Due diligence

Legal due diligence

Describe the legal due diligence required in the context of a real-estate business combination and any due diligence specific to a real-estate business combination. What specialists are typically involved and at what point in the transaction are the various teams typically brought in?

The scope and degree of due diligence depends on the target’s portfolio of real-estate assets. In a public real-estate M&A deal, if the target’s portfolio consists of a limited number of material properties, or includes a few material properties among many immaterial properties, the acquirer may focus only on those material properties. Otherwise, the acquirer may perform diligence on a representative sample of properties or forego property-level diligence entirely. Property-level diligence may include reviewing the status of the target’s legal title to some or all of the property (eg, whether a clear chain of conveyance documents evidences ownership, whether there are liens on the property, and whether other parties have rights to the property, such as easements) and reviewing change of control provisions, anti-assignment clauses, third-party consent rights, termination rights or economic terms under material contracts. In any real-estate M&A transaction, research may also be conducted on the target’s owners or major shareholders to determine whether the acquirer should expect resistance to the transaction.

In addition to the above, a review of tax, employment and environmental diligence will be typically be undertaken. Litigation-related diligence may also be necessary if the target is the subject of a material litigation.

Searches

How are title, lien, bankruptcy, litigation and tax searches typically conducted? On what levels are these searches typically run? What protection from bad title is available to buyers and does this depend on the nature of the underlying asset?

As described above, the scope and degree of due diligence is a function of the target’s portfolio and the acquirer’s risk analysis. Bankruptcy, tax and litigation searches are typically run by third-party service providers that search multiple local and national databases to determine any issues.

With respect to title to the property, the acquirer may engage a title insurance company to perform title searches. These searches check land records and other sources to determine the current owner’s state of title (eg, ownership and any encumbrances, conditions, covenants or restrictions to which such ownership is subject) and any issues of which the acquirer should be aware. If the target does not currently have title insurance policies, the acquirer may purchase the policies, which provide coverage against claims by third parties against an owner’s title to real property.

Representation and warranty insurance

Do sellers of non-public real-estate businesses typically purchase representation and warranty insurance to cover post-closing liability?

R&W insurance is available for purchase in the US to cover liability to the purchaser for breaches of a seller’s R&Ws. Such insurance is typically used as a replacement for seller’s obligation to indemnify purchaser for such liability and is often used in the context of transactions involving privately held business combinations. However, such insurance has not become widely used in privately held real-estate entity combinations unless a significant tax issue is involved. In that case, insurance is purchased to cover seller’s liability for the specific tax-related R&Ws.

Review of business contracts

What are some of the primary agreements that the legal teams customarily review in the context of a real-estate business combination, and does the scope vary with the structure of the transaction?

Typically, acquirers will review some or all of the leases and other contracts entered into by the real-estate owning entity as part of its due diligence. The primary concern regarding material contracts and leases is whether the target’s counterparty has a termination or consent right that will be triggered by a change of control or assignment resulting from the transaction. Depending on the transaction, each material agreement or a specified selection of agreements will receive individual analysis. An acquirer may also review individual leases and agreements for their economic terms, which may be fundamental to the underlying M&A transaction.