However, from a buyer’s perspective, having a net worth covenant does not truly guarantee their ability to recover. This can be appealing to the seller because it eliminates the need to set aside any proceeds of the sale, allowing for immediate distribution and use of funds. Having confirmation and assurance from the seller that it will maintain a net worth of a minimum amount confirms to the buyer that the seller will be able to satisfy a judgment. Noted below are brief descriptions of the most common credit enhancement options and some of their relative benefits and drawbacks. Unless the liability involved were inordinately high, the expense of pursuing this course will almost surely be higher than the disputed amount under the PSA. Not so for a purchaser: in order to pursue funds that have already been distributed up through a corporate structure, a purchaser would have to “pierce the corporate veil” and trace the proceeds of the sale to their ultimate recipients. In addition, since many properties are owned via special purpose entities, it would allow the seller to almost immediately liquidate the entity and “close the books” on the transaction. This is optimal for sellers, as it would allow the entire proceeds of the sale to be distributed to investors immediately without any delay or holdback. It is instructive to understand what would happen in the instance where there were no post-closing credit provision in the PSA. The risk allocation achieved by a comprehensive list of seller representations is useless without accessible cash to backstop any resulting liability. Purchasers cannot lose sight of the fact that during the battle around representations, the war is won or lost on the economic substance that will bolster these contractual obligations. These are, of course, heavily negotiated and leverage-dependent however, a reasonable rule of thumb is that the maximum liability cap should be between 2-5% of the purchase price and the survival period should be between 6 and 15 months after closing. Market standard has settled on defining the scope of the seller’s liability by including a “maximum liability cap” as well as a survival period where any claims made after such period are uncovered. Once the parties have agreed that the seller will remain liable for certain of its representations after closing, it becomes necessary to define a scope of exposure. All real estate purchase agreements should therefore include an express statement of survival. Therefore, any obligations in the contract that are not also either reflected in the deed or expressly stated to survive are extinguished upon recording the deed. The “Merger Doctrine” of property law states that the provisions of the contract of sale “merge” into the deed of conveyance. Together, these three elements can accomplish the ultimate goal of seller representations: allocation of risks related to the property as between buyer and seller. finally (and most importantly), post-closing credit enhancement to support any incurred liabilities.a properly defined liability cap and durational scope and.an express statement that the obligations will survive.There are three essential pieces any purchase agreement needs to include to provide some financial backstop to the accuracy of seller representations: Since real estate assets are commonly held in special purpose bankruptcy remote entities, it is highly likely that the seller will have little to no net worth after closing, effectively hampering any potential recovery efforts. While these types of representations are heavily negotiated, it is alarmingly common for purchaser’s attorneys to neglect to include any “teeth” by way of appropriate credit support for seller’s surviving liabilities. Second, the risk of a failure of such seller representations are allocated such that a buyer can look to the seller for recovery in the event of a failure. Seller representations serve two related functions first, they fill in gaps on the buyer’s legal and physical due diligence since there are certain items that the buyer is either unable to independently verify (i.e., that the seller has not received specific notices relating to the property) or is not contractually permitted to independently verify (i.e., certain matters that would involve prohibited contact with a tenant). Seller representations are often the most carefully negotiated provisions in a real estate purchase and sale agreement.
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