Commercial Real Estate Blog

This is the second article of a seven part series I will be writing to help guide commercial real estate buyers through all of the steps involved in the purchase of commercial property.

Every commercial real estate transaction is contingent on a written purchase and sale agreement.  It lays out the foundation of the entire transaction.  If it is done properly then most problems that might come up between the parties will be answered and the deal will continue on to closing.  Almost all commercial real estate contracts are bilateral meaning they are binding on both parties.  If either party fails to perform then that party is subject to the default penalties written into the contract.  Here are the legal requirements needed to create an enforceable contract.

Offer

The contract must state a specific offer to purchase the property.  It must include the purchase price, the time allowed for the transaction to close and any special clauses or conditions that must be met by either of the parties.

Acceptance

Only the person who legally owns or has control of the property may accept the offer.  Be very careful to determine who this party is before executing the contract.  Many times an owner of a property will give a power of attorney to someone else to sign contracts on their behalf.  Have your own attorney review this document carefully.  If it turns out the power of attorney is flawed in any way then you could potentially waste months of time and money working on closing a deal the seller is not legally bound to comply with.  Also, the acceptance must be without making any changes to the contract. If a change is made this constitutes a counter offer and negotiations resume until a final agreement is signed by both parties.

Consideration

Consideration is something of value.  It can be money, property, stocks, etc. It can also be a service or a promise to perform.  If there is no consideration being transferred between the parties then the contract is null and void.

Legality

The contract must be for a legal purpose.  If a contract is written up to transfer a property either illegally or the property itself is an illegal structure then the contract is invalid.

Capacity

All parties to the transaction must be mentally competent and of legal age to enter into the contract for it to be enforceable.  Another form of capacity revolves around corporate entities.  If a corporation is not licensed to do business in a particular state then they “lack the capacity” to enter into contracts in that state.

Writing

All real estate contracts must be in writing as required by the statute of frauds.  All of the terms of the contract must be in writing for it to be valid.  You cannot have some terms written down and others agreed to orally.  Only the parts actually written down will be enforceable.

Form of the Contract

Contrary to popular belief you do not have to use a standardized form when creating a commercial real estate contract.  The form of the contract can be long or short.  It can even be comprised of several documents and letters that, when added together, create a binding contract and satisfy the requirements of the statute of frauds.

Parties

The parties to the contract can be either individuals or any other legal entity.  Be careful when preparing a contract to make sure that all parties necessary to validate the contract execute the documents.  For example if the seller is a corporation and the by-laws of the corporation state that both the CEO and COO of the company must sign a contract for the sale of real property then you need both signatures.  Only having one of them sign will not create a valid contract.  Also when dealing with corporations, determine if a shareholder's agreement is required before the officers can sell the property.  Many companies require a majority vote of the shareholder's in order to enter into a contract.  If this is so have the seller present you with a signed and notarized document stating the shareholders have met and agreed to allow the officers to enter into the contract.

Premises

The actual property being sold must be included in the contract.  The more detailed the description of the property the fewer problems that could arise before closing.  The contract should state the properties postal address as well as the legal description of the property which can be obtained from either a title company or from the last recorded deed of transfer of the property.  The contract should also state what personal or business property is being included in the sale such as office furniture, loading docks, etc.

Deed

The type of deed that will be used to transfer the property should be clearly stated.  The deed which offers the most protection to a buyer is a General Warranty Deed.  In this deed the seller warrants or guarantees to defend the chain of title on the property back to its origination.  The deed which offers the least protection to a buyer is a quit claim deed.  In this document the seller is not warrantying the title in any way and is notifying the buyer they are taking the property “as-is” with all liens and encumbrances associated with the property remaining on the property.

Purchase Price

The total purchase price must be included.  It also is wise to give a breakdown of the purchase price such as “X dollars for the purchase of Building A, Y dollars for the purchase of Building B, Z dollars for the purchase of equipment.”  This way if there is any dispute over the calculation of the overall purchase price it is clearly spelled out in the contract.

Mortgage Contingency

If you will need time to obtain financing on the property before being able to purchase then it is critical you put a mortgage contingency into the contract.  This is a clause which allows you a certain time period (it can be anything but normally 30-60 days) to obtain financing at the terms you state in the contingency, such as $500,000 at 7.25% over 30 years.  If you do not obtain your financing at the terms you stated, or better, during the time period allowed then you and the seller have the option of either extending the time period or canceling the contract with no liability to either party.

Closing

The time and place of closing should be clearly stated in the contract.  If the closing of the contract at a certain time is critical make sure to put the phrase “time is of the essence” into this clause.  This puts the seller on notice that they must close by this date or you have the right to cancel the contract in its entirety.

Title Insurance and Survey

The contract should clearly state what company or attorney will be performing the title search on the property and ordering the survey and any other requirements such as an environmental study.  You always want this to be a neutral third-party to the transaction.  They will hold all of the buyer's down payment funds in escrow and will act as the facilitator of the transaction.  They will determine the chain of title on the property and insure the seller actually owns the property and has the right to transfer it.  They will search the property for any liens or encumbrances and clear them before closing.  They will order the survey and inspect it for accuracy as compared to the legal description of the property.  They will also normally either prepare the closing documents or review the documents prepared by the parties and make sure they are executed property.

Adjustments

The contract should state what items will be adjusted for on the day of closing.  These could be anything from property taxes to water/sewer bills to incoming rent.  It should also state which party will be responsible for what closing costs and if any of them will be split between the parties such as the cost of the survey or title commitment.

Execution

All of the parties necessary to complete the transaction must execute all of the documents and the deed must be transferred from the seller to the buyer in the form stated in the contract.  It is at this point the actual sale of the property is completed.

If you would like to use a pre-made form to prepare your commercial real estate contracts you can find them here.

Don't miss part three of this series where I will be discussing the legal due diligence issues a buyer of commercial real estate must perform. Please leave your questions or comments!

Disclaimer: Nothing stated in this article should be taken as the giving of legal advice.  As always, you should check with a licensed, competent real estate attorney who specializes in your field when unsure of how to proceed.