Chapter 7 Land Surveys and Other Due Diligence

• Library: Practical Guide to Commercial Real Estate in South Carolina (SCBar) (2024 Ed.)

Chapter 7 Land Surveys and Other Due Diligence¹

Brett David Budlong

A. What We Talk About When We Talk About Due Diligence

In the context of commercial real estate, "due diligence" is the process conducted prior to the closing, whether by the potential purchaser, lessee or lender, whereby the party conducts various investigations of real property to determine its suitability for an intended purpose. In the context of the potential acquisition of commercial real estate, this process is typically conducted after the execution of a purchase and sale agreement but prior to the closing. In the majority of commercial real estate contracts, the prospective purchaser is afforded some period of time, often called an "inspection period," "feasibility period" or "due diligence period," during which it and its consultants and counsel obtain, assess, and evaluate various available factual information pertinent to the real estate that the client proposes to acquire, develop, lease, or use as security for a loan. Typically, the purchaser has made an earnest money deposit under its purchase agreement, and has the right to terminate that contract prior to the expiration of the due diligence period and be refunded that deposit, if the results of its investigations are unsatisfactory. If the purchaser elects to proceed to closing, it declines to exercise its termination rights before the expiration of that period, and usually its earnest money deposit becomes non-refundable except under limited circumstances. The due diligence process under a commercial real estate transaction is often much more detailed then what would be typical of a residential real estate transaction.

The due diligence process affords a buyer the opportunity to evaluate the suitability of a particular property before the buyer is obligated to consummate the acquisition of that property. It also helps the buyer (and its lender) assess the degree of risk associated with the property. Those risks can arise in different forms:

1. Matters involving the title to the property and its physical condition, as shown on a land survey;

2. Compliance with applicable laws and regulations (whether involving the property in its current condition, or as the purchaser proposes to develop it); or

3. Development, construction, and engineering issues with respect to existing or contemplated improvements (e.g., soil quality, availability of necessary utilities, construction conditions).

During the due diligence process, factual information should be compiled from a variety of sources. Some investigations (e.g., procuring insurance, analyzing service contracts) are more appropriately spearheaded by the purchaser itself, while others (such as review of title and survey) require the attorney to bear primary responsibility. Once the various due diligence materials are assembled, counsel is expected to analyze the information to assess the client's potential legal liabilities and risks. This facilitates the purchaser determination on whether to proceed with the acquisition and if so, how best to structure the transaction.

In an acquisition, particularly when the purchaser intends to develop the property and construct buildings and/or other structures thereon, the client may have begun its due diligence prior to engaging counsel. Often "core" due diligence materials (e.g., copies of existing title insurance policies, surveys, environmental and geotechnical reports, rent rolls, accounting records, and existing leases for income-producing properties) are included among marketing materials offered by the seller and serve to give the buyer and counsel a head start on their investigations. However, at whatever point the buyer engages its counsel and charges the attorney with responsibility for commissioning and analyzing due diligence reports, the attorney should be ready to coordinate with the client, and with the various third parties needed to prepare or obtain the necessary reports or information, in order to help the client make an informed assessment of the possible risks associated with the proposed transaction. The real estate attorney should be prepared to quarterback the due diligence process from the outset, even when delegation of checklist items is appropriate, so there is no confusion about who is responsible for obtaining a particular item.

Most typically, a project is financed through a mixture of outside debt (whether via traditional bank, or otherwise) and equity funding (ranging from friends and family, to institutional equity providers, and even now "crowdsourced" funding). In the event the purchaser is financing the acquisition, the lender or investor in this scenario will likely have their own idea of what information should be obtained and analyzed during the due diligence process. The funding parties (and their attorney) must be satisfied with the condition of the real estate and the development plans of its borrower. It wants to feel comfortable with its borrower's prospects for success with the acquisition and development, which typically serves as the primary source of repayment of the loan, but also needs to be mindful of the possibility that it may become the owner (or controlling party) of the real property in the unfortunate event of a foreclosure or similar default. Lenders and their attorneys will typically review the reports and materials obtained by the purchaser, and often will have various pre-closing conditions outlined in the respective funding term sheet or commitment letter that the purchaser and its attorney must satisfy with respect to the assessment of the property. The borrower's attorney must be prepared to address the various issues raised by the opposing counsel during the due diligence period in a manner that is satisfactory to the lender's counsel. As a result, commonly borrower's counsel is actively involved in the due diligence process with counsel representing the funding sources, and often work in tandem to satisfy their respective clients' concerns about the information derived through these diligence investigations, or in the event such concerns cannot be adequately satisfied, then working through a solution to get everyone to the closing table by agreeing to how any risks will be allocated and/or mitigated.

B. Scope of Due Diligence and the Role of Counsel

The due diligence process varies depending on the nature of the property to be purchased or leased. In virtually all cases, title of the property will need to be evaluated and, almost as often, a survey of the property should be reviewed. Improved property such as office buildings and shopping centers may be subject to various leases that must be analyzed. The buyer's attorney will also want to investigate and determine whether the property is in compliance with applicable laws, including environmental and zoning laws.

The scope of the due diligence required in a commercial real estate transaction depends on a variety of factors, including:

1. The type, nature, or characteristics of the real estate, including whether it is improved property (and if so, the type of operations conducted), and whether it is subject to one or more leases to third parties.

2. The intended use of the property by the client (for example, whether the building on the property violates any zoning setback requirements may not matter to a purchaser who intends to demolish the structure and redevelop the site, or the presence of overlay districts may be material to the potential use of the property).

3. The length of the buyer's due diligence period and the deadline by which closing must occur, as established by the underlying purchaser and sale agreement.

4. The cost of performing due diligence and the expectations of the client.

The responsibilities of buyer's counsel can vary during the due diligence process, depending on the nature of the transaction and the client. At the very beginning of the due diligence process, the parties should verify their responsibilities and the real estate lawyer should manage that process. Communication among the various parties is essential, and the lawyer's focus at the beginning of the due diligence process should be to counsel the client on what investigations are needed, and who is charged with conducting or obtaining the necessary information. The lawyer should work to implement and monitor the process in a timely, well-organized, and cost-effective manner. This includes allocating responsibilities among the lawyers and non-lawyers. For example, will the client order the survey? Who is responsible for obtaining a zoning letter? Are there certain permits or reports or other items which will require a particularly long time to obtain?

Typically, the real estate lawyer will prepare a closing checklist to guide the due diligence process and circulate it among the purchaser and its various representatives. At the conclusion of this chapter, a basic checklist of items that a practitioner may find useful in organizing the due diligence process is attached. Due diligence checklists, like any checklists, must be tailored to the type of transaction involved, to the client's demands and budget, and to the nature of the client itself. Is the client a sophisticated real estate development company with in-house capabilities to review and abstract leases, investigate utility availability, and obtain an updated survey? Or is the client a small business that wants to relocate to a new facility but whose expertise lies in areas other than real estate development? Once the lawyer and client have worked together over a series of similar transactions, they may develop a history that helps the attorney anticipate the client's needs and expectations. Until then, however, the lawyer should start a dialogue with the client early on about what due diligence is needed and who will be responsible for obtaining and analyzing necessary materials. Open communication is essential.

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