Due Diligence

AuthorGregory M Stein - Michael D Goodwin - Morton P Fisher Jr
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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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
§ 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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