The common goal of all due diligence efforts is to find out precisely what the seller is selling and what the buyer is buying.  (Or, what the landlord is offering to rent, and the tenant is going to get if it leases the property.) 

This sounds simple, but is not so easy: the challenge is to find out about the property while relying only on sources of information that are known to be highly accurate (and, if possible, on sources that carry liability insurance against their own errors).  One of the most important tools available to a buyer or tenant is a title report. 

A title report will disclose who owns the land, and precisely what legal interest the owner/landlord has in the land, together with a list of other interests in the land owned by other people.

Who Owns the Property, and What Rights That Person Owns, is Typically Shown by Searching the Title.  A preliminary title report (a “PTR”) is a product issued by a title insurance company which shows the following:

• the legal description of the land (as opposed to the address of the improvements located on the land);
• what the estate in the land is (such as whether it is a fee or leasehold estate, or something else such as an easement);
• who has title to the estate in the land; and
• what exceptions to title currently exist according to the public records and the title insurance company. 

Obviously, the first step in reviewing a PTR is to confirm who owns the property to make sure that the buyer (or lender) is dealing with the property owner.  The next step is to confirm the legal description against the deed by which the current owner obtained the property (to make sure that the legal description has not changed) and against the survey, to make sure that the land described in the legal description is the same as that shown on the survey.  The lawyer must then confirm precisely what rights the owner has in the property, such as ownership of the fee, a leasehold estate or an easement. 

Exceptions to and Exclusions from Title.  The review gets more involved as the lawyer checks the exceptions to and exclusions from the vested owner’s title.  The exceptions and exclusions are a list of the rights in the property that have already been granted to third parties, usually by contract or operation of law.  The exceptions also include a brief statement of the annual property taxes due for the property.  The lawyer performing diligence will check to make sure that all taxes have been paid current on the properties.  If all taxes are not paid current, the taxing authority may be able to divest the buyer (or lender) of any of its rights in the property if it does not pay the taxes (including back taxes); obviously, this can create havoc with the economics of a given transaction.  If the due diligence discloses non-payment of taxes, the buyer (or lender) can usually make arrangements to have the overdue taxes paid at the closing.

Easements.  A PTR will often contain a list summarizing exceptions to or exclusions from title, such as exceptions for easements.  An easement is an interest in land given by the owner of the land to a third party, such as the right to use part of the property for a driveway, for access, or for utilities.  Even though some of such uses may benefit the property, such easements are said to “burden” the land, because once the property owner grants such a right, his or her ability to use the area of his or her land affected by the easement is limited.  In addition, once such an easement has been transferred by a property owner, his or her successors in interest, such as later buyers of the land, are also limited to using that portion of the land in ways that do not conflict with the rights of the easement owners.  Easements often have previously granted to utility companies for electrical transmission lines, sewer pipes, or gas lines; easements in favor of the city in which the property is located giving the city the right to widen the neighboring streets; and exceptions for mineral or water rights.

Where easements have been given to third parties, the lawyer will examine the grants of easement to determine whether they are exclusive or non-exclusive (in other words, whether the easement owner can keep others from using the easement area, or not), and whether the property owner may use the surface area of the easements (owned by the third party easement owner) for its own purposes, such as a driveway or for parking. 

A lawyer performing due diligence will also try to determine exactly what part of the property is burdened by each easement.  The precise location of any easement is very important, and can be quite difficult to ascertain.  For example, if the buyer wants to purchase a piece of property which has not been developed and is hoping to develop new buildings on it, and an easement for a high-voltage power transmission line runs directly through the middle of the area that the buyer wants to develop, that’s a big problem (a bigger problem if the planned development is residential; a smaller problem if it is industrial).  The same power transmission line running along the perimeter of the property might not create any problem for the buyer’s planned development.  Therefore it is important to review the exceptions to title (not just the easements) very carefully, and also to have them shown on, and locate them in, the survey, as discussed later.

Need to Review Underlying Documents.  No matter what the type of easement or exception is, the lawyer performing the diligence must obtain (from the title insurance company) and read all of the underlying documents which have been listed as exceptions to or exclusions from title to determine precisely what rights to the property have already been given away.  Sometimes the description in the PTR of the rights previously given away is not correct; sometimes the easements or other exceptions to title burden property other than that which is being sold or encumbered; sometimes the exceptions have expired by their own terms, and no longer burden the property.  If the exception is not in effect for one of these reasons, often the title insurance company will agree to insure against the risk described by agreeing to not show that item as an exception to or exclusion from title in the title insurance policy. 

Other Exceptions.  Easements are not the only types of interests which may be shown as exceptions to or exclusions from coverage on the PTR.  While an exhaustive list is beyond the scope of this article, exceptions may include covenants, conditions and restrictions; development agreements; special assessment districts; and many other types of planning documents.  If any planning restrictions burden the property, the lawyer will review them to determine whether the use the buyer (or the borrower) plans to make of the property will be allowed, and whether any governmental or private entity has the right to collect payments from the owner of the property or to encumber the property with liens or foreclose on the property if such payments are not made.

Monetary Liens.  If any monetary liens, such as mortgages or deeds of trusts, are shown as exceptions in the PTR, and encumbrances on the property, the lawyer doing diligence for a buyer (or lender) must review the underlying liens very carefully.  (In addition, as noted above, third parties' rights to burden the property with monetary liens may be hidden in other documents listed as exceptions, such as covenants, conditions and restrictions, which often contain lien rights on behalf of the developer or a homeowner’s association.) 

Typically, a buyer (or lender) will require that all such monetary liens be paid off and released of record at or before the closing of the sale or loan.  (A tenant usually won’t:  its review will be limited to determining whether its lease would survive a foreclosure if the landlord/owner quit paying its mortgage.  If this is a large concern for a substantial tenant, the tenant can sometimes require that the owner’s mortgagee provide a subordination and nondisturbance agreement, pursuant to which the mortgagee would allow the tenant to stay in place after a foreclosure as long as the tenant were paying rent and satisfying its lease obligations.) A lawyer representing an acquiring company seeking to buy a target company will want to note what monetary liens burden the company’s real property, the amounts of such liens, and what obligations they secure.  In addition, such a lawyer should determine whether any of the obligations secured by such liens will be due on sale or upon change of control of the target company if the transaction occurs. 

Title Insurance as a Risk-Shifting Solution.  Depending on what exceptions to title are shown in the PTR, a buyer (or lender) may be able to purchase title insurance in order to minimize or mitigate the risks to itself caused by the existence of the exceptions to title.  For example, it is very common in California to buy, and to use as collateral, real property as to which subsurface mineral rights have been previously granted to third parties.  A review of the document creating the exception will usually disclose whether the person or entity that owns the subsurface mineral rights has any right to enter onto or drill from the surface of the property.  If the document creating the exception is well drafted and states clearly that surface drilling rights are not included, then the buyer (or lender) can typically buy an endorsement to its title insurance policy ensuring that the owner of the mineral estate has no rights to drill on the surface estate or at any point above a certain depth (such as 500 feet) below the surface of the land.  As a practical matter, this eliminates the risk of any disturbance of the surface of the property, by contractually shifting it to the title insurer.

Review of Rights to Neighboring Land.  In addition to reviewing the exceptions to and exclusions from title, the lawyer also needs to review any rights on neighboring land that benefit the property.  In order to use a piece of land effectively, often certain easements are needed; for example, the owner of a store on its own parcel in a shopping center often needs a reciprocal easement to allow its customers to park on shared parking lots which are on other parcels actually owned by other entities.  Typically, this sort of arrangement is documented in a reciprocal easement agreement.  If a buyer is considering buying that piece of property, or a retail tenant is considering leasing it, then that buyer or tenant needs to be sure that it will obtain the rights under the reciprocal easement agreement as well. 

No matter what issues are disclosed by the PTR, the lawyer doing due diligence should communicate any issues arising out of the due diligence review to his or her client, so that appropriate steps can be taken to resolve them. 

Buying Title Insurance.  In a simple real estate purchase or a loan secured by a deed of trust or mortgage, most experienced real estate lawyers will recommend that the buyer (and its lender) purchase a policy of title insurance, which will take effect at the same time that it closes the purchase (or loan).  This policy insures that the buyer (or lender) has the interest in the property that it was to have obtained through the closing of the transaction. 

Title insurance is typically not purchased by tenants of multi-tenant buildings, but is sometimes prudent for tenants of single-tenant buildings, or those with very long leasehold estates, depending on their circumstances and what issues are shown in the initial title review – as well as what issues are addressed by covenants from the landlord in the lease.  The broader the landlord’s covenants, the more comfortable a tenant may be without buying title insurance for its leasehold estate.

Title insurance is different from other insurance in that title insurance only covers the past:  the policy only insures against unknown risks that exist as of the day the policy is issued.  Before issuing such policies, title insurance companies analyze the public records (or their own title plant), and exclude from coverage any interests in the property arguably owned by third parties.  In practice, this means that the lawyer for the buyer (or a tenant or lender) must independently review those documented rights initially identified by the title insurance company as exceptions to title in the manner described above, and must either convince the title insurance company to accept the risks presented by them, or determine that the buyer (or tenant or lender) can do so. 

In a purchase, the buyer’s lawyer will draft closing instructions to the title insurance company (and the escrow holder) which reflect the results of this diligence and which specify the form of the policy of title insurance to be issued at closing, including statements about precisely what exceptions to and exclusions from title will be shown on that policy, and what endorsements providing additional coverage will be included in that policy.  Usually most purchase and sale contracts will provide that the escrow holder and/or the title insurer will pay off all existing monetary liens, cause them to be released of record and make sure that they are not shown as exceptions on the title insurance policy that is eventually issued, but if they do not, the lawyer for the buyer must make sure this is done.  The lawyer also specifies what additional insurance coverages (endorsements) are required in the policy. 

Best practices involve specifying all of this information in advance of closing in writing so that there is no dispute later, when the title policy arrives, about whether it meets the requirements of the buyer or tenant.