Purchase Agreement Pitfalls to Avoid—Traps for the Unwary

By Hope K. Plasha and Misty M. Sanford

Hope K. Plasha is a partner at Patterson Belknap Webb & Tyler LLP in New York City. Misty M. Sanford is a partner in the Los Angeles office of Willkie, Farr & Gallagher LLP. She serves as the firm’s Chair of West Coast Real Estate. This article is revised and excerpted from an article under the same title originally published in the Fall 2022 American College of Real Estate Lawyers (ACREL) Papers.

Hidden snares can trip up real estate practitioners in many stages of negotiating various types of commercial sale purchase agreements. This article offers suggestions for how to navigate around less evident pitfalls. Topics addressed include implied warranties in deeds, liability waiver carveouts, and the sole discretion standard.

Protecting Implied Warranties in Deeds

Beware! Have you ever inadvertently gutted the implied warranties or covenants contained in a deed? You may have, without even knowing it. A diligent buyer’s counsel often takes great care when negotiating purchase agreements to modify the as-is and seller release provisions so that such provisions do not release the representations and warranties of the seller in the purchase agreement, or in the other documents delivered at closing. The buyer’s counsel often accomplishes this by meticulously adding to each provision language such as “except for the representations of Seller [expressly] set forth in this Agreement or the closing documents delivered by Seller in connection with the sale of the Property.” The seller’s counsel will often demand that the word “expressly” be included because she wants to limit the carveout to ensure her client is on the hook only for the specifically negotiated representations and warranties of the contract, including all of the limitations (i.e., limited survival, baskets, and caps) agreed to by the parties—and nothing more.

In negotiating this release carveout, however, the parties often overlook the implied warranties or covenants of the deed. In most commercial transactions, the property is conveyed through a grant deed, limited warranty deed, or special warranty deed that may include implied warranties that protect the buyer. For example, in California, any fee simple conveyance that uses the word “grant” contains the following implied warranties: (a) the grantor did not previously convey the property or any interest therein to anyone else; and (b) at the time of the conveyance, the property is not burdened by any encumbrances “done, made or suffered by the grantor.”

See Cal. Civ. Code § 1113 (West, Westlaw through Ch. 8 of 2024 Reg. Sess.). So if the buyer agrees in the purchase agreement to waive all representations and warranties in connection with any of the closing documents (other than “express” representations and warranties) then, a waiver and release may very well include the implied warranties of the deed.

Buyer’s counsel could address this issue by requesting inclusion of a statement that the release of “all” implied warranties not apply to the implied warranties of the deed, perhaps by proposing a clause similar to the following

Except as provided in the express representations and warranties of Seller set forth in Section [__] (Seller’s Representations and Warranties), Article [__] (Brokerage Commission) and the obligations of Seller in the Closing Documents (including, without limitation, any implied warranties of the Deed), …

Seller’s counsel, in turn, may question whether waiving the implied warranties of the deed is a legitimate concern for the buyer given that most sophisticated buyers of commercial real estate will obtain title insurance to protect the buyer regardless of any waiver. A question arises whether title insurance provides the protections a Buyer needs under these circumstances. Many clients (and counsel) prefer not to rely exclusively on the expectation that the title company will cover damages that arise from a title issue for which the title company is, or may be liable. Certain exclusions from the title policy could make it difficult and time-consuming to collect against the title company. Moreover, if the title company ends up having to pay on a claim resulting from a breach of the implied warranties, it will likely subrogate against the seller. See Midfirst Bank v. Abney, 850 N.E.2d 373 (Ill. App. Ct. 2006); see also Am. Title Co. v. Anderson, 125 Cal. Rptr. 24 (Ct. App. 1975). A title company may be displeased to learn that subrogation is unavailable because the buyer expressly waived the implied warranties (and the title company may even refuse coverage under the common policy exception for acts of the insured).

Seller’s counsel may further argue that the title company does not need to rely on subrogation, anyway, because the title company likely required the seller to execute an owner’s affidavit, under which the seller expressly represented and warranted to the title company the same facts and circumstances covered by the implied warranties. In the authors’ experience, however, title companies are uncomfortable relying solely on the owner’s affidavit (particularly when the seller is a single-purpose entity that will have no assets once the sale transaction closes), and generally do not want the implied warranties to be waived.

Arguing that the implied warranties should be waived is a slippery slope. The whole point of a general warranty, special warranty, or grant deed in a commercial transaction (as opposed to a quitclaim or release deed) is for the seller to provide some assurances with respect to the title it is conveying (if applicable). If the parties intended to waive the covenants or implied warranties and rely exclusively on title insurance, why not just use quitclaim deeds or release deeds?

The answer is a practical one—many title companies are uncomfortable insuring title in the absence of title covenants, express and implied, and such an approach deprives the buyer of its principal benefit in any deal, namely, good title. Accordingly, waiving the implied warranties of the deed is a step too far because it would disrupt the delicate balance of risk that has evolved in commercial purchase transactions, and upon which the title industry relies.

Other Potential Release Carveouts—Covenants, Fraud, and Third-Party Claims

In addition to the implied warranties of the deed, there are other issues that can arise for unwary buyers when negotiating the seller’s release provisions in a purchase agreement. If buyer’s counsel is not careful enough to closely parse seller’s counsel’s proposed release language, buyer’s counsel may later find that the language (intentionally or unintentionally) waives the following matters that a buyer may not want to waive: (a) seller’s covenants (as distinct from its representations and warranties) under the purchase agreement, the closing documents, and any other separate agreements; (b) fraud or material misrepresentation by the seller or its affiliated parties; and (c) third-party claims for events occurring at the property or arising before closing (including as a result of the seller’s due diligence investigations).

Here is an example of buyer-friendly carveout language to consider:

Nothing herein shall release Seller or the Seller Parties from any claims or liabilities arising out of (i) any breach of covenants, representations, or warranties set forth in this Agreement, any Closing Documents, or any other agreement, instrument, or document entered into by Seller or any of the Seller Parties after the Effective Date; (ii) fraud or material misrepresentation by Seller or the Seller Parties; or (iii) claims brought by any third party arising as a result of an event occurring at the Property prior to the Closing Date which was not caused by Buyer (collectively, “Excluded Claims”).

We will discuss each of these clauses in turn.

First, a carveout for the seller’s other obligations under the purchase agreement or any agreements intended to survive the closing should not be a controversial addition to the release. Purchase agreements typically include covenants made by the seller during the escrow period (e.g., a covenant not to enter into new leases without the buyer’s consent, a covenant to maintain the premises in the ordinary course, etc ), which need to remain enforceable by the buyer, and should not be released as of the signing of the purchase agreement. Also, at the closing, the seller will be executing the deed, a bill of sale, assignments, and other closing documents that include additional provisions that also need to remain enforceable by the buyer, and should therefore not be subject to a buyer’s global release of the seller. If the release in the purchase agreement broadly covers the seller’s affiliates, or is not limited solely to agreements related to the property, the parties may consider

narrowing the scope of the release or carving out any other agreements that are in place now or that may be entered into with the seller’s affiliates that should not be released. For example, if an affiliate of the seller is staying in the deal, there may be a joint venture or other agreement with an affiliate that should not be released. Another example is ongoing agreements of the parties with respect to matters unrelated to the specific property being sold. All such agreements must remain enforceable and not be inadvertently released by the provisions of the purchase agreement.

Second, buyers typically do not release the seller if the seller commits fraud or material misrepresentation. In the majority of contract negotiations, the seller’s counsel will agree to exclude both from the seller’s release given it is difficult to argue that its client should have the ability to lie or conceal information without consequence. In another setting, some practitioners objected to the authors’ approach that a seller should be allowed such an unfettered contract right. Those sellers argued that they could not agree to exclude fraud from the seller’s release because an allegation of fraud could open the door to liability for matters that the parties agreed should be the buyer’s responsibility.

Other sellers may argue there is no need to carve fraud out of the release given that claims of fraud cannot be waived as a matter of law. Although this proposition may be acceptable in most jurisdictions, it is not true in all jurisdictions. In those jurisdictions where fraud carveouts are acceptable, enforcement of such releases may not be easily accomplished. A savvy buyer’s counsel will argue that if fraud in fact cannot be waived as a matter of law, then there is no harm to the seller in expressly stating so in the contract. For example, in some jurisdictions (such as Delaware), a release of certain kinds of fraud claims given by a sophisticated commercial actor represented by counsel will be enforced. See Express Scripts, Inc. v. Bracket Holdings Corp., 248 A.3d 824 (Del. 2021). For this reason, attorneys who do not primarily practice in the jurisdiction in question should seek advice from local counsel about the scope of any fraud waivers and requested carveouts.

That said, in most jurisdictions across the country, it is indeed customary for a seller to agree to exclude fraud and material misrepresentation from the seller’s release and as-is provisions. Even so, a seller may consider trying to limit this carveout in several ways.

A seller may try to limit the scope of the parties whose actions or statements can trigger a fraud claim to those the seller controls, such as the seller entity itself and its controlled affiliates. Often this will be accomplished by limiting the defined term “Seller Parties” to exclude agents or other third parties. Buyer’s counsel should consider pushing back because the seller selected those agents and has the power to enforce remedies (and to make claims) against them directly. Seller’s counsel may also want to limit this carveout to only fraud and material representation “as determined by a court of competent jurisdiction in a non-appealable decision”—language that does not significantly alter the parties’ respective risk and therefore often is agreeable to the buyer.

Third, a buyer should not release the seller from third-party claims that may be brought against the buyer for events that occurred before the buyer takes title to the property. The quintessential example of this is a “slip and fall” claim brought against the buyer after the closing but that clearly occurred during the seller’s period of ownership. The need for this carveout arises only if the parties have not included post-closing mutual indemnities, indemnifying each other for events that occur during their respective periods of ownership. If the parties agree to such indemnifications (and if buyer has been careful not to waive the covenants under the purchase agreement and closing documents as discussed in the first carveout above), then this issue will already be covered. But if the transaction occurs in a market where it is not customary to include mutual indemnifications, then (unlike the two carveouts discussed above) this may be more controversial. In such instances, seller’s counsel may argue that the seller should have no liability to the buyer for these third-party claims because the buyer will have a solid defense against the claim—that the event did not occur during the buyer’s period of ownership. Some sellers will offer to include language that nothing in the release prevents the buyer from asserting a defense that the buyer was not the owner of the property during the applicable period or language that expressly permits the buyer to interplead the seller into the action brought by a third party. From the buyer’s perspective, this simply does not go far enough. If the buyer has to expend money defending itself in a lawsuit brought by a third party and the buyer has a viable claim for damages against the seller, then the buyer should be able to bring it without being barred by the seller’s release language. Furthermore, if the seller is released from the claim by the buyer, the seller’s insurance may no longer cover the claim.

On the other hand, seller’s counsel may want to impose certain key limitations to protect her client as a condition to the seller’s agreement to exclude from the seller’s comprehensive release third-party tort claims occurring before the closing. For example, seller’s counsel should consider limiting the events to those that occur during the seller’s period of ownership only (as opposed to any time prior to closing). In addition, some sellers are especially sensitive to environmental claims (particularly operating companies that may have acquired a property through a series of mergers without records about its long-term use). Counsel for these sellers will have crafted the environmental representations and warranties carefully to be as limited as possible and may be concerned that any carveouts from a broad release will undermine them.

Many buyers will not agree to release environmental claims, however. Indeed, some buyers require a carveout from the release for all environmental matters related to the property generally—regardless of whether a third-party claim is brought. If the buyer agrees to exclude claims for environmental matters from the carveout for third-party claims, the buyer should, at the very least, consider adding language clarifying that the release for environmental matters does not prohibit the buyer from impleading or otherwise naming the seller in the buyer’s defense. But if a seller has a lot of leverage, it may even try to prohibit a buyer from impleading the seller for environmental claims, using language like the following:

If, after the Closing, any third party or any governmental agency seeks to hold Buyer responsible for the presence of, or any loss, cost, or damage associated with, Hazardous Substances in, on, above, or beneath the Property or emanating therefrom or for any other environmental condition related to the Property, then Buyer shall not (i) implead the Seller or any affiliate, (ii) bring a contribution or similar action against the Seller or any affiliate, or (iii) attempt in any way to hold the Seller or any affiliate responsible.

This is aggressive, seller-friendly language, but some sellers have leverage to impose it either because of their reputation or the particular market conditions surrounding the asset.

Carveouts from the Cap on Seller’s Post-Closing Liability

Many of the same issues with respect to carveouts from the seller release provisions (e.g., fraud, material misrepresentation, third-party claims, etc.) also apply to the limitations on the seller’s post-closing liability. Typically, purchase agreements limit the seller’s liability post-closing to a specific survival period (anywhere between three months and two years depending on the market and the dynamics of the particular deal) and impose an overall ceiling (and sometimes a floor) amount on such post-closing claims brought by the buyer. We refer to these here as the “seller’s post-closing limitations.” While the release carveout for the seller’s other obligations under the purchase agreement and closing documents discussed above does not apply to the seller’s post-closing limitations (because the whole point of the seller’s post-closing limitations is to limit these obligations), the other two release carveouts discussed above should be considered in the context of the seller’s post-closing limitations.

If buyer’s counsel stops there, though, she will miss considering additional carveouts to the seller’s post-closing limitations. Historically, the seller’s post-closing limitations applied only to breaches of the seller’s express representations and warranties in the purchase agreement (not to the seller’s breach of its covenants and obligations under the purchase agreement or closing documents). But sometimes sellers attempt to expand the seller’s post-closing limitations to apply to all of the seller’s post-closing liability for any covenants, obligations, representations, or warranties of the seller under the purchase agreement and closing documents. If the parties agree to expand the seller’s post-closing limitations in this way, then buyer’s counsel needs to be diligent in identifying key provisions of the purchase agreement that should be excluded from the cap and not time barred.

None of these should be controversial if identified, but it is easy to miss when moving too fast. For example, buyer’s counsel should exclude the deed entirely from the seller’s post-closing limitations. The same reasoning applies here as described above with respect to excluding the express and implied warranties of the deed from the buyer’s comprehensive release. Also, the negotiated provisions of the purchase agreement that have allocated certain costs and fees between the parties should not be subject to the cap, floor, or survival period, including attorney fees, broker indemnities, prorations, closing costs, and any Code Section 1031 exchange indemnity.

Here is an example of a buyerfriendly carveout provision where the seller’s post-closing limitations are expanded to include all of the seller’s post-closing liability:

Notwithstanding any provision to the contrary contained in this Agreement or the Closing Documents, the following shall not be subject to the Basket Amount nor limited by the Cap Amount nor the Survival Period: (i) any liability arising under the Deed; (ii) any acts constituting fraud, intentional misrepresentation, or torts by Seller, as determined by a court of competent jurisdiction in a non-appealable decision; (iii) any third-party claims against Buyer or its successors and assigns brought as a result of an event occurring at the Property prior to the Closing Date not caused by Buyer; and (iv) any liability of Seller pursuant to Section [__] (Prorations; Credits), Section [__] (Brokers), Section [__] (Closing Costs), Section [__] (Attorney Fees), and Section [__] (1031 Exchange).

If the parties have agreed to postclosing mutual indemnities for events that occur during their respective periods of ownership, or if the seller has provided seller estoppels for leases (in lieu of tenant estoppels), then these indemnities and seller estoppels should also be excluded from the seller’s postclosing limitations.

Implied Covenants and Sole Discretion

Purchase agreements typically provide buyer and seller with various rights to approve or disapprove of certain matters (e.g , for the buyer, the results of due diligence investigations) and to take (or to refrain from taking) certain actions (e.g , for the seller, permitting an assignment of the contract) at their respective “discretion.” While the unsuspecting lawyer may assure her client that the contract is clear on its face and, of course, it can exercise its discretion without fear because it says so right there in the contract, discretion does not mean sole and absolute discretion, thanks to the implied covenant of good faith and fair dealing.

It is well established that “[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” Restatement (Second) of Contracts § 205 (Am. L. Inst. 1981). What does this oft-quoted phrase mean in practice? “Neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.” Kirke La Shelle Co. v. Paul Armstrong Co., 188 N.E. 163, 167 (N.Y. 1933).

Would acting in bad faith in the exercise of one’s discretion “injure” the right of the other party to receive the “fruits” or “benefits” of a contract? Arguably it would. The duty of good faith requires the parties to negotiate reasonably with each other and it applies “when one party has discretionary authority to determine certain terms of the contract.” Amoco Oil Co. v. Ervin, 908 P.2d 493, 498 (Colo. 1995). In such instances, discretion must be exercised in a good faith, reasonable manner so as not to undermine the expectations of the parties entering into the contract. However, the implied covenant of good faith and fair dealing does not “prohibit a party from doing that which is expressly permitted by an agreement.” Carma Developers (Cal.), Inc. v. Marathon Dev. Cal., Inc., 826 P.2d 710, 728 (Cal. 1992).

For instance, “the implied covenant of good faith and fair dealing does not apply where a party to the contract has the absolute and exclusive authority to make the decision at issue.” Davco Acquisition Holding, Inc. v. Wendy’s Int’l, Inc., No. 2:07-cv-1064, 2008 WL 755283, at *7 (S.D. Ohio Mar. 18, 2008). This is because, “as a general matter, implied terms should never be read to vary express terms.” Carma Developers, 826 P.2d at 728. But where an agreement does not clearly and expressly address an issue, courts can try to “fill in the gap” as to the parties’ intent by reference to what a reasonable person would have expected under the implied covenant of good faith and fair dealing.

To avoid the uncertain outcomes of such judicial interpretation, a seller and a buyer may prefer that their rights and obligations with respect to discretionary actions are clearly stated. One can accomplish this by providing that decisions will be taken not at the discretion or reasonable discretion of a party, but, rather, at such party’s sole and absolute discretion (and for any reason or no reason). A number of jurisdictions have found that sophisticated commercial parties can negotiate around the implied covenant by applying a sole and absolute discretion standard:

[T]he plain language of the contract makes clear that termination of the contract was a possibility and the parties, who were sophisticated, counseled business entities negotiating at arm’s length over a prolonged period of time, should have understood and expected that termination of the agreement could occur during that specified window of time, and that such a decision was the purchaser’s alone and did not need to be accompanied by any specific justification.

ELBT Realty, LLC v. Mineola Garden City Co., 144 A.D.3d 1083, 1084 (N.Y. App. Div. 2016) (internal citations omitted).

Although the parties may think it would provide further comfort to just expressly waive the implied covenant itself, this is usually not permitted as a matter of law. See Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434, 443 (Del. 2005). Regardless, the strategies above may achieve the same goals without the full waiver, depending on the jurisdiction.

Conclusion

Buyers and sellers rely on their counsel to see not just the forest but also the trees. To that end, this article has identified important concepts that can sometimes be overlooked, proposed specific language from the perspective of both the buyer and the seller to address those concepts, and posed questions practitioners must consider to guide their clients away from hazards in the real estate jungle.