Representations As Part Of Proper Due Diligence

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Last week, we Ruminated about what “AS-IS” might mean in an agreement and when it might be an appropriate “agreement.” You can see that posting by clicking HERE. Basically, we think that the contracting party in the “best position to know” should “take the risk.” Sometimes, however, the one with the “lesser” knowledge may not need to rely on the one with the “best” knowledge. For example, Someone who owns a car for all five years of its life is in the “best” position to know if it leaks oil, but if it only takes ten seconds to look under the car, then it wouldn’t be unreasonable to ask a buyer to take the risk that the car leaks oil. Of course, if the seller fraudulently hid the leak or refused to allow inspection, that’s separately actionable.

Today (and in next week’s blog postings) we’re going to cover “AS-IS,” but in the context of a property purchase agreement and only as to how accepting a property in its “AS-IS” condition bears on the kind of representations a buyer might want to get from the seller. That’s a long and awkward way to say we are writing about representations a seller might be asked to make in a property purchase agreement.

While we are going to list a whole bunch of possible seller representations, we are going to list only those that don’t have to do with the property. That means we aren’t going to list items such as “seller is authorized to do business… or seller has the power to sell … .” That leaves items that go directly to the value of the property.

It would be a fair question to ask what relationship a seller’s representations have to the “AS-IS” concept. Basically, before anyone should accept a property or any aspect of a property in its “AS-IS” condition, that person should conduct an inspection – do “due diligence.” Asking the seller questions about the property is an important component of a thorough due diligence inspection. “Does the car leak oil?” “Has the car ever had any body repair?” You get the idea.

Representations serve a number of purposes. One of them is to serve as part of the due diligence process. Instead of being sent to the seller after the agreement is executed, these questions are built into the agreement in the form (or guise) of “representations.”

Keep in mind that the representations we’ll be listing aren’t only as to “brick and mortar” issues. Even though you’ll see some of those, you’ll also see that each covers the kind of concerns that a buyer might have. A buyer shouldn’t be limited to making inquiries of “third parties,” it is entitled to hear from the seller as to the “qualitative” aspects of the property.

We’ll start with the following, pretty broad representation. It could be broken down into separate parts:

The Property is zoned so as to permit the operations of the improvements thereon as those improvements are being operated as of the date hereof; and to the best of Seller’s knowledge there are no known violations of any kind pending or threatened against the Property; and there are no viola­tions of zoning laws, building laws, fire codes, statutes, ordi­nances, orders, or requirements affecting the Property, noted or issued by any governmental agency or any department thereof, nor has Seller ever received any notice concerning such non-compliance, the terms of which have not been com­plied with by Seller.

The buyer isn’t asking if the property is zoned for whatever purpose the buyer might use the property. It is asking about the current use. Certainly a buyer and its seller have equal access to zoning laws and to governmental officials, only the seller fully knows the operations at the property. This is a “use” issue, and the buyer needs to guess or speculate as to the way the property is then being used. The seller is in the best position to know that use. As to violations, the seller is in the better position to know what is “wrong” at the property. Even though a buyer could (and should certainly) commission a physical inspection, that shouldn’t relieve the seller of an obligation to reveal “what it knows,” and that’s all this suggested representation asks for.

Seller has received no notice of an intention that any property will be taken by the powers of eminent domain) where such taking would affect the Property.

Here, and as to a number of suggested representations that follow, all that is being asked about is whether the seller has received any notices. Why should a buyer take the risk that it failed to identify a possible condemning authority (perhaps a railroad or a utility company with such a power) when the seller should know if it has ever received a notice. Here and in other representations that follow, why should a buyer have to ask known and unknown third parties what the seller should know?

Seller has received no notice of unconfirmed or con­firmed assessments against the Property.

Seller is unaware of any actions, litigation, suit proceedings or claims affecting the Property.

Again, a buyer can do a less than thorough investigation (i.e., look for the absence of evidence), but its seller is the one in the best position to know “what it knows.”

Except as delivered in accordance with this Agreement, there are no maintenance, property management, service or supply agreements to or for the benefit of the Property which are to be performed or supplied for the Property; all such delivered agreements are cancelable on thirty (30) days’ notice.

This is generally non-controversial. That’s why we list it. It is non-controversial because sellers intuitively understand that a buyer can’t make inquiry of every business in the country to find out if it has an agreement with respect to the property. That, however, is true of other possible concerns a buyer may have: how can it be certain that is asked every possible supplier or governmental authority?

There are no real estate brokerage commissions or fees due or payable with respect to the Property or to any leases affecting the Property.

Yes, some leases might name a broker; many don’t. And, few leases that name a broker actually describe the terms of the commission agreement. The seller knows; the buyer can’t know unless it asks or gets lucky. No buyer should bear the risk of failing to find out.

Except as described on a schedule to this Agreement, Seller has not received any notice from any tenant, mortgagee, insurance carrier or other person, firm, corpora­tion, or entity of any physical defects requiring repairs on the Property or any other work, which work has not been satisfactorily completed.

That’s one rarely rejected in its entirety by sellers. That’s because sellers intuitively know that buyers don’t have access to such information. Paradoxically, many sellers want to limit the list to tenants and mortgagees. That would acknowledge the inability of a buyer to get such information from identifiable persons, but ignore that the greater concern relates to persons the buyer can’t imagine or identify as someone who might send a notice, such as a neighboring property owner or an invitee.

Ruminations has eight more such proposed representations for a purchase agreement and will cover those next Sunday (Labor Day weekend) so that they can be discussed at readers’ end-of-summer bar-b-que parties all around the globe. We’ll probably have a pithy wrap-up (or, maybe not).

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Comments

  1. Randall Gunn says:

    I agree with all of the thoughts to this point in the discussion set out in the article but would add a few thoughts in the case of corporate sellers. I would add that the representation is made without a duty to further investigate. I have worked for large corporations who had 100’s of plants, warehouses, offices, and vacant land holdings. There truly are some instances where individuals at a plant or property have not said anything to the corporate office regarding some matter. I can recall instances where it wasn’t until the plant was in final shut down and most of the employees were gone that some maintenance person, machinist, or engineer will say, “you know I recall when…”

    This could be for a “midnight dumper” along the property line, oil in the parking lot, to other matters. Especially with manufacturing plants, it is very difficult to know what may or may not have happened over the years at the plant.

    PS: The plant’s do not like anyone from “corporate”. I recall a situation where the plant agreed to show a person from corporate one of the warehouses where they housed off the book equipment but not the other two. I know of an instance where desks, equipment, and cabinets were stored in grain silo’s so that they would not be found at the plant by corporate.

  2. John Eric Pollabauer says:

    I agree with the excellent comments made by Randall Gunn above. I really like and enjoy reading your Blog, your choice of topics are excellent and your depth of knowledge and willingness to share your craft is very generous. Allegations of material misrepresentations by the Vendor and/or a Vendor’s Realtor are areas of property law practice which are reoccurring on what appears to be a more frequent basis. Thank you.

  3. Darth Vader says:

    I agree with your list, but what about situations where the buyer has greater knowledge than the seller, such as a tenant buying the premises it occupies under a triple net lease. Representations can be very fact driven based on the context of the transaction.

  4. In the case of outstanding commissions payable to brokers, perhaps it would be more efficient thusly: Seller will provide a complete list of commissions payable to brokers including amounts due, payment due dates, premises for which the amounts are due, broker name and contact information, tenant name”. Then, during the due diligence period, the list can be checked against leases, contracts (such as a listing agreement or unrepresented landlord commission agreement) or payables such as broker invoices. It could then be a condition of closing that the commissions be paid in full out of the Seller’s proceeds. This is important because unpaid commissions can become a lien against the property (at least this is true in Arizona) and it generally isn’t wise to assume operational debt.

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