SELLER’S REPRESENTATIONS AND WARRANTIES IN

COMMERCIAL REAL ESTATE TRANSACTIONS

1.              INTRODUCTION

An important component of most real estate transactions is the negotiation of seller’s representations and warranties with respect to the property and the provisions related to enforcing them.

Sellers avoid making representations and warranties to the extent possible, and prefer lengthy “AS IS” provisions limiting the scope, number and general usefulness of representations and warranties to minimize the risk of liability in the event a representation or warranty turns out to be incorrect.  Sellers often take the position that there are many representations and warranties that they do not need to make because the buyer can acquire the same information from other sources, such as title insurance companies, or in the course of buyer’s due diligence.

Buyers, on the other hand, request long lists of representations and warranties from sellers regarding all aspects of the seller, the property and related issues to assist the buyer in learning about the property in connection with its due diligence.

2.              REPRESENTATIONS AND WARRANTIES

A.            What are they?  Courts have defined warranties as statements made as part of a contract of sale describing the character, quality or title of goods and by which the seller promises or undertakes to insure are, or shall be, as the seller describes them.  The definitions of representations and warranties often overlap and are used interchangeably.

B.             Purposes:

i.               In general, to disclose information to the buyer that only the seller knows or to which only the seller has access.

ii.              More specifically, a forum for seller to disclose or highlight known risks, such as pending litigation, tenant defaults, known defects.

iii.            Allow the parties to allocate responsibility for risks among themselves.

iv.            Operate in conjunction with, and may act as a partial substitute for, due diligence by the buyer.  Buyer may rely on seller’s representations and warranties, but should be very cautious.

C.             Types of Representations and Warranties:

i.               Status and authority of the seller.

• Requested by the buyer to assure that the seller is a valid entity in good standing, that the seller has the right, power and authority to perform, that the contract is enforceable against the seller, and that seller is not a foreign person. These are generally within the exclusive knowledge of seller and not controversial.

ii.              Describe the status of the property.

• Designed to require the seller to disclose facts that are necessary or helpful for the buyer to make an informed decision as to whether the property is in a condition acceptable to the buyer’s risk tolerance. Examples:
  1. Ownership and Conveyance – Seller has marketable title to the property. Commonly refused by sellers and deferred to title insurance.
  2. No Condemnation. Seller has no knowledge or notice of pending or threatened condemnation.
  3. No Violations of Applicable Law. Seller has no knowledge or notice of violations of applicable law.
  4. Seller has no knowledge or notice of pending or threatened litigation.
  5. No Liens. Seller has no knowledge or notice of liens.
  6. Parties in Possession. Seller has no knowledge of parties in possession except for specific tenants.
  7. No Other Contracts. Seller has no knowledge of contracts affecting the property not provided to buyer.
  8. Access to the Property. The property has legal access to a public right of way.
  9. No Environmental Violations. Heavily negotiated, and often accompanied by indemnifications.  Buyers want protection from all costs for environmental issues accruing prior to closing.  Sellers very reluctant to give.
  10. No Violation of CC&R’s. Seller has no knowledge or notice of any violations of CC&R’s applicable to the property.  Note: Many forms of CC&R’s include estoppel certificate provisions much like leases.

iii.            Describe the operation of the property.

1. Tenant Leases. That the leases supplied by the seller during the review period are complete, accurate and in full force and effect, and that there are no outstanding leasing commissions.  Also addressed from tenant perspective through estoppel certificates.
2. Operating Agreements. Identification of management agreements, service contracts and other vendor agreements.
3. Books and Records. Confirming the accuracy and completeness of seller’s books and records relating to the property.  Protects the buyer from inaccurate financial information and used to determine the revenue, expenses and net operating income.
4. Maintenance and No Defects. Sellers typically resist representations and warranties regarding the physical condition of the property, and require the buyer to perform its own inspections.

3.              KNOWLEDGE QUALIFICATIONS

As a condition to giving a representation and warranty, sellers routinely require it be expressly qualified to seller’s “knowledge”, “actual knowledge”, “best of seller’s knowledge” or the like.  Courts have held that knowledge may include not only knowledge of which a party has express knowledge, but also that which would have been gained from a reasonably diligent inquiry.  If a knowledge qualification is used, a definition of the term “knowledge” should be included, and address the following:

i.               Whose knowledge?  If seller is a business entity, which officers’, directors’, members’, managers’, agents’ or employees’ knowledge is included?

ii.              Is knowledge to be “actual”, or will implied or constructive knowledge be included?

iii.            Should seller’s duty of inquiry be limited?

4.              SURVIVAL AND CLAIMS

Sellers will want all representations and warranties to come to an end at closing, and the buyer will want all representations and warranties to survive until the applicable statute of limitations has expired.  Two general approaches are taken in regard to survival of representations and warranties, with the second being much more common:

i.               Not addressed in the contract, and deferring to applicable law.

ii.              Negotiated survival provisions in the contract.  Sellers pushing for brief survival periods (3 – 9 months) and Buyers pushing for 12 months or longer, but typically at least through the end of the next operating year or CAM reconciliation period.

Sellers will also want to have contractual provisions limiting their exposure to claims and liability for breach of representations and warranties.  Claims must be brought within the survival period, and seller’s exposure to damages for breached representations and warranties are often subject to floors (claims must exceed a certain amount in order to be made) and caps (claims may not exceed a certain total amount).

5.              EXAMPLES

Seller represents and warrants (which representations and warranties are true and correct in all material respects on and as of the Effective Date and the Closing Date) to Buyer that:

i.               Fee Title.  Seller is the sole current legal and beneficial fee simple title holder of the Property and has the authority and power to enter and execute this Agreement and convey the Property to Buyer free and clear of the claims of any third party or parties (including, without limitation, any elective share, dower, curtesy, purchase options, rights of first refusal, or community property rights of any spouse), except for the Permitted Exceptions without further authorization or signature of any other person.

ii.              Leasing Commissions.  There are as of the date hereof, and there shall be on the Closing Date, no leasing commissions due or owing, or to become due and owing, in connection with any leases, licenses or other occupancy agreements in connection with the Property.

iii.            Leases.  There are as the date hereof, and there shall be on the Closing Date, no leases, licenses or other occupancy agreements in connection with the Property except for the Leases included in the Seller’s Documents.  Seller is not in breach or default of any material obligation under the Leases.

iv.            Condemnation.  Seller has no knowledge of and has received no written notice of any pending or contemplated condemnation proceedings affecting all or any part of the Property.

v.              Structural.  There are no material structural defects in the building or improvements on the Property, nor are there any major repairs required to operate the building and/or improvements in a lawful, safe, and efficient manner.

vi.            Zoning/Violations.  There is not now pending nor, to Seller’s knowledge, are there any proposed or threatened proceedings for the rezoning of the Property or any portion thereof.  During the period of Seller’s ownership of the Property, Seller has no knowledge of and has received no written notice that any zoning, subdivision, environmental, hazardous waste, building code, health, fire, safety or other law, order, ordinance, or regulation is violated by the continued maintenance, operation or use of the Property, including, without limitation, the improvements located thereon and any parking areas.

vii.           Permitted Exceptions.  Seller has performed all obligations under and is not in default in complying with the terms and provisions of any of the covenants, conditions, restrictions, rights‑of‑way or easements constituting one or more of the Permitted Exceptions existing as of the date hereof.

viii.         Permits.  All permits, licenses, authorizations and certificates of occupancy required by governmental authorities for Seller’s management, occupancy, and operation of the Property are in full force and effect.

ix.            Litigation.  No proceeding, suit or litigation relating to the Property or any part thereof, or Seller as it relates to its ownership of the Property or any aspect of the Property, is pending or, to Seller’s knowledge, threatened in any tribunal.  Seller is not the subject of, nor during the two (2) years prior to the Effective Date has Seller been the subject of,  nor has Seller received any written notice of or threat that it has or will become the subject of, any action or proceeding under the United States Bankruptcy Code, 11 U.S.C. §  101, et seq. (“Bankruptcy Code”), or under any other federal, state or local laws affecting the rights of debtors and/or creditors generally, whether voluntary or involuntary and including, without limitation, proceedings to set aside or avoid any transfer of any interest in property or obligations, whether denominated as a fraudulent conveyance, preferential transfer or otherwise, or to recover the value thereof or to charge, encumber or impose a lien thereon.

x.              FIRPTA.  Seller is not a “foreign person” within the meaning of Section 1445 of the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder.

xi.            Development.  Except as may be contained in the Permitted Exceptions, Seller has not entered into any written agreement currently in effect with a third party, including, without limitation, any governmental authority, relating to any development of the Property, and Seller has received no notice and otherwise has no knowledge of any restrictions on the ability of the Seller to develop or expand any portion of the Property in the future, other than as may be set forth in zoning and other applicable laws, ordinances, rules and regulations.

xii.           Agreements.  Seller is not a party to, and has no knowledge of, any agreements relating to the Property currently in effect other than the contracts provided to Buyer contained in the Seller’s Documents and the Permitted Exceptions.  Seller is not in breach or default of any material obligation under any agreement related to the Property to which Seller is a party.

xiii.         Environmental Matters.

(1)           To Seller’s knowledge, during Seller’s ownership of the Property there have been no: (A) claims, complaints, notices, or requests for information received by Seller with respect to any alleged violation of any Environmental Law (as defined below) with respect to the Property, or (B) claims, complaints, notices, or requests for information to Seller regarding potential or alleged liability under any Environmental Law with respect to the Property.

(2)           To Seller’s knowledge, no conditions exist at, on, or under the Property that would constitute a Hazardous Condition (as defined below).

(3)           To Seller’s knowledge, Seller is in compliance with all orders, directives, requirements, permits, certificates, approvals, licenses, and other authorizations relating to Environmental Laws with respect to the Property.