The historic concept of “caveat emptor” (let the buyer beware) permitted a seller to shift the obligation to the buyer in a real estate transaction. Many states have altered that rule over the years to place a greater obligation on the seller, while still largely leaving the risk on the buyer in commercial transactions. In Oregon for instance, the courts generally allow parties to a real estate deal to allocate the risk as to the property by enforcing “as-is” clauses. The courts focus on two key aspects when looking at seller’s liability: first, if the contract does not contain an “as-is” clause then seller’s misrepresentations - even if innocent - are actionable, and second, if the contract does contain an “as-is” clause then seller’s misrepresentations are only actionable if buyer can prove that the misrepresentations were made fraudulently.
As the real estate market continues to experience double digit growth and developers are expanding their reach from Oregon and down into California, it is important to understand the additional risks imposed on sellers in California. The risk is not the same. Sellers may be surprised to know that contrary to Oregon law, under a California agreement the seller simply cannot contract away liability for failing to disclose known material matters.
California courts have long established that the “as-is” clause is strictly interpreted to mean that the buyer takes the property in the “condition visible to or observable” by the buyer, and that notwithstanding how broad such language may be, courts have not allowed such clause to protect a seller from liability for nondisclosure of known material matters or fraud. In the seminal 1963 case Lingsch v. Savage, the California District Court of Appeal established the rule that “where the seller knows of facts materially affecting the value or desirability of the property which are known or accessible only to him and also knows that such facts are not known to, or within the reach of the diligent attention and observation of the buyer, the seller is under a duty to disclose them to the buyer.” And, even if a seller could establish that no duty to make a disclosure existed as a basis for a fraud claim by a buyer, a seller could still be liable under the “mere nondisclosure” test:
The elements of a cause of action for damages for fraud based on mere nondisclosure and involving no confidential relationship would ... appear to be the following: (1) Nondisclosure by the defendant of facts materially affecting the value or desirability of the property; (2) Defendant’s knowledge of such facts and of their being unknown to or beyond the reach of the plaintiff; (3) Defendant’s intention to induce action by the plaintiff; (4) Inducement of the plaintiff to act by reason of the nondisclosure[;] and (5) Resulting damages.
California’s public policy, found in Civil Code section 1668, also limits a seller’s attempt at waiver: “[a]ll contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.” Courts have uniformly held that a contract cannot disclaim the failure to disclose material facts:
It is settled beyond doubt, manifestly on sound grounds of justice, that a seller cannot escape liability for his own fraud or false representations by the insertion of provisions such as are embodied in the contract of sale herein.
Even so, some sellers may try to point to the standard “waiver” provision contained in most seller-oriented purchase contracts to avoid nondisclosure liability. The typical language states that seller is not making any representations or warranties regarding the documents or materials provided to buyer in connection with its due diligence review. While this language has been held to disclaim any warranty as to the truthfulness or completeness of the documents or materials that a seller actually provides, it does not waive the contractual obligation (and legal obligation) requiring a seller to deliver or provide such documents to a buyer in the first place. Such language can never be construed to apply to documents or information that a seller had, but failed to disclose. This standard is upheld under both the contract and the common law duty of disclosure.
Finally, when a seller does make disclosure and delivers documents, such delivery must be the whole truth about the matter disclosed, not just certain pieces of information that the seller chooses to hand over to the buyer. For example, if a seller has in its possession two property reports, one containing a list of several problems affecting the property and the other with only one noted problem, the seller must provide both reports or risk liability for incomplete or misleading information. Let the seller beware.
Sylvia Arostegui is an attorney in the Real Estate practice group at Stoel Rives LLP and may be reached at 916-319-4740 or firstname.lastname@example.org.
Tami Boeck is an attorney in the Construction and Design practice group at Stoel Rives LLP and may be reached at (916) 319-4678 or email@example.com.