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The Patriot Act and Real Estate Transactions

Fall 2006Cole Schotz DocketAttorney: Christopher J. Caslin

A common component of purchase and sale agreements in real estate transactions are representations and warranties, the majority of which are made by the seller.  Among the universe of seller representations and warranties, sellers are more frequently being asked to represent compliance with the “Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001,” more commonly known as the Patriot Act.  The stated purpose of the Patriot Act is “to deter and punish terrorist acts in the United States and around the world, to enhance law enforcement investigatory tools, and for other purposes.”

Not surprisingly, sellers, in turn, are asking purchasers to make the same representation.

While the content of this representation seems to be relatively innocuous, and in most cases would seem to be easily made, careful consideration and analysis of the wording of the representation should be undertaken as to the extent of the parties covered by the representation. 

For example, in the context of real property owned by a corporation, partnership or limited liability company (by itself or through a subsidiary or affiliate), a purchaser may seek a representation covering not only the entity, but also the constituent owners of that entity, including the upstream parent and its shareholders.

A common representation may provide that neither the seller nor any of the members, partners, shareholders (whether or not a controlling interest), officers or directors of the seller:

(a)  Is listed on the Specially Designated Nationals (“SDN”) list maintained by the Office of Foreign Assets Control (“OFAC”) or any other similar list maintained by the United States Department of State, Department of Commerce or any other government authority or pursuant to any Executive order of the President.  On its SDN list (available at http://www.ustreas.gov/ofac, and regularly updated), OFAC lists individuals and entities suspected of activities linked to criminal activities whose assets are blocked and with whom U.S. citizens are prohibited from dealing.  The SDN list also includes individuals and companies owned or controlled by, or acting for or on behalf of, targeted countries.  It is over 240 pages long and contains many common names, which could make determining compliance time-consuming. 

(b)  Have been determined to be subject to the prohibitions contained in Presidential Executive Order No. 13224.  This order authorizes the Secretary of the Treasury and the Attorney General, or the Secretary of Treasury, in consultation with the Secretary of State and the Attorney General, to designate individuals or entities that have committed, or pose a serious risk of committing, acts of terrorism.  These individuals or entities are known as Specially Designated Global Terrorists (“SDGT”) and are incorporated in the SDN list.  No U.S. citizen or company may do business with any SDGT.  The penalties for doing so are up to $500,000 for companies or up to $250,000 and/or ten years imprisonment for individuals. 

(c)  Have been previously indicted for or convicted of any Patriot Act Offense.  The term “Patriot Act Offense” can include any criminal violation relating to terrorism or money laundering, including offenses under the Patriot Act, the Bank Secrecy Act, the Money Laundering control Act of 1986, or criminal laws against terrorism and/or money laundering.  A Patriot Act Offense may also include conspiracy to commit, or aiding and abetting another to commit, a Patriot Act Offense.  The penalties imposed on an individual who violates the Patriot Act can consist of a fine of up to $500,000 and/or 20 years imprisonment, while the penalties for an entity that violates the Patriot Act can consist of a fine of up to $1 million and the assets of the entity being frozen. 

Parties have gone so far as to require in a purchase and sale agreement disclosure of the other’s internal guidelines on compliance with the Patriot Act.  The burden on a small, closely-held company to determine whether its members, partners, shareholders, officers and directors, or any owners of a direct interest, are on the SDN list or have committed a Patriot Act Offense is different for those of a publicly-traded company.  The process for a smaller company may not be as time-consuming or complicated as the process might be for a publicly-traded company which might have thousands of shareholders – a daunting task to undertake which would likely add extraordinary delays in closing a transaction.

In a recent real estate transaction between two publicly-traded companies, negotiations involving the delivery of a certificate by the purchaser as to compliance with the Patriot Act delayed closing for over 10 days.  The seller imported a majority of its goods from various overseas sources and had rigid compliance systems in place to make sure it did not run afoul of the Patriot Act.  The seller’s compliance systems called for every party it did business with to sign a certificate containing the certifications outlined above.  The purchaser, as a publicly-traded company, refused to make a blanket certification covering all of its shareholders as it had little control over what individuals held its stock at any given time and had not undertaken the diligence with respect to its officers and directors with respect to Patriot Act matters (whether this company – or any other company whether publicly-traded or not – should have undertake such diligence as a matter of course is a separate issue for discussion).  After lengthy negotiations that delayed closing for 10 days, the purchaser agreed to certify that any shareholder holding more than a 10% interest in the purchaser was not on the SDN List and to its knowledge had not been found guilty of a Patriot Act Offense.  The compromise satisfied the seller’s Patriot Act compliance protocols and enabled the purchaser to ensure that its certification was valid (but what really helped was the fact that the purchaser had only one shareholder with a 10% or greater interest, and that shareholder was itself a large mutual fund).  The certification also did not go beyond the direct shareholder to the shareholders of the shareholder.  Not only must there be a finite cutoff point as to how far up the chain of ownership the representation reaches, but it should be limited to only those interests that control the party in question. 

As the above example illustrates, when a publicly-held company is on one side of the table, the party on the other side, whether it be an individual or a large or small company, should give careful thought to the extent to which it is being asked to represent its compliance with the Patriot Act.  There must be flexibility on both sides of the table with respect to this issue, and both sides should be prepared to negotiate the terms of a representation or a certification with respect to this matter to give each side an adequate level of comfort to allow a transactions to proceed in the normal course.

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