Originally Published in Real Estate Weekly, October 15, 2008
There are various issues that may arise in connection with commercial property acquisitions that are not typically addressed in the standard form of Contract of Sale. These are known as “hidden issues” as nothing in the standard form of Contract of Sale would necessarily alert a purchaser or their representative counsel.
Water charges are typically determined by usage or by “frontage” (based on a fixed amount determined in advance by the city). When the water charges are based on frontage, the city is entitled to a “look back” period whereby the city can audit the actual usage to determine whether or not the usage was in excess of the frontage. If the city determines that the usage was in excess of the frontage, the city can potentially impose additional water charges against the property (whereby a purchaser can inherit water charges incurred by the prior owner).
In order to protect yourself when acquiring a property subject to frontage, you will want to ensure that the city performs its audit prior to closing and thus, you must have authority within your contract to require “flat rate account reconciliation” prior to closing. The fiat rate account reconciliation serves as the city’s current audit and eliminates the possibility for the city to exercise its “look back” period (for a period from the prior ownership). Further, if the reconciliation shows that the usage is in fact greater than the frontage, you will also want to have language in your Contract requiring the Seller to pay such excess at closing.
The Department of Housing Preservation and Development (HPD) has recently adopted an enforcement mechanism for the correction of housing maintenance conditions in distressed multiple dwellings. HPD now has the ability to identify multiple dwellings that are not properly maintained and ensure that violations and the conditions that caused the violations are corrected. The last validly registered owner and managing agent are notified of the violations and typically given a short time frame to correct the conditions. In the event that the conditions are not corrected within the required period, HPD performs “emergency repair work” on behalf of the owner and then bills the owner for the cost of the repairs. If the charges are not paid promptly, there is often a lien or liens filed against the property.
The problem, however, from a purchaser’s perspective, is that there may be a substantial lapse of time between the time of the work performed and the unpaid charges ripening into a lien against the property. This could mean that a title report may not disclose the issue and put the parties on notice prior to closing. In order to protect the purchaser, the contract must require that the seller be responsible for payment of all emergency repair work performed by HPD (or any other governmental agency) as of the date of closing, even if the work had not yet appeared as a violation of record or lien against the property as of the date of closing. Further, you may try to negotiate for the seller to remain responsible for any emergency repair work that is performed at the premises after closing, but that stems from conditions existing prior to closing.
If you are acquiring a property subject to existing leases, it is essential that you are not only aware of how much security is being held by the landlord, but also the form of that security. If the lease security is in the form of a letter of credit, you must see the original letter at closing and get confirmation from the issuing bank as to its full force and effect. Without this level of due diligence, you run the risk of inheriting a security deposit (for which purchaser granted a credit in favor of seller at closing) that may not be enforceable or collectible by the new landlord/purchaser.
In addition to obtaining estoppel certificates from commercial tenants, you should also require an estoppel certificate from any guarantor to a commercial lease. As a purchaser, you want to make sure that the guarantor under the commercial lease you are inheriting acknowledges his or her continuing obligations as guarantor and is not trying to dismiss his or her role or duties based on an amendment to the lease or otherwise.
The standard Contract of Sale states that purchaser shall accept the premises “as is” and in its present condition, subject to reasonable use, wear, tear and natural deterioration between now and the closing. However, there typically is no language requiring any form of clean up at the premises, specifically within the common areas. At closing, you must ensure that Seller delivers the basement, the roof, any common areas and any vacant apartments broom clean and free of debris. To protect yourself in the event that seller fails to satisfy this requirement, your contract must require seller to compensate purchaser at closing in an amount equal to the reasonable cost for the removal of garbage, abandoned furniture, equipment, debris, etc. Often sellers fail to remove garbage, particularly from the common areas and purchasers typically have no recourse based on the standard contract language and the standard due diligence/inspections performed by purchaser prior to contract signing.
Purchasers must ensure that all of the apartments and buildings are lawfully occupied and in accordance with a Certificate of Occupancy, which is presently outstanding and in force and effect. Illegal tenancies have become more common as a way for landlords/sellers to maximize rental income. Therefore, you must perform a thorough analysis of the rent roll to make certain that sellers are not overstating it by including illegally collected rents.
The hidden issues presented here are not intended to be exhaustive, but merely a sampling of the myriad issues that can arise in connection with commercial property acquisitions. It is not only important to identify and discuss these issues with your attorney, when applicable, but to know they may also trigger. the discussion of additional pertinent issues that are not otherwise addressed in the Contract of Sale.