Anatomy of a Real Estate Transaction–Pre-Contract Period

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Merriam-Webster defines “exposition” as “a setting forth of the meaning or purpose.” But in music, an exposition is “the first part of a musical composition … in which the thematic material … is presented.”

In the sonata allegro form frequently used in classical concerti, sonatas, and symphonies, an exposition follows a standard pattern. Frequently, an exposition will have two themes. The first theme is in the key in which the composition is written, which matches the key signature.

After the first theme, the music will modulate (change keys) into another key, frequently the dominant (fifth note in the scale). The second, contrasting, theme is introduced in this secondary key.

Like musical compositions, most real estate transactions share a common pattern. This is the second in a series of articles about the Anatomy of a Real Estate Transaction. This article discusses what happens before the parties sign a real estate purchase contract.

What is the Pre-Contract Period?

In a real estate transaction, the “exposition” is the time when the parties agree on the major purchase and sale terms. Although some may think that the real estate purchase contract (Contract) is the first stage in a real estate transition, the “exposition” usually occurs long before the parties sign a Contract.

The parties’ dealings in a real estate transaction before they sign a contract is the pre-contract period. The pre-contract period consists of everything that happens before the buyer and seller sign a real estate purchase contract (Contract).

At a minimum, this will include negotiation of the purchase and sale terms, such as price and timing of the transactions. In a commercial real estate transaction, the pre-contract period might take weeks or months.

Early Access to Financial Documents

It’s expensive to pay attorneys to negotiate a Contract, and most parties don’t want to spend that money unless they are fairly sure they want to buy the real estate. However, it can be difficult for a buyer to evaluate a property’s value without information about the property’s financial performance. Therefore, sometimes, sellers will share property financial information with prospective buyers before they enter into a Contract.

In other transactions, the seller might share property information with prospective buyers hoping to streamline the Contract negotiations and Due Diligence Inspection Periods. Or, buyers, themselves, may extensively evaluate both financial performance and property condition to assure that the property meets the buyer’s acquisition criteria before even making an offer to purchase the property.

Whenever a seller provides nonpublic information to a prospective buyer, the seller should require a nondisclosure agreement (NDA). Although a Contract usually will include NDA language, when information is provided to the buyer during the Pre-Contract Period, the buyer should sign a standalone NDA.

Early Access to the Property

Sometimes, access to financial and other nonpublic documents isn’t enough to satisfy a prospective buyer. A prospective buyer may want access to the property, itself, to determine if it meets the buyer’s specific needs, such as for a development or renovation project.

Or, when the seller is taking bids from multiple prospective buyers, the seller may want to assure itself that bidders are serious. By requiring that bidders conduct their basic property inspection before making an offer, the seller can require that the buyer waive those inspection items in the Contract. The result can be to severely limit the scope of the due diligence inspection, which will both speed up the transaction and make it more challenging for the buyer to change its mind.

Sellers should require that prospective buyers sign an Access Agreement before entering onto the property. An Access Agreement may include NDA language, but it also will discuss the process and prerequisites for entering onto the property. A typical Access Agreement will also require that the buyer obtain insurance before entering onto the property, require that the buyer restore any damage it causes, and include indemnification language.

Letter of Intent

In most commercial real estate transactions, the buyer will issue a letter of intent (LOI) during the Pre-Contract period. An LOI describes the basic terms of the Contract the parties intend to negotiate. Typically, the LOI will describe the property being purchased, the purchase price, who pays for closing costs, and key transaction dates/deadlines. Sometimes, the parties negotiate the LOI, itself, before both buyer and seller sign it.

An LOI enables the parties to assure that they agree on the major transaction terms before they invest thousands of dollars in time, attorney fees, and other expenses pursuing the transaction. An LOI also may include NDA language or an exclusivity clause in which the seller agrees not continue to market property while the parties are negotiating their contract.

Real Estate Purchase Contract

After they agree upon an LOI, the parties will prepare and negotiate a Contract. The Contract will incorporate and possibly, expand upon, terms agreed to in the LOI.

The Contract also should establish a framework for the remaining “periods” in the real estate transaction. The Contract should describe timing and scope of the buyer’s property inspection during the Due Diligence Inspection Period, as well as the process for terminating the Contract if, after inspection the property, the buyer decides not to go through with the purchase.

The Contract also should describe the parties’ obligations to each other and whether and under what circumstances the parties can terminate the Contract during the Pre-Closing Period. The contract should also delineate each party’s conditions to closing and deliverables at the closing, as well as remedies for breach of the Contract. And, the Contract should describe what obligations the parties will have to each other after the closing and how long those obligations will last (i.e. the duration of the Post-Closing Period).

Hire an Attorney

Pre-Contract shouldn’t mean pre-attorney. Some home purchasers don’t hire attorneys or wait to hire an attorney until after they have signed a contract because they want to save money. Since a home purchase is the single most expensive purchase most people make, they should protect themselves and their investment by hiring an attorney before they commit to the purchase.

In commercial real estate transactions, because they are only a few pages long, some parties view NDAs, Access Agreement, and LOIs as boilerplate documents and don’t hire an attorney before signing them. Sometimes, parties will enter into a Contract without first consulting an attorney. Because every real estate transaction is as unique as the real estate involved, parties who delay hiring an attorney do so at their peril.

NDAs and Access Agreements aren’t worth more than the paper they are written on (which is nothing if they are distributed electronically) if they don’t provide the protections relevant to the specific real estate involved. NDAs and Access Agreements that aren’t tailored to the transaction may not include meaningful seller remedies should the buyer breach the agreements. But if the NDA or Access Agreement isn’t tailored to the transaction, it could saddle the buyer with unnecessary obligations or costs.

Parties rarely intend for the LOI to be a binding contract to purchase real estate. Yet, if they don’t hire an experienced real estate attorney to review the LOI before signing it, they could include terms that make the LOI a binding contract.

Even if a client hires an attorney to prepare and negotiate the Contract, agreements made in the LOI, NDA, and Access Agreement may limit the attorney’s ability to protect the client’s interests in the Contract. By hiring an attorney early and paying close attention to their actions and documentation during the entire Pre-Contract Period, the parties will be contributing to the transaction’s overall success.

This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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