You would never buy a used car without first having it thoroughly inspected. Purchasing a piece of real estate should not be any different. The due diligence provisions of an agreement of sale are like taking the used car to your mechanic, a way you can investigate a potential property prior to closing.
I recently gave a presentation called “Real Estate For In-House Counsel: An Examination of Title Issues, Contracts and Negotiations in Real Estate Deals” at the Association of Corporate Counsel (Delaware Valley Chapter)’s 2nd Annual In-House Counsel Conference in Philadelphia, Pennsylvania. My co-panelists were Michael Moyer of Land Services USA, Inc. and Aileen Schwartz of Hill International. The drafting and negotiation of due diligence language in an agreement of sale was one of the main focuses of our seminar.
There are three common areas in an agreement of sale where due diligence is addressed:
- Seller’s representations and warranties,
- Title review and
- Property investigation.
I will address each of those areas over the course of three postings, beginning with this one.
The negotiation of the representations and warranties during the preparation of the Agreement of Sale is essentially the first form of due diligence for the Buyer. Think of it as a kind of discovery. It allows the Buyer to flag issues before the execution of the Agreement.
Here are just a few things to consider as you negotiate the reps and warranties for the Buyer:
- The reps and warranties that Buyer requests from Seller should be as expansive as possible. The Seller’s refusal to provide certain reps, or its inability to give certain reps without qualification, help the Buyer learn more about the property (and whether it wants to continue to pursue the Agreement).
- In PA, reps and warranties will merge into the Deed at closing unless the parties agree that they will survive for a specific period of time after closing. This is known as the “Doctrine of Merger.” It is common for a Buyer to seek a survival period of 6 months to a year at a minimum.
- The Buyer will often require that the Seller execute a Restatement of Representations and Warranties at Closing that also restates the survival period as additional guard against the Doctrine of Merger.
- A Seller will look to limit the scope of its representations by qualifying them as to “Knowledge,” with “Knowledge” being defined as the “actual knowledge, without investigation or inquiry, of [a specific person or persons]”. This helps to prevent the Seller from being imputed to have the knowledge of all of its employees, and also avoids Seller having to expend funds to perform an investigation as to its representations.
The negotiation of the Seller’s representations and warranties is a fantastic (and relatively inexpensive) way for the Buyer to identify issues with the property and to drill down on those items before committing to move forward with the transaction and to perform more in depth and costly analyses. Buyer’s counsel should take full advantage of this opportunity on behalf of their client.