In the Dirt: A Real Estate Legal Update

In the world of real estate, what lies beneath the surface can be just as important as what stands above it.

Buyers frequently focus their commercial real estate due diligence on topics including structural integrity, environmental factors, title and survey, zoning, and financing. However, there is one critical issue that is frequently overlooked: the condition of underground sewer and drain systems. 

Sewer and drain systems are essential infrastructure for any building, whether that be industrial, retail, office, or multifamily assets. When these systems fail—whether due to collapse, clogging, root intrusion, or corrosion—the consequences can be severe, especially for unsuspecting buyers. Buyers may be faced with unexpected repair costs, health hazards, and even potential regulatory penalties if the issues are not addressed. The age of many buildings heightens these risks.

To help mitigate these risks, buyers may consider the following strategies and considerations during the course of a transaction.

Due Diligence Strategies

• Request information from the seller. Seller’s disclosure materials under the purchase agreement should include all information relating to the sewer systems, including inspection and maintenance records.
• Include inspection in the purchase agreement. Specifically include in the purchase agreement and due diligence items, the right to inspect the sewer and drains as part of the due diligence process.
• Scope the system. As early as possible, conduct a professional sewer scope inspection with video documentation of the sewer system’s condition.
• Obtain estimates. If necessary, obtain repair estimates and assess impact on building operations. Depending on the proposed use of the premises, it is possible not all defects will have a significant impact on the property.
• Negotiate representations and warranties. Representations and warranties are often heavily negotiated in a purchase agreement. Buyers may be able to include specific representations and warranties from the seller regarding the condition of sewers and drains on the property.
• Include Indemnification Provisions. In some cases, depending on the relative leverage of the parties, a buyer may be able to include seller indemnification of concealed defects in the purchase agreement. This is especially appropriate and may offer an alternative solution if the seller has no records relating to the condition of the sewer/drainage systems or will not allow a buyer to conduct its desired inspections.

Negotiation Considerations

• Negotiate Purchase Price Reductions. A buyer may be able to utilize the inspection evidence and repair estimates to negotiate a purchase price concession. It is prudent to demonstrate a thoughtful and evaluative request, including how the requested repairs impact the buyer’s proposed use of the property and the necessity for the scope of repairs. The benefit to the buyer is a reduced purchase price and the ability to control the scope and timing of the repairs with the buyer’s own contractors.
• Seller Completes Repairs. The buyer may require the seller, or the seller may choose on its own to make the sale, to complete the repairs prior to the transaction closing. In this circumstance, the buyer does not have to estimate costs to repair or worry about post-closing surprises. This may also help reduce operational disruption for a buyer after closing.
• Escrow for Post-Closing Repairs. The parties may negotiate a purchase price hold back or post-closing escrow for the buyer to utilize in connection with the repairs for a number of years. This may help reduce the risk to the buyer to accurately estimate the cost of repairs and will allow the seller some certainty that it is only contributing towards actual repair costs. The timing of the transaction closing can remain relatively intact and the buyer or seller (depending on who agrees to do the work) can commence the repair work post-closing.

Hidden sewer systems, if compromised, can lead to operational disruptions, costly repairs, and maybe even legal disputes. Proactive due diligence and strategic deal structuring can help buyers identify risks early, avoid unexpected costs, and protect the long-term value of their investment.