Transactions In A Post 9/11 World

September, 2008Article
Real Estate Southern California

In the post-9/11 world of real estate deals, an increasing number of purchase and sale agreements now contain comprehensive anti-money laundering ("AML") provisions. These provisions broadly demand compliance not only with traditional AML laws, but also with the Patriot Act, the Bank Secrecy Act (the “BSA”), the Trading with the Enemy Act, as well as regulations promulgated by the Office of Foreign Assets Control, Department of the Treasury (“OFAC”). 

These provisions require broad warranties and representations to ensure that the money involved in a deal will not wind up financing terrorism or other illegal activity. Noticeably absent from many purchase and sale agreements, however, are adequate survivability and remedies clauses providing sufficient protection in the event that the AML representations and warranties are breached. This oversight is particularly problematic because buyers and sellers often cut corners when it comes to AML due diligence, or simply do not perform any due diligence at all. Part of this problem stems from the fact that while the AML laws mandate certain prohibitions, they do not always spell out how far down the due diligence rabbit hole parties have to go to protect themselves from liability.

While the Financial Crimes Enforcement Network, Department of the Treasury (“FinCEN”) briefly summarized the American Land Title Association’s list of “red flag” situations in real estate transactions in 2003, FinCen has yet to issue finalized regulations for applying the BSA to “persons involved in real estate closings and settlements."

As a result, the BSA’s application in the real estate purchase and sale agreements is still unclear.  For example, while some AML laws clearly apply when these “red flag” situations are deliberately ignored because of the willful blindness standard - in which a person or entity is shown to be "objectively aware of the high probability of a fact in question" - the statutes do not provide particularized advice or best practices for real estate buyers and sellers. 

OFAC’s regulations are perhaps the most clear.  OFAC enforces the Trading with the Enemy Act and Executive Order 13224 by promulgating regulations that are country or activity specific and by maintaining a list of specially designated nationals or entities with whom U.S. citizens and entities are simply forbidden from transacting business with.

Just recently, FinCEN released a new report showing a drastic increase over the last few years in suspicious activity report filings describing structuring or money laundering in the real estate sector, giving the distinct impression that at least some buyers and sellers may be doing shoddy  due diligence when it comes to complying with these laws and regulations. This increase in money laundering should be combated not only with proper due diligence, but also with AML provisions supported with adequate remedies and survivability.

Typically, survivability and remedies clauses in purchase and sale agreements affect all the representations and warranties. However, including survivability and remedies clauses that are specifically tailored to breaches of the AML provisions can be important, particularly if there is a need to give leeway on the survivability and remedies for other provisions. 

Regardless of whether survivability and remedies clauses are specific or general, buyers and sellers of real estate should recognize what effect and applicability they will have on breaches of AML representations and warranties. For example, if the survivability of a seller’s representations and warranties expire at the closing date and proceeds from the sale are ultimately used to finance terrorism, the buyer potentially has more exposure to liability. 

Moreover, even if those same representations and warranties survived in perpetuity, they could still be rendered ineffectual if the stipulated remedy was insufficient. Thus, it is important to consider whether and how remedies and survivability clauses will apply if an AML provision is breached and the deal money is suddenly frozen or seized by the government, or criminal liability is incurred.

The key message is that including comprehensive provisions requiring broad representations and warranties without also including adequate remedies and survivability clauses leaves a gaping hole in one’s AML liability aegis. 

There is a simple solution for both buyers and sellers: if you must generally limit the remedies and survivability for your representations and warranties, provide a specific exemption ensuring added protection for breaches of the AML representations and warranties.