This article, written by attorney Eric Kilchenstein, was originally published in the NH Bar News and can be found here (p31).
“As we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns — the ones we don’t know we don’t know.” – Donald Rumsfeld
It is not often, actually never, that I get to incorporate the above Donald Rumsfeld quotation into my practice. Nor do I go around quoting Donald Rumsfeld in my personal life. However, with among other factors, shifting (though moderately rebounding) office space demands and near-term uncertainty with tariffs and interest rate projections, the normal projections and planning intertwined with commercial real estate decisions are more difficult and the usual presumptions of “known unknowns” has shifted. While the existence of additional “known unknowns” undoubtedly makes construction costs, leasing and capital market activity particularly difficult for clients to forecast and resulting decisions with commercial real estate less obvious, often overlooked variables (“unknown unknowns”) can often be eliminated by increased and early, even if internal, due diligence.
Whether real estate concerns are a part of a larger transaction involving an affiliated business or real estate is the business, quite often unexpected factors (“unknown unknowns’’) are discovered prior to a transaction. However, unlike economic forecasts, quite often the unexpected could have been discovered prior to the subject real estate being put under the microscope as part of the transaction. The “unknown unknowns” could have been “known unknowns” or even just “knowns” that have been resolved prior to transactional due diligence.
Not unlike a lot of practitioners in northern New England my practice regularly involves companies of all sizes ranging from single member entities to publicly traded corporations. While the large corporations have dedicated teams of professionals tracking their real estate interests, they are not immune from the existence of “unknown unknowns” and variables popping up that could have been discovered before an impending acquisition, lease renewal, sale or other disposition of commercial real estate. Although many businesses and organizations undertake regular internal initiatives of accounting, governance and policy review, internal due diligence of real estate interests seems too often to be an afterthought. While most businesses and organizations keep detailed tabs on lease renewal dates, tax data, expenses and other accounting details, a complete survey of a company’s real estate interests is often incomplete until the piper comes calling by way of due diligence via the attorneys that are party to an impending transaction. Some minimum real estate due diligence review by your client’s business or organization, as a preemptive matter, is an easy way to abate possible problems and eliminate the “unknown unknowns” for your client down the road and prior to when the clock starts ticking for transaction due diligence. The below are just a few basic and common real estate “unknown unknowns” that often pop up prior to a transaction that could have become “knowns” and remediated ahead of time:
Unknown Title Issues
Unknown title issues, though avoidable with an occasional title update, have in my experience slowed down transactions from modest to hundreds of millions of dollars in size. Businesses and organizations would be well-served to take measure of all real estate loans, lines of credit, equipment loans and other loan facilities, present or past, to the business and whether they are secured against your company’s real estate. Next, make sure any of the old loan facilities that are secured by the real estate have been properly discharged, including a sufficient recording in the correct registry of deeds. Once counsel is hired by the other party to your transaction, any such encumbrances should be caught by a title search and your counsel will get to work on discharging the same. However, old mortgages and other encumbrances can sometimes take a very long time to properly get discharged and doing so may slow down the underlying transaction. As to encumbrances from current and existing loan facilities, it is often the case that due to confidentiality and other concerns, companies do not want to tell their lenders of the possibility of sale, merger or refinance, however, taking measure of what encumbrances on title exist and coming up a with a plan, including payoff information ahead of time, will also speed up the process. Beyond mortgages and other possible encumbrances on your company’s real estate from lenders, past and present, there are a wide range of title pitfalls that may become apparent when counsel to the other party reviews the title report(s) to the real estate. Previously unknown rights of right of first refusal, or other purchase rights (particularly common in large office condominium complexes and ground leases among others), may exist. Easements, never considered or previously an issue, or use restrictions never thought of or known, may be lingering in the title and when discovered may slow or impede a transaction.
Unknown Leasing Concerns
Similarly to title issues, the real estate pitfalls involved with leased properties are often “unknown unknowns” and not caught until a transaction is underfoot. Most obviously, a major issue with leased property is obtaining the landlord’s consent to an assignment of a lease. In general, assignment terms in commercial leases can be particularly onerous and include very strict requirements, though they often can be negotiated. Moreover, for closely held businesses where the principals are guarantors to a lease, assignment might be granted but the principals will not be released as the current lease is literally being “assigned” and the terms, including the guarantors, do not change. A termination of the current lease and a new lease with a buyer is usually ideal but can be difficult to negotiate. Another potential pitfall with commercial leases that I find could have often been addressed sooner is the issue of exclusives or use restrictions. In large commercial plazas these can be particularly tricky as the landlord is beholden to a wide variety of tenants and the exclusives may narrow what businesses can be located on the premises.
The above considerations, abbreviated to fit the word limit of this article, are just a snapshot from my experience of the many variables to which any detriment to a transaction could be mitigated by earlier discovery. While economic factors are, and to some extent are always, a “known unknown”, early and internal due diligence is an easy path for clients to address what is squarely discoverable, add to the known column and better align themselves for expedient transactions.