Duration of Seller Warranties
Negotiating seller’s representations and warranties in a commercial real estate purchase and sale contract can be contentious since buyer and seller have very polarized positions. At one end of the spectrum, seller believes that, independent of any seller representations, buyer is capable of learning as much about the property as buyer needs to know. So, seller argues that no seller representations or warranties are required. Buyer, on the hand, maintains that seller should disclose information about the property in the form of representations and warranties since much of the information is uniquely within seller’s knowledge.
A common misunderstanding is that by stating in the contract that the property is sold “as is,” seller can avoid common law and statutory disclosure obligations. While such a provision may serve as a kind of “red flag” warning to the buyer that the property may not be in perfect condition, seller still has – and cannot thereby avoid – common law obligations to disclose any facts within seller’s knowledge that materially affect the value or desirability of the property if seller also is aware that those facts are not known to buyer or within reach of buyer’s diligent attention and observation.
In negotiating the purchase and sale agreement, the distinction between “representation” and “warranty” is often blurred as these concepts are typically lumped together as if they are one and the same. The technical difference between these two terms is that a representation is an inducement to the parties’ entering the contract but does not become part of the contract. A warranty, however, is made contemporaneously with and becomes part of the contract. Even so, in most purchase and sale agreements this is a distinction without much of a practical difference and the substance of the representation or warranty is seller’s primary concern.
The practical consequence to seller in making representations and warranties is that, as long as they remain in effect, buyer may sue seller for their breach. But representations and warranties by law merge into the deed at the closing and are thereby extinguished. Buyer cannot sue for breach of representations and warranties after the closing, unless the parties expressly agree they survive the closing. If the parties’ intent is to negate the “merger” doctrine, the purchase and sale agreement should expressly provide that seller’s representations and warranties will survive the closing and specify for how long. If the parties are silent on how long seller’s representations and warranties will survive after the close of escrow, then California’s four year statute of limitations period applies. Typically, the parties contractually shorten this period which would otherwise apply to buyer’s suit for breach of contract.
In a recent case, buyer of a winery sued since, in violation of the purchase and sale agreement, seller did not disclose prior to close of escrow information relating to earthquake issues of which seller was aware. After the close of escrow, buyer discovered an active fault trace on the property that substantially increased buyer’s costs of developing the property. Buyer contended that seller knew of and should have disclosed existence of the active fault trace since seller adjusted the siting of the building pad of the winery to avoid the fault trace, as documented in two reports. Seller argued that seller’s duty to disclose the fault trace did not survive the closing because the purchase and sale agreement did not expressly state that such duty survived the closing while the contract specifically stated other seller duties did survive the closing.
The California Court of Appeal held the doctrine of merger did not extinguish seller’s contractual duty to disclose potentially hazardous seismic conditions. The court limited application of the merger doctrine to circumstances where the contractual terms are inconsistent with the terms of the grant deed delivered at the closing, or where the parties clearly intend to have all contractual obligations merge into the recorded deed. Here, the court found there was no obvious conflict between the terms of the parties’ purchase and sale agreement and the terms of the grant deed. Even though some paragraphs in the purchase and sale agreement specifically provided for their survival, that fact did not, as a matter of law, mean no other provision could survive without stating that they survived.
The merger doctrine has been subject to significant criticism and this decision is an example of an attempt to mitigate potential unfairness resulting from a strict application.