Co-Author: David A. Farus, Esq.
Colorado has returned to having a State approved real estate purchase contract designed for commercial transactions. This article identifies differences between the new Colorado Real Estate Commission (CREC) approved commercial and residential forms, a conceptual flaw in the commercial form, and a partial solution to the flaw. Most of the important comments on the commercial contract also apply to the new “Income-Residential” form.
Compared to the residential form, the new commercial form omits sections that are typically not relevant in commercial transactions, including clauses addressing: FHA and VA financing; sources of potable water; carbon monoxide alarms; lead based paint; methamphetamine; and the Colorado Foreclosure Protection Act. The commercial form adds provisions addressing trade fixtures, environmental inspections, Americans With Disabilities Act (ADA) evaluations and tenant estoppel statements, including separate contingencies for the environmental inspections, ADA evaluation and tenant estoppel statements.
While the attempt to create a practical, CREC-approved commercial contract form is welcomed, the new form is likely to be perceived by many in the commercial real estate community as having a conceptual flaw. The more common practice in commercial transactions is for the buyer to have fewer and broader contingencies than in residential deals. Contracts in commercial transactions are often drafted to include only a single, all-encompassing “free-look” due diligence contingency. This practice differs significantly from the custom in residential transactions where different categories of due diligence have their own contingency. For several years, for example, residential contracts have typically segregated contingencies for financing, appraisal, common interest community documents, title, “off-record” matters, survey matters, insurability, and the condition of the property.
Rather than conforming to the custom in commercial real estate of having fewer and broader contingencies, however, the new CREC-approved commercial form has added contingencies for environmental and ADA evaluations, and tenant estoppel statements, as well as a new contingency included in all the new, 2011 forms regarding the buyer’s satisfaction with “Due Diligence Documents.” Depending upon how one counts, the commercial contract has eleven separate, subjective buyer contingencies. In addition to fighting custom, the overlapping nature of many of the eleven separate contingencies in the commercial form, and the differing consequences associated with some of those contingencies, potentially creates problems.
Consider, for example, a situation involving a neighboring property owner’s retaining wall that encroaches onto the property under contract. Several of the contingency provisions of the commercial form might apply to such an encroachment. If the buyer learns of the encroachment through its own investigations, §8.2 appears to apply. If a previous survey provided by the seller discloses the encroachment, then either §8.2 or §10.8 (through §10.7.10) would seem to apply, depending on when the seller delivered that survey. If the buyer learns of the encroachment from a new Survey obtained pursuant to §7.3, then the §8.3.2 contingency seems to apply; and if the title company includes or adds an exception to its commitment based on any such new or previous survey, the §8.1 contingency could apply to that exception.
If the buyer learns of the encroachment both from a previous survey delivered by the seller and the buyer’s new Survey, if the §8.2 Off-Record Matters Objection Deadline is earlier than the §8.3.2 Survey Objection Deadline, and if the buyer fails to send a “notice to terminate” under §8.2 based on that encroachment, can the buyer still validly terminate under the later §8.3.2 Survey Objection Deadline based on that same encroachment? (Consider the last sentence of §8.2, which indicates the buyer “accepts title subject to such rights, if any, of third parties of which Buyer has actual knowledge.”) Lawyers can make arguments on both sides of that question.
Other potential problems stem from the differing consequences associated with those overlapping contingency provisions. A notice to terminate given under §8.3.2 or §10.8, for example, results in the automatic termination of the contract. A “notice to terminate” under §8.2 or §8.1, however, does not result in the automatic termination of the contract. The provisions of §8.5 set forth both a qualified obligation on the seller’s part to try to cure an unsatisfactory matter objected to under §8.1 or §8.2, and a right for the buyer to waive those objections and proceed with the contract. Consider the situation described above where both the seller’s and buyer’s survey disclose the neighbor’s encroaching retaining wall. Assume timely notice by buyer under any provision. What follows if the buyer sends a notice to terminate based on that encroachment? Does the contract automatically terminate, or does the seller have the obligation and the right to seek to cure the encroachment (with the corresponding right of the buyer to waive its objection if the encroachment is not cured by the time of closing)? Does the buyer have the right to dictate the result by specifying the particular contingency provision under which the buyer’s notice is given?
The “off-record” and survey situation described above is but one illustration of the overlapping contingency provisions of the new contract form, and the associated problems that might arise from such overlapping contingencies.
Partial Solution to Flaw
One way of making the CREC’s commercial contract more like customary commercial contracts is to use one unified deadline for all the contingencies. While this would help solve potential problems with timing or sequencing the contingencies, it would not eliminate potential problems associated with the different consequences for different contingencies. One of the reasons the commercial real estate industry may have evolved the custom of fewer but broader contingencies is to avoid these problems.