Heads of Agreement

Transactions involving the acquisition and disposal of commercial property proceed in stages:

• • introduction of the parties and the property;
• • negotiation;
• • the parties entering into a preliminary agreement such as a Heads of Agreement, a confidentiality agreement or exclusive dealing arrangement;
• • the purchaser undertaking pre-contract due diligence;
• • the parties entering into a formal contract;
• • the purchaser undertaking post-contract due diligence; and
• • completion — the passing of ownership, payment.

Prior to entering binding contracts, parties may enter into preliminary agreements such as a Heads of Agreement, which sets out the key terms of a transaction. One of the main purposes of a preliminary agreement is to protect confidentiality because due diligence involves the disclosure of commercially sensitive documents by the vendor to the purchaser. It also signifies the parties entering into a negotiating relationship. Another such purpose is so that the purchaser can secure an exclusive right to negotiate the purchase while pursuing due diligence.

See Heads of Agreement.

Due diligence

Due diligence is the process whereby the purchaser carries out an investigation to:

• • determine if it is acquiring what it thinks it is acquiring;
• • evaluate the benefits and risks;
• • flag issues to be dealt with prior to entering into a binding contract; and
• • test the representations made by or on behalf of the vendor.

If due diligence is not undertaken, the purchaser must rely on the vendor's warranties in the contract (if any) and must typically commence proceedings to enforce its rights under the warranties if they are breached. Even if the purchaser is successful, the recovery of damages will depend on the financial standing of the vendor or may be limited as a matter of law (see eg Bain v Fothergill (1874) LR7HL 158; [1874-80] All ER Rep 83 in the states where it still applies).

Whether or not the parties enter into a preliminary agreement or formal due diligence will depend largely on the nature of the property being acquired. For instance, where the purchaser is acquiring a single retail shop which is subject to a lease due diligence may be a matter of the purchaser's solicitor requesting information and documents from the vendor's solicitor prior to exchange. The vendor's response may be the subject of vendor warranties included in the contract or rights arising if there has been a breach of the statutory obligations of the vendor under the relevant state or territory legislation.

Where the property being acquired is, eg a multi-story office building, the parties may enter into a Heads of Agreement which will contain, amongst other things, obligations of confidentiality and the key terms agreed by the parties in principle and possibly an exclusive dealing arrangement.

If due diligence is undertaken it should be concluded with a report to the client prior to the expiry of the due diligence period as the purchaser will need time to absorb it and to respond. If no due diligence is undertaken, a comprehensive letter of advice should be prepared.

Due diligence requires a team approach and usually involves at least two of the following disciplines:

• • legal;
• • financial;
• • structural;
• • contamination; and
• • technical.

An effective due diligence process requires:

• • the flow of information ideally coordinated by one representative from each side;
• • requests for information; and
• • control of the flow and management of information and documents.

See Due diligence.

Contract methods

The primary structures to acquire commercial property are:

• • a contract with reciprocal obligations and rights to buy and sell;
• • a call option;
• • a call and put option;
• • acquisition of the property itself; and
• • acquisition of shares in the company, or otherwise taking control of an entity which owns the property, such as a unit trust.

Call option

A call option is granted by the vendor to the purchaser. A call option gives the purchaser an option but not an obligation to purchase the underlying property at an agreed written price at a specified time in the future.

While the grant of a call option is not dutiable, the following events will give rise to a stamp duty liability assessed on the ad valorem rate of duty:

• • exercise of the call option;
• • an assignment of the grantee's rights in the call option; or
• • exercise of the option by the nominee.

Put option

As a put option is “given” by the prospective purchaser, that party is the grantor and the owner of the land is the grantee.

A put option gives the grantee a right to “put” the land to the grantor — the grantor is then required to buy the land. The consideration for the grant of the put option will be the put option fee and the period during which it can be exercised will be the put option period. Upon the exercise of the put option by the grantee, the grantor is required to buy, and the grantee is required to sell the land.

Put and call option

A put and call option is a combination of a call option and a put option in respect of the one parcel of land. It is usually contained in a deed (although can be an arrangement arising in separate documents) and comprises:

• • a call option granted by the owner of land entitling the prospective purchaser, on the valid exercise of the call option during the call option period, to require the owner to enter into a contract for the sale of the land with the prospective purchaser to sell the land; and
• • a put option entitling the owner, on the valid exercise of the put option during the put option period, to require the prospective purchaser to enter into a contract for the purchase of the land with the owner.

Usually, but not always, the call option period precedes the put option period. This enables the owner of the land to require the purchase of the property if the grantee has not exercised the call option.

Incidentally, the put option is not the acquisition of a new right and so a put option agreement is not a dutiable transaction. See Call and Put options above.

Contract for the sale of land

Cooling off periods

A put and call option is a combination of a call option and a put option in respect of the one parcel of land. It is usually contained in a deed (although can be an arrangement arising in separate documents) and comprises:

Unit Sale Agreement/Share sale agreement

This is a set number of days after your client makes a purchase in which they can cancel the transaction. On cancellation, they may have to pay the seller a fee but it is generally not a significant amount. However, in some jurisdictions where statutory cooling-off periods apply in a contract for the sale of land, there is no cooling-off period if the property was sold at auction or the underlying property is not residential. See Cooling off period above.

See Contract methods.

Exchange, settlement and in between

Between settlement and exchange:

• • minimise the potential for delays in exchange and settlement by ensuring all documents are not in order at exchange or settlement;
• • check contracts are correctly executed so that their validity is not challenged;
• • lodge a caveat, priority notice or settlement notice immediately after exchange of contracts (whether it be arising from exercise of an option arising under a deed of call option, deed of call and put option, or a contract for sale of land) to protect the purchaser's interests — unless prohibited by the contract from doing so; and
• • in those states where protection by priority notice or settlement notice is unavailable, carry out final searches as close as possible to settlement, and not, say in the morning of a settlement scheduled to take place in the afternoon

The importance of the lodgment of a caveat, priority notice or settlement notice and the timing of the final search was highlighted in the High Court case of Black v Garnock (2007) 230 CLR 438; 237 ALR 1; BC200705972. In this case:

• • A Writ for Levy of Property (issued the day prior to settlement) was lodged with the Registrar-General after the final search was carried out but prior to settlement scheduled to take place that day.
• • Settlement was effected in the afternoon without the purchaser being aware that a writ had been registered on the title.

See Exchange, settlement and in between.