Warranties and Representations in Purchase Contracts

We were recently involved in a transaction where the buyer’s counsel insisted on numerous representations and warranties from the seller in a transaction involving the sale of a free-standing, single-tenant retail location where the tenant was primarily responsible for the operation and maintenance of the property. The seller resisted many of these requests given that the tenant was primarily responsible for many of the issues being addressed and the seller was in no position to make representations on issues for which it had no direct knowledge. It is not uncommon for the buyer and their counsel to ask the seller to make representations on many issues, as even if a transaction is an AS-IS sale or a variation thereof, the seller still is often required to make representations as to certain issues. Subsequently, this is where the negotiations begin.

The negotiations usually are centered on the scope of the representation and the level of knowledge of the individuals deemed to have knowledge, and imputing that knowledge to the selling entity. Assuming that both the buyer and seller have the same bargaining power, the non-controversial representations (those dealing with corporate good standing, corporate authority, authorized signatories and the like) are generally drafted to be absolute non-qualified representations, as the items discussed therein are absolute. For example, either the company is in good standing or it is not; and verification of such item is fairly easy. So those items are rarely negotiated.

warranties and reps.jpgThe issue becomes those areas that are not easily ascertainable and which are more appropriately within the domain of the seller’s knowledge. A typical one is the status of tenant leases, security deposits, rent rolls and the like. In a typical retail situation, the selling landlord has absolute control of these facts, and it is fairly common for the buyer to receive representations from the landlord as to these issues. In a large company or a REIT, the issue of “actual knowledge” becomes important when making representations. Not everyone at the company will have the same level of knowledge as to all issues. So, the standard of knowledge is negotiated, as is the liability of anyone making the representations. Generally, the resolution is that the liability for disclosure is limited to the “actual knowledge” of the individual signing the sales contract. Also, it is typical for the seller’s counsel to insist that even though the contract addresses the actual knowledge of that individual, the individual himself/herself will not have any personal liability in the event that the representations are later found to be incorrect. Only the selling entity shall have liability.

Another area of great negotiation is environmental disclosures. Nevertheless, since this is an area that is generally easily determinable through investigation during the inspection period, many times the seller refuses to make any representations except as to disclosing prior known and treated contamination.

Our firm’s other real estate attorneys and I have years of experience in negotiating warranties and representations in sales contracts. We write about important commercial real estate legal and business issues in this blog on a regular basis, and we encourage industry followers to submit their email address in the subscription box at the top right of the blog in order to automatically receive all of our future articles.