Mitigating Risk Ahead of the Storm

The most recent hurricane season drives home the importance of drafting strong casualty and force majeure provisions for commercial properties.

Hurricane Helene’s financial toll on residential and commercial properties across the Southeast, including in areas such as western North Carolina that have historically not been prone to such disasters, is estimated to be almost $60 billion. Hurricane Milton, which caused significant damage in many parts of Florida, resulted in losses exceeding $35 billion.

For real estate developers, buyers and sellers, there is a crucial period after a contract is signed for a commercial property but before the closing takes place. Storms like Helene and Milton serve as important reminders about often-overlooked tools that can help mitigate the risks associated with potential damage to commercial properties during sales. Whether purchasing or selling a property, it is essential to review the purchase and sale agreement closely, paying particular attention to the casualty and force majeure provisions.

A casualty or risk of loss provision, as the name suggests, addresses which party bears the risk of loss when the property is damaged. A force majeure provision addresses the impact to the parties’ performance obligations under a contract upon the occurrence of events outside of the control of the parties, including natural and human-made events such as wars, strikes or civil unrest. These provisions are crucial in clearly defining who bears the financial responsibility for property damages and under what circumstances a party’s obligation to fulfill the contract may be excused or delayed. Drafting strong provisions before calamity strikes can help avoid confusion, uncertainty and unnecessary conflict during what is likely to be a stressful time.

When Casualty and Force Majeure Provisions Kick In

After a storm passes and the parties begin to assess the damage, both buyer and seller will turn to the negotiated purchase and sale agreement and its provisions to determine the next steps. Therefore, negotiating these terms between parties at the onset is critical. The purchase and sale agreement will ultimately govern when a party may terminate the agreement, who keeps any earnest money, who is responsible for completing repairs and paying the associated costs and expenses, and whether any deadlines are subject to extension.

For example, timing language is helpful. A risk of loss or force majeure provision that clearly states the seller must alert the buyer of property damage within a specific period of time and that the buyer also has a specific period of time after that to assess its options and decide what direction to take — terminate the agreement, seek a price reduction or proceed to closing — can provide clarity and keep conversations moving forward. In the case of a termination, the casualty and force majeure provisions can also spell out which party keeps the earnest money.

Other best practices include clearly defining what level of damage triggers the casualty provision. One way to accomplish this is by defining what constitutes material damage through monetary values or levels of property damage. The provision could, for example, explicitly state that when the cost to repair the damages exceeds a certain threshold or when the time to repair them would take longer than a specific time period, either party can terminate the agreement. Or the provision might state that when more than a certain percentage of the property is damaged, the agreement can be terminated. Any damage that does not rise to these levels would be treated as business as usual under the purchase and sale agreement.

Force majeure provisions can also govern delays to each party’s performance of its obligations under the purchase and sale agreement. Such provisions can allow the parties to stay under contract, at least for some predetermined period, when an unexpected event occurs that is out of either party’s control. This can be important for long-term relationships such as residential development lot takedown agreements between developers and builders. Both parties are engaged in substantial work prior to land conveyance with potential ongoing work that survives the closing. Termination of the deal may not be a desired result for either party.

Naturally, the buyer will negotiate these terms in a way that offers them the most flexibility and protection of their earnest money. The buyer benefits from lower thresholds to activate the casualty provision and longer timelines to perform under the force majeure provision. These put the most options on the table to receive a price reduction, require certain repairs ahead of closing or walk away from the deal with the earnest money in hand. Severely damaged properties come with financial risk and slow project timelines down, so having these options to determine whether the deal still pencils out can be helpful.

The seller, meanwhile, will want to limit this language as much as possible to keep the agreement status quo. Sellers will want higher thresholds, shorter timelines and rights to keep the earnest money as consideration for taking the property off the market, even if the buyer terminates the deal. Buyers and sellers often go back and forth on these metrics and will typically land somewhere in the middle of each of their starting points.

Ask the Right Questions

Strong casualty provisions are not just about putting monetary values on damage caused. They should also contemplate insurance claims and proceeds.

After a tree falls on half of the units at a self-storage facility, hail damages a logistics center’s roof or a river floods an apartment complex, one of the first things an owner will do is alert its insurance company. If any of these casualties occur while the owner is under contract to sell the property, then a buyer has an equally vested interest in the owner making a timely claim and receiving proceeds from its insurance company.

Among the questions for a casualty provision to address are which party receives the insurance proceeds, does the owner assign the claim to the buyer, or will the owner keep and pursue the claim and reduce the purchase price? By not answering these questions in the purchase and sale agreement at the outset, either party may be leaving dollars on the table and losing leverage in negotiations after the damage is done.

A Critical Piece of the Playbook

A purchase and sale agreement is the playbook for buyers and sellers while under contract. Provisions in these agreements commonly address what is reasonably foreseeable, such as guardrails for conducting diligence on the property. However, it is equally important to include provisions that address the unforeseeable, like a hurricane striking the entire city of Asheville, North Carolina. During the negotiation of a commercial property transaction, many stakeholders overlook provisions that address the unforeseeable or view them as boilerplate. In reality, there is nuance in the details, including how both parties view material damage that results from severe storms.

This past hurricane season demonstrated that even areas long thought safe from such weather disasters are becoming more prone. It also put the need for strong casualty and force majeure provisions into sharp focus. Developers, buyers and sellers can better avoid disputes, reach quicker resolution and mitigate their financial exposure by accounting for the “this will never happen to me” scenario at the onset of a deal and including it in their playbook — the purchase and sale agreement. 
 
Megan Naioti is a real estate and commercial development lawyer. She is an associate with Parker Poe in Atlanta. Laura Goode is a commercial real estate lawyer in Parker Poe’s Raleigh, North Carolina, office.

California Wildfires The wildfires that broke out in Southern California in January are estimated to have erased $30.42 billion in property value, including land, according to an analysis based on exclusive data from CoStar Group. Approximately 11,200 residential and commercial properties were burned in the fires. CoStar News reported that 74 apartment buildings containing 870 units were destroyed across Los Angeles in the Palisades and Eaton fires. The properties were valued at an estimated $390 million. “Also destroyed in the combined fires were 26 office buildings totaling 248,000 square feet and valued at an estimated $114 million, two industrial buildings totaling 208,000 square feet with an estimated $60 million value; and 23 other building types, including religious properties, totaling 210,000 square feet,” according to CoStar News. “No hotels were destroyed.”

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