The Term Sheet is often used in a real estate transaction as a preliminary document that is incidental but not integral to the ultimate transaction because it is usually defined as “non-binding,” “confidential,” “preliminary” and/or “expiring.” But that should not lull either party in the transaction—property buyer or property seller—into discounting the importance of this document. The Term Sheet is integral to the transaction and one of the key contractual documents as the transaction moves toward closing.
Let’s take a closer look both at the Term Sheet—its structure, purpose and areas of protection or controversy—and also the more detailed Purchase and Sale Agreement.
What is the Term Sheet’s purpose, and how specific should it be?
Often the potential parties will prepare a Term Sheet or Letter of Intent to flush out how close they actually are to reaching an understanding regarding a transaction and where the areas of dispute are. The Term Sheet is typically much shorter than a Purchase and Sale Agreement (PSA), but it still is essential that it accurately and completely define the potential deal points. That is because the Term Sheet will usually be looked upon as defining the terms and conditions to be included in the PSA and may be argued to be a binding agreement through the date of its expiration and beyond that date as to terms stated to survive the expiration date. Further, despite the fact that the Term Sheet is a preliminary document, it still can be argued to be a source of liability.
What are the sources of potential liability?
Although only in effect for a limited time, unless expressly stated to the contrary, the Term Sheet may be viewed as a binding contract at least through the stated date of its termination. The PSA may contain provisions later found to be ambiguous or incomplete. In such circumstance the Term Sheet will often be reviewed to shed light on the intent of the buyer and seller as to such provisions. The Term Sheet may also be looked to where claims of fraud or concealment are asserted by either the potential buyer or property owner.
What are some of the critical terms that should be included in the document?
• A description of the property under discussion and specifically whether personal property, easement, right of way and licenses may impact the property under consideration.
• The proposed purchase price and how it is to be paid, as well as amount and timeline of any financing, and details of the deposit (amount, terms under which it will become non-refundable, and whether deposit will be released to the seller or held in escrow).
• The nature and extent of the due diligence and due diligence period.
• An “as-is” provision, if applicable.
• A confidentiality clause that survives the termination of the Term Sheet.
• A provision that there are no representations made and no liability associated with the Term Sheet and that there is no reliance by either party as a result of the execution of the Term Sheet.
• A statement that both parties were represented by brokers and/or counsel.
• A date is included as to when the Term Sheet will expire and be of no further effect except for provisions stated to survive. Unless stated to the contrary, the parties should consider themselves bound by the terms of the Term Sheet through the stated expiration date.
• Reference to any special conditions or contingencies related to the close of escrow.
• An integration clause, which, if properly drafted, incorporates all prior discussions and negotiations.
• A provision as to the length of the due diligence period and the kinds of due diligence that are anticipated and the limits of due diligence. If intrusive testing is possible, this provision may include reference to the conditions under which such testing may be conducted and indemnity provisions in the event harm results from such testing. The provisions as to intrusive testing are typically designated as surviving the expiration of the Term Sheet.
• The Term Sheet will often also address whether the property owner can continue to accept back-up offers during the time that the PSA is being negotiated and documented.
How does the PSA differ from the term sheet?
The Term Sheet is typically only a few a few pages focusing on only the most significant items and except for a few provisions is typically a non-binding document. The PSA is typically far more detailed than the Term Sheet, including reference to items not addressed in the Term Sheet and once executed becomes a binding contract. There are various PSA forms available, although these forms may prove to be incomplete, too generic or inaccurate in reflecting the terms and conditions of a particular transaction. Circumstances or events often arise after the PSA is executed that require the terms of the PSA to be modified. It is, therefore, not uncommon for the PSA to be modified or supplemented by Escrow Instructions, Riders, Addenda or Amendment.
What are typical areas of litigation arising from a PSA?
The following are common areas of possible dispute and which therefore need to be crafted very carefully:
DEPOSITS: Whether a deposit has become non-refundable often leads to disputes between a buyer and a seller. This typically arises around the buyer’s termination of the transaction and demand for the return of its deposit and the seller arguing either that the buyer breached or is otherwise not entitled to the return of its deposit. It is essential that the contract termination provisions be very detailed, including a “time is of the essence” clause. There also should be standard general provisions that any modification to the PSA must be in writing.
INACCURATE OR INCOMPLETE DISCLOSURES: An “as-is” provision or waiver will generally not be a protection against a lawsuit where there has been a material misrepresentation or concealment by the seller or seller’s agent nor will the buyer’s negligence in failing to discover the defect necessarily constitute a defense to a claim of fraud. Thus, the failure to disclose a material fact can constitute actionable fraud to the same degree as making a material misrepresentation.
For example, in one lawsuit brought by the buyer of an apartment complex, the seller knew and failed to disclose that the adjoining contiguous property was an operating house of prostitution with seedy men often frequenting the business operation at off hours of the day and night. Withholding material property conditions or the death of a past occupant of the property in the property may also result in fraud litigation. Even though the buyer exercised its right to inspect the property by a professional inspector and to review public records, the seller may still be forced to settle rather than risk a trial and significant litigation expense. It is therefore extremely important that the seller disclose all possible conditions or potential governmental actions that are under consideration and that may affect the property or its value.
In another recent case, the plaintiff was a buyer of real property that was on a hillside. The seller knew the property had risks of a landside based on unstable soils conditions but did not disclose these conditions nor the resulting risk. The buyer could have but did not investigate soil conditions. After the sale closed, the property slid and became essentially valueless. Despite an “as-is” provision in the PSA and the buyer’s arguable negligence, the buyer recovered a seven-figure fraud judgment at trial.
LIMITATIONS ON RECOVERY: Many times, both the buyer and seller will want to limit their potential liability if they are found to have breached their respective obligations under the PSA. Depending on the terms included in the PSA, these recovery limitations may or may not apply if issues of fraud or concealment exist. Damage limitations may be as to a maximum dollar amount or a category of expenses (such as due diligence costs of the seller).
BROKER AGREEMENTS: Sellers often sign listing agreements with brokers without considering the ramifications of these documents. Often these agreements contain draconian terms such as provisions extending the broker’s right to a commission for an extended period after the initial listing period. Also, listing agreements rarely define exactly what efforts the broker is required to engage in to market the property. Therefore, these agreements should be carefully reviewed and negotiated before signing a listing agreement by the seller or a mortgage brokerage agreement by the buyer seeking financing.
Are there any areas of due diligence that are often overlooked?
There are a few areas of concern that the buyer may consider as part of its due diligence:
THE PROBLEM TENANT: Rents may be current and at market and problems may still exist as to tenants threatening rent strikes, demanding unreasonable repairs and improvements or filing grievances with governmental agencies, the Better Business Bureau, etc. Often this does not become apparent until after closing.
demographic changes in the community: Long-term demographics can have a drastic effect on property values and rents.
ECONOMIC TRENDS: Planned employment, retail, construction, traffic, parking and a host of other future concerns can also have a dramatic impact on rents and market value.
FLEXIBILITY IN TIME: Often a buyer or seller is trapped as the closing date nears, by such things as a delay in financing, a cloud on title, a permit or license issue or a delay in repairs being completed. These unforeseen events often can be resolved by a Post-Closing Agreement where the closing occurs and title is transferred with rights as to the open item reserved. However, just as often, these time issues lead to intense negotiations of adjustments in the deposit provisions, increased deposits or adjustments in the price in order to keep the transaction from being terminated. Provisions can be built into the agreement that allow for extensions in either a general form or as to specific possible areas of delay.
GOVERNMENT AGENCIES: The views and attitudes of the Planning Commission and other agencies’ responsibilities may dramatically affect the viability of a proposed project and its cost and time to complete. For example, certain projects may be desired by the local government and result in the availability of permit, fee or tax deferments, waivers or rebates. Other situations may be extremely negative and create obstacles and costs. These factors may include such things as whether the community wants this type of project (ask Walmart), building standards, the view of the community toward outsiders, the time and cost to obtain permits, building and environmental standards, traffic abatement requirements, parking requirements, noise abatement requirements, etc. Simply using an out-of-locale architect or contractor versus a local consultant may, in the wrong locale, create significant and costly impediments to a project’s viability. These concerns must be explored by the buyer contemplating a project in a new locale.
POTENTIAL SOURCES OF FINANCING: In areas under rehabilitation or needing more hotels or other types of businesses, tax abatement or favorable development agreements or government financial support may be available. The other extreme may also exist where financing is either extremely limited or very expensive for the project under consideration.