The novel coronavirus/COVID-19 (CV-19) pandemic will mercifully end at some point and commercial real estate transactions will rebound. But the landscape for negotiating and documenting purchase and sale agreements (PSAs) and conducting due diligence may be altered. Whether those changes will be temporary or long term remains to be seen, but what is clear is that at least in the near term "business as usual" will likely not be the norm. This article will highlight various areas that may be affected by the CV-19 crisis in drafting and negotiating PSAs and conducting due diligence.
1. Due Diligence; Title and Survey. A vital component of any due diligence process for the acquisition of commercial real estate involves a physical inspection of the property. The surveyor will need access to the property, the environmental consultant will need to inspect the property, and the building inspector will need to examine the physical structures on, and mechanical systems serving, the property, such as air handling systems. Air quality considerations will likely take on greater importance in an era where air handling systems will be designed to be less likely to promote the spread of airborne viruses. The buyer or its agent will want to interview tenants leasing space at the property or the property manager. The CV-19 experience, focused on social distancing, may influence post-CV-19 due diligence activities. For example, a seller may want assurance that any agent of buyer physically entering the property will not have tested positive for CV-19 or any other highly communicable virus and, while on the property, may require buyer and its agent to maintain a defined distancing from others. Space leases may require some form of social distancing if seller/landlord or its agents enter the leased premises and may place additional limitations on the seller/landlord's activities within the tenant's space more generally due to CV-19 and related concerns. Seller and buyer will need to identify how any form of social distancing will work on elevators, narrow corridors, and other confined areas within the asset. A seller may also require that a buyer and its agent comply with any visitation requirements, such as a requirement to wear a mask, gloves, and other personal protective gear while on the property. Some assets, such as healthcare facilities and assisted-living facilities, may even prohibit access by outsiders during a health emergency.
A related point that PSAs may need to address is whether the due diligence period should be extended if a CV-19-type event occurs during the pendency of due diligence. Government offices may be closed, thereby precluding buyers from inspecting government records that are not on an online, accessible database. Shelter in place orders may limit the ability of buyer and its agents from conducting physical inspections of the property. Buyers may want the due diligence period automatically extended in these circumstances, but sellers will likely insist on an outside date.
Title insurance companies have performed remarkably well, even with courthouses and land record offices closed for personal visits. Much of the title examination work is performed on-line, and many—but certainly not all—land record offices accept electronic filings. Extended closures of land records offices may lead title insurers to narrow the scope of their gap coverage, but lenders and others may resist that approach, and require more expansive affidavits and indemnities from sellers.
Although electronic execution of documents and the validity of electronic signatures have long been recognized, electronic and remote online notarizations may also gain acceptance in light of the desire by some to avoid in-person notarizations and in instances in which in-person notarization is impossible or impractical. At present, about half of the states allow some form of electronic or remote online notarization, but federal legislation (S. 3533) introduced on March 18 seeks to offer a uniform national standard. Known as the "Securing and Enabling Commerce Using Remote and Electronic (SECURE) Notarization Act of 2020," this act would recognize remote online notarizations through a multifactor authentication process. Notably, by Order of the Governor of the State of Maryland, effective as of March 30, 2020, electronic notarizations are expressly permitted in Maryland.
The CV-19 crisis has ushered in an era of greater reliance on the electronic execution of PSAs and other documents. DocuSign and other services allowing the electronic signature of documents highlight the ease of using digital signatures. A PSA's counterpart signature clause should expressly allow this form of document execution. The Electronic Signatures in Global and National Commerce Act of 2000 (the E-Sign Act), a federal law passed in 2000, provides that a signature may not be considered invalid merely because it is electronic and that a contract or record may not be considered invalid merely because it is in electronic form. Similarly, the Uniform Electronic Transactions Act (UETA), adopted by 48 states and the District of Columbia, provides for the validation and recognition of electronic signatures.
2. Seller Representations and Warranties; Survival Period. The CV-19 crisis may lead to the inclusion of certain seller representations and warranties that would not have been the subject of much discussion before the crisis. For instance, the buyer may require a representation and warranty that, to seller's knowledge, no occupants of the building tested positive for coronavirus or any other highly communicable disease (e.g., Ebola). A buyer may be concerned that such a fact may stigmatize the asset if publicly known. A seller, by contrast, may resist this type of provision, since it offers no insight about whether the asset itself has any lingering risk of exposure to the virus in question. A buyer may insist on information as to whether tenants have complained about a building's air handling system.
A buyer may seek a representation and warranty that seller has not sought or received any proceeds from a business interruption insurance claim arising out of the CV-19 crisis affecting the property, nor to seller's knowledge has any tenant sought or received such proceeds with respect to the property.
The representations and warranties for leases may seek confirmation that seller has not granted any rent abatement or rent deferrals to any tenants except as set forth in a detailed schedule attached to the PSA. A distinguishing characteristic of the CV-19 crisis has been the prevalence of tenants seeking rent abatements or deferrals, and a buyer will need to understand the impact of these concessions on the asset's financial performance.
Environmental representations and warranties are typically subject to considerable negotiation. The CV-19 crisis may prompt a buyer to seek a representation and warranty regarding whether seller has taken any remedial action in response to the CV-19 crisis, such as specific cleaning protocols or whether the asset was the subject of an intense cleaning regimen because an occupant tested positive for coronavirus.
The CV-19 crisis may lead a buyer to seek protection if a CV-19 event arises post-closing during the survival period. A buyer may contend that the survival period should be extended for a period equal to the duration of the CV-19 event because buyer may not have had the full opportunity to assess the accuracy of a specific seller representation and warranty. For example, if a government authority issues a shelter in place order or otherwise severely limits or restricts access to an asset, a buyer may be unable to assess the accuracy of a specific representation and warranty, especially those that may affect the physical condition of the asset.
3. Force Majeure Provisions. The CV-19 crisis has highlighted the importance of drafting force majeure provisions that address the unique circumstance presented by a pandemic. Force majeure provisions are purely contractual in nature, and there is no common law right of force majeure. For that reason, PSAs need to include force majeure provisions that will broadly cover CV-19-type events. A force majeure provision addressing pandemic events will need to identify the trigger that will invoke the provision, such as a declaration by the World Health Organization declaring a pandemic or an order issued by the applicable government authority declaring a state of emergency because of a pandemic. The declaration or order will likely identify the duration of the event in question. The force majeure provision should avoid stating that a highly communicable virus constitutes a force majeure, since that concept lacks a reference point or trigger for the provision. The virus must result in a defined, objective consequence. After the profoundly jarring events arising from the CV-19 crisis, parties will undoubtedly focus much energy on crafting this type of provision.
PSAs typically contain provisions providing for an automatic extension of the deadline for performance in instances in which the date for performance falls on a day that is not a "business day." In light of CV-19, and given the difficulty of performance of some business transactions during this pandemic, the concept of a "business day" may be expanded to not only exclude, for instance, days on which banks in the jurisdiction are not open for business, but also days on which any sort of state of emergency or similar moratorium on business activities is in effect. Given the anticipated lag in returning to "business as usual" as the effects of this pandemic subside, PSAs may provide for automatic extensions for a period of days after the lifting of any such moratorium.
4. "As Is" Provisions. Ubiquitous "as is" provisions in PSAs may now include a reference to the presence of any communicable virus or other pathogen on or about the property. It is not unusual to see detailed "as is" provisions dealing with mold and fungus matters, and an extension of this concept to communicable viruses would not be surprising. It is not clear how a prospective buyer will be able to conduct diligence on the presence or absence of any such virus.
5. Estoppel Certificates. Estoppel certificates have a defined shelf life. After a certain period, they become stale and need to be refreshed. An estoppel certificate that a tenant delivered two months ago will likely be of little utility to a buyer and its lender. If the parties extend the closing date, the PSA will need to address whether the seller is obligated to obtain another estoppel certificate from a tenant or, at a minimum, a written acknowledgment from the tenant that the previously delivered estoppel certificate remains unchanged.
6. MAC Considerations. Carefully drafted PSAs contain provisions detailing a buyer's right to terminate the PSA if a material adverse change (MAC) occurs in any of seller's representations or warranties, the closing conditions, or the condition of the property. MAC clauses usually do not define a specific dollar threshold for what constitutes a MAC or identify specific events that would trigger the application of the MAC clause. A drafter will need to assess the interplay, if any, between the MAC clause and a force majeure provision. PSAs may also address whether buyer's obligation to proceed to closing be conditioned upon a minimum percentage of tenants remaining in possession and paying rent.
7. Pre-Closing Covenants. PSAs typically obligate the seller to operate and maintain the property in accordance with its historical practice. The parties may want to be specific that the seller will maintain the property in accordance with certain guidance published by government health authorities, such as cleaning protocols for interior areas of buildings.
Other operational covenants detail the latitude a seller has to enter into new leases and modify existing leases. The CV-19 crisis generated considerable rent abatement and deferral requests, and the operational covenant governing leases should establish the contours of any abatement or deferral that would require buyer's approval.
Another operational covenant deals with expenses incurred to maintain and operate the property. A seller usually agrees not to incur any capital expense or enter into significant, non-cancellable service contracts without buyer's approval. A CV-19 event may cause a seller to direct the existing janitorial service to perform more intensive cleanings—at more expense. Is buyer's consent required in that situation? What if the contract is cancellable without penalty? What if such a cost is a pass-through expense to tenants?
8. Closing Date—Adjournment. If a CV-19 event occurs during the period after the expiration of the due diligence period and before the scheduled closing date, the parties may want the PSA to remain in effect and the closing deferred until the event passes or subsides. The parties will need to identify an outside closing date, and the CV-19 experience shows that a pandemic is not a transitory event that will vanish quickly or with certainty. Both parties may have valid reasons for wanting the right to terminate the PSA if the closing date has not occurred by a date certain. An extension of the closing date will trigger other concerns, such as the risk of estoppel certificates becoming stale and the expiration of lender commitments to fund the purchase price for the acquisition.
9. Time of Essence; External Deadlines. Most PSAs contain a time of the essence provision, meaning that the parties must strictly comply with any time periods prescribed in the PSA. The shadow cast by the CV-19 crisis on time periods in contracts will require parties to make sure the time of the essence provision works in concert with the time provisions specified in the PSA.
One area that may require increased focus is PSAs involving an I.R.C. Section 1031 like-kind exchange or a reverse like-kind exchange. The time periods for executing those transactions are strict and unforgiving. Although the Internal Revenue Service has extended the deadline for the filing of income tax returns, it has not yet issued a pronouncement on whether the CV-19 crisis will extend the applicable time periods.
10. Virtual Negotiations. The CV-19 crisis has led to a boom in the use of video communications in business transactions (e.g., Zoom), which may be one of the long-term lasting legacies of the crisis. The use of this technology has facilitated personal interactions during an elongated period of stress, and it would not be surprising to see continued reliance on this form of communication after the CV-19 crisis passes. Business principals and their counsel have seen the ease with which these communications can be used in transactions, and some may believe that this virtual presence may hark back to the days of in-person negotiation sessions where the parties would sit in a room to negotiate a PSA. This may be the twenty-first century equivalent of in-person twentieth century negotiations. This approach resurrects the atmosphere and dynamics of in-person negotiations and would supplement the often faceless and impersonal exchange of PSA drafts by e-mail.
11. Takings. In response to the acute shortage of hospital beds arising out of the CV-19 crisis, some government authorities may temporarily take privately owned facilities, such as hotels and office buildings, for use as temporary care facilities. Condemnation provisions in PSAs typically focus on permanent takings, but these provisions should also address situations where a government authority may temporarily take all or part of a private property for these types of uses.
Conclusion
The unique challenges presented by the CV-19 crisis have highlighted the need for parties to recalibrate their approach to the negotiation of PSAs and the approaches taken to perform due diligence. Business will not be as usual, at least for the short term. The lasting effects of the CV-19 crisis will unquestionably influence commercial real estate transactions.