Drafting Purchase Contracts: Make Sure Your Due Diligence Period Is Long Enough
A good purchase and sale contract is like a road map for the real estate transaction. It will articulate the business terms clearly and will lay out all of the steps of the transaction in straightforward language. This is important because the parties will continually look back to the contract language for guidance when issues come up during the transaction.
Purpose of the Due Diligence Period
One of the more important provisions in the purchase contract is the due diligence period. This is the time period in which the purchaser has the opportunity to physically examine the property and to review all of the title matters relating to it. The purchaser will review the survey, title commitment, and zoning and will arrange for structural and environmental exams of the property. This also is the time when purchaser finalizes any loans it needs to acquire the property.
It is hard to know all of the issues that will arise for a purchaser during its due diligence review. When buying an office building, reviewing the tenant leases may be the biggest concern. For an industrial or warehouse property, environmental matters, such as an underground tank or a suspicious oil stain on the ground, might be the focus. An urban property may have unique title or survey concerns relating to its immediate neighbors.
Make Sure Enough Time is Built Into Your Due Diligence Period
When negotiating the purchase and sale contract, one of the most important things a purchaser can do is to build enough time into the due diligence period to allow it to complete its entire review. A seller typically may want the period to be 30 days long. A purchaser, however, may need 60, 90, or 120 days to complete its review. For example, environmental Phase I and Phase II reviews can take several weeks, and lenders likely will not commit to lending until the environmental issues are completed.
Too Short a Period Results in Poor Options
If the due diligence review is not completed before the end of the due diligence period, a purchaser will have to either proceed to close or terminate the contract. Both scenarios are bad choices. By terminating a contract, a purchaser could lose the property to another buyer or be forced to renegotiate the contract terms on a worse basis.
If the seller grants an extension to the due diligence period, it may demand that purchaser pay its carrying costs for doing so. This would mean that purchaser might have to deposit additional earnest money or pay a monthly fee to seller for the delay.
Don’t Forget Any Zoning Approvals
One other thing to consider is that purchaser may need to obtain zoning approvals as part of its purchase. These may include a rezoning or a special use approval for purchaser’s intended use. If this is the case, the due diligence period should include a realistic window of time to allow purchaser to secure these approvals.
The time and effort spent on drafting the purchase and sale contract will pay dividends during the transaction. It will be the road map for the deal and will provide guidance for handling the unexpected issues that arise.