Now that British Columbia and the rest of Canada are beginning to open back up, and life is gradually returning to a somewhat tempered “normal”, we all hope that our commercial spaces and businesses will come back to life in full force. Realistically, however, it is expected that the effects of COVID-19 will continue to be felt for some time. For the real estate industry, this likely means that significant uncertainty will remain in the market for most asset classes for months, or possibly years. Eventually, landlord/tenant relationships, as well as development projects, will rebound from the shock of the initial shutdown, and new equilibriums will be established that may look significantly different than existed prior to the pandemic.
As owners assess the stability and sustainability of their positions, opportunistic buyers, especially those with readily available or accessible cash, will be well-positioned to negotiate for and secure properties that come to market. With this in mind, we set out below some of the key issues for real estate buyers and sellers to (re)consider in their purchase and sale agreements (“PSAs”) as we move through the COVID-19 era, including many tried and true provisions that may typically get glossed over. While the below focusses on PSAs for income-producing/tenanted properties, many of the comments will apply similarly to bare land/development projects.
Purchase Price – Parties may want to look for ways to negotiate a floating purchase price that is dependent on past or expected rental revenues from the property, or that automatically adjust upon the occurrence of any (or certain) lease terminations, rent deferral agreements or other events that could materially affect net operating income (“NOI”). Rather than using a static purchase price and relying on “all or nothing” closing conditions or other PSA terms to mitigate against the occurrence of material unforeseen events, consider whether a formulaic purchase price may be more appropriate. Also consider using an earn-out or other post-closing payment mechanism (e.g., a vendor-take back mortgage or other similar security), which may allow both parties to find an efficient and mutually agreeable allocation of risk in an uncertain and unstable market.
Due Diligence Deliverables and Timing – Market instability will result in buyers wanting additional or more detailed property information and documentation, which might not be captured in typical PSAs and may take longer for sellers to collect and deliver. Information with respect to the seller’s outstanding receivables, communications with tenants regarding their ability and plans to pay rent, rent deferral agreement negotiations, and applications for government benefits such as the Canada Emergency Commercial Rent Assistance Program will likely become crucial to buyers’ NOI projections. Searches, comfort letters, and professional investigations and reports may take longer to obtain, and site visits will likely require more coordination and cooperation between buyers and sellers, as well as tenants and other third parties. Further, buyers may need more time to analyze this information and confirm their comfort level with the subject property, current/forecasted NOI, and tenant mix (including their exposure to or isolation from impacts from COVID-19). Accordingly, it will be important for both sides to consider how all of this may impact PSA terms dealing with due diligence.
Deposits, Closing Payments and Financing – In addition to ensuring maximum flexibility by contemplating several methods to pay amounts due under PSAs (including wires and direct deposits), parties need to be realistic about delivery timing for those funds after the applicable triggering event (e.g., PSA execution, subject removal, etc.), as some or all of these procedures may occur at a time where physical office/bank access is more limited than on the execution date. These same considerations apply to mortgage financing, where timing is even more crucial. Parties should consider the inclusion of minor automatic extensions in the event that all closing conditions are met, but mortgage financing has been held up due to processing delays. Counsel for both sides should work together to ensure that the parties have flexibility to complete transactions as intended in the event that minor procedural matters are not completed exactly as contemplated, by building contingencies into closing escrow agreements and solicitor’s undertaking letters.
Closing/Post-Closing Adjustments – PSAs often contain fairly standard terms addressing closing and post-closing adjustments, including deadlines for completing readjustments and entitlements to and responsibility for the collection of pre-closing receivables that remain outstanding after closing. In a market where partial payments, payment defaults and rent deferrals are more common, buyers and sellers should reexamine the allocation of risk between them with respect to these receivables, including the enforcement of rent deferral agreements with payment deadlines after closing and, as noted above, the allocation of purchase price thereto. Tax and utility payment deferrals, government assistance and related matters should also be considered.
Pre-Closing/Closing Conditions – In addition to revisiting their pre-closing conditions, both sides should also think about adding to and/or revising the common “representations materially true” and “covenants materially satisfied” closing conditions which obligate them to complete the transaction. Consider, in particular, clarifying the meaning of “material” for the purpose of these thresholds, especially as the status of leases, rent payments and tenants have the potential to change significantly between subject removal and closing.
Seller’s Representations, Warranties and Estoppels – Parties will want to take a closer look at the seller’s representations and warranties, particularly as they relate to tenancies and the correctness of financial statements (which may evolve materially over time), as well as those addressing operating costs which may or may not be passed through to tenants. Negotiations over less vs. more, knowledge qualifiers and materiality thresholds will remain important, but the substance of representations and warranties will become increasingly significant as both sides navigate new realities. Buyers should also focus carefully on statements made by tenants in estoppel certificates, and should consider negotiating for specific remedies under their PSAs if there are material deviations from the affirmative statements requested therein.
Pre-Closing Operating Covenants – Most PSAs require sellers to continue operating the subject property prior to closing in accordance with its “usual business and management practices”, as would a “prudent owner owning similar property”, or similar wording, and/or require that the seller obtain the buyer’s consent before taking certain actions. In the context of the current pandemic, there is no clear consensus on what is “usual” or “prudent”. As such, these parameters are likely too subjective and open-ended, and may need to be replaced with specific terms as to what is and is not permitted by unilateral action, especially with respect to rent deferrals or abatements, applications for government benefits, and the incurring of additional operating costs (however prudent they may be). Buyers will want to pay particularly close attention where a seller owns other properties not being sold, as this may impact their actions (or omissions).
Force Majeure/Material Adverse Change Rights – Since COVID-19 has shut down much of the business world, many parties to pre-pandemic PSAs have re-examined their agreements to determine whether they are terminable for force majeure, a material adverse effect/change or under the common law doctrine of frustration. While such arguments may be difficult to make absent explicit terms, buyers and sellers should seriously consider whether their typical PSA terms may implicitly introduce such concepts. Also, when negotiating new PSAs, parties may wish to explicitly introduce these concepts and, if necessary, circumscribe or expand on their use, impact and scope (i.e. consider whether they should permit termination, only delay, or some hybrid approach). Given that these types of arguments are being used and will remain relevant for some time, it would be wise to more definitively allocate these risks between the parties at the outset of the contractual relationship.
While the considerations listed above are not meant to be exhaustive, we hope that they highlight how many PSA terms historically thought of as “boilerplate” may suddenly require further consideration, and the need for both sellers and buyers to take stock of existing standard forms and reflect on potential unintended consequences. Ultimately, the impact of COVID-19 and the resultant economic slowdown may be unpredictable, and is expected to last for some time, so parties would do well to begin building these considerations into their strategies sooner than later.