The Sale & Purchase of Non-Residential Properties – The Term Sheet and Often Missed Due Diligence and Liability Concerns

Written By: Eric D. Dean

Eric D. Dean The Term Sheet is often used in a real estate transaction as a preliminary document that is incidental but not integral to the ultimate transaction because it is usually defined as “non-binding” “confidential” and “preliminary” and “expiring”. However, such a view is for the reasons set forth below, not prudent as often the Term Sheet is integral to the transaction and one of the key contractual documents as the transaction moves towards closing.

A. Should the Term Sheet or Letter of Intent Be Limited and Brief or Complete?

Response:  Often the potential parties will prepare a Term Sheet or Letter of Intent (“Term Sheet”) to  flush out how close they actually are to reaching an understanding as to a transaction and where the areas of dispute are. While the Term Sheet is typically a shorter document than a Purchase and Sale Agreement (“PSA”), it is essential that the Term Sheet be accurate and complete as to defining the potential deal points both because the Term Sheet will usually be looked upon as defining the terms and conditions to be included in the PSA. Further, despite the fact that the Term Sheet is a preliminary document, it still can be argued to be a source of liability.

B. Sources of Potential Liability Evolve Around a Fraud or Concealment Claim

The property owner may argue that the potential buyer negotiated and executed the Term Sheet knowing that the potential buyer could not perform to freeze the property and discourage other possible deals. The potential buyer may argue the reverse, that the Seller engaged in negotiations proposing terms that the Seller actually never intended to agree to or could not perform to cause the potential buyer to pass up on other potential purchases.

Critical Terms in a Term Sheet should include at least bullet points including the following:

  1. A Description of the Property under Discussion and specifically whether personal property, easement, right of way and licenses impacting the property under consideration.
  2. The proposed purchase price and how it is to be paid. If financing is involving the description and amount of the financing and the timeline as to the financing. Reference should also be made as to the amount of the deposit and on what terms it will be non-refundable, and whether it will be released to the seller or held in escrow.
  3. The nature and extent of the due diligence and due diligence period.
  4. An AS IS provision if applicable.
  5. A Confidentiality Clause that survives the termination of the Term Sheet.
  6. A provision that there are no representations made and no liability associated with the Term Sheet and that there is no reliance.
  7. A statement that both parties were represented by brokers and/or counsel.
  8. A time period in which commence of the drafting of the PSA must start and when the PSA must be executed.
  9. Reference to any special conditions.
  10. An integration clause which if properly drafted incorporates all prior discussions and negotiations.

C. How Does the PSA Differ From The Term Sheet

The PSA and Term Sheet focus on essentially the same areas, except the PSA once signed will be a binding document. However, the language is far more detailed and complete.  There are various PSA forms available such as the CAR form. However, these forms may prove to be incomplete, too generic or not accurately reflect the terms and conditions of the transaction in all respects.  If a form is used, the form can in some instances be modified by an addendum that deletes or changes provisions.

D. What Are the Typical Areas Of Litigation Arising From a PSA

The common areas giving rise to disputes as to a PSA Include the following and correspondingly, these are the areas that need to be crafted very carefully:

  1. Deposits: When a deposit becomes non-refundable often leads to disputes between a buyer and a seller of property.  This typically arises around the buyer’s termination of the transaction and demanding the return of its deposit and the seller arguing either that the buyer breached or is otherwise not entitled to the return of its deposit under the express contract terms.  It is essential that the contract termination provisions be very detailed and that general provisions prohibiting binding modifications not documented in writing and that a time is of the essence provision be included in the PSA.
  2. Inaccurate or Incomplete Disclosures. An “AS IS” Provision or Waiver will generally not be a protection against a lawsuit where there has been a material misrepresentation or concealment by the Seller or Seller’s agent nor will the Buyer’s negligence in failing to discover the defect. Thus, the failure to disclose a material fact can constitute actionable fraud to the same degree as making a material misrepresentation. For example, in one suit the author represented a buyer of an apartment complex, the seller new and failed to disclose that the adjoining contiguous property was an operating house of prostitution with seedy men often frequenting the business operation at all hours of the day and night. A lawsuit was filed that resulted in a six figure settlement in favor of the author’s clients.  In another recent suit the author represented a seller that had failed to disclose window and ceiling leaks in various units as well as leaks in a central water heating system.  Even though the buyer exercised its right to inspect the property by a professional inspector, the seller was still forced to settle rather than risk a trial and significant litigation expense. It should be noted that an AS IS provision or even the buyer’s negligence, may not protect against a misrepresentation or concealment claim.  It is therefore extremely important that all possible conditions or potential governmental actions that are under consideration and may affect the property be disclosed by the Seller. For example, in another case, the property was on a hill side. The seller knew the property had risks of a landside based on unstable soils conditions. The seller did not disclose these conditions. The buyer could have but did not investigate soils conditions. After the sale closed the property slid and became essentially valueless. Despite an “AS IS” provision in the PSA and the buyer’s arguable negligence, the buyer recovered a seven figure fraud judgment at trial.
  3. Limitations on Recovery: Many times both the buyer and seller will want to limit their potential liability if they are found to have breached. These limitations may or may not apply if issues of fraud or concealment exist. Limitations may be as to a dollar amount or a category of expense (such as due diligence costs of the seller).

E. Are There Any Areas of Due Diligence That Are Often Overlooked?

There are a few areas of due diligence that the buyer may consider as part of its due diligence:

  1. The Problem Tenant: Rents may be current and at market and problems may still exist as to tenants threatening rent strikes, demanding unreasonable repairs and improvements or filing grievances with governmental agencies, the Better Business Bureau etc. Often this does not become apparent until after closing.
  2. Demographic Changes In the Community: Long term demographics can have a drastic effect on property values and rents.
  3. The Economic Trends: Planned employment, retail, construction, traffic, parking and a host of other future concerns can also have a dramatic impact on rents and market value.
  4. Flexibility In Time: Often a buyer or seller is trapped as the closing date nears by such things as a delay in financing, a cloud on title, a permit or license issue or a delay in repairs being completed. Often these can be resolved by a Post-Closing Agreement where the closing occurs and title is transferred with rights as to the open item reserved. However, just as often, these time issues lead to intense negotiations of adjustments in the deposit provisions, increased deposits or adjustments in the price in order to keep the transaction from being terminated. Provisions can be built into the agreement that allow for extensions in either a general form or as to specific possible areas of delay.
  5. Government Agencies: The views and attitudes of the Planning Commission and other Agencies responsibilities may dramatically affect the viability of a proposed project and its cost and time to complete. For example, certain projects may be desired by the locale government and result in the availability of permit, fee or tax deferments, waivers or rebates. Other situations may be extremely negative and create obstacles and costs.  These factors may include such things as whether the community wants this type of project (ask Walmart), building standards, the view of the community towards outsiders, the time and cost to obtain permits, building and environmental standards, traffic abatement requirements, parking requirements, noise abatement requirements etc.   Simply using an out of locale architect or contractor versus a local consultant may, in the wrong locale, create significant and costly impediments to a project’s viability. These concerns must be explored by the Buyer contemplating a project in a new locale.
  6. Potential Sources of Financing: In some types of areas or related to certain types of projects, governmental financing may be made available on very favorable terms. The other extreme may also exist where financing is either extremely limited or very expensive.

Conclusion 

The importance of the Term Sheet in the real estate purchase and sale project cannot be overstated. As a matter of practicality, it not only sets the tone of the transaction going forward but typically is looked upon as the source of the terms of the Purchase and Sale Agreement. It also will be one of the documents looked upon as defining the intent and expectations of the parties if a dispute arises. In a dispute, the Term Sheet is also often looked upon as evidence of fraud by the Seller and whether there was justifiable reliance by the Buyer.  Therefore, viewing a Term Sheet as an immaterial document because it is generally not binding is unwise. It is also prudent for some level of due diligence to commence during the time the Term Sheet is being negotiated and documented and before the Purchase and Sale Agreement is executed.