Do the Due Diligence: 5 Important Provisions for Purchase Contracts
Many real estate purchase contracts provide for an analysis period after the contract is signed called a due diligence period, study period, or feasibility period. Regardless of the term used, this is a very important time for both the buyer and the seller. During this time, the buyer conducts an in-depth analysis of the condition of the property and the feasibility of purchasing the property while maintaining the right to terminate the contract if this analysis produces unsatisfactory results.
Due diligence is an essential provision in the contract. The terms should be carefully drafted to protect each party’s interest. The following are issues that arise from conflicting seller and buyer interests to address in this contract provision.
The seller has information that the buyer needs to evaluate the purchase. Property records, such as title reports, maintenance records, leases, property studies, violation notices, and financials, should be given to the buyer. The due diligence provision should require the seller to deliver this information to the buyer within a certain number of days from contract execution. Because this information often is prepared by someone other than the seller, the seller will want a provision indicating that it does not warrant the information provided.
The due diligence period should not commence until the seller has delivered all records. There is a current trend where sellers try to get the due diligence period to begin once a letter of intent is signed rather than the contract. This can be dangerous for the buyer, as funds will be spent to evaluate the property before contract protections are in place. Letters of intent usually are nonbinding. The seller could walk away if a contract is not agreed upon and the buyer would spend funds needlessly.
The buyer should ensure that the due diligence provision allows both the buyer and hired consultants to enter the property and conduct studies at reasonable times. The seller will want to receive notice when the buyer enters the property and to limit the extent of studies (e.g., prohibiting the drilling of holes into the ground). In addition, the seller will want the buyer to indemnify the seller for any damages resulting from tests on the property and to carry insurance to cover this indemnity.
The purpose of the due diligence period is to allow the buyer to terminate the contract if the buyer does not wish to make the purchase post-analysis. This termination right must be written carefully. The provision should state that the buyer can terminate for any reason by sending a termination notice before the date and time specified as the end of due diligence. The provision also should state that the termination notice can be sent to the seller via fax or e-mail. Some buyers prefer to draft the agreement so that the buyer affirmatively notifies the seller to the contrary.
As indicated earlier, a buyer expends significant funds during due diligence. If the seller defaults and the buyer’s only options are either to terminate or to sue for specific performance, the buyer will not be able to recover its costs. The default provision in the contract should provide that if the seller defaults, the buyer receives reimbursement for these due diligence costs. A seller may want to put a limitation on the aggregate amount of costs to be reimbursed.
Sometimes the due diligence period is called a “free” look at the property because of the buyer’s termination right. But there is nothing “free” about this period. It is an important time during the purchase/sale process and both the seller and the buyer must ensure that this provision is carefully written.
Ann Marie Mehlert is a real estate attorney at Lerch, Early & Brewer who works with real estate developers, investors, and owners on all aspects of commercial real estate. For more information on purchase contracts, contact Ann Marie at (301) 907-2803 or email@example.com.