In a buyer beware situation, good legal counsel can put out fires before they start
In a buyer beware situation, good legal counsel can put out fires before they start
onald M. Pepe, a Scarinci Hollenbeck partner and chair of the commercial real estate practice, recently saved a client from an explosive situation. Literally. “I was handling a purchase, joint venture transaction and approvals on an environmentally challenging, multi-family site in Jersey City,” he said. “Our client took all of the standard precautions, having a Phase I and Phase II environmental investigation performed, hiring a Licensed Site Remediation Specialist, and developing a Remedial Action Workplan. They went so far as to bid the cleanup before closing — basically everything the textbooks say to do on diligence and more.”
But there was a hidden and potentially deadly surprise once the site work started: “The excavation contractor dug up pockets of white phosphorous that burst into flames when the particles hit the air; and the ground was literally on fire,” he recalled. “I’m told it was likely the result of the property having previously been used to make incendiary bombs during WWII. The additional cost was over $1 million.”
Commercial and industrial real estate deals often involve big bucks and complex issues — and they can be particularly tricky in New Jersey, which has an outsized share of environmental and other issues. That’s why it can be a good idea to call in the lawyers early on.
Fortunately for the client, Pepe had advised shelling out a few more dollars for a Pollution Limited Liability insurance policy that picked up the cost of the previously undiscovered hazard. “The best advice I could give to any developer is that sometimes there are no measures you can take to prevent apparent catastrophe,” he said. “But if you surround yourself with the right legal and other professionals and call on their collective experience, you may be able to mitigate the fallout from the unexpected.”
Most real estate transactions aren’t that dramatic. But a good real estate attorney can help to “uncover any skeletons early on,” according to Brach Eichler Member Allen Popowitz. “In one case, we represented a buyer in a five-property commercial portfolio transaction where the seller wanted us to take the property ‘as is’ and was not willing to cure any open violations at the property. So instead of negotiating the violations section, we knew the municipality required a certificate of continued occupancy to be obtained on any transfer and required the seller to deliver the certificate.”
That doesn’t sound exciting. But the thing is, to get the certificate the seller had to let in inspectors from each municipality. “And they turned up a laundry list of fire violations in two of the five properties,” Popowitz explained. “The deal went through, but the seller had to clean up the violations, which ended up saving our client a lot of money. That illustrates the importance of having an experienced attorney who can help negotiate a good contract.”
Sometimes an attorney has to convince a client to do the right thing. Almost every commercial or industrial property “has some environmental issue associated with it,” according to Craig W. Alexander, a partner in the Real Estate group at Mandelbaum Salsburg. “I represented a buyer whose lender, oddly enough, was not requiring an environmental investigation of the industrial property and relied instead on an environmental questionnaire. When I suggested at least having a phase 1 environmental assessment, my client resisted, noting that the bank wasn’t pushing for it. But I convinced him to do so and the environmental consultant discovered an underground tank. That led to further negotiations with the seller, who paid for the removal of the tank. Fortunately, there was no contamination and the deal went through. A commercial real estate attorney should have the working knowledge to draft a contract, and should also know when to bring in specialists, including land-use, tax lawyers, and others.”
Buyers aren’t the only ones who need a good lawyer — sellers should also consult with counsel when negotiating the terms of a contract of sale, advised Porzio, Bromberg & Newman Real Estate Principal Carmen Andrade.
“In a best-case scenario, a seller doesn’t retain any obligations after it delivers the deed to the property on the date of closing,” she said. “But that doesn’t always happen. A seller’s attorney should negotiate in the contract of sale that no seller representations or warranties survive beyond the closing date. You also want to try to get the buyer to release the seller from any obligations that arise with respect to the property from post-closing discoveries, including environmental contamination. On occasion I have negotiated contracts where the buyer agrees to indemnify the seller if a third party pursues the seller for matters that arise after the closing with respect to the property.”
Unexpected issues can also pop up in the middle of a pending transaction. That happened to John Suwatson — counsel at Genova Burns and a member of the firm’s commercial real estate & redevelopment practice group — when a municipality changed its affordable housing requirements for a new development.
“Recently, a client signed a contract and was seeking governmental approvals for a multifamily development site — but then the municipality suddenly enhanced its affordable housing requirements in a way that weakened the financial viability of the deal,” he said. “Fortunately, we had included ‘protective approvals contingency’ language in the contract that gave our client the option to terminate without penalty in such an event. We did try to renegotiate the purchase price with the seller, but when that failed our client was able to simply walk away without liability.”
Thanks to the pandemic, indoor environmental concerns have taken on added importance, said Karl Frederic, a Windels Marx partner who focuses on real estate development, leasing, construction and related workout and litigation matters.
“A seller may consider paying for an indoor air quality study that will focus on issues related to a property’s ventilation and air circulation system,” he said. “It’s part of the due diligence process to that will help remove a significant potential surprise that could affect negotiations.”
Generally, “we recommend that a client selling a commercial property perform a title search and review an updated property survey,” added. “That there are no surprises that need to be addressed when a buyer performs due diligence; in the post-pandemic world, the performance of a building’s air handling system and the ability to use the highest levels of filtration become a concern for a buyer so that gets added to the pre-sale checklist.”
The first line of defense, however, is “knowing who you’re dealing with,” added Frederic. “When a commercial real estate client is running an auction-type sale, we often run a litigation search on potential buyers to identify ones who use litigation as a routine business practice to delay closing or gain leverage.”
The complexity of commercial real estate deals can throw a wrench into negotiations. That was illustrated in a transaction handled by Ivette P. Alvarado, a partner in the Real Estate Department of Sills Cummis & Gross P.C. in Newark and president of the nonprofit networking organization Commercial Real Estate Women, Inc. New Jersey or CREW NJ.
“The vital importance of due diligence was demonstrated when I represented a longtime commercial tenant who was operating a warehouse-distribution center, and had the opportunity to purchase the property from the landlord,” she recalled. “We entered into a contract that identified the site as including a building, a loading dock and a large parking area that occupied a large portion of the site. But you can imagine our surprise when we ordered a title search and discovered that the parking area was not actually owned by the seller — instead, an adjacent site owner had title to it and had granted an easement to the seller. Worse, the easement specified that it would be extinguished upon the sale of the property.”
Armed with that knowledge, Alvarado helped her client to reduce the purchase price, and separately negotiated a purchase of the parking area from the rightful owner. “This was a huge issue that delayed the closing,” she said. “And of course in these deals, time is money.”
In some cases, an attorney has to be a detective and a businessman. “In any real estate transaction, information is key, particularly for a commercial deal,” according to Mitchell S. Berkey, a member of Chiesa Shahinian & Giantomasi and chair of the firm’s Real Estate, Development & Land Use Group. “In New Jersey, environmental information is one of the paramount elements. “Even if a seller makes representations and warranties, it’s essential for a buyer to be prudent and conduct his or her own due diligence. You don’t want a major surprise post-closing.”
A Phase 1 Environmental report performed by an environmental consultant is just the start, he said. “Beyond that, a prudent New Jersey buyer should have its consultant expand that report to constitute a Preliminary Assessment to afford the buyer certain legal protections. Title review by a qualified title insurance company is also essential to determine if any easements or other restrictions exist that might impact the buyer’s plans to use and operate the property.”
A buyer should also confirm the rental stream it is counting on as the basis for its purchase price, he added, noting that requires examining commercial tenant leases, and confirming through seller representations and tenant estoppel certificates that the leases are free from default and rent is being paid.
Many lawyers can draft a contract and are familiar with the technical elements of a closing. “But a good lawyer understands the real estate business,” added Berkey, who used to manage properties and hire lawyers. “They’ll also understand their clients’ goals and have the ability to go beyond strictly legal issues, and understand how all the elements are related.”