Putting the ‘Do’ in Due Diligence (J. Cliff McKinney Commentary)

J. Cliff McKinney

When a client is considering buying real property, a question I typically get is what due diligence should be done before deciding to buy the property. Clients are often not sure what is really necessary. This article will briefly highlight three of the most critical areas of due diligence and define some of the key terminology.

Survey. A survey is critical to identifying the boundaries of the property, possible boundary line issues, the flood zone designation and the location of easements. There are two primary types of surveys: 1) A boundary survey, which just shows the boundaries of the property and the location of buildings; and 2) an American Land Title Association survey, which is performed to more stringent standards and identifies the location of all easements and setbacks. An ALTA survey is significantly more expensive but provides much greater detail and protection.

Title Review. In the old days, title was reviewed by examining an “abstract,” or complete title history, of the property. In modern times, this has been replaced by obtaining a title insurance policy. Title insurance starts with a title commitment from a title agent. If the property is commercial, the title agent needs to be experienced in commercial closings since title agents who devote most of their time to residential matters may not have the experience necessary for a complicated commercial closing. From a title review perspective, the most important part of the title commitment is called “Schedule B-II,” which lists the exceptions to coverage under the title policy.

These exceptions make up a list of “standard” exceptions and “special” exceptions, which are title issues unique to the property. The title company should provide a complete copy of all of the documents listed as special exceptions (i.e., the “special exception documents”), and it is critical to review all of them to be sure none will interfere with the planned use of the property.

An ALTA survey will incorporate all of the special exception documents and make it easier to determine if an exception could cause a problem. Though many are unaware, there are ways to improve a title policy to provide significantly more coverage by acquiring extended coverage and endorsements. Also, don’t forget that a title commitment alone does not provide any coverage — the buyer must obtain an actual title policy to have any coverage from title flaws.

Environmental Inspections. There are a variety of state and federal laws that can make a landowner liable for the cost of cleaning up environmental problems associated with property even if the current owner did not cause the problem. The only way to have any defense to liability for pre-existing environmental problems (or to be sure no such problems exist) is to conduct a Phase I. A Phase I examines the property for potential environmental problems and identifies each potential problem as a “recognized environmental condition” or REC. A Phase I does not confirm the existence of a problem.

Instead, a Phase II must be conducted if the Phase I identifies a REC. A Phase II is a specialized environmental study designed to determine whether a REC is an actual problem. The environmental inspection should also include a “wetlands delineation” to determine if the property contains any federally protected wetlands since disturbing wetlands without proper permits can cause major legal problems.

There can be other important due diligence steps that need to be undertaken depending on the property and the planned use, such as a building inspection, traffic study or zoning review.

Buyers often want to skip some of the due diligence steps if the seller has already done them. However, if there is a mistake in any of the existing due diligence, the consultant who prepared the report has no liability to the new owner unless the report is certified to the new owner.

Conducting due diligence is the legal equivalent of getting a flu shot and having an annual physical. Much of the time, the due diligence will not reveal any problems. However, when there is a problem, it is much easier (and cheaper) to identify the problem early, particularly before you buy the land.

J. Cliff McKinney II is a member of Quattlebaum Grooms Tull & Burrow of Little Rock, where he concentrates his law practice on real estate, green building, land use and business transactions. Email him at CMcKinney@QGTB.com.