Understanding Casualty and Condemnation Provisions in a Commercial Purchase Agreement
One of the things that a commercial real estate purchase agreement does is allocate the “risk of loss” for the property prior to closing. Typically there is a period of time, frequently 60-90 days, but sometimes as long as a year or more, between when the parties agree to the terms of the sale and when the sale actually closes. The question is what happens if the property is damaged or rendered unusable during that period of time – is the buyer still obligated to buy the property? If so, is the purchase price affected? A well drafted purchase agreement creates a framework for working through these scenarios.
What are Casualty and Condemnation Events?
Casualty Events
Casualty events encompass unforeseen incidents that cause damage or destruction to the property. These can range from natural disasters like fires, floods, or earthquakes to human-caused events such as vandalism or accidents. The defining characteristic of casualty events is their sudden and unpredictable nature, which can significantly affect the property’s condition and value.
Condemnation
Condemnation refers to governmental actions that restrict or change the use of a property. This is most commonly the result of a public authority’s exercise of its eminent domain power to acquire part or all of the property for public purposes. Condemnation can also result from zoning changes or other regulatory measures that limit the property’s permitted use.
Contractual Provisions
Casualty and condemnation provisions in a commercial purchase agreement typically distinguish between two different forms of casualty and condemnation, those events that constitute a “major loss” and those that do not.
If a casualty or condemnation event does not rise to the level of a “major loss”, then generally there will be no right for the buyer or seller to terminate the contract. The seller will either repair the damage that has occurred or transfer to the buyer at closing any insurance proceeds or condemnation award relating to the damage and the parties will proceed to closing with no adjustment to the purchase price (other than a credit to the buyer of the amount of the deductible under any applicable insurance policy). In essence, the parties will “close over” the occurrence of the casualty or condemnation.
If a casualty or condemnation event does rise to the level of a “major loss”, then the parties will generally have an election to either proceed as they would with a smaller casualty or condemnation and “close over” the loss with no adjustment to the purchase price, but with insurance proceeds or condemnation award proceeds being allocated to the buyer. Alternatively, the buyer will have the right to terminate the purchase agreement within a specified timeframe following the occurrence of the casualty or condemnation. If the buyer elects to terminate due to a major loss, the buyer will generally be entitled to a refund of their deposit, even if the deposit has otherwise become nonrefundable (“gone hard”) under the contract. This termination allows both parties to walk away from the transaction.
Defining a Major Loss
Based on the framework described above, defining what constitutes a “major loss” is critical. Oftentimes for a casualty, the parties will agree on a dollar amount or percentage of the purchase price as the threshold. For condemnation events, the threshold can be a bit trickier. Parties typically continue to rely on a dollar or percentage threshold, but will also frequently include material changes to the character of the property such as permanent impairments to use, zoning non-compliance, or changes to access and egress points.
In negotiating these provisions, it is a good idea to consider whether there is some essential characteristic to the property that, if destroyed, would make the property no longer desirable to the buyer.
Conclusion
Although the likelihood of a casualty or condemnation event occurring between the signing of a purchase agreement and the closing of the contemplated transaction is low, if one does occur, it can have a significant impact on the character and value of the property. When negotiating a purchase agreement, it is worthwhile to be thoughtful in addressing how the parties might respond to a casualty or condemnation if one were to occur.
