Commercial Real Estate Transactions - Due Diligence Considerations for Purchasers
Updated: May 16, 2019
Conducting appropriate due diligence is a fundamental part of any commercial real estate transaction. For purchasers, due diligence is necessary to adequately inform them as to the nature of the property and to assess the covenant of the vendor before committing to the purchase. For vendors, due diligence can save time and costs, as well as alert them of potential issues that may need to be dealt with before closing. This article is Part One of a two-part series where we will outline how commercial real estate lawyers can assist purchasers and vendors with their due diligence respect to the purchase and sale of commercial properties. In this Part One, we will be discussing the due diligence considerations from the perspective of the prospective purchaser. In Part Two, we will explain the due diligence we recommend vendors undertake when preparing to sell their commercial property.
It is paramount for purchasers to establish and consult with a team of professionals when conducting their due diligence. Depending on the nature of the commercial transaction and property being purchased, the team members may differ. Brokers who have experience dealing with commercial transactions should be used to assist in the negotiation between the purchaser and vendor of the business terms of the deal. Planning consultants would be consulted to help with advising on the development, zoning and land use planning aspects of the transaction. If the property is contaminated or the transaction involves some environmental risk being assumed by the purchaser (e.g., due to the nature of the vendor’s current and past business activities or the purchaser’s intended business activities on the land), then environmental consultants should be involved. If buildings and other structures are intended to be built or renovated, construction experts and possibly architects should be involved. Accountants would be vital to your team when there are important tax consequences that need to be understood. Finally, although lawyers must be retained to close the transaction, they should also be consulted during the due diligence process to perform and advise on title searches, off-title searches, and searches against the vendor.
A title search will be one of the most critical due diligence procedures a commercial real estate lawyer will conduct on behalf of their purchaser client. By reviewing the title search, the lawyer will be able to advise on the registered owner(s) of the property, confirm any rights of way or easements affecting the property, identify any registered encumbrances that cloud the vendor’s ownership (e.g., mortgages, liens), ensure that the legal descriptions for adjoining parcels of land are consistent with the legal description of the subject lands, determine if the property has legal access to a highway or public road, reveal any violations of the Planning Act, and more.
While a title search will reveal the quality of title, the quantity or the extent of title will require reviewing a survey. An up-to-date survey will reveal the dimensions of the property and location of boundary lines, the location of public and private improvements relative to the boundary lines along with the setbacks to the property boundaries, the location of adjacent properties, roads, lanes, etc., as well as the location of easements and rights of way and other encroachments on the property. Although almost all real estate transactions include the obtaining of title insurance to cover defects that would have been revealed by an up-to-date survey, reviewing a current survey is still highly recommended, especially if the purchaser is making substantial alterations or renovations to the property or building on it. If there is no survey available, the purchaser must decide whether the cost of hiring a certified land surveyor to develop a survey would be worthwhile; this can be an item of negotiation between the purchaser and vendor.
Off-title searches are inquiries made to governmental authorities to determine the existence of outstanding claims, restrictions and regulations affecting the property being purchased. Many governmental regulations can have a significant impact on the use of real property and because some do not need to be registered against title, they will not be revealed vis-à-vis a title search. The nature of the property, its intended use and the time available are all factors that will dictate which type of off-title searches should be undertaken.
Common off-title searches include the following:
Realty Taxes (to disclose tax arrears, if any) and local improvement charges;
Public Utilities search (to disclose any outstanding balance under any existing water or sewer accounts);
Building/Zoning search (to disclose current zoning of property, and the existence of any open permits and work orders);
Electrical Safety Authority search (to reveal if there are any open or outstanding notifications pertaining to electrical work improperly done at the property);
Fire Department search (to disclose the existence of any violations of the fire code);
Unregistered Hydro Easements;
Condominium Status Certificates (for condominium properties);
Conservation Authority (for greenbelt and other rural properties);
Liquor License Board (for restaurants, hotels, bars, etc.);
Development charges (for new construction or redevelopment properties).
If there will be agreements to be assigned to the purchaser on closing, there may be additional “off-title” due diligence required, such as reviewing lease agreements, service contracts, licenses, permits, etc.
Searches against the vendor should also form part of the purchaser’s due diligence process. When the vendor is a corporation, a corporate profile report and certificate of status should be pulled to ascertain the corporation’s existence, whether it is in good standing, the directors/officers of the corporation and other information necessary to assess the vendor’s ability to convey good title. Other recommended searches against the vendor include the following:
Personal Property Security Act search (to indicate whether the personal property of the vendor is encumbered and subject to security interests of a secured creditor);
Execution search (to identify any outstanding judgements against the vendor);
Bank Act search (to determine if any bank has taken security over any of the vendor’s inventory and/or equipment);
Bankruptcy and Insolvency Act search (to reveal if there is any record of any bankruptcy or insolvency proceeding against the vendor or whether the vendor is or has been bankrupt);
Litigation searches (to identify if there are any litigation actions involving the vendor at various levels of court and in various jurisdictions).
In addition to assisting in the due diligence process, a commercial real estate lawyer should also be involved in preparing or at least reviewing the agreement of purchase and sale. The lawyer will work to ensure a purchaser’s intentions are clearly stated, risks are mitigated through appropriate conditions and representations and warranties made by the vendor, and, more generally, that the purchaser’s rights are protected.