Overcoming Fear – Representations A Seller Should Give – Part 2

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Building on the excitement generated by last week’s blog posting (to see it again or for the first time, click: HERE), we “Press on Regardless.” [“POR,” as we know it – ask us, see HERE]. Briefly summarized, we think a property seller should make representations in the purchase agreement as part of its answers to what would be reasonable and appropriate due diligence questions from the buyer. For a more thoughtful, though not necessarily commanding, explanation read through today’s posting until its putative end, and we’ll try to do a “wrap-up.”

Extending the list we started last week, here are some additional representations we suggest a buyer might ask for and a seller should deliver:

No party or entity has any rights of possession or oc­cupancy to the Property except for the persons occupying un­der the Leases. Seller will promptly provide Purchaser with a copy of any notice of default received from any tenant be­tween the date hereof and the Closing[, and Seller will cure any landlord default prior to the date of Closing]. No tenant has subleased all or any part of its space nor as­signed its Lease and each tenant is in possession; Seller has the sole right to collect the rents under the Leases and there are no collateral assignments of rents to anyone.

As with a number of other examples suggested last week and below, this is information that would otherwise be difficult for a buyer to obtain. Yes, there will be tenant estoppel certificates (though not necessarily from every tenant), but those come too late in the game. Even if a buyer queried every tenant and personally visited every leased space, it wouldn’t know what the seller knew and thus wouldn’t know the “facts.” The text bookended by “[” and “]” probably doesn’t belong here, but should be elsewhere in the purchase agreement in that form or in some more specifically negotiated form.

No prepaid rent [other than rent prepaid no more than one (1) month in advance pursuant to the terms of the relevant Leases] has been collected.

This suggested representation presents a situation similar to what the first representation presented. It asks something that cannot be learned other than by asking the landlord or the tenant and where the landlord is the immediately available “single point” source. An alternative way to get this information at the outset of the transaction would be calling for a well-designed certified rent roll to be attached to the purchase agreement or delivered quickly after the agreement is executed.

Except as disclosed on a Schedule to this Agreement, Seller has no knowledge or notice of: (i) any intention of any tenant of the Property under any of the Leases to va­cate, prior to the termination of the Lease of such tenant, the Property leased by such tenant; (ii) any right of offset against rent claimed by any tenant of the Property; or (iii) any assertion by any tenant of the Property of rights to im­provements not made or options not disclosed.

We’re not sure why this frightens sellers other than they probably didn’t yet think about these questions (unless the answer to any one of them is, “Yes”). If the answer is, “Yes, we are aware (have knowledge) of a tenant intending to bail out early,” then the fear must be that the buyer will “find out.” But, if this wasn’t in the purchase agreement and the buyer asked these questions later, what would the seller say and be honest in its reply? It could tell what it knows or it could stonewall. If it stonewalls, the buyer can assume that the answer would not have been in favor of a “good thing.” Short of the buyer tracking down each tenant’s decision maker, how would the buyer know about these things, each of which goes to the value of the property?

Seller does not have any knowledge or notice of any public request, plans or proposals for changes in road grade, access or other municipal improvements that may af­fect the Property or result in a tax, levy or assessment against the Property.

We could gild the lily or further “pad” today’s blog by not referring you to our comment just above this particular suggested representation. We won’t.

Seller has no knowledge or notice of any existing or intended use of any adjacent or nearby real property which would adversely affect the use or value of the Premises.

Ditto.

Seller has no knowledge or notice of any existing or intended use of any adjacent or nearby real property which would adversely affect the use or value of the Property.

Déjà vu all over again.

To the best of Seller’s knowledge, there are no pol­lutants, contaminants or other substances, hazardous or otherwise, on or beneath the surface of the Property which Seller or any other person or entity has placed or caused or allowed to be placed upon or beneath the Property, which are or may be on or beneath the Property in violation of any law or regulations of any local, state or federal government or agency thereof, or which are or may be a nuisance or health hazard or threat to occupants, invitees, permittees or licensees of the Property or other residents of the sur­rounding area.

This is the single requested representation that most strikes fear in the hearts of men. Keep in mind, however, the Japanese proverb that roughly translates to: “Fear is only as deep as the mind allows” or abide by Thomas Jefferson’s words: “There is not a truth existing which I fear or would wish unknown to the whole world.” After all, as Robin Williams’s character in One Hour Photo recited: “The things which we fear the most in life have already happened to us.”

This is NOT a representation that none of these “bad” things exist or existed. It only goes to what the seller knows. [For Ruminations’ thoughts on the levels of knowledge or awareness often called for in representations, click: HERE.] If there is a reasonable place for a seller to express reasonable concern, it would be revealed by asking, “How would I know what would constitute a “nuisance or health hazard or threat”? The outcome (rightfully) depends on bargaining power.

There are no mechanics’, materialmen’s, construction or similar claims or liens presently claimed or which will be claimed against the Property for work performed or commenced prior to the date hereof or prior to the date of Closing.

The crux of this suggested representation is not whether there are any liens of public record. It is whether there might be any down the road. Not all contractors, subcontractors or material suppliers are listed in the Yellow Pages. So, even the most diligent buyer wouldn’t be able to contact every potential claimant and ask, “Are you?”

We promised readers a wrap up. After all, as Virginia Woolf wrote, “The first duty of a lecturer is to hand you[,] after an hour’s discourse[,] a nugget of pure truth to wrap up between the pages of your notebooks and keep on the mantelpiece forever.”

There is more than one reason to ask for a representation. One, and not the one we’ve been exploiting this week and last week, is to get, in effect, a guaranty from the representing party. Those representations aren’t based on knowledge. They are like: “Seller represents that the engine will start when you turn the key.” It doesn’t matter whether the seller knew it would start or hoped it would start or if it previously started each and every time. All that matters is if the car doesn’t start upon turning the key, the buyer will have recourse against its seller.

In contrast, if the representation is that, “Seller has never received written notice from the municipality that the property’s use was not permitted under zoning laws,” the seller isn’t liable if those laws are being transgressed, only if it had received a notice to that effect and said it hadn’t. Basically, this type of representation is about receiving notices, not the property itself. That’s a key distinction.

Most of our suggested representations seem like a pretty simple question – “Do you know [such and such]?” Either you do or you don’t. If the representing party has an issue with “knowing,” it should explain why. In almost all cases it is afraid that it doesn’t know, but might or should have known. Almost all of those cases can be covered by stipulating that the representation is being given “without any duty to investigate.”

Property sellers are expected to keep business records “in the ordinary course of business.” If the records have been inconsistently maintained or if there was a “fire,” then say so. Explain, in the representation that the records may be incomplete because [reason], but you have no present recollection of having received any notices, etc. Buyers are not asking sellers to guaranty anything about the property in this kind of representation (the “due diligence” kind), just to have the benefit of what the seller knows about specific items.

In that regard, we’ll return to what was written at the very beginning of last week’s blog posting, though somewhat differently. Sellers are in the center of whatever affects the property. Yes, there are third parties who may have the same information, but in many cases reaching out to them is like herding cats. [Get that image in your head.] Why beat the bushes for information that the seller might have? That doesn’t preclude a buyer from inquiring of others, and failure to do so is a risk that such a buyer would be taking. But, when you’ve got the seller in front of you, it would be irresponsible not to ask the questions inherent in the representations Ruminations has suggested this week and last.

Let’s face it. The real reason sellers don’t want to make representations is that they don’t want to be responsible if the representation turns out to be false. That’s to be expected. After all, why take responsibility for being wrong? There’s a pretty decent answer: because you are being paid a lot of money for the property. You didn’t have to sell it. If a buyer sees a 2015 Lexus LS-460, it can inspect it and compare it to others on the road. Based on that, it can pretty much figure out what to offer as a purchase price. On the other hand, if it were told that inside a locked garage was a 2015 Lexus LS-460 and you can’t see it, what would it offer? It might make an offer, but it would be a “worst scenario” price. If the seller represented that the car had never been in a collision and that there were no scratches or dents, that price offer might be higher. You get the point.

Ruminations recognizes that the market will dictate how much, in any given situation, a seller will need to “disclose” in the purchase agreement. If there have been no offers for two years, a motivated seller might be willing to lay everything bare. If the property hasn’t even been marketed and ten buyers have shown up at the door, well – it’s “auction time – buyer beware.” In the normal situation however, there are a few interested buyers and they all want the same basic package of information.

The representations we’ve suggested could be left out altogether and the questions inherent in them could be posed to the seller as part of the buyer’s due diligence examination. Whether they are in the purchase agreement or asked during the “inspection period,” these are questions that really have to be asked. So, why not ask them up front? After all, if any of the representation can’t be made because they would be untrue, and the buyer won’t buy the property for that reason, why spend everyone’s time and money of contract negotiation, title searches, due diligence, etc.?

We know that the marketplace often lets some types of sellers off the hook. Generally those include sellers who have barely owned a property, such as foreclosing lenders, bankruptcy trustees, flippers, and sellers similarly situated. We’ve already conceded that less is expected when the tenant is buying from the selling-owner of a “sale-leaseback” property, especially a property that was developed by that very tenant. Similarly, a long-term tenant that has been responsible for all aspects of its leased premises might be a little off-base asking its absentee landlord to make representations about the condition of the property. In fact, it probably wouldn’t be allowed to rely on any such representations by the seller-landlord. Even under each of those examples, it isn’t unreasonable to ask, “Have you received any notices?”

Corporate type owners who operate properties for self-use often aver that they really aren’t property managers and thus aren’t organized to “know” about an insignificant property that they barely knew they owned. We would respond, “So, why should the buyer take that risk unless the property cost less than an equivalent property that had been properly monitored?”

In the real world, a/k/a “the marketplace,” these sellers are often allowed to give scant representations. And, it would be disingenuous to deny that even very organized investor-operator-owners are sometimes given a “pass” on making full disclosure (i.e., making the requested representations). Why? Answer: efficiency. Theoretically, there is no reason why any property owner shouldn’t tell what it knows even if the buyer might already know the same thing and more. After all, one can’t rely on a representation if she or he knows something to the contrary. In fact, there are court rulings that don’t allow someone to complain about a (mis)representation if she or he could easily have investigated or inspected.

What does Ruminations mean by “efficiency”? If the seller acquired the property yesterday, how much will it really know? So what if the seller won’t represent whether the property is in a flood zone? That’s something that can be easily found out. If the buyer is going to have the HVAC professionally inspected, how much value is there to the seller’s representation as to its condition? The inspection will be much more informative and once the inspection has been done, it doesn’t matter if the seller misrepresented the HVAC as being in good working condition. The buyer can no longer “rely” on what it knew to be wrong or mistaken.

In the end, the objective is to buy and sell a property, not to negotiate a purchase agreement. Yes, we think sellers should give the suggested representations. We also think that representations asking for information that can be mostly gotten from third parties are less worth pursuing than the ones where the seller is really the “collection point” for that information. Also, there is often as much information in a refusal to give a representation as there is in one that is given, so long as the buyer can figure out whether it is the seller’s negotiator who is unwilling to allow the representation as contrasted to the seller being unwilling to give it. That, of course, leads to another point. Negotiators have a responsibility to know whether the party they represent really doesn’t want to make the representation instead of assuming that it wouldn’t do so. Let’s not raise everyone’s blood pressure and transaction costs protecting a seller from making a representation it is readily willing to make or insisting, on behalf of a buyer, that the seller make a representation that the buyer isn’t particularly interested in. [For example, why insist on a representation zoning laws allow for the current retail use if the building is going to be torn down right away and replaced with a farm?]

Lastly, here is a caveat, one that was offered before and should have been obvious. There are other representations that should be sought in a purchase agreement, but this week and last we’ve only addressed ones that go to the property itself and its actual use. So, by way of example, one might ask for a representation that there are no other persons or entities that hold a superior right to purchase the property.

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Comments

  1. Darth Vader says:

    Great post.

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