LOS ANGELES—Owners of real property rely on “as-is” and “independent investigation” clauses in their real estate contracts and leases to shield them from litigation over mistaken or misinterpreted statements made in the course of negotiations. However, recent court decisions have called into question the effectiveness of these provisions, giving buyers and tenants an unexpected new weapon in contract litigation. Property owners should tread cautiously from the beginning of negotiations to minimize litigation risk.
The “parol evidence rule” is a longstanding legal principle preventing parties to a contract from presenting evidence interpreting the contract, other than the terms contained in the contract itself. To reinforce that rule, real estate contracts and leases are drafted with strong “as-is” disclaimers expressly disavowing anything said in negotiations that doesn't appear in the contract. Based on the rule and this typical contract provision, a buyer or tenant claiming to have been misled in negotiations can usually succeed in litigation only if the misrepresentation also appears in black and white in the agreement. However, new California cases have created an exception allowing the court to consider evidence beyond the terms of the contract itself.
In one case, a landlord's statements during a prospective restaurant tenant's walkthrough were admitted as evidence of fraud. The landlord assured the tenant during the walkthrough that the restaurant equipment was in good working order. The tenant never tested the equipment. Despite the provision of the executed lease that tenant took the premises “as-is,” relying solely on its own investigation, the court held that the landlord's oral statements during the walkthrough could be admitted as evidence of fraud in inducing the tenant to sign the lease.
In another case, a landlord gave a prospective tenant estimates of the tenant's share of operating expenses. The tenant and landlord were sophisticated, and the executed lease stated that tenant had relied solely on its independent investigations. But when the tenant's actual share of operating expenses far exceeded the estimates, the tenant sued and the court allowed the estimates to be admitted as evidence.
While these two cases occurred in California, the courts' legal reasoning could equally well apply in other jurisdictions.
How can you protect the “as-is” nature of the deal against these fraud claims? The first step is to be aware from the moment that conversations with a potential buyer or tenant begin, your communications may be used as evidence against you, so they need to be thoughtful and accurate. Second, ensure that you have good legal counsel involved early on to review written documentation of the negotiations, such as letters of intent, to be sure that the disclaimers are as strong as they can be. With these new attacks on longstanding rules of evidence, anything you say can and will be used against you.
Grace Winters and Liz Levin are associates and Tom Muller is co-chair of the Real Estate and Land Use Practice Group at Manatt, Phelps & Phillips. They may be contacted at [email protected], [email protected] and [email protected], respectively. The views expressed here are the authors' own.
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