Best Practices: The Need to Review Title Exceptions

Most, if not all, commercial real estate developments contain covenants, conditions, and restrictions (commonly called “CC&Rs”) used to regulate the use, appearance, and maintenance of commercial real property.  These CC&Rs are recorded in the public records and run with the land, i.e., in perpetuity, unless otherwise terminated.  They are identified as title exceptions in title insurance commitments or preliminary title reports.  In addition to CC&Rs, there could be other matters of record, such as deed restrictions, easement provisions, subordinations, leases and options, and other provisions which may have a negative impact on a transaction involving the purchase of commercial real property financed with an SBA loan.

Under long-standing SBA lending principles, a lender “must consider the impact that covenants and other restrictions recorded against the collateral may have on its value and marketability.”  SOP 50 10 6, page 257.  Importantly, lenders must document this analysis in their file.  Id.  Failure to conduct this analysis may impact your 7(a) loan guarantee and may preclude your 504 loan project from going into debenture, if District Counsel refuses to approve a loan from going to sale in light of a restriction deemed to impact the value or marketability of the project.

 While restrictions regarding the appearance and maintenance are of importance, those that impact the “use” of the property are critical and require in depth review.  Generally, those restrictions pertaining to the use of the property, which are intended to protect the “health and safety of occupants,” are acceptable.  The example cited in the SOP is of “deed restrictions based upon environmental concerns including restrictions on residential use, use as a day care center for children or seniors, use as a school, or use as a hospital.”  SOP 50 10 6, page 257.

Commercial development documents contain a myriad of restrictions that could be classified as ones protecting ‘health and safety.’  Take, for instance, those that prohibit hazardous materials to be stored on site, sale or exhibition of sexually explicit materials, crematories, junk yards, etc.  But, there are other use restrictions that may impair the value and marketability of the real property or may even prevent the very business intended to occupy the premises.  For example commercial developments with large specialty anchor tenants may have restrictions that prohibit, a paint store, lawn and garden stores, decorating centers, restaurants, coffee shops, gas stations or convenience stores.  Some of the restrictions may be very exacting such as those, for instance, that prohibit bars and taverns but allow restaurants that serve alcohol, provided their primary business is a restaurant and at least 70% of their total revenue is derived from food sales.

Review of CC&Rs and other restrictions can be time-consuming, difficult, and tedious.  Some restrictions run into the hundreds, if not thousands, of pages depending on the size of the commercial development.  The best practice is to get these title exceptions to your legal counsel for review as early as possible in your closing process to avoid unnecessary delays or unpleasant surprises.  For more information regarding review of land use restrictions, contact the attorneys at Starfield & Smith at 215-542-7070.