Due Diligence

• Author: Gregory M Stein - Michael D Goodwin - Morton P Fisher Jr
• Pages: 137-209

137

CHAPTER 3

Due Diligence

§ 3.01 What Is Due Diligence? Gathering Information,

Reviewing Information, and Addressing Problems

The buyer needs to obtain as much information as it can about the

property before the closing. If the buyer discovers problems after

it signs the purchase agreement but before it closes, the buyer may

have contract remedies against the seller, and it may retain the right

to terminate the purchase agreement without losing its deposit. If

the purchase agreement provides for a study period and the buyer

discovers problems before the expiration of that period, the buyer

enjoys a clear right to terminate the purchase agreement and receive

a refund of its deposit. If the buyer does not discover these same

problems until after the closing, it may be left with remedies that

have little practical value or with no remedies at all. For these

reasons, the prudent buyer will undertake a thorough investigation

of the property—often referred to as the buyer’s “due diligence”—

before the closing so that it can take advantage of these preclosing

options if it needs to.

Chapter 2 emphasized the ways in which the buyer can use the

purchase agreement as a discovery device. The buyer obtains rep-

resentations, warranties, covenants, indemnities, and closing condi-

tions from the seller, thus causing the seller to disclose facts about

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138 CHAPTER 3

the property, including some facts that the seller might not have

volunteered without this prompting. The buyer’s first tool in its due

diligence arsenal is a purchase agreement drafted in a way that trig-

gers seller disclosures.

The buyer’s due diligence does not stop with the execution of

the purchase agreement. The buyer will use any study period and

also the remainder of the period before the closing, known as the

“executory period” or the “due diligence period,” to undertake

further due diligence investigation of the property. In addition to

reviewing the seller’s contractual statements and exhibits and con-

firming their accuracy and acceptability, the buyer should under-

take its own independent investigation of the property. This is the

time when the buyer continues and completes the process of gath-

ering and reviewing information. From this information, the buyer

determines if there are any problems with the property and, if there

are, how to address them.

This chapter discusses the buyer ’s due diligence obligations and

how the buyer meets them. It lists the major issues the buyer must

consider, describes how the buyer can investigate these issues, gives

examples of problems that commonly arise, and illustrates ways of

resolving these problems.

§ 3.02 Due Diligence and the Purchase Agreement

This chapter’s discussion of the buyer ’s due diligence obligations

will, in many ways, mirror the previous chapter’s coverage of the

purchase agreement. This is not surprising, because the purchase

agreement plays a significant part in the buyer’s due diligence

investigation. The purchase agreement takes a prospective approach:

the buyer asks the seller to reveal information about the property,

and the parties agree ahead of time what will happen if this

information proves to be inaccurate. Once the parties sign the

agreement, their emphasis shifts from planning for problems that

may be discovered in the future to investigating and addressing

them now.

The typical buyer knows much less about the property than

the seller does and must learn everything it can before it closes. As

a result of this asymmetry, the buyer bears most of the due dili-

gence burden during the executory period. For this reason, this

chapter will examine due diligence matters mostly from the buyer’s

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Due Diligence 139

perspective, focusing on the responsibilities of the buyer, the buy-

er’s lawyer, and the other professionals working for the buyer. If

the buyer discovers problems during the course of its investigation,

the parties next must attempt to address them in a mutually satis-

factory way, and this chapter will also discuss the resolution of due

diligence issues.

Note that the sequencing of this chapter differs from that of the

previous one. Chapter 2 categorized the provisions in the purchase

agreement by type, beginning with preliminary matters specific to

each sale before shifting to representations, closing conditions, and

miscellaneous other matters. This chapter, in contrast, groups due

diligence matters by their subject matter, on the assumption that

most lawyers will find it more useful to prepare their own check-

lists on a topic-by-topic basis. The chapter begins by discussing title

and survey matters and then turns to lease review and estoppels,

the physical condition of the property, corporate matters, and loan

issues.

§ 3.03 Contract Remedies for Problems Unearthed

during Due Diligence

The executory period is the time during which the buyer is given

the opportunity to uncover due diligence problems. If the buyer

was able to negotiate a fairly protective purchase agreement, it will

provide the buyer with an array of possible responses, and the buyer

will have to choose the one that is most appropriate to any problem

that arises. The buyer’s lawyer should already be thinking about

the legal responses the buyer can make upon discovery of specific

due diligence concerns. The buyer’s legal position will be strongest

if it negotiated for an expansive list of seller representations and

obligations in the purchase agreement and if the buyer enjoys a

wide range of options if it discovers problems about which it was

previously unaware.

Comment: What are the buyer’s options if it discovers problems during

the due diligence period? The seller may have agreed to resolve the prob-

lems the buyer discovers, to resolve them up to a set dollar limit, to

reduce the purchase price, or to compensate the buyer in another way.

More typically, the buyer will have the option to terminate the purchase

agreement and receive a refund of its earnest money.

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