California Purchase and Sale Issues for Buyers

California Purchase and Sale Issues for Buyers Stevens A. Carey Stevens A. Carey is a partner with Pircher, Nichols & Meeks, a real estate law firm with offices in Los Angeles and Chicago. The author thanks Rob Krapf (DE), Fred Klein (DC), Marty Schwartz (FL), Josh Kamin (GA), Gene Leone (IL), Kevin Shepherd (MD), John Sullivan (MA), Joshua Stein (NY), and John Nolan (TX) for their input regarding their respective jurisdictions (as indicated parenthetically), Jeff Brown for his input regarding litigation matters, Michael Caplinger for his input regarding sales and use tax matters, Michelle Hickey for her input regarding statutory seller disclosure requirements, Michael Soejoto for his input regarding tax matters, John Cauble and Richard MacCracken for providing comments on a prior draft of this article, and Kaleb Keller and Tim Durkin for cite-checking. This article is not intended to provide legal advice. The views expressed (which may vary depending on the context) are not necessarily those of the individuals mentioned above, Pircher, Nichols & Meeks or the publication. It is important to remember that every transaction is different and what is appropriate for one transaction may not be appropriate for another. Any errors are those of the author. SALES OF CALIFORNIA real estate are typically governed by California law and customs. While there are exceptions to this rule, a buyer may find it difficult to deviate from the norm and, in the author s experience, most buyers do not even try. So what does this mean for the prudent commercial buyer? Aren t the laws and customs for commercial real estate purchases basically the same throughout the United States? The answer is no, and sometimes the variance can be significant, especially in an outlier state like California. As noted by one author, California sometimes operates like its own country, with laws that aren t like anyone else s. Zimmermann, Three Things To Know About Doing Business in California, Xconomy. com (Jan. 28, 2016), available at http://tinyurl.com/ z9tu8nw. Consequently, it is important to understand the local rules and to seek the advice of local experts to make an informed purchase. While not intended to be exhaustive, this article will highlight some of the local matters for a buyer to keep in mind when entering into a California commercial real property purchase agreement. 38 The Practical Real Estate Lawyer July 2016

California Purchase and Sale Issues for Buyers 39 Capsule Summary 1. Recitals. In California, recitals are conclusively presumed to be accurate so the buyer should be careful about what is recited in the purchase agreement. 2. Due Diligence Termination Right. Seemingly broad due diligence termination rights may yield unexpected results based on California case law: the buyer s discretion to terminate during the due diligence period may not be as unlimited as the buyer thinks; and if it is unlimited, there is a risk that the purchase agreement may be subject to challenge as an illusory contract if it is not supported by independent consideration. 3. Title Insurance and Escrow. California title insurance forms and rates are more flexible than some states (e.g., Texas, Florida and New York) but less flexible than others (e.g., Illinois). Unlike some states (e.g., Florida), the buyer should not expect any recourse against the title company in California if the title report it obtains is inaccurate, even if the title company has been negligent in preparing the report. Also, attorneys do not act as title agents in California as they do in some states (e.g., Florida and Georgia) and, although allowed by California law, generally do not act as escrow agents in the author s experience (other than relatively informal arrangements between counsel to hold signature pages while counterparts are collected pending delivery). 4. Closing Procedure. The customary forms of several closing documents in California may be different from the forms in other states (e.g., the form of deed, state tax withholding certificate, preliminary change of ownership report, and local transfer tax statements). The customary closing cost allocations in California may vary not only from the customs in other states but may also vary depending on the location in California. 5. Certain Remedies and Defenses. California has a statute governing liquidated damage clauses in real property purchase agreements, and statutes indicating that a liquidated damage provision does not eliminate the possibility of specific performance by the seller. California also has some conflicting case law regarding survival limits, numerous statutory seller disclosure requirements, a broad concept of fraud, limitations on waivers of fraud, conflicting case law regarding the survival of fraud if a buyer closes the purchase with knowledge of the fraud (and the contract is silent as to this circumstance), and special rules regarding jury trial waivers, arbitration, judicial reference and attorneys fees clauses. 6. Special Qualifiers (Good Faith, Best Efforts and Knowledge). In California, the terms good faith and best efforts and the various knowledge qualifiers that are frequently used in purchase agreements may not always mean what the buyer expects. 7. Supplementing and Modifying the Written Agreement. It may be easier in California than some other states for courts to expand upon and sometimes even change what is set forth within the four corners of the written purchase agreement. 8. Timing. Time is of the essence clauses are sometimes enforced in California, but sometimes they are not. Also, California has statutes addressing business days and time zones, some of which may be surprising. 9. Entity, Property, Transfer and Sales Taxes. California taxes may be relevant in determining the form of the buyer, the price, and the structure of the transaction. 10. Property and Transaction Specific Matters. Numerous other California laws and customs may be relevant depending on the nature of the property and the structure of the transaction. Page # 40 40 41 42 44 52 53 54 55 62 A more detailed discussion follows.

40 The Practical Real Estate Lawyer July 2016 1. RECITALS Most purchase agreements begin with recitals, which may tell the story behind the deal (to establish the background and create a framework for the agreement). In California, buyers may prefer to keep this story short. According to the California Evidence Code: The facts recited in a written instrument are conclusively presumed to be true as between the parties.... Cal. Evid. Code 622. With the exception of a recital of consideration (which may be questioned), this statute estops the parties to deny the truth of the recitals. See, e.g., 13 Witkin, Summary of California Law 193(1)(c) at 531 32 (10th ed. 2015). Many California legal practitioners were surprised in 2000 when a California court, relying on this statute, found that a tenant was bound by an inaccurate termination date set forth in its estoppel certificate. Plaza Freeway Ltd. Partnership v. First Mountain Bank (Cal. App. 4th Dist. 2000) 81 Cal.App.4th 616. In the author s experience, it is typically the buyer who wants to add, and the seller who wants to delete, information about the property (e.g., square footage) in the recitals. But query whether the buyer would be precluded from complaining if the information it added turns out to be wrong (e.g., the stated number of square feet overstated the actual number)? An open question is whether placing contractual terms in a recital will safeguard the parties against claims of promissory fraud.... CEB, California Real Property Remedies and Damages 3.80 at 3-101 (2d ed. 2015). (But see Bruni v. Didion (Cal. App. 4th Dist. 2008) 160 Cal.App.4th 1272, 1291, which states that section 622, however, does not bar an assertion of fraud or other grounds for rescission. ) 2. DUE DILIGENCE TERMINATION RIGHT Buyers often, if not usually, want the right to decide during the due diligence period whether or not to proceed with the purchase without being second-guessed. The discretion given to the buyer to make this decision, namely whether to terminate the purchase agreement during this period, is key to determining whether the buyer s decision may be challenged. For example, some commentators have suggested that sole discretion merely indicates whose discretion is being exercised and may not preclude the imposition of the implied covenant of good faith and fair dealing. And even absolute discretion might not be entirely free from doubt in California. But if this termination right (sometimes called a free look ) is crystal clear, it may come at a cost if it is not supported by independent consideration: the purchase agreement may be subject to attack as an illusory contract. Thus, there are two concerns when the buyer expects to have an ironclad termination right during the due diligence period: (1) making sure the buyer has unfettered discretion to exercise the termination right; and (2) making sure there is independent consideration to avoid an illusory contract. To address these two points, many California purchase agreements (1) provide that the buyer may decide whether to proceed for any or no reason, and (2) require the buyer to pay the seller some amount (often $100) of independent consideration that may be part of the deposit that is deposited in escrow, but ultimately goes to the seller under any and all circumstances, and is nonrefundable (and that obligation survives any termination of the purchase agreement). For more background (including a discussion of some of the relevant California case law), see Carey, Cauble & MacCracken, The Free Look in California You Get What You Pay For, 33 Real Prop. L. Rep. 89 (July 2010).

California Purchase and Sale Issues for Buyers 41 3. TITLE INSURANCE AND ESCROW 3.1 Regulation of Forms and Rates. In California, the types of forms and the rates the industry may charge are largely unregulated. The Insurance Code, however, does set forth general rate guidelines and requires that all rates be filed with the Department of Insurance. California also requires that each title insurer file with the Insurance Commissioner any policy form it intends to use on a regular basis.... CEB, California Title Insurance Practice 6.8 at 6-13 (2d ed. 2015). In the author s experience, title insurance companies in California seem to have considerably more flexibility regarding the forms of and rates for endorsements (than they have for the basic policy). 3.2 Customary Forms of Policy and Endorsements. There are essentially two types of title insurance policies available in California for owners of real property interests CLTA policies and ALTA policies. CLTA policies insure primarily against defects in title that are discoverable through an examination of the public record. ALTA policies [may] provide greater coverage in that they [may] also insure against [certain] off-record defects.... Ibid. 6.10 at 6-15. Although a CLTA form is available, and its cost may be relevant for the allocation of closing costs, in the author s experience, buyers in commercial real estate purchases typically obtain a 2006 ALTA extended coverage owner s policy. A 2006 ALTA standard coverage owner s policy in California includes the so-called Western Regional Exceptions and provides coverage comparable to a CLTA owner s policy. Ibid. 7.21 at 7-20. In California, as in many states, the CLTA endorsement forms are used along with the ALTA endorsement forms and customized forms that may be negotiated with the title insurance company. 3.3 Preliminary Reports and Title Commitments. It is common in California, as in many states, for the buyer to obtain a preliminary report. This report is sometimes referred to in purchase agreements as a preliminary title report, although the name was changed in California by statute effective January 1, 1982. Cal. Ins. Code 12340.11. The deletion of the word title was intended to distinguish a preliminary report from a title abstract, because (unlike a title abstract) a preliminary report is not intended to create any duty or liability for the title insurance company. Although the preliminary report appears to be a report of the status of title, it is loaded with disclaimers (including a statement that there may be other title exceptions) to make clear that a buyer relies upon it at its own risk. By statute, it is not to be construed as a title representation. Cal. Ins. Code 12340.11. And case law has made clear that [a] party that seeks to hold an insurer liable for negligently providing title information upon which the party relied must obtain an abstract of title.... In short, there are two ways in which an interested party can obtain title information upon which reliance may be placed: an abstract of title or a policy of title insurance. Soifer v. Chicago Title Company (Cal. App. 2d Dist. 2010) 187 Cal.App.4th 365, 374. Sometimes, the buyer will obtain a commitment rather than a preliminary report, but commitments may fare little better because the statute refers to both preliminary reports and commitments. Cal. Ins. Code 12340.11. Until a contract to issue a policy is created..., the commitment carries with it the same statutory protections as the preliminary report. CEB, California Title Insurance Practice, supra, 5.31 at 5-29. Commitments can create a binding obligation to issue a policy, but they often do not reach that stage because, for example, they may not include the name of the buyer or the liability amount or the commitment fee has not been paid. See ibid. 5.33 at 5-30.

42 The Practical Real Estate Lawyer July 2016 3.4 Property Tax Liens. Generally, the tax lien for each fiscal year (July 1 June 30) in California arises on the immediately preceding January 1. Cal. Rev. & Tax. Code 2192; Cal. Gov. Code 29001. The lien for government improvement special assessments (for assessment districts or community facilities districts) arises when a notice of assessment or notice of special tax lien is recorded. Cal. Sts. & Hy. Code 3114 3115. The 2006 ALTA form owner s policy generally covers any liens for taxes or assessments that are due or payable and are unpaid and are not specified on Schedule B. See paragraph 2(b) of the Covered Risks. But what if the voters approve a local special assessment for public improvements and the government has not yet levied an assessment and the lien does not attach until after the deed is recorded? This special assessment is not likely to be covered by the 2006 ALTA title insurance policy because of paragraph 3 of the Exclusions From Coverage: Defects, liens, encumbrances, adverse claims, or other matters... (d) attaching or created subsequent to Date of Policy. And what happens if the purchase is not expected to result in a reassessment? See infra part 9.2. Might there be some assessments specific to the property that have not been processed and could increase the property taxes for the period after closing? See Cal. Rev. & Tax. Code 75.54(c) for proration of supplemental assessments between seller and buyer and Cal. Rev. & Tax. Code 531.2 for potential proration between seller and buyer of escape assessments. 3.5 Escrows. California real estate purchases often, if not usually, involve an escrow, both to hold the deposit and to consummate the closing. The most common closing alternative, namely a New York style or table closing (in which the parties meet face to face to close the transaction), is rarely used to close a California purchase agreement. See 3 Friedman on Contracts and Conveyances of Real Property 13:4 at 13-26 13-29 (7th ed. 2015) for a description of a New York style closing. See also CEB, California Title Insurance Practice, supra, 10.3 10.4 at 10-3 10-4. (Even in New York, the New York style closing has largely become a part of history. Most real estate purchase closings occur through escrow.) Although independent escrow companies are occasionally used in Southern California, many, if not most, practitioners in California prefer to use an escrow agent that is affiliated with the title company. See ibid. 10.3 at 10-3. 3.6 Role of Attorneys. In California, unlike some states (e.g., Florida and Georgia), attorneys are not used as title agents and, although allowed, typically do not function as escrow agents (although arrangements between counsel to hold executed signature pages or counterparts pending closing or further instruction are common). See, e.g., NAIC Title Insurance Task Force, Survey of State Insurance Laws Regarding Title Data and Title Matters (Mar. 22, 2010), available at http://tinyurl.com/gv6q7jk; Bernhardt, Attorneys as Escrow Agents, 29 Real Prop. L. Rep. 342, 344 (Sept. 2006) ( California not only allows attorneys to serve as escrow agents, it makes it easy to do so by waiving [certain] license requirements.... The best thing we might do for ourselves is to get that exemption repealed. ). 4.1 Closing Documents. 4. CLOSING PROCEDURE 4.1.1 Form of Deed. In California, the custom is to use grant deeds. The statutory form is set forth in Cal. Civ. Code 1092. Unless otherwise provided, the following are implied covenants under a grant deed in California: