Commercial real estate transactions involve the properties used for business purposes. These transactions can be complex, involving a range of legal, financial, and practical considerations. To ensure a smooth and successful transaction, it is important to have a comprehensive purchase and sale agreement in place. The purchase and sale agreement centers on risk allocation between the parties; where the seller wants certainty of the sale and to mitigate risk associated with the sale of the property, and the purchaser wants the flexibility to obtain the property for their intended use and on favorable terms. One aspect of the purchase and sale agreement is representations and warranties. What exactly do representations and warranties cover and how are representations and warranties used in the purchase and sale agreement?

Reps and warranties are a common tool used in transactions that are often heavily negotiated to protect both the purchaser and seller. In simplified legal terms, a representation is an assertion as to a fact, true on the date the representation is made, that is given to induce another party to enter into a contract or take some other action. A warranty is a promise of indemnity if the assertion is false. Below are examples of common types of representations and warranties. More specific representations and warranties are often found in purchase and sale agreements.

Common Entity Representations and Warranties

The most common entity-related representations and warranties given by a seller are:

• Seller’s organization. The seller is duly organized and validly existing in the state where the property is located (and the state of its creation, if different).
• No bankruptcy. The seller is not, and has not been, the debtor in any bankruptcy action.
• Consents and approvals. The seller has obtained all necessary consents to sign the purchase and sale agreement and perform its obligations under the purchase and sale agreement.
• Government approvals. No approval of any governmental authority is required to consummate the sale of the property.
• No litigation. The seller is not party to any litigation that could prevent or affect the sale of the property.
• Office of Foreign Assets Control (OFAC) and Patriot Act. The seller and its constituent owners are not parties with whom it is illegal to transact business under any anti-money laundering or anti-terrorism laws.

Common Property Specific Representations and Warranties

The more common property representations and warranties given by a seller are:

• Compliance with laws. The property’s current use complies with all applicable laws, rules, regulations, zoning codes and licenses, and permits required to operate the property.
• Environmental condition. No hazardous substances are known to be located on the property, the property has not been subject to any hazardous substance remediation activities, and no specific regulations or orders have been issued for the property under any environmental laws.
• No condemnation. The property is not subject to any condemnation action or proceedings.
• Seller’s deliverables. All property-related materials (for example, financials, leases, third-party service contracts, title documents, and survey) delivered to the purchaser are complete with amendments and are true and correct copies of the originals.
• Violations of agreements. The property is not in violation of any easements or development covenants and restrictions to which it is subject.
• The property is not subject to any liens other than the liens disclosed in the purchaser’s title commitment for the property.
• The property is not the subject of any litigation.
• All property and business-related taxes have been paid and no taxes are delinquent in payment as of the date of the contract and at closing

Property Type Specific Representations and Warranties

A purchaser should consider requesting the following additional representations and warranties depending on the use of the property:

• Hospitality property. The seller representations and warranties should address the hotel franchise agreement and hotel management agreement.
• Office, industrial, retail development, or Multifamily. The seller representations and warranties should address the state of the leases (for example, leases are enforceable, there are no defaults thereunder), and should represent and warrant that the rent roll is true, correct, and accurate.

Purchaser’s Representations and Warranties

The purchaser commonly only makes representations and warranties related to its:

• Entity in good status.
• Authority- Ability to execute and perform under the purchase and sale agreement.
• Status under the Patriot Act.

These representations and warranties are substantially similar to those given by the seller.

While the above examples seem straight-forward, in actuality, representations and warranties are more complicated because the parties involved in a transaction often negotiate provisions implicated by the representations such as:

• Survival of Representations and Warranties and Seller Indemnity
• Qualifiers of the Representations and Warranties – e.g. to Seller’s best or actual knowledge
• Security for the Seller’s Post-Closing Obligations and Indemnity.
• Liability Caps and Floors

Survival of Representations and Warranties and Seller Indemnity

In a purchase and sale agreement, the survival period refers to the length of time the representations and warranties are legally enforceable against the party making the representation or warranty. A purchaser should require an express survival period for the seller’s representations and warranties and a seller indemnification obligation for any losses resulting from any misrepresentation. The typical survival period in most purchase and sale agreements is 6 to 12 months. Longer survival periods are often negotiated for representations that are uniquely important to the property. It is common for a seller to want all representations and warranties to merge into the deed at closing, while the buyer desires as long a period as they may be able to negotiate, and which expressly do not merge into the deed at closing. It should be noted that there may be statutory laws which govern the survivability of representations and warranties.

Qualifiers of the Reps and Warranties

A seller should consider requiring language qualifying its representations and warranties to the extent that the diligence materials delivered to the purchaser reveal contrary information. Qualifiers protect the seller from an unintentional misrepresentation that is corrected or controverted in the diligence materials and could prevent (or limit) the purchaser from bringing a misrepresentation claim regarding matters that purchaser knew about before closing.

Conversely, the purchaser can limit the reach of the qualifiers provision by clearly defining diligence materials and limiting the qualification to those matters that are expressly disclosed in the diligence materials.

At the same time, the seller wants to minimize the scope and specificity of its representations and warranties. The seller can accomplish this by:

• Limiting representations and warranties to its actual knowledge with no duty to investigate, and try to stay away from “knowledge” or “best knowledge,” definitions that impute a duty of investigation on the seller. For example:
  • Seller will limit all representations and warranties made by individual knowledge in this Agreement are made based on the actual knowledge of [NAME], without any duty to review or investigate
• Purchaser will want the person named to have actual knowledge of the property and day to day operation of property
• Adding materiality qualifiers where possible (for example, that the property complies with zoning requirements in all material respects).

Security for the Seller’s Post-Closing Obligations and Indemnity

The purchaser often requires security to cover the seller’s post-closing indemnity obligations. If a seller is a single purpose entity (SPE) whose only asset is the property being sold, then this becomes even more important. The security can take the form of one or a combination of:

• A holdback escrow for a portion of the purchase price
• An evergreen letter of credit in favor of the purchaser.
• A guaranty from a creditworthy entity affiliated with the seller, such as the seller’s corporate parent.
• A representation and warranty insurance policy with the buyer as the beneficiary.

The purchaser should ensure that any form of security or any combination of security provided by the seller is equal to the negotiated cap on the seller’s potential liability under the purchase and sale agreement.

Liability Caps and Floors

The seller usually negotiates a cap and floor on its post-closing indemnification liabilities. The cap sets out the maximum amount of liability and any payments from the seller, while the floor (also known as a basket) protects the seller against liability for minor claims. The purchaser may negotiate an exception from the cap regarding specific issues unique to the property, such as environmental issues and cleanup or know, active litigation.

Representations and warranties are a key component to purchase and sale agreements. They serve as useful tools to protect both the purchaser and seller throughout the transaction process and for a time period following the transaction. Most purchase and sale agreements have a full release of the seller and a waiver of all claims by the purchaser for matters not expressly represented by the seller. Consequently, the purchaser should be diligent in confirming that all necessary representations and warranties are included in the purchase and sale agreement. Whether a purchaser or seller, it is important for all involved to work closely with their legal counsel throughout the entire process to ensure the proper indemnity provisions are in place should any issues occur.