Step 1. Sign an Agreement to Lease
The first step for the investor is to lock in the price and prevent the lessor from leasing the property to someone else. Locking up the property is done with a document called an “Agreement to Lease.” If there is already a lease and the investor will be buying the existing lease, we call this agreement an “Agreement to Assign Lease.” In this article we refer to both types of agreements as simply “the Agreement.”
The Agreement only locks up the property for a short period of time, so that the investor can be sure the property will meet the investor’s needs, that the lessor actually has good title to the property, and so that the investor can move money into the CNMI to pay for the lease.
The Agreement is sometimes called a Sale and Purchase Agreement or an SAP. Technically it is not an SAP. Ownership of property in the CNMI is restricted to persons of Northern Mariana Islands descent (a term with a special definition given in Article XII of the CNMI Constitution). Most investors cannot “purchase” land in the CNMI, so there is no agreement to “sell” it to them (no “sale’ and “purchase” agreement). What investors can acquire is a long-term lease of up to 55 years.2
The Agreement is an enforceable contract and must be supported by consideration. The consideration is generally the promises in the Agreement and the placing of a deposit for the lease. It is highly recommended to have an attorney help with the drafting of the Agreement because getting the consideration right can be tricky.
The Agreement should be recorded but often they are not.3 A reason to record the Agreement is that it protects the investor’s interest in the property against third parties (third parties are put on legal notice that the lessor cannot lease to anyone but the investor for the term of the Agreement). Reasons not to record the Agreement is that it clutters the title record for the property, and it discloses the terms of the deal. The Agreement is enforceable against the lessor as a contract even if it is not recorded.
The Agreement usually provides for the payment of a deposit. Most deposits are 10% of the total price, but there is no fixed rule. Sometimes the deposit is given directly to the lessor. Very often the deposit is given to an escrow company to hold until the closing. If the deposit is given to an escrow company, it is only released to the lessor if the investor fails to close without good cause (like the investor cannot come up with the rest of the money). If the investor does close, generally but not always, the deposit is applied to the total rent.
The Agreement will usually contain some warranties from the lessor or the assignor. The basic warranty is that the lessor or assignor has title to the property and the right to lease it to the investor. Other warranties will line up with concerns that will be explored in due diligence. For example, if there is a concern that there are wetlands on the property, a warranty will be given that the property is wetland free. If due diligence establishes that there are wetlands the investor can cancel the Agreement and get the deposit back because the warranty will have been breached.
The Agreement usually sets a period of time to complete the due diligence, and may provide for an extension of that period, if necessary. At the end of the due diligence period there is what is called a “closing,” where the balance of the payment is paid, and the actual Lease, or Assignment of Lease is executed.
The Agreement can serve a double purpose as escrow instructions. When using a third-party escrow, such as a title insurance company, written instructions are required, and the Agreement can serve as those instructions (no separate escrow instructions are required if the Agreement is written properly).
An investor can go straight to leasing the property and skip the Agreement. The purpose of this first step is primarily to give the investor time to preform due diligence, to move money into the CNMI to pay for the property, and to make sure that no one else gets the property in the meantime.
Step 2. Conduct Due Diligence
This is the step that is the most confusing to investors. They hear that they should conduct due diligence before the closing, but they don’t know what due diligence to do. “Due diligence” simply refers to investigating the property. The due diligence to be done will vary depending on the property.
On all properties due diligence as to title (ownership) should be performed. This is generally done by purchasing a Preliminary Title Report (“PTR”) from one of the two title insurance companies on island, and reviewing the PTR with an attorney.4 The PTR will show title defects like tax liens, the need for probates, and if the property has already been leased to someone else.
A title issue that often comes up in the CNMI is the need for the lessor’s family to complete a probate. You can provide in the Agreement to Lease or the Agreement to Assign Lease extra time before closing for probate issues.
Zoning restrictions should also be reviewed for all properties. If you know what business you want to operate on the property it is a good idea to make sure the zoning restrictions that apply to the property allow for the type of business you want to operate.5
The location of the property will inform what other due diligence should be performed. As examples:
a. Lots that are small and close together and that have already been built on like in Garapan will often have boundary and encroachment issues. A boundary survey is often a good idea to have performed during the due diligence period to make sure you are not leasing a lawsuit because the building you will be getting is sitting in part on someone else’s land.
b. Large tracts on the hillsides of Saipan that have not been developed will rarely have boundary issues and a survey of a large lot will be expensive. But access to these tracts may not exist, and maps should be reviewed for access. Also, these tracts may have endangered birds and a survey for endangered species might be advisable.6
c. Property in Tanapag and Susupe may have wetlands (so might other properties). Wetlands cannot be built on. A survey for wetlands is advisable if you suspect there might be wetlands on the property.7
d. Property in Lower Base (and a few other locations) may have had hazardous waste such as fuel oil dumped on the property. This is because Lower Base is an industrial area and in the past, businesses were not careful with their waste products. A survey for hazardous waste is advisable if the property has a history of a past industrial use.8
e. Any property with a building on it warrants a building inspection. There can be issues over subsidence (the building sinking into the ground) and with the quality of the cement used in the original construction. A contractor hired to inspect the building can search for structural cracks and concrete spalling where the rebar inside the concrete has rusted and expanded.
f. Test wells, percolation tests, and topographical mapping can all be done in due diligence if a large development is planned and if these issues will be important in the development of the property. But generally, these time consuming and expensive tasks are done after the property is acquired, and the investor leases the property hoping they will not be an issue.
g. Searching for historical artifacts, war remains, and human remains can also be done in due diligence. However, these sorts of searches, if more than just a walkthrough of the property with an archeologist, are time consuming. The lessor may not allow enough time for this due diligence, and these issues can generally be remediated when the property is developed (but remediation will cost money).9
The above list are just examples of due diligence. Working with an engineer or architect can help determine what due diligence should be do based on the planned use of the property under consideration for lease.
There is no time limit set by law to complete due diligence. It has to be agreed upon between the lessor and the lessee in the Agreement to Lease or the Agreement to Assign Lease. Typical time limits are 30 to 90 days. If you know you will want to engage in a particular survey that will take an extended time to complete before you agree to lease the property, you will want to provide for enough time in the Agreement for the due diligence you want to undertake.
Step 3. Close the Deal
The end of due diligence period marks the time for the closing. At that time a decision must be made by the investor: to take the property (“close” on the property) or not.
The closing is the last step in the process of leasing land. 10Closings are usually handled by a third party. The most common third parties to handle closings are title insurance companies. They also offer escrow services to hold money and documents until the closing. At closing they will offer the opportunity to purchase title insurance to the investor.11
If the investor has found a problem with the property that is a breach of the warranty giving in the Agreement, the investor can refuse to close for cause, and get the deposit back (unless the deposit was nonrefundable). In this case we say that there was a “failure to close”.
If the investor has found a problem that is a breach of a warranty by the lessor or assignor, the investor can decide to waive the defect and close anyhow. Waiving a defect is common because there are often minor problems discovered in due diligence. An alternative when a problem is discovered in due diligence is to renegotiate the price in light of the defect at the closing. The Agreement to Lease or the Agreement to Assign Lease can also provide for an automatic reduction in price if a defect is found that reduces the area of land that can be developed (such as a portion of the property having a wetland on it).
Final issues with the title to the property can be dealt with at the closing to enable a closing. For example, if a claim against the property has been discovered, like a tax lien, the tax lien can be paid off out of the consideration for the lease by the escrow agent so that the investor will get clear title (but the Agreement needs to provide for this contingency).
If a broker was involved, they should be paid at the closing out of escrow. It is best not to leave any lose ends or outstanding claims related to the property after the closing.
Taxes are owed for the transfer of title to property by the transferor (the lessor or assignor).12 The taxes must be paid within ten days of the closing. Although they are owed by the transferor, if they are not paid, the transferee can be held liable. Therefore they should be paid at the closing.
If the investor decides to close, the actual Lease (sometimes called a “Ground Lease”) will be executed and recorded. The consideration for the lease (the rent) will be paid, taxes will also be paid, and the transaction will be complete. The transaction will have “closed.”
Leasing property in the CNMI, or purchasing an existing lease, is not difficult. It is a three-step process. The first step is to enter into a well written and carefully thought out Agreement to Lease or an Agreement to Assign Lease. Step two, due diligence, will involve title research, checking the zoning, and possibly some surveys or reports from experts depending on the nature of the property to be leased. Step three, closing, will go smooth if the Agreement that was signed at step one covered any contingencies that came up in step two.
1 As with all the articles that appear on our website, this article is not a substitute for meeting with an attorney and discussing your actual situation. Hopefully this article will help the reader understand the basic process and make meeting with the attorney more productive.
2 Article XII of the Commonwealth Constitution can be found here: https://cnmilaw.org/articlexii.html
3 The CNMI Code requires that any interest in land be recorded. See, Statute of Frauds, 2 CMC §4912. As the Agreement is intended to create rights in the land in the investor it should be recorded.
4 The two title companies are Security Title, Inc. https://www.securitytitle.net/ and Pacific American Title Company http://pamericantitle.com/
5 Saipan’s Zoning map can be found here: http://www.zoning.gov.mp/resources/files/WHOLE%20MAP.pdf Zoning is one aspect of leasing property that particularly warrants consulting with an attorney. If the property under consideration is not properly zoned there is a possibility of obtaining a variance.
6 Here is a list of endangered species in the CNMI: https://sablan.house.gov/sites/sablan.house.gov/files/documents/EndangeredSpecies2011.pdf
7 Here is some information on wetlands: https://dcrm.gov.mp/resources-publications/wetlands-streams-and-mangroves-publications/
8 Information regarding environmental screening in the CNMI can be found here: http://www.deq.gov.mp/sec.asp?secID=64
9 Unexploded ordinances from World War II can be an issue for property development. Here is some information on the subject: https://www.epa.gov/pi/cleaning-commonwealth-northern-mariana-islands-cnmi-remedial-action-plan-rap-manage-and-treat
10 Prior to the closing the investor may want to set up a CNMI company to hold the lease and should open a bank account. The investor may also want to begin hiring employees, applying for building permits, and contracting for the property development all before the closing to save time.
11 We recommend the purchase of title insurance.
12 See, Withholding on Real Estate Transactions, 4 CMC §1823.