With almost daily reports of either blizzards in the Midwest, tornadoes in the mid-Atlantic states, fires in California, or hurricanes in Florida, it's no surprise that the once-benign and sometimes ignored clauses addressing "acts of God" are now front and center as parties negotiate the purchase or lease of real estate.
Acts of God refer to any natural event, such as a flood or storm, associated with a force of nature over which no person has any control. Consequently, no one can be held accountable for the consequences.
In recent years the application has been expanded to include not only natural disasters but also human-caused catastrophic events that significantly impact transactions. In many legal circles, the preferred term is force majeure, a French phrase that translates to "superior force," and covers both natural and human disasters. Because case law is murky and varies from state to state, the wisest choice is to use the broadest term that refers to all such events regardless of causation.
Landlords, tenants, and real estate buyers and sellers would be well-advised to pay particular attention to this clause. Natural disasters such as Hurricane Katrina and human-caused devastation such as the terrorist attack of Sept. 11, 2001, stand out as events that have strongly affected the day-to-day transacting of commercial real estate deals. Other occurrences such as the anthrax contamination of a South Florida building several years ago illustrate the potential for disaster that can affect any property.
While not a new issue, force majeure often is the last issue to be considered in a contract's boilerplate language. Today, however, with the threat of terrorism and the prevalence of natural disasters, all parties involved with a real estate transaction should take the time to examine the consequences of the clause contained in the contract.
There are many boilerplate versions of the force majeure clause. They range from very narrow to broad, all with the purpose of excusing parties from performing their obligations due to a catastrophic event. Such clauses can cover only natural disasters, but they should be written to include such events as disruptions in telephone service, blackouts, riots, acts of terrorism, strikes, and national-level software glitches.
There are numerous ramifications once a disaster occurs, and a well-thought-out force majeure clause will cover these circumstances. Below are some of the most apparent.
Financing. If an owner wants to sell a commercial property that has been damaged by a storm or other natural disaster, the force majeure clause may come into effect when the buyer's lender appraises the property. If the clause does not hold the insurance company - or seller - liable for complete and total renovations, the bank may not appraise - and thus not finance - the asset at its proper value.
This matter should be settled during the inspection period, since banks will not close without the appropriate certificates of insurance, and even minor damage can keep a bank from funding at closing.
Insurance. Insurance has an important interplay with the force majeure clause. In leases, landlords can include a clause making it obligatory for the tenant to have insurance, including business interruption insurance, which would decrease any claim that a tenant might have in the event of damage to the space. Moreover, by obtaining appropriate insurance the landlord can decrease his own exposure.
In the purchase/sale arena, if a natural disaster occurs after the buyer has put down his deposit but before the closing, the insurance company can revoke its promise to supply the buyer with insurance following the disaster. This may result not only in the cancellation of the sale, but the forfeiture of the deposit by the buyer.
Non-Conforming Uses. If the asset is substantially destroyed before the closing but after the buyer's deposit is at risk, the buyer may be faced with reconstruction issues. Zoning laws may require more parking than the building had for the original number of units; other laws may require more expensive materials, such as hurricane-grade windows or different concrete and wiring, that hike construction costs. The buyer could be forced to close and even take the seller's insurance.
Buyers should first determine if the property they are purchasing is conforming or non-conforming. If it is non-conforming, a buyer would certainly not want a clause that enforces closing on the property and assignment of all insurance money. Even with all insurance money, the buyer may not be able to rebuild to the new standard required.
Most communities use their zoning codes to purposely limit an owner's ability to rebuild a structure if it has been damaged or destroyed. It is very possible that a buyer, even with adequate insurance coverage, cannot rebuild a particular property in the same configuration that it existed. While communities such as New Orleans and Fort Lauderdale, Fla., are addressing these issues in their codes, it is still a legal labyrinth.
Despite its placement in the boilerplate section of contracts, drafting force majeure language differs depending on the situation.
The Seller's Clause. Property owners who are selling want the most options possible with an excuse for non-performance. In purchase and sale agreements, the seller wants to keep control of the situation and have the option to excuse performance or sell the property with an assignment of insurance but not have to undertake repairs.
The Buyer's Clause. From a buyer's perspective, the very best clause forces the seller to sell only after making repairs. This excuses the buyer from paying for the property for some lengthy period of time while the seller rebuilds, and the buyer would receive all the benefit of a newly rebuilt property without any increase in purchase price. The seller would have to endure the permitting period and the expense and cost of rebuilding, sometimes to a higher standard because of the application of new construction requirements.
If a buyer is unable to obtain a clause allowing for sale with complete repair, he must make some decisions about the risk associated with the transaction. It has become customary to have longer due diligence periods during which an investigation of the property is conducted. It also is typical that as soon as the due diligence period is over, the buyer is locked in. If the buyer is unable to obtain a favorable force majeure clause, he must now understand his exposure between the end of the due diligence period and the actual closing date.
One final item to consider is that in today's electronic age face-to-face closings are the exception. Consequently, businesses require adequate communications that must be addressed in the force majeure clause. For example, if there is an earthquake in San Francisco, it is highly unlikely that a buyer can complete a wire transfer to Buffalo, N.Y., to purchase property in Tampa, Fla. However, a snowstorm in Buffalo or a hurricane in Tampa also could interrupt the transaction. Electronic funds transfer, electronic execution, and electronic filing present new challenges, and traditional clauses often do not take these matters into account.
During the last few years, there clearly has been increased awareness about force majeure clauses. This once-boilerplate clause is now a major issue in consummating real estate transactions.