What is a purchase contract for commercial property?
Simply speaking, a commercial property purchase contract is a contract between a buyer and a seller on a parcel of commercial real estate stating that the parties have agreed to exchange a property for a sum of money. More specifically a commercial property purchase agreement is an agreement between the Seller of a commercial property and the Purchaser that forms the basis of a transaction wherein the Seller agrees to sell the commercial property to the Purchaser and where the Purchaser agrees to purchase the commercial property from the Seller. Commercial property is any property that is purchased to earn income, to be operated in a profit-seeking business or simply not considered residential. The profit motive and commercial intent behind a commercial property separates it from what is typically regarded as residential property which is primarily for your use as a home or as a second home (i.e. cottage), but even a second home can be used as a potential income generator such as by being a part of the short-term rental industry.
Although every commercial property purchase agreement will differ , a standard commercial property purchase agreement will generally provide for the following:
- A description of the parties to the contract.
- An accurate description of the property being sold.
- A list of items included with the purchase or not included (such as tenant leases or fixtures)
- A purchase price.
- Terms of payment.
- The manner in which title will be conveyed.
- Time for closing, which is generally the date the sale is completed, along with other contingencies to closing.
- A provision for allocating liability for breaches of contract to each party.
- Specifying any future rights that each party may have
- A default provision that explains the rights and obligations if either party defaults.
- What happens if the property is destroyed before closing.
- If the buyer is entitled to an inspection period, set out the terms of the buyer’s right to inspect the property and how long they have to do so.
- Separated at closing, who will be paying for items such as title searches, registering documents or inspection fees.
Key features of commercial contracts to purchase real estate
The most important part of the Contract is the Property Description. The Property Description can be a very specific legal description that would be found at the beginning of a deed or a tax receipt. A more generic description of the Contract Property would be sufficient for smaller transactions such as a shopping center with a single building and no out-parcels. If there’s more than one building, or more than one parcel of land, make the description as clear as possible.
Purchase Price. The purchase price is the aggregate amount of money the Buyer agrees to pay. While small variations in the purchase price will not give grounds for termination, the purchase price must be accurate before closing.
Contingencies. Contingencies are events that must occur before either party must perform their obligations. A contingency might be any of the following: execution of the required Loan Documents or the exact conditions to be contained in the Loan Documents, execution and delivery of the required corporate authorizations (if the Buyer or Seller is a corporation), approval by any Homeowners Association (HOA), completion of an engineering study or other due diligence requirements, etc.
Due diligence. Due diligence usually takes place and is completed prior to closing. Any inspections or studies should be completed during the due diligence period.
Closing. The Closing Date is the date on which the sale will close. The closing will take place at the Buyer’s attorney’s office unless otherwise specified. The parties’ attorneys and title company will schedule the closing date. Title to the property will pass from the seller to the buyer on the closing date.
Common contingencies in a contract of purchase for real property
Contingencies commonly included in commercial property purchase agreements are the financing, property inspection, zoning approval, and building permit contingencies. These contingencies allow the buyer to back out on the "closing date" if unexpected conditions arise.
Financing Contingency
The most important contingency for the buyer is the financing contingency. When a buyer makes an offer, the purchase price is often a significant amount of money. Unless the buyer has all cash at the time of closing, they will rely on a lender such as a bank to provide the necessary funds to complete the purchase. A financing contingency frees the buyer from having to close if the lender refuses to approve the loan for any reason.
Property Inspection Contingency
Another important contingency is the property inspection contingency. This contingency gives the buyer the right to have the property inspected by a professional inspector. The buyer must order the inspection within a specified time period after the purchase agreement is signed by all of the parties. If the inspection report reveals defects, the buyer can give the sellers written notice of termination of the purchase agreement or of a request for repairs within a specified number of days after receipt of the report. The seller may request up to an additional 30 days to address the defects. The buyer may not terminate the purchase agreement during that additional 30 days but may terminate within 10 days after the seller’s response if the seller fails to cure the defects. If the seller complies with all of the buyer’s requests or the time period for doing so has expired, the buyer must proceed to close no later than the "closing date," which is the date specified in the purchase agreement.
Zoning Approval Contingency
Another common contingency is the zoning approval contingency. Commercial properties are often subject to local zoning regulations that require a site plan application, special permit, site plan modification, zoning map amendment, or other actions prior to development. If the buyer is unable to obtain zoning approval, they can terminate the purchase agreement.
Building Permit Contingency
A less common contingency is the building permit contingency. This contingency does not apply if there are no changes planned for the property that would require a building permit. However, if the buyer plans any alterations that will require a building permit, the permit contingency will be important because it protects the buyer from having to close if the local building department denies the permit application or imposes unreasonable conditions on the issuance of the permit.
A purchaser should not complete a real estate transaction without a contingency that addresses each of these risks.
The role of due diligence in contracts of purchase
Due diligence refers to the research that a buyer must complete before signing the purchase contract. Along with the third-party inspection and appraisal, this process extends the time period in which the buyer can negotiate with the seller and move forward with the purchase. Due diligence is critical for any commercial property buyer. The due diligence period lasts a specific number of days. This information should be included in the purchase contract, along with other important points like the deadline for obtaining the contingency release. During this time, the buyer has an opportunity to inspect the property and research the market to determine if the current listing price is appropriate. These tasks are done as part of the due diligence process. The buyer should also put together a SWOT analysis during this period. SWOT stands for strengths, weaknesses, opportunities and threats. A buyer should note all the positives and negatives of the potential purchase, then do the same for the missed opportunities and threats to the property. After this, the buyer uses the information he or she has obtained to determine the most appropriate purchase price. The buyer should have the seller sign a contingency release form, as specified in the purchase contract, if the buyer decides not to purchase the property after all.
Negotiating a purchase contract for commercial property
The process of negotiating the terms of a commercial property purchase contract is often critical in determining the ultimate success or failure of the transaction. Although many of the terms of a commercial property purchase contract are boilerplate "legalese" phrases, there is often room for negotiation between the parties, and careful attention should be paid to identifying and addressing those provisions in order to achieve the best possible outcome for you as the purchaser. Key areas of focus for negotiation may include the following:
•Loan Contingency Clause
A loan contingency clause protects the purchaser in the event that the purchaser is unable to obtain favorable financing terms within a specified period of time, and can "buy time" by extending the inspection and contingency periods (see below). To be especially protective, the loan contingency clause should be carefully crafted to provide that if the purchaser recommends a financial institution which it has historically always done business with, and the financial institution cannot provide financing in a certain period of time (such as 45 days), then the seller must cooperate with the purchaser in obtaining financing.
It is not uncommon for the seller to simply refuse to cooperate or provide any financial statement information, etc., in response to a request for approval of the proposed financing.
•Inspection Contingency Clause
An inspection contingency clause allows the purchaser to conduct due diligence regarding the condition of the property, and allows the purchaser a specified period of time, typically 30 or 60 days, to complete all inspections and to provide the seller with noticed of any objections it may have.
While a seller will often not object to a general inspection contingency clause, a seller often may not be so agreeable to a seller’s request for a specific inspection due to the costs and time involved . It may be appropriate to discuss the need for specific inspections with the seller, particularly if there are certain issues where the seller may not have sufficient disclosure or record-keeping of material conditions at the property (for example, environmental conditions, historic use, seismic disclosures, etc.).
Another potential negotiating point is providing the purchaser with the right to extend the closing for failing to timely close due to the purchaser not being able to timely complete inspections or resolve financing contingencies – a provision that can be required in order to ensure the parties close the transaction. Without such protection, the seller may become frustrated after providing you with an extension of time, and simply refuse to close despite having identified no issue with the property, your financing, etc.
•Earnest Money
The additional terms of the contract that are often ripe for negotiation include whether the purchaser is required to deposit additional earnest money and/or non-refundable earnest money at certain stages of the transaction (for example, when completing an inspection, securing financing, etc.). Although the market is currently largely in the purchaser’s favor, requiring additional earnest money deposits and contingencies to drop off can strengthen the chances that the seller will close, and may result in the purchaser being able to secure the property without over-zealous terms.
As indicated, the above contract terms are typically the most commonly negotiated in a commercial property purchase contract. It is also important to be aware that the seller may not be equally as interested in negotiating other provisions, including contract provisions where the seller has little negotiating power (such as establishing whether the title company will issue an ALTA policy).
Important legal issues and traps in a purchase contract
When engaged in the process of buying or selling commercial real estate, it is crucial to understand the legal considerations that must play a part in drafting or signing an agreement of purchase and sale. For some, the tendency may be to consider a purchase and sale agreement a document that is rather straightforward — merely setting out a simple offer and acceptance along with the price.
The truth is a commercial property purchase contract is a complex document and a legally binding agreement — one in which there’s room for potential complications down the road if specific issues aren’t addressed effectively. For this reason, it’s in the best interests of buyers and sellers alike to consult an experienced business lawyer before signing on the dotted line.
Some examples of overlooked or misunderstood legal considerations include the following:
Who Drafts the Commercial Property Purchase Contract You may think a seller has a legal obligation to draft the agreement, but this is not true. The seller may have a real estate agent who draws up a draft or you could put together one yourself. In the end, however, the specific terms are still largely up to negotiation.
Contingency Period & Due Diligence While there is no standard timeframe for the contingency period — the time between making an offer and obtaining a purchase and sale agreement — there needs to be a due diligence period included in written form and signed by both parties after the offer and acceptance are made. This period gives a buyer time to perform inspections and background research on the property.
Subject to Clauses A subject to clause allows offers to be made based on conditions such as a buyer needing an "out" from the agreement if, for example, they are unable to pay for the purchase of the commercial real estate. Many businesses are unwilling to go above and beyond to investigate a property if there is a high likelihood they will be walking away from the deal anyway. For this and other reasons, it’s important to ensure that an appropriate subject to clause is included.
Warranties and Representations Failure to understand a warranty could result in costly consequences. For example, it’s possible for a buyer to be held liable for aspects of a property beyond the sale price if they are involved in the development of a portion of the property and an environmental liability is discovered. This is why having a business lawyer is your best chance of figuring out which warranties are important and how they apply.
In conclusion, signing a commercial real estate agreement of purchase and sale is not something that should be taken lightly. It’s vital to ensure that all bases are covered and that you’re protected in the event of an untimely complication.
The process of closing a contract to purchase
At the closing of a commercial property purchase contract, the attorney will finalize the documents, including a title plan and search, the copies of permissions and approvals and the mortgage deed or other security deed supporting the purchase. The seller delivers the completed deed and the buyer provides full payment. The attorney will pay off any existing mortgages on the property from the consideration paid by the purchaser. The entire amount then passes to the seller. If there is a charge over the property taken by the purchaser, the purchaser will pay the fee to register the charge with the Land Registry and Registration of Deeds Office. Any deficiency in the proceeds will be made up from the purchaser’s own funds.
Documents will include a note of the prices of the goods and services supplied by the lawyer, which are reimbursed by the purchaser, stamp duty on the transfer (which is currently 1% of the total), a stamp duty on the mortgage deed of €12.50, an adjudication fee due to the Revenue Commissioners on the balance of the consideration paid by the purchaser or the debtor, with the register’s fee for registering the change of ownership on the title. The stamp duty paid on the mortgage deed is borne by the purchaser alone. Following all of these payments, the attorney will register the change in ownership with the Land Registry, and the mortgage. If the Land Registry is closed, the closing may be held on a Friday to permit entries to be made on the Monday so as to identify any risks in the property that the purchaser should know about.
The final step is to take possession of the keys to the new property. In commercial transactions, the keys are usually received along with an inspection of the works completed on the property, and the agreement on the key plan to confirm the precise premises to be taken over.
The need for professional legal help
The stakes in a commercial property transaction is much higher than in a consumer sale. This is because almost invariably, the buyer of a commercial property will be a sophisticated entity such as a corporation or a limited liability company. Thus, there is far more at risk when closing a commercial real estate deal, and the stakes are naturally much higher for any failure to consummate the purchase.
For this reason, it is extremely important to hire an attorney who has experience in commercial real estate purchases in your state. An attorney who does not understand commercial real estate transactions will not be able to despite any issues in the contract . Lawyers who are used to residential transactions or even inexperienced lawyers who are dealing with their first commercial transaction may have far less experience in handling issues which arise in a typical commercial real estate purchase contract than real estate attorneys who specialize in commercial.
If the seller is selling a commercial property, its lawyer will want to ensure that its provisions of an indemnity to the buyer and any lenders for any issues would arise post closing, in the event of the transaction closes.
Without appropriate professional assistance, buyers and sellers could have substantial risks and liabilities which they may not even be aware of.