• "As-Is" Clauses in REO Transactions: A Look at Enforcability
  • July 11, 2012
  • Law Firm: Mack Watson Stratman PLC - Phoenix Office
  • With the influx of Real Estate Owned (REO) properties obtained by lenders post-foreclosure over the last several years, the use of “as is” contracts in the sale of residential property has increased substantially. In standard contracts, buyers can expect certain representations and warranties regarding the condition of property, including seller’s obligation to disclose known defects. With REO properties, however, lenders typically require “as is” provisions in contract documents, which purport to disclaim all warranties and representations in an effort to limit potential liability for nondisclosure.

    The enforceability of such disclaimers in the context of an REO sale has not recently been considered. However, in a reported Arizona decision, the question of “as is” clauses in general real estate transactions was directly confronted by the Arizona Court of Appeals in S Dev. Co. v. Pima Capital Management, Co., 201 Ariz. 10, 31 P.3d 123 (App. 2002). In that case, two years after the close of escrow the buyer discovered defective plumbing in two apartment buildings and brought suit against the seller for nondisclosure. In response to the claims, the seller moved for summary judgment, relying on the following “as is” provision within the purchase contract:

    Disclaimer of warranties. Buyer acknowledges that except as expressly set forth in this Agreement, Seller makes and has made no representations or warranties of any kind whatsoever, including but not limited to warranties concerning the condition of title, physical condition, encroachments, access, zoning, value, future value, income potential, any survey, environmental report, or other information prepared by third parties, loan assumption, or the presence on or absence from the Property of any hazardous materials or underground storage tanks. Buyer is purchasing the Property as a result of its own examination thereof in its “AS IS” condition, and upon the exercise of its own judgment and investigation.

    Despite this language, the trial court denied the seller’s motion for summary judgment and the case proceeded forward. Following a trial by jury, the buyer prevailed and was awarded $3,690,000.00 for its nondisclosure claim.

    On appeal, the seller argued the “as is” clause removed a critical element of the buyer’s nondisclosure claim—the duty to disclose facts material to the transaction. Accordingly, the seller contended, it was under no obligation to disclose the existence of known plumbing defects and summary judgment was appropriate.

    In affirming the trial court’s denial of the seller’s motion for summary judgment, the Arizona Court of Appeals focused on two issues. The first was whether the defect was latent or patent. While the court acknowledged the determination of a patent versus latent defect is a fact-specific inquiry, and ultimately an issue for the jury to decide, the court expressed that “as is” provisions may shield liability for the nondisclosure of patent defects that the buyer is given an opportunity to investigate. On the other hand, if the known defect is latent or the seller does not provide the buyer an opportunity to investigate, the seller may be liable for nondisclosure, notwithstanding an “as is” provision. Therefore, under Pima, “as is” clauses will not protect a lender from failing to disclose known latent defects. Furthermore, “as is” clauses should not protect the seller where the buyer is prevented from inspecting the property for latent defects.

    Another issue to consider is the knowledge of the lender. Under Pima, it is clear a seller is obligated to disclose known latent defects. What about a lender that has never visited the property and, therefore, likely has no knowledge of property condition or defects? According to the court in Pima, the lender may nonetheless have liability for nondisclosure of latent defects where its agent has knowledge of a defect, even if the lender does not itself have actual knowledge. As a general proposition, knowledge acquired by an agent within the course and scope of employment is imputed to the principal. See Manley v. Ticor Title Ins. Co. of California, 168 Ariz. 568, 816 P.2d 225 (1991). Accordingly, if the listing agent has knowledge of an undisclosed latent defect, the lender may be charged with the same knowledge and be liable to the buyer for nondisclosure.

    Has the law changed since the Pima decision? Several recent decisions in Arizona have confirmed the general enforceability of limiting liability through contract. In Elm Retirement Center v. Callaway, 2010 WL 4312757, 594 Ariz. Adv. Rep. 27, the buyers of real property sued the agents and sellers after discovering that the square footage of the property had been misrepresented in the purchase contract. The contract at issue contained a typical provision that any reference to square footage was “approximate” and that it was the buyer’s obligation to verify the square footage if material to the buyer. Relying on that provision, the court held that the seller had disclaimed any liability for representation of the square footage of the property and, for that reason, the buyer could not state a claim for breach of warranty.

    Another recent case addressing a party’s ability to limit liability through contract is in 1800 Ocotillo, LLC v. WLB Group, Inc., 219 Ariz. 200, 196 P.3d 222 (2008). In 1800 Ocotillo, the Arizona Supreme Court considered a limitation of liability clause in a contract between a construction developer and an engineering firm the developer hired. Pursuant to the parties’ agreement, the liability of the engineering firm was limited to the amount of its fee, which in that case was approximately $14,000.00. Noting judicial hesitancy to declare contract provisions unenforceable on public policy grounds, the court held that the provision was effective to limit the engineering firm’s liability as set forth in the parties’ agreement.

    While the Elm and 1800 Ocotillo decisions support the enforceability of contract terms, whether to disclaim warranties regarding property size or to limit liability to a specific amount, neither case changes the result in Pima nor suggests that a subsequent decision will overturn that case.

    AN “AS IS” PROVISION WILL NOT SHIELD A LENDER/SELLER FOR FAILING TO DISCLOSE KNOWN MATERIAL FACTS.

    Similarly, an “as is” provision will not protect a lender/seller if the buyer is not given an opportunity to inspect for defects before the close of escrow. However, if the lender/seller is unaware of any defects and the buyer is given an opportunity to inspect, recent decisions suggest that an “as is” provision will be enforced as written.