A seller puts its multi-million dollar, multiple-occupant retail shopping center with certain structural and environmental challenges up for sale. The property is offered on the following terms: the seller provides no representations about the asset or its condition; the buyer is given seven days of due diligence to discover the condition of the property; the buyer must make a hefty, non-refundable deposit; and the asset is sold in an as-is condition with disclaimers by the seller for all actual or potential defects. In other words, the seller doesn't tell the buyer the condition of the property, doesn't provide the buyer a reasonable opportunity to discover the condition of the property, and then prevents the buyer from any recourse should a defect be found after the purchase is closed. Common sense would dictate that such a contract would be rejected. But, for over a decade, during the sizzling real estate market, contracts such as this were not uncommon when sellers dictated most, if not all, material terms of a real estate acquisition.
In today's market, however, the number of real estate transactions that make economic sense is dwindling. Fewer buyers are able to obtain adequate financing due to the recent credit crunch. Thus, an imbalance between seller supply and buyer demand now exists in the real estate market. The negotiating pendulum long thought to be stuck at the top of the seller's side is finally returning to an even position. The return of balance due to the changing market should allow buyers to negotiate more favorably certain hot button issues concerning due diligence, deposit, as-is and release provisions, representations and warranties, and seller remedies.
Diligence And Deposit
In the past, sellers were able to negotiate the terms of a purchase contract such that buyers would close transactions without any meaningful diligence. Consequently, too often at the closing table buyers were left wondering: Can this building survive an earthquake? Will the roof hold up after the next significant winter storm? If not, is the property properly zoned so that it can be rebuilt? Rather than feeling insecure, buyers in today's marketplace may see a return to normality with sellers providing a reasonable period to perform diligence on the underlying real estate.
Bargaining for a longer diligence period, however, raises other issues concerning the posting of deposits and the distribution of the purchase price to sellers. It had become commonplace for sellers to require that a portion of the deposit go hard before the expiration of the due diligence period. Today's market suggests that there are a few transactions in which buyers are able to post deposits that are refundable through the due diligence period.
"As Is" And Release
In every purchase agreement, buyers are confronted with seemingly dozens of pages of BOLD TEXT IN ALL CAPITAL LETTERS warning them of everything that is, or could be, wrong with the property. During the last decade, these sections tended to get longer and more comprehensive, with sellers reciting all potential defects in the purchase agreements in order to insulate themselves from the possible recourse of the buyers. The as-is and release provisions were often used to insulate sellers from liability for existing environmental and archaeological discoveries. If it is later discovered that the purchased property rests on top of a waste site filled with hazardous substances or above a Native American burial ground things that might have been discovered with a reasonable due diligence period - buyers are out of luck.
In today's changing market, these provisions may be called into question. Even if buyers are able to squeeze a longer window of diligence out of sellers, buyers cannot be expected to have complete knowledge of a property's deepest and darkest secrets, especially in situations where sellers have owned the property for a substantial period of time. Given the pro-seller environment over the last 10 years, sellers are going to be reluctant to accept such a paradigm shift in the terms of their purchase contracts and will continue to desire to place the diligence risk on buyers. However, it remains to be seen how these provisions will withstand an even greater swing in the market.
Seller Representations And Warranties
Other than informing buyers of their organizational makeup and their authority to enter into a particular transaction, sellers have typically not made any meaningful representations concerning the property or its history. Sellers have been successful in refusing to make worthwhile representations while, at the same time, limiting diligence for buyers. In this changing marketplace, there will be greater push back on sellers to make certain representations and warranties.
Representations from sellers concerning matters that buyers cannot adequately examine through diligence may over time come to the forefront of negotiations between buyers and sellers. Although buyers may not be able to obtain unqualified representations from sellers, buyers may now be able to negotiate for representations concerning information known to the seller. In addition, because buyers do not want to inherit litigation when purchasing real estate, buyers could ask that sellers identify all litigation proceedings involving the property or actions that may lead to future litigation. Lastly, buyers should consider that no matter how successful buyers are in receiving representations from sellers, without a survival period such representations may be meaningless. But, getting such a survival period will continue to be a tough negotiation between buyers and sellers.
Remedies
A real estate contract is essentially nonbinding when a buyer's remedies, due to a seller's default, do not provide for specific performance. Because liquidated damages do not adequately remedy buyers who, at the conclusion of the transaction, want to own the property, specific performance is the only remedy capable of putting the buyer back in the position the buyer would have been in but for the seller default. Furthermore, anything other than specific performance would make it too enticing for sellers to walk away from a binding contract in order to sell the property at a higher price even after the payment of liquidated damages to the first buyer. In today's real estate market, this may not be an issue, so buyers should be able to negotiate specific performance. In the absence of such a provision, buyers may want to pay attention to the liquidated damages figure to create a deterrent for sellers from backing out of contracts for higher purchase prices.
Conclusion
In this ever-changing real estate marketplace, sellers will no longer have the luxury of dictating one-sided, seller-friendly purchase agreements. Instead, as the pendulum swings to its nadir, savvy buyers will now have more ability to maximize value and obtain certainty through negotiating more balanced real estate purchase agreements.
Goodwin Procter LLP is one of the nation's leading law firms, with a team of 700 attorneys and offices in Boston, Los Angeles, New York, San Diego, San Francisco and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.
This article, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP or its attorneys. © 2008 Goodwin Procter LLP. All rights reserved.
