Daniel Richard Stegall, A Professional Law Corporation concentrating in Real Estate Law, Estate Planning and Taxation and the Representation of Small Business Entrepreneurs

Ask the Expert - Points of Interest For Small Business and Commercial Real Estate


1.  Small Business: Teaming Agreements.   Many small enterprises and entrepreneurs looking for opportunities in government contracting, high technology contracting, construction contracting or other areas which are hard to enter into because of the size requirements, including staffing and bonding requirements, may consider teaming with a larger entity to secure such a contract.  In most situations, if the “team” is accepted, the teaming member becomes a subcontractor to the “team leader” or prime contractor.  Often the scope of responsibilities of the subcontractor ad the major terms that would be incorporated into the subcontract are attached to the teaming agreement.  The team member should make certain that the agreement obligates the team leader to diligently pursue the obtainment of the prime contract and if successful, enter into the subcontract with the team member/subcontractor

2.  Non-Disclosure Agreements.   Prior to entering into any negotiations with another business to establish any business relationship such as those mentioned above, it is wise to negotiate and execute a non-disclosure agreement (NDA), also known as a proprietary information agreement (PIA) confidentiality agreement, or confidential disclosure agreement (CDA). The NDA is designed to allow one or both parties to receive confidential information from the other party which is necessary to evaluate the potential business relationship, but protects the confidential information from being disclosed to third parties and prevents the receiving party from using such information if no business relationship develops. The NDA protects confidential and proprietary information and trade secrets, but does not protect information in the public domain.  The NDA usually is unilateral where one party passes information to the other party for analysis, but desires the information to remain secret; it may also take the form of a mutual agreement, where both parties are supplying confidential information to each other.

It is important that the NDA properly define the confidential information which it is designed to protect. Normally, It is common for NDA’s to set out a list of to include within the definition of confidential and proprietary information, including financial data, vendor and customer lists, processes, business practices, business strategies, pending patent, trademark, and copyright applications, general business know-how, etc.  It is also important the NDA indicate exclusions from the definition of confidential information to protect the recipient. There are a number of typical exclusions, including for example, if the information is or subsequently becomes generally available to the public, if the information comes subsequently to the recipient from a separate source, or if the recipient had prior knowledge of the information. In addition, there is usually a time limit in years on the confidentiality obligation, as well as other restrictions on how the recipient can use the information.  These are only a few of the provisions which need to be considered.  An attorney well-versed in this area is recommended.

3. Commercial Real Estate Contracts for Purchase and Sale:   The Earnest Money Deposit. Too often real estate contracts are deficient in setting out where the earnest money deposit is held, under what circumstances it is paid out and to whom is it paid. The deposit should be held by an independent third party under an escrow agreement detailing the proper disposition, under a particular set of circumstances and the timing of the disposition.  Thus, the seller should not hold the deposit, although that seems to happen in many "unsophisticated" transactions.  If the seller holds the deposit and the buyer becomes entitled to a return of the deposit, the buyer may be left only with a lawsuit, normally a time consuming and expensive process, in order to realize a rightful return of the deposit.

The earnest money deposit may take alternative forms.  The Seller will want the deposit to take the form of a liquid asset, e.g., securities or bonds, in order to insure that there is a ready fund from which to realize a forfeiture of the deposit if the buyer defaults under its contract obligations.  The buyer, however, may resist having any of  its liquid assets tied up for any period, and instead will want to use a promissory note or letter of credit as a substitute for  cash deposit or other form of liquid asset.  Obviously the buyer may refuse to pay the principal amount of the promissory note if the buyer defaults, leaving the seller with a lawsuit to realize upon the deposit.  Although a letter of credit provides more certainty, since a financial institution is standing behind the underlying obligation represented by the letter of credit, there still remains some avenues under which the buyer may delay payment.  From everyone=s point of view, a cash deposit held by an independent third party is most favorable.  In the future we will look at appropriate terms for a third party escrow agreement for holding the deposit.

 4.  Commercial Real Estate Leasing: The Common Area Maintenance Clause.   The first tenants taking possession of their space during the development period of a retail center should review their lease carefully regarding the covenant to pay their pro-rata share of common area maintenance expenses.  It is not uncommon for the clauses to be written without regard to whether or not the center is fully leased.  Thus, the tenant's pro-rate share may be defined as the square footage in the tenant's space divided by the square footage of all tenants occupying space in the center.  This type of clause, however, works a hardship for the initial tenants in the center since they will be picking up the total common area maintenance expenses for the whole center until the center becomes fully occupied. 

For example, in a 10,000 square foot retail center being developed where there are perhaps only one or two tenants initially, these two tenants will pay the CAM expenses for the whole center, including real estate taxes, insurance expense, and other CAMs.  From the tenants's point of view, it would be more equitable to have each tenant pay CAM expenses based on the tenant's square footage divided by the total square footage in the center  to be leased, regardless of whether the space is occupied or even constructed.

 5.  Commercial Real Estate Financing:  Lenders and  Leases. The leases in a commercial property often are the most important ingredient in a lender's loan underwriting decision. The value of the lender's security is determined, in large part, by the income generated by the property.  Indeed, capitalization of the income stream may often be the best measure of the value of the collateral for underwriting purposes. This arises because the lender, in the event of default and foreclosure, will rely on the income stream to pay costs of ownership, to make up any deficiency in the event of foreclosure, and to establish value for the property to facilitate a resale after foreclosure. Although there may be inherent value in the land and structures, unless there is a reliable income stream from the leases, the land and structures will result in cash outflow in terms of upkeep and carrying costs.

Since the leases and the income stream they represent are so important, the lender will review the leases with a keen eye with regard to the credit worthiness of the tenants in the property and the actual terms of the leases. Most important, the lender will require tenant estoppel certificates to ascertain the facts surrounding the leases.   The estoppel certificate when signed by the tenant and should provide the lender with confirmation that the information supplied by the borrower is correct.   Alternatively, the estoppel certificate may point out any discrepancies in the information supplied by the borrower and any disputes between the tenant and the borrower.  In that event, the lender will reexamine its underwriting decision regarding the loan.   In the future we will consider the major terms of typical estoppel certificate.

 6.  Tax Deferred Exchanges: Common Misconceptions.  The tax -deferred exchange may be one the last tax breaks left to the real estate industry.  In this first installment of the frequently asked questions regarding exchanges, we will begin to explore some of the misconceptions the industry may have about the mechanics of tax-deferred exchanges.

A common misconception is to characterize Section 1031 exchanges as a "tax shelter."  In reality, Section 1031 exchanges result in a deferral of the recognition of gain if the taxpayer's property had been sold rather than exchanged.  In an exchange of like-kind property solely for like-kind replacement property, the tax basis of the taxpayer's property given up in the exchange becomes the tax basis of the replacement property.  Thus the gain inherent in the taxpayer's property carries over to the replacement property and is taxed when the replacement property is sold.  The same general rule applies if the replacement property is subsequently exchanged in another transaction qualifying for Section 1031 treatment.  The only time that the gain inherent in the taxpayer's property is fully forgiven under current law, and becomes a true tax shelter, occurs upon the death of the taxpayer, whereupon the taxpayer's property (i.e., in our example, the replacement property) acquires a "stepped-up" basis under IRC Section 1014 to its fair market value.

This discussion of Frequently Asked Questions is not intended as a substitute for legal advice from legal counsel. While every precaution has been taken to make the discussion accurate, we assume no responsibility for errors or omissions, nor for damages resulting from the use of the information in this discussion.

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