Contributed By Allen Matkins Leck Gamble Mallory & Natsis LLP
California is a contract law state. Unless restricted by public policy, all duties and obligations can be written into the contract. Unless the agreement contractually imposes specific representations and warranties, they do not otherwise exist, and the impact of breaches may be limited by maximum exposure limits and time periods. However, public policy prevents a contractual arrangement limiting liability resulting from an established fraud.
Typically, the seller will try to limit its representations and warranties to those items a diligent buyer cannot independently verify. Typical entity-level representations and warranties include that the seller has the authority to sell, and that no third party consents are required (unless otherwise disclosed) in order to effectuate the sale. The seller will also represent that it is not bankrupt or insolvent. Operational representations will relate to validating the income-producing potential of the property, for example, that true and correct copies of any contracts and the leases for all tenants have been shared, and that the seller has turned over all notices from any government agencies. Both seller and buyer will represent that they are in compliance with the Order of Foreign Asset Control (OFAC).
Lastly, a seller will represent that it will notify the buyer if any material changes occur to the representations or warranties during escrow. Typically, the parties will negotiate what constitutes a material change. When the buyer waives contingencies, much of the risk of change shifts from the seller to the buyer, and this shift is typically reflected in the contract.
If there is a breach of one or more of the representations and warranties, the buyer will have several options. It can terminate the contract and recoup some of its costs, such as attorney and consulting fees, pursue specific performance, or elect instead to close over the known breach. Sometimes, the parties will agree to toll the closing for a short period to the extent the breach is curable and the delay may allow time to remedy it. If a buyer discovers a breach after closing, it can choose to pursue a claim against the seller, within certain time limits and caps. There is a window of liability, which is negotiated; typically, this is six to 12 months (most often nine). Additionally, damages are capped, typically at 2-3% of the purchase price (the larger the value of the property, the smaller the percentage and vice versa). This is also negotiated.