Overlooked Provisions when Negotiating Purchase and Sale Contracts
Published: June 8, 2022
In protracted contract negotiations, many clients become dismayed when a deal they thought had been agreed in a letter of intent is suddenly the subject of contentious exchanges between the parties and their counsel. The clients may be comfortable with the purchase price or due diligence timelines, but many clients have never considered, let alone negotiated, the various other critical terms in a purchase contract. These terms are often as, if not more, important, as they will define the scope of the parties’ rights relating to the transaction and exposure for lawsuits after closing. This article is designed to give a primer on the basics of these concepts so that parties may be better prepared when negotiating their purchase contracts at the letter of intent stage.
First, the parties should carefully decide what documents, records, and information will be disclosed by the seller during due diligence. Inartful letters of intent may omit this issue completely or worse, may require the seller to deliver “all material information relating to the property” (which also happens to be the standard in the popular AIR purchase forms). This creates an impractical standard, essentially requiring the seller to determine what records are relevant to the buyer. While a buyer may believe the breadth of this standard to be beneficial, it’s also problematic for buyers, who cannot and should not rely on the seller’s determination of materiality when collecting due diligence materials. A better approach is to specifically identify the due diligence materials to be delivered so that both parties know what information will be provided. This allows sellers to avoid the trap of inadvertently failing to disclose material information while allowing buyers to decide and determine what information is important to their evaluation of the property.
Another critical topic typically overlooked at the letter of intent stage are the parties’ representations and warranties. In today’s seller-favorable market, sellers are pushing for less representations so as to make their contracts as close to “as-is” as possible. Buyers should ardently push back where feasible, as buyers must often rely on sellers’ representations and warranties to address certain unknown facts about the property that buyers may not be able to independently verify during due diligence. For example, a buyer may want to push the seller to represent that seller did not place any hazardous materials on the property during its ownership, that seller has not granted any rights of refusal or other rights of acquisition to any third parties, or that seller is not aware of any non-compliance with law or construction defects at the property. Even where they are limited to a seller’s knowledge, these representations and warranties may become valuable to a buyer if an unexpected condition is discovered at the property after closing.
Liability thresholds are another increasingly popular concept in purchase transactions. In this regard, sellers may attempt to limit their post-closing liability relating to the property by providing that the seller will not be liable to the buyer unless buyer’s damages either exceed a minimum threshold (to avoid minor claims) or are less than a maximum threshold. Maximum liability caps can be as low as 1% of the purchase price or less, meaning that even if the seller has breached the contract, its liability could be limited to a fraction of buyer’s actual damages. In the current seller-favorable market, these concepts may be unavoidable for a buyer, but buyers should push back as much as possible. Moreover, buyers should push for exclusions to these thresholds for so-called “fundamental” representations, such as whether the seller has authority to sell the property.
Obviously, there are a host of other critically-important issues that should be addressed in a purchase contract that aren’t typically agreed at the letter of intent stage. The three concepts discussed above can be some of the most important provisions, however, and often serve as the basis for extensive negotiations between contracting parties. While full resolution of these concepts in many cases cannot be achieved in a letter of intent, sophisticated parties will attempt to set bounds on these issues as early as possible. Doing so may increase a party’s leverage and expedite resolution of these terms, hopefully achieving a signed agreement more quickly and efficiently.