Risk Analysis Regarding Permitted Exception Provisions

August 20, 2015 | by

Most acquisition lawyers are well-versed in the variety of “permitted exception” provisions that appear in seller-friendly contracts. For the most part, the provisions are consistent and reasonable parties agree to “market” revisions when negotiating a purchase contract. On occasion, a seller will offer a contract providing that, in addition to items not objected to during the study period, “Permitted Exceptions” will include a list of enumerated items. Such a list of enumerated items may include:

  • present and future zoning, building, environmental and other laws;
  • covenants, restrictions, easements and agreements for the erection and/or maintenance of utilities, over, across and under the property; and
  • violations of building, fire, sanitary, environmental, housing and similar laws and regulations.

I have been asked on a number of occasions to explain what it means for a buyer to agree to such an enumerated list of Permitted Exceptions when a contract is signed. At first glance, a buyer may believe that if they perform diligence confirming that there are no unsatisfactory issues related to the enumerated exceptions there is minimal (or no) risk. However, such a list of enumerated exceptions can expose a buyer to risk after a deposit has “gone hard” if the remaining provisions of a contract are not carefully tailored to appropriately eliminate cross-references to such exceptions.

Below are some suggestions for reviewing and commenting to a “laundry list” of Permitted Exceptions when representing a buyer on a commercial property acquisition.

  1. Buyer’s Right to Terminate: Out of an abundance of caution, confirm that the buyer’s right to terminate prior to the expiration of the study period is absolutely within the buyer’s sole and absolute discretion. Regardless of the likelihood of such a provision being enforced, make certain there is not language providing that the buyer is agreeing to (or has pre-approved) any of the enumerated exceptions at the time the contract is signed.
  2. Due Diligence: Of course, the buyer should make sure it performs appropriate diligence on the enumerated exceptions to confirm they do not negatively impact the property.
  3. Analysis of Defined Term: It is best to search for the places that the defined term which encapsulates such enumerated items is used in the contract. For example, if “Permitted Exceptions” includes all of the enumerated items, consider the following:
  1. Representations & Warranties: Is the defined term used in the context of seller representations and warranties thereby unfairly allocating risk to the buyer? Are representations and warranties that would normally be unqualified with respect to pre-contract and post-contract matters limited by the defined term? For example, if a seller represents that there are no violations of law affecting the property, but elsewhere the contract provides that the property will be sold subject to “Permitted Exceptions” (which includes violations of law) … what does this mean for the buyer? In connection with reviewing such provisions, it is prudent to understand the buyer’s remedies if a seller breaches a representation or warranty.
  2. Post-Contract Operational Covenants: In the portion of the contract that provides for how the property must be operated between the effective date of the contract and closing, review whether the seller is granted any discretion that might present issues for the buyer. For example, if Permitted Exceptions includes utility easements and there is not any limitation on what easements a seller may record after the contract is signed and prior to closing, a buyer could wind up in a difficult situation (particularly when a seller will continue to own adjacent property).
  3. Condition of Property & Title At Closing: There may be one or more provisions describing what the condition of the property or title must be at closing. If the seller’s obligation to deliver title or the property in a certain condition is subject to Permitted Exceptions, does this unfairly allocate risk to the buyer? For example, if building violations are “Permitted Exceptions” does the use of the defined term as a carve-out to closing conditions require a buyer to close despite new violations that appear following the study period?

There are a number of ways to mitigate risk in similar situations. Among other things, a buyer might negotiate a right to object to new matters it is not aware of at the expiration of the study period. The negotiation of such a provision also requires careful thought and consideration to make sure that a buyer is appropriately protected.

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