In Part 1 of Modifications to the AIR Purchase Agreement, I discussed four areas of the AIR purchase agreement that Sellers frequently modify. Part 2 focuses on perhaps the greatest area of liability to Seller after the Closing – Seller’s 12 representations and warranties that it makes to Buyer.
Paragraph 12.1 of the AIR purchase agreement contains the representations Seller makes to Buyer. Every Seller should carefully read Paragraph 12.1 to ensure that each representation is true.
The following are 3 modifications that Sellers sometimes make to limit the likelihood that they will be sued after the Closing if a representation is untrue, or if Buyer believes a representation is untrue:
1. Shortening the Survival Period: According to Paragraph 12.1, Seller’s representations “survive” for 3 years after the Closing. Buyers can therefore sue Sellers for up to 3 years after the Closing for an untrue representation. Sellers frequently change the survival period to 6 months or 12 months.
Tip: To explain this change, Sellers often advise Buyers that the owners/members/shareholders wish to distribute the proceeds from the sale soon after the Closing, and should not have a contingent liability for 3 years after the Closing. This may prevent complete distribution of the funds for a long period of time.
2. Hazardous Substances Rep: Paragraph 12.1(c) states: “Seller has no knowledge, except as otherwise disclosed to Buyer in writing, of the existence or the prior existence on the Property of any Hazardous Substance, nor of the existence or prior existence of any above or below ground storage tank.” This representation may expose Seller to substantial liability. If a Hazardous Substance is discovered after the Closing that was not disclosed to Buyer in writing, Buyer may believe that Seller had knowledge and did not disclose it. As a result, Sellers sometimes delete this representation.
Tip: If Seller wishes to limit its exposure on this representation but nevertheless provide a Hazardous Substances representation to Buyer, it can modify this representation. Seller can represent that it is delivering to Buyer all reports prepared by third parties relating to Hazardous Substances on the Property. In addition, it can qualify “Seller’s knowledge” as discussed in item 3 below.
3. Clarifying Seller’s Knowledge: Seven of the 12 representations in the AIR purchase agreement are qualified to Seller’s knowledge. For example, Seller represents that it does not know of any unpermitted improvement. Therefore, if an improvement was made to the Property without a permit, but Seller is unaware of it, Seller’s representation is true.
What if Seller suspects that an improvement may have been made without a permit, but is not sure? Or what if Seller’s property manager knew of an unpermitted improvement (made before Seller purchased the Property) but never told Seller? In these situations, does Seller have “knowledge” of an unpermitted improvement? To assist in limiting liability in these situations, Sellers frequently define Seller’s knowledge to mean the “current actual knowledge” of [person X] (a specific individual with Seller responsible for the Property), without any obligation to undertake any inquiry or investigation. Sellers also clarify that the named individual is named to establish an objective reference for measuring Seller’s knowledge, and is not making the representations in his individual capacity.
Tip: Seller should not view this qualification as a way to avoid disclosure of a material item. Even with this qualification, Seller can be liable for fraud for non-disclosure of a material fact.
In Part 3, I will suggest additional Seller modifications.
What do you think of these modifications? Post your comments or questions below.