Title Issues that are Unique to Commercial Property Transactions

Commercial real estate transactions in California represent significant investments and opportunities, characterized by a higher degree of complexity compared to residential property deals. These transactions often involve intricate legal and financial considerations, including zoning laws, environmental regulations, and complex title issues. Title companies play a crucial role in these transactions, conducting thorough title searches to uncover any liens, encumbrances, or claims against the property.

Complex Ownership Structures

Commercial properties are rarely held by single individuals. Instead, they are frequently owned by complex entities designed to limit liability, manage taxes, or facilitate investment. This creates unique title considerations.

Multiple Owners/Entities

Limited Liability Companies (LLCs): LLCs are a popular choice for holding commercial real estate due to their liability protection and tax advantages. However, the operating agreement of the LLC must be carefully reviewed to understand ownership percentages, management structure, and any restrictions on transferring ownership.
Partnerships (General and Limited): Partnerships, whether general or limited, involve multiple individuals or entities sharing ownership. The partnership agreement dictates the rights and responsibilities of each partner, including their authority to bind the partnership in real estate transactions.
Corporations (C-Corps and S-Corps): Corporations offer liability protection but have more formal requirements, including bylaws and shareholder meetings. Understanding the corporate structure and shareholder rights is essential.
Real Estate Investment Trusts (REITs): REITs are companies that own or finance income-producing real estate. They often involve complex ownership structures and require specialized due diligence.
Tenants in Common (TIC): This arrangement allows multiple parties to share ownership of a commercial property in either equal or disproportionate shares.

Authority and Due Diligence

A critical aspect of any commercial transaction is verifying that the person signing on behalf of the owning entity actually has the authority to do so. This involves:

Reviewing Governing Documents: Carefully examine the LLC operating agreement, partnership agreement, corporate bylaws, or trust documents to identify authorized signatories.
Obtaining Resolutions: Requesting resolutions from the entity’s governing body (e.g., board of directors, members, partners) specifically authorizing the transaction and the designated signatory.
Good Standing Certificates: Obtaining a certificate of good standing from the California Secretary of State to confirm the entity is legally authorized to conduct business.

Chain of Title Complications

Complex ownership structures often lead to a more intricate chain of title. Each transfer of ownership, change in entity structure, or internal transaction can create a potential point of weakness. A broken or unclear chain of title can make it difficult to establish clear ownership and may require a quiet title action to resolve.

Easements and Restrictions

Commercial properties are rarely free from easements and restrictions that can significantly impact their use and value.

Commercial Easements

Easements grant rights to others to use a portion of your property for a specific purpose. Common types in commercial settings include:

Access Easements: Allow access to neighboring properties or public roads. These are crucial for landlocked parcels or properties with shared driveways.
Utility Easements: Grant utility companies the right to install and maintain infrastructure (power lines, pipelines, etc.) on the property.
Reciprocal Easement Agreements (REAs): Common in shopping centers and multi-building complexes, REAs establish shared rights and responsibilities for common areas, parking, and access.
Conservation Easements: Restrict development to protect natural resources or open space.
Prescriptive Easements: may arise when an entity, governmental or otherwise, or individual, uses a portion of another’s real property in a way that is open, adverse, continuous, and uninterrupted for a period of 5 years.

Restrictive Covenants

Restrictive covenants are limitations placed on the use of the property. These can be:

Zoning Regulations: Local government ordinances that dictate how property can be used (e.g., commercial, industrial, residential).
Private Restrictions (CC&Rs): Covenants, conditions, and restrictions imposed by developers or previous owners, often found in planned developments or business parks. These can limit building height, architectural style, or types of businesses allowed.
Historical Preservation Constraints: Properties designated as historic landmarks may be subject to strict regulations regarding alterations and renovations.

Impact on Development

Easements and restrictions can significantly limit a property’s development potential. For example, a utility easement running through the middle of a site could prevent the construction of a building, or a restrictive covenant might prohibit a desired use.

Leases and Tenant Rights

Existing leases are a major consideration in commercial property transactions. They represent both income streams and potential liabilities.

Existing Leases

A thorough review of all existing leases is paramount. This includes:

Lease Terms: Understanding the remaining lease term, renewal options, and rent escalation clauses.
Tenant Rights: Identifying any special rights granted to tenants, such as options to purchase, rights of first refusal, or exclusive use clauses.
Lease Amendments: Ensuring all amendments and modifications to the original lease are documented and reviewed.
Default Provisions: Understanding the landlord’s remedies in case of tenant default.

Subordination, Non-Disturbance, and Attornment Agreements (SNDAs)

SNDAs are crucial for protecting the interests of both lenders and tenants in a commercial property with existing leases.

Subordination: The tenant agrees that their leasehold interest is subordinate to the lender’s mortgage. This means that if the landlord defaults on the mortgage, the lender can foreclose and potentially terminate the lease.
Non-Disturbance: The lender agrees that if they foreclose, they will not disturb the tenant’s possession of the property, provided the tenant is not in default of the lease.
Attornment: The tenant agrees to recognize the lender (or a new owner after foreclosure) as the landlord.

Leasehold Mortgages

A leasehold mortgage is a loan secured by the tenant’s leasehold interest in the property, rather than the fee simple ownership. This is common when a tenant makes significant improvements to a leased property. Title insurance for leasehold mortgages requires careful consideration of the lease terms and the landlord’s rights.

Environmental Issues

Environmental contamination is a significant risk in commercial real estate, particularly for properties with a history of industrial or commercial use.

Phase I and Phase II Environmental Site Assessments (ESAs)

Phase I ESA: A preliminary assessment that involves reviewing historical records, conducting site reconnaissance, and interviewing individuals familiar with the property’s history. It aims to identify potential environmental concerns (Recognized Environmental Conditions or RECs).
Phase II ESA: If the Phase I ESA identifies RECs, a Phase II ESA involves collecting and analyzing soil, groundwater, and/or building material samples to confirm the presence and extent of contamination.

Contamination and Remediation

If contamination is found, remediation (cleanup) may be required. This can be extremely costly and time-consuming. The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also known as Superfund, imposes strict liability on property owners for environmental cleanup, even if they did not cause the contamination.

Impact on Marketability

Environmental issues can significantly impact a property’s marketability and value. Lenders may be unwilling to finance contaminated properties, and buyers may be hesitant to assume the risk of environmental liability.

Zoning and Land Use

Zoning and land use regulations dictate how a property can be used and developed.

Zoning Compliance

It’s essential to verify that the property’s current use complies with the applicable zoning ordinances. Non-conforming uses (uses that were legal when established but no longer comply with current zoning) can create problems.

Variances and Special Permits

If a property’s current or intended use does not comply with zoning, a variance or special use permit may be required. Obtaining these approvals can be a complex and time-consuming process.

Future Development Potential

Zoning regulations can significantly impact a property’s future development potential. Understanding the zoning restrictions, allowed uses, building height limits, and setback requirements is crucial for evaluating a property’s long-term value.

Liens and Encumbrances

Liens and encumbrances are claims against a property that can affect title and ownership.

Mechanic’s Liens

Mechanic’s liens can be filed by contractors, subcontractors, and material suppliers who have not been paid for work performed on the property. These liens can take priority over other encumbrances, including mortgages.

Tax Liens

Unpaid property taxes can result in a tax lien, which gives the government the right to seize and sell the property to recover the unpaid taxes.

Judgment Liens

Judgments against previous owners of the property can attach as liens, creating a cloud on title.

UCC Liens

Uniform Commercial Code (UCC) liens are placed on personal property used in a business, such as equipment or inventory. While not directly a real estate title issue, if the personal property is considered a fixture (permanently attached to the real estate), the UCC lien could affect the overall transaction.

Access and Infrastructure

The availability and adequacy of access and utilities are critical for commercial properties.

Public vs. Private Roads

Access to a property via a private road can create complications. It’s essential to determine who is responsible for maintaining the road and whether there are any easements or agreements governing its use.

Utility Infrastructure

The availability of water, sewer, electricity, gas, and telecommunications is crucial for most commercial uses. It’s important to verify that adequate utility services are available and that there are no outstanding connection fees or assessments.

Access Rights

Any potential issues with access rights, such as disputes with neighboring property owners or lack of legal access, must be identified and resolved.

Title Insurance Considerations

Title insurance protects against financial loss due to title defects.

Extended Coverage Policies

For commercial properties, extended coverage title insurance policies are highly recommended. These policies offer broader protection than standard policies, covering issues such as unrecorded easements, boundary disputes, and zoning violations.

Endorsements

Title insurance endorsements are additions to the policy that provide coverage for specific risks. Common endorsements for commercial properties include:

Zoning Endorsement: Provides coverage if the property’s current use violates zoning ordinances.
Easement Endorsement: Covers losses related to unrecorded or undisclosed easements.
Environmental Protection Lien Endorsement: Protects against losses from environmental liens.
Comprehensive Endorsement: Adds extra protections and coverages related to encroachments, and CC&R Violations.

Negotiating Title Insurance

The terms and cost of title insurance can be negotiated. Working with an experienced real estate attorney can help you secure the best possible coverage at a competitive price.

Due Diligence and Title Examination

Thorough due diligence is essential for uncovering potential title issues before closing a commercial real estate transaction.

Comprehensive Title Search

A comprehensive title search by a reputable title company is the foundation of due diligence. The search should examine public records, including deeds, mortgages, liens, judgments, easements, and restrictions.

Survey Review

A current ALTA/NSPS survey is crucial for identifying boundary lines, encroachments, easements, and other physical features of the property.

Document Review

All relevant documents, including the purchase agreement, leases, environmental reports, zoning reports, and entity governing documents, should be carefully reviewed by legal counsel.

Protect Your Investment: Contact Our Southern California Real Estate Attorneys Today

Commercial property transactions in California come with their own set of title issues that require careful attention and expert guidance. Complex ownership structures, intricate lease agreements, environmental concerns, and zoning regulations can all pose hidden risks. At Garmo & Garmo, our experienced legal professionals take a proactive approach to due diligence, including comprehensive title searches, survey reviews, and thorough document examination. We can help you navigate the complexities of commercial property transactions, mitigate risks, and protect your investment.