In the last year or so the major or “gateway’ markets in the U.S., including Los Angeles (and I would include most of California south of L.A. as well) have become more and more “seller’s markets” and you will find more resistance than before to what previously were the more or less “standard” set of warranties*. Knowledge qualifiers have become more limited as well. The phrase “to the best of Seller’s knowledge” carries with it a duty to have investigated. This is always difficult to get and especially so if the property is an attractive one that can be counted on to attract a number of interested buyers. The phrase “to Seller’s knowledge” is limited to what the Seller actually knows, without having investigated. Also, the identification of the “Seller” will be limited to certain key individuals in the Seller’s organization. All of this is a matter of the relative bargaining leverage and sophistication of the parties, the quality of the property involved, and the negotiating skill of the parties’ representatives. A sophisticated seller will also negotiate for a short time limit on survival post-agreement (or no survival at all) of the warranties and a dollar limitation on liability for them). But warranties are never a substitute for thorough due diligence, and even that is being increasingly circumscribed by sellers with premiere properties. *The “standard” warranties that buyers try to obtain are many pages long.
What contractual warranties does the seller of a commercial real estate property usually give?
I'm particularly interested in the definition of "knowledge" in the context of what sellers admit to knowing, and how our due diligence team can evaluate this. We are a Chinese insurance group looking to acquire a mixed-use commercial property in Southern California. We will begin negotiating the contract in Q1 2018.
Sellers have to disclose known defects or defects that they should have known. This test is an objection and subjective test. Seller doesn't necessarily have to know about something, but if the industry standard states they should have known about the problem, the sellers are still liable. Typically, the only warranty provided is ownership. The seller will warrant that the property is owned by them. Other warranties such as the condition of the property, defects, repairs etc. are usually negotiated or you buy insurance policies to cover the potential risk.
A seller will always warrant due authority and, depending on the type of asset, will try to make representations and warranties subject to knowledge. We can return to the overall question if we continue to correspond. I would like to focus my response on the part of your question you’re particularly interested in. If a seller is an entity, as a limited liability company or a limited partnership, it will want to be certain that any representations that are not absolute (which the seller will resist giving with respect to questions of fact) are qualified to be to the knowledge of a knowledgeable party. The entity as a whole is unlikely to undertake the liability. If the entity is a partnership, knowledge of one partner is imputed to the others. So, the representation will be limited to a knowledgeable party, such as the manager or a general partner. In order to avoid imputed knowledge, the word “actual” will be inserted before knowledge. To limit its liability even further, the seller will limit the representation by adding after due inquiry and investigation. If the property manager is not a member of the seller, the language may be further qualified in such instance by adding after due inquiry and investigation with the property manager. A sophisticated lawyer can walk you through appropriate qualifications for representations depending upon the facts and circumstances of the transaction.
Hi, thanks for the question. While these warranties are negotiable, typically the standard ones are corporate authority and good standing of the Seller entity. Also, for the Property, which includes title representations, no encumbrances on title, compliance with law, environmental conditions, existing contracts (leases, service contracts, permits and licenses), no litigation and eminent domain pending and availability of utility service. As for knowledge, it can be qualified and limited to one or to specified persons. In some instances, the knowledge qualifier is not applicable. These representations are for items that your team can’t easily discern. In addition, the seller’s representations survive the recordation of the deed, so if you were to discover after the closing that a representation in the contract was not true, you would have a claim against the Seller. Good luck with your deal.