With today’s post we begin a new series on important points to watch in commercial real estate purchase and sale agreements. Admittedly, “top ten” countdowns are a little arbitrary, but when our clients send us contracts to review for their interest, whether as buyers or seller, the subjects on this list are always at the forefront. We’ll devote an article to each subject, in no particular rank of importance.
Here’s our “Top Ten”:
- Who are the parties?
- When do we close?
- What’s the property and how good is its title?
- What’s the purchase price and how is it paid?
- What are the transaction expenses and who’s paying them?
- What kind of disclosures or warranties am I making (or receiving) about the property and what happens If they’re false?
- What happens if I can’t close the deal and break the contract?
- How do I assess and limit the risks of owning the property?
- How much work on the property needs to be performed before (or after) closing?
- How do I obtain useful and reliable information about tenants or other parties on the Property?
Let’s begin with Question #1, “Who are the parties”? This is a broad and deceptively simple question to answer. It’s actually two questions: “With whom am I contracting and does he, she, or it have the right to enter into the contract?” and (2) “Will the party that comes to closing of the sale be the same party that signed the contract?” The answers from the seller’s and buyer’s side can mean a big difference in outcome, particularly if the deal goes bad. We’ll address the first question in today’s post and the next soon
From the seller wants to be sure that the buyer, whether individual or business entity, has the power and authority to execute and create a binding contract. If so, then if the buyer can’t close, the seller can take the buyer’s earnest money deposit as liquidated damages or pursue its other remedies under the contract. The buyer wants to be sure the seller has the same power and authority, because the stakes can be even higher from the buyer’s perspective. If an unauthorized seller executes the contract, all of the buyer’s out-of-pocket cost and expenses (which can be substantial, especially in land acquisition for development purposes) are potentially at risk if the seller defaults.
If human individuals are involved in the transaction, the main authority risks are that the seller or buyer is incompetent or a minor (which under Florida law means that he or she hasn’t reached age 18). Such problems are uncommon in commercial transactions and not terribly difficult to spot (unless you are so in love with the deal that you choose to ignore obvious “red flags”).
If a business entity is the buyer or seller, however, the power and authority issues are more complicated. By the way, we find that most principals in real estate investment entities (usually limited liability companies, partnerships, or S corporations) don’t recall what the management and decision-making provisions of their entity organizational documents say. Few entrepreneurs can tell you quickly how many signatures are necessary to enable their business entity to execute an enforceable contract (unless of course they are the only member of the entity). Thus, the ever-present risk is that a party who executes a sales contract on behalf of a business entity will exceed his or her authority – resulting in an immediate defense to enforcement of the contract if a default arises later in the deal.
How do we protect against such authorization problems? In two ways:
1. By simple investigation before the contract is signed. Most states now maintain online business entity records by which to check the entity filing information and a wealth of other data about business entities that are formed by a state filing. Florida maintains an advanced (and generally reliable) website on which such information for corporations, limited liability companies and limited partnerships can be found, including copies of regular annual filings showing the names of the registered principals or officers of such entities. All this information is free-of-charge for online viewing. Thus, in a transaction in which the parties are corporations, for example, each party should review the online list of current officers and directors, according to the latest annual filing for that entity. If the contract is not being executed by a listed officers, a red flag arises and assurances of authority should be required (such as a written action by the directors authorizing the president to sign and perform the contract). See the Florida Division of Corporations search page at http://www.sunbiz.org/search.html
2. By contractual provisions that bind the parties after the contract is signed. The contract itself should contain covenants requiring early delivery of copies of the parties’ entity organization documents for review (such as the articles and by-laws of a corporation or the articles and operating agreement of a limited liability company). Sensitive information can be redacted prior to delivery, since the most important provisions concern the consents or votes necessary to authorize execution of the contract and performance of its terms.
Backstopping such covenants should be representations and warranties confirming the authenticity of such documents when delivered (and the absence of undisclosed modifications that would change their terms). Additional representations and warranties in the contract should confirm that the parties have taken all action necessary to authorize execution and performance of the contract, including the enactment of resolutions or joint consents of the principals authorizing sale of the property. Don’t assume that typical form contracts contain such provisions: many do not.
READ THE ORGANIZATIONAL DOCUMENTS CAREFULLY upon receipt; there are many twists and turns lurking within their pages and reading them carefully will save wasted time and money. Under Florida corporate law, for example, even though the president of a Florida corporation has inherent authority to contract for the sale of the corporation’s property, if the sale consists of “substantially all of the assets” of the corporation, an affirmative vote of the shareholders may be required to validate the contract and obligate the corporation to close the deal. Other entity documents contain high-majority or unanimous consent provisions that must be satisfied in order to create a valid contract for sale of the entity’s real property (partnership and limited liability company documents are notorious for such requirements).
ONE FINAL CAUTION: be especially careful regarding sellers or buyers of real estate that are trusts (of any species) or general partnerships. In Florida, these legal relationships do not require any filing or registration with the Florida Department of State; in effect, they are “secret entities.” Your information about them is only as good as the documents, representations and warranties you receive from the other party to the transaction, so insist on receiving complete copies of the trust or partnership agreements and appropriate representations and warranties in the sales contract. Special rules may apply with respect to so-called Florida land trusts, which are covered by a special statute, so counsel should always be consulted when one is contracting with such a trust, whether as buyer or seller.
NEXT POST: THE SECOND HALF OF QUESTION #1: “Will the party that comes to closing of the sale be the same party that signed the contract?”