions precedent to closing.
Closing conditions are those conditions that must be met, either by the buyer or the seller, before the closing can take place. Closing conditions contained within a commercial real estate contract include things such as third-party approval, financing, zoning approvals, title insurance, the condition of the property, and more. Further conditions include the parties reaffirming their representations and warranties, the parties performing and complying with all material terms of the contract before and up to closing, the parties executing all closing documents, the seller delivering actual possession of the property, the seller providing important items such as the deed, and the buyer paying the full purchase price (less any deposits, credits, and prorations).
The contract may note that any closing condition may be waived by the opposite party by written notice or another avenue.
Costs, Credits, and Proration Calculations
The contract will outline which party is responsible for each cost associated with the transaction. The buyer will obviously be responsible for paying the purchase price, but other costs may be divided among the parties. For example, the contract may state that the buyer and seller are each responsible for their own legal fees, the buyer will pay for fees associated with the investigation and survey of the property, the parties will equally divide all escrow costs, and the seller will pay the premium for standard title insurance.
A proration provision will usually include the date and time on which the proration calculations will be based (often the closing date), the formula for the calculations, and which expenses or income will be prorated. For example, a purchase and sale agreement for a commercial property with current tenants will most likely include a proration provision for prepaid rent and security deposits. Other prorations might include property taxes, utilities, and insurance premiums for policies that will continue past the closing date.
Termination and Default Provisions
The termination and default provisions of a commercial real estate contract may be short, but they are important. These provisions outline exactly what will happen when the buyer or seller defaults on their obligations. A termination and default clause might state that upon a default by the buyer or seller, the contract terminates, but sometimes the defaulting party will have the chance to cure the default first. It might additionally specify that the non-defaulting party may choose to waive the default rather than terminate the contract.
The contract might state that the remedies outlined in the termination and default provisions, including any liquidated damages, will be the parties’ sole remedy in the event of a default. This means that the parties generally cannot sue one another for additional damages above and beyond those defined in the contract. It might alternatively say that one or both of the parties are entitled to exercise all possible rights and remedies in the event of a default or a certain type of default.
A seller’s remedies for a buyer’s default might include liquidated damages, which often consist of the buyer’s deposit. A buyer’s remedies might include a return of their deposit, any costs and fees associated with the transaction (which are often capped), or specific performance.
Specific performance = an equitable remedy requiring a breaching party to go through with performing their contractual obligations when other remedies would not be sufficient; in a real estate context, an order that the seller must sell the property to the buyer
Liquidated damages = a specific sum of damages agreed to for a breach of a contract when actual damages would be difficult or impossible to prove
A contract will sometimes contain a general indemnity section wherein the parties agree to indemnify, defend, and hold harmless the other party for any liability or damage arising from their own breach or non-performance, liability arising out of breaches or alleged breaches of contracts related to the property by the seller before the closing date or by the buyer after the closing date, or liability or damages arising from their own material breaches with respect to representations, warranties, or covenants discovered within a certain amount of time. The buyer might also indemnify the seller with regard to liability arising from the ownership, maintenance, or operation of the property for conditions or events occurring after the closing date.
The contract might additionally include provisions for instances where the property is damaged, destroyed, or condemned during the transaction. It will also probably include language typical in many contracts, such as a disclaimer that the written contract constitutes the entire agreement between the parties, whether the contract may be modified and how so, that the contract will be governed by the laws of a certain state, and which party will pay attorneys’ fees in the event of a lawsuit related to enforcement or interpretation of the contract. It might finally contain an exclusivity provision stating that the seller will stop marketing the property or entertaining other offers once the contract is signed until it is terminated, and a severability provision stating that if one provision of the contract is deemed invalid, the rest of the contract will be construed as if that provision did not exist.
Last reviewed September 2023
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