Commercial real estate transactions generally occur in the context of a contract containing an “as is” clause. The objective of such a clause is to avoid any liability of the seller after the transaction for defects in the property. Since real estate sales present the risk of the buyer acquiring not only the land, but liability for any contamination or pollution thereon, as is clauses present questions of how they affect environmental liability of both the seller and the buyer, and whether the buyer may return to the seller if environmental surprises spring up in the days, months, or even years after the sale. This latent environmental risk often arises as a primary issue in real estate transactions, and, where not discovered at the time of the sale, often results in litigation over the meaning of the contract and to what extent the seller is relieved of environmental liability for the property.
As is provisions are usually contained in a long section of the purchase and sale contract, and often also contain what are referred to as “waiver-of-reliance clauses.” These clauses are designed to address an element of fraud or misrepresentation, namely that the buyer relied on any representation, or, in some cases, the failure of the seller to disclose known material information.
Of course, real estate transactions almost always involve at least some form of investigation of the potential environmental risks associated with the property in the form of Phase I or Phase II Environmental Site Assessments. The typical real estate contract will contain a due diligence period in which the potential buyer is permitted to conduct the investigation it feels necessary to evaluate the property, usually including the ability to conduct a Phase I, and, where the environmental consultant who performs the Phase I recommends a Phase II to actually conduct testing of the property, usually soil and groundwater testing. The contract often states that the buyer must conduct this investigation and determine whether it wants to proceed with the transaction or not—if electing to proceed then this is often described in the contract as the basis for the client being satisfied there are no defects in the property, whether environmental or otherwise.
Real estate contracts are often drafted with these types of “boiler plate” provisions. Unfortunately, the strategy for drafting a particular real estate contract and the environmental assessment that is conducted may not be best exercised with a standard approach or language. With respect to the contract language itself, in particular, the buyer may not want to accept that the seller may fail to disclose or misrepresent the environmental conditions of the property.
The Texas Houston Court of Appeals recently provided an illustration of this contracting practice and reviewed the case law in Texas on the application of as is and waiver of reliance provisions. In Warehouse Associates Corporate Centre II, Inc. v. Celotex Corp., (192 S.W.3d 225 (Tex. App.—Houston [14th Dist.] 2006)) the plaintiff learned the hard way that a standard as is contract may not provide the seller protection from fraud committed against the buyer. The The Houston Appellate Court preserved protections for buyers, but only in limited circumstances.
However, another area of perhaps more importance is statutory environmental liability. An open question not discussed by the appellate court is whether as is provisions provide any relief for sellers from statutory environmental liability in Texas.
The facts of the case involved a buyer who purchased a property that was the site of a former shingle manufacturing plant—where, unknown and intentionally withheld from the buyer, asbestos was used in the process and buried in the ground. The contract provided that the property would be sold on a “where is, as is” basis, “with all faults,” imposed no obligation on the seller to provide documents or records relating to the property’s condition, but allowed the plaintiff to inspect the property for 60 days and to terminate the contract for any reason based on its sole discretion within that period. If the buyer proceeded to close, the buyer would accept the property and assume all liability for owning, using, or possessing the property, including any liability imposed by local, state, or federal environmental laws or regulations.
The seller produced only a portion of an environmental report to the buyer that discussed asbestos in the buildings, but did not discuss asbestos in the soil or its use in the manufacturing process. The part that discussed asbestos use in the manufacturing process was not disclosed to the buyer.
Moreover, during the inspection period, a contractor excavating soil on the property discovered what appeared to be raw, friable asbestos buried below the surface of the property. The contractor’s employee contacted the director of environmental affairs for the seller, and was told to backfill that area of the property and not to perform any other excavation in the area.
The environmental consultant engaged by the buyer to conduct a Phase I Environmental Site Assessment did not ask the director of environmental affairs about asbestos and no mention of the buried asbestos was made. When asked about the materials used in the manufacturing process, again asbestos was not mentioned. The consultant also conducted a Phase II Environmental Site Assessment and collected soil samples from the property; however, no asbestos testing was performed on the samples collected.
After the closing of the purchase and sale, the buyer engaged a contractor to remove the slabs from the property. In doing so, the buried asbestos was discovered. Extensive sampling determined that asbestos contamination was widespread and reached to 13 feet below the surface. As a result, the buyer filed suit under theories of common law fraud, negligent misrepresentation, statutory fraud under Section 27.01 of the Texas Business and Commerce Code, and sought rescission of the contract, punitive damages, and attorney’s fees. The seller counterclaimed, and both parties filed motions for summary judgment.
The trial court granted summary judgment against the buyer as to its claims, and granted the seller attorney’s fees of two million dollars for fees and various costs. The buyer appealed the summary judgment and dismissal of its claims.
In reviewing the applicable case law on these issues, the Houston Court of Appeals considered two prior Texas Supreme Court decisions, Prudential Insur. Co. of Amer. v. Jefferson Assoc., Ltd. (896 S.W.2d 156 (Tex. 1995)) and Schlumberger Technology Corp. v. Swanson (959 S.W.2d 171 (Tex. 1997)) as to the application of the as-is and waiver-of-reliance language in real estate contracts to exclude inducement by fraud and activities of the seller that impaired, obstructed, or interfered with buyer’s inspection of the property. The appellate court concluded that the Prudential exception survives the later Schlumberger Supreme Court opinion.
These cases that have come before the Texas Supreme Court over the years raise two competing concerns: on the one hand, an interest in allowing parties to enter into agreements that finally resolve all issues between them, and on the other hand, a desire to prevent fraud in real estate transactions.
The first case reviewed in some detail by the court was Prudential. The Prudential case set out two exceptions to the “as-is” and “waiver of reliance” language in contracts. The first is where the buyer is induced into entering the contract by a fraudulent misrepresentation or concealment of information by the seller. The second exception is where the facts show that the seller impaired, obstructed, or interfered with the buyer’s inspection of the property.
A. Inducement by Fraudulent Misrepresentation or Concealment of Information
The defendant seller in the Warehouse Associates case argued that even where the facts showed fraud, the as-is and waiver-of-reliance language can be enforced. The defendant relied on the Supreme Court’s decision in the Schlumberger case. In that case, the Supreme Court attempted to avoid fraud to a point. However, in the end, it concluded that the facts of the particular case warranted upholding a release of liability based on the specific facts of that case. In that case, the issue involved a settlement of the disputed value of an asset or commercial project. Because the waiver of reliance was directed at the dispute over value, the appellate court upheld the waiver as a matter of law and would not permit the buyer’s claim of fraud.
In the Warehouse Associates case, the Houston Court of Appeals did not agree with the seller that the Schlumberger case stood for the proposition that waiver-of-reliance provisions voided any claim that the buyer fraudulently induced a buyer to enter a sales contract. Rather, the Houston Court pointed out that the Schlumberger case stated that the Texas Supreme Court was resolving apparent divisions in prior cases and establishing the rule of law in accordance with a forty-year-old case that it would refuse to enforce fraudulently induced “waiver of reliance provisions.” This was considered to be consistent with “the great weight of authority, the Restatement of Contracts, and the views of eminent legal scholars.”
The court also noted that the Prudential opinion recognized other situations in which the as is or waiver-of-reliance provisions would not apply based on the totality of the circumstances. Several possible factors were identified. The first would be where the sophistication of the parties were in question or where one or more were not represented by counsel. The second was whether the contract arose in an arm’s length transaction. Third, the relative bargaining power and whether the contract was freely negotiated were identified as a significant issue. Finally, and one of importance to practicing attorney’s, is whether the as is or waiver-of-reliance provision rose to the level of an important feature of the negotiations or whether it was simply part of the boilerplate in a form real estate contract. This latter issue is important, since most real estate attorneys or their clients maintain forms that are used in most of their transactions. As is and waiver-of-reliance provisions usually are standard provisions inserted into contracts. Showing which provisions are actively discussed and which were not, may be an important part of future environmental fraud cases.
In the Warehouse Associates case, the seller attempted to turn these factors against the buyer and argued that because the buyer was represented by counsel in an arm’s-length transaction, the waiver of reliance provision should be enforced and the fraudulent-inducement exception should not be applied. The court rejected this position. The court believed that where the jury had found that in fact the seller had withheld material information and fraudulently induced the buyer to enter the contract, the waiver-of-reliance provision should not be enforced. It must be kept in mind that the Schlumberger case involved a disputed claim over the value of the asset, and this is what the waiver-of-reliance provision was designed to address in a settlement agreement. This is different than a real estate transaction, where the buyer is simply attempting to ensure that it identifies and evaluates any environmental contamination or condition. The buyer often is at a disadvantage of not knowing of environmental conditions known to the seller that are not readily discoverable by performing an environmental site assessment.
One issue that arose is whether the buyer should have known of the buried asbestos. The court ruled that information regarding the buried asbestos was concealed from the buyer and that it was not clear to even an environmental expert that asbestos had been used at the former manufacturing plant. The court also rejected the argument that the buyer was charged with all information in the public record, for example records in the files of a governmental agency.
Finally, the court did not adopt the seller’s argument that the fact the buyer engaged in its own inspection of the property for environmental conditions, Phase I and Phase II environmental site assessments, the fraudulent-inducement exception did not apply.
B. Impairment of Inspection
The impairment-of-inspection exception to the as is and waiver-of-reliance provisions was not applied by the court in this case. As a first step in deciding whether to apply this exception, the court stated that it analyzes the “impairment-of-inspection exception separately from the fraudulent-inducement exception.” The court ruled that the property was open for physical inspection and testing. The failure to provide information is not perceived to meet the exception, but only conduct that impairs, obstructs, or interferes “with the buyer’s exercise of its contractual right to carefully view, observe, and physically examine the property.”
The court’s rational of the decision is important. The opinion supports the ability of sophisticated parties to enter into contracts in which statements of the seller cannot be relied upon so that the exception does not swallow the rule of permitting as is transactions. In particular, the court noted that the parties were sophisticated and represented by counsel in “an arm’s length commercial transaction in a way that allocated the risk of discovering adverse property conditions entirely to the buyer, and the parties placed the burden of inspecting the property for such conditions entirely on the buyer.” Thus, the court appeared to leave the issue of concealment of information to the fraudulent-inducement exception, and concluded that obstruction of access to the property is the key to successfully invoking the impairment of inspection exception.