Representations, Warranties, and Covenants
A fine string instrument is an expensive purchase. Professional level instruments are hand-made by individual luthiers. Each instrument is unique and has its own history. Sometimes, that history is reflected in scratches and repairs. Many blemishes and repairs only add character to the instrument, but others impact the sound quality or value.
Violinists may select a violin based upon how it sounds and how well it fits the individual musician’s playing style. But better sound or condition don’t necessarily translate to a higher cost.
An instrument’s value depends upon the reputation of its maker, as well as the instrument’s sound quality and condition. So, two instruments that sound similar and are equally easy to play can vary drastically in value.
It would be easy if a musician could trust the label inside of the violin, but those frequently aren’t accurate. For instance, Vuillaume and the Vollers were famous violin forgers (although Vuillaume’s instruments were so well made that they later became sought after in their own right).
My violin, which was made by a member of an esteemed family of Italian luthiers, bears the label of a different, little known maker. The only way I know the true maker is because I have a certificate from the recognized violin dealer that sold me the violin.
When violinists select their instruments, they rely not only upon their own judgment, but also on representations that the dealer makes about the instrument and its history. Dealers frequently will provide a warranty that the violins they sell are in good condition and that any repairs have been done properly. Some dealers will covenant to allow the musician to “trade up” or to exchange the instrument if the musician wants a different instrument.
The distinctions between the dealer’s representations, warranties, and covenants, seem obvious in a violin purchase. Yet, many parties and even attorneys mix them up when writing real estate contracts. This article discusses the differences among representations, warranties, and covenants and why they are important.
Representations are statements of fact. For a violin, the dealer might make representations about the violin’s physical condition or provenance, like my violin’s certificate. In real estate transactions, representations usually relate to the property’s physical or financial condition.
Representations can include statements about historical situations, such as who made a violin or whether real estate is a reclaimed landfill. Representations also can be a statement of present fact, such as the violin’s current condition or whether the real estate has pending code violations.
However, violin dealers and real estate sellers can’t see the future. Therefore, representations never include statements of future circumstances or events.
Who is making the representation also is important. The world-renowned reputation of Moenig, which sold me the instrument and gave me the certificate, is respected as reliable. The same certificate from an unknown violin shop might not be respected or even be accurate.
The same is true of “to the best of my knowledge” representations in real estate contracts. Most sellers will want to limit “knowledge” to the knowledge of specific individuals. Those representations are only as reliable as the people whose knowledge is the basis for the representation.
Sellers should include a definition of “knowledge” in a contract. If there isn’t a definition, knowledge of entry-level employees could be imputed to a seller, even if management knows the facts. Sellers should make the definition as narrow as possible.
Buyers have the opposite goal. They want the sellers to be encouraged to scour business records and to be responsible for facts known by all employees, no matter what their level.
Despite this, frequently, “knowledge” is limited to the actual knowledge of one or two key management employees. And sometimes, the definition is limited to actual knowledge, with no duty for the named employees to make any effort to learn the facts.
When the definition of “knowledge” is limited, it’s important that the buyer confirm that named individuals know the facts. With a violin purchase, the luthier who repaired the instrument may know of its condition but not its provenance. The expert responsible for acquiring instruments might know of the instrument’s provenance but not its current condition. Similarly, the property manager is most likely to know about the property’s condition, but the accountants may know more about its financial performance.
Most people have seen a piece of paper labeled “warranty” which guarantees a product is free from defects and promises a refund or replacement for a stated period. Like a representation, a warranty usually includes a statement of fact, but it goes a step further by guaranteeing that the statement is true. Therefore, unlike representations, which are based upon past and present facts, a warranty may include a guaranty that the facts won’t change. Warranties also usually describes consequences (e.g., repair or replacement) even if the seller didn’t intend to make a false statement.
Traditionally, for real estate, the rule was caveat emptor, which translates to buyer beware. Most states have passed laws creating exceptions to this principle by creating implied warranties, particularly in sales of consumer goods and residential real estate. To avoid confusion, it’s still best for both parties to state in their contract what warranties the seller is (and is not) giving.
Commercial real estate contracts usually include a remedy for buyers if the “representations and warranties” aren’t true. Therefore, most of seller’s factual “representations” actually are warranties.
Most commercial real estate contracts include several seller warranties about the property’s condition. The contracts usually include either representations or warranties about the accuracy of information the seller is giving to the buyer. Sellers usually want to limit the number and scope of warranties and to disclaim all implied warranties in commercial real estate contracts. Sellers also want to limit the consequences if the warranty isn’t true.
Buyers should examine the representations and warranties. If there isn’t a stated consequence for breach of the warranty, it’s a representation. The buyer’s recourse for breach of a representation usually is limited to fraud, which requires that the seller intentionally make a false statement.
In a real estate contract, the buyer’s remedy for breach of a seller remedy is to cancel the contract and receive a return of buyer’s earnest money deposit. Sometimes, a seller also will agree to reimburse the buyer for some of its due diligence expenses. This is most common where the seller has made an intentional misrepresentation.
A covenant is a promise. Unlike both representations and warranties, covenants don’t include statements of fact. Covenants also focus on the future. They aren’t concerned about what happened in the past or what is happening in the present.
Some covenants are combined with representations. For instance, a contract might include a representation that says there have been and are no hazardous materials used at the property. Then, the contract might add a related covenant where the seller agrees not to use hazardous materials at the property in the future.
Like warranties, there can be implied covenants, as well as express covenants. Implied contracts may be created by statute. The most common implied covenant is that of “good faith and fair dealing.” When parties enter into contracts, they assume the other parties will deal fairly and be reasonable.
Contracting parties may try to disclaim or dilute covenants. A contract that states that the seller can decide something “in its sole and unfettered discretion” could allow arbitrary and unreasonable conduct. To prevent this a buyer’s attorney might add the word “reasonable” before discretion.
Addressing Common Contract Flaws
Contracting parties can confuse representations, warranties, and covenants, and make contracts ambiguous. This confusion also can leave the buyer without a remedy for breach. Common errors include:
Covenants in the Representations and Warranties Section. Contract representations and warranties sections usually with a phrase such as “Seller represents and warrants that” and is followed by a laundry list of items. Parties may include future promises in that list, such as by saying “The seller has not, currently is not, and will not use hazardous materials at the property.” The promise not to use hazardous materials at the property in the future is a covenant, not a representation or warranty.
Besides being intellectually inaccurate, the difference matters because the consequences for breach of a representation or warranty may differ from those for breach of a covenant.
Making Representations but not Warranties. Sellers may not want to warrant their factual statements. But real estate buyers need a few basic warranties. Buyers need to rely upon the seller’s business records to evaluate whether to buy commercial real estate. At a minimum, sellers should warrant that the financial and other property records they provide are accurate and complete.
Most sellers don’t intentionally lie, but some do make mistakes and provide incomplete information. Remedies for breach of warranties usually are triggered by negligent breaches. A buyer might not collect for breach of a representation unless it can demonstrate the seller intentionally misrepresented the facts and the buyer relied upon the misrepresentation.
Omitting Covenants to Update Representations. Representations can only state current and past facts. Facts that are true when a real estate contract is signed might not be true later.
There are several ways the parties can update representations. A contract might require that the seller update representations as a condition to closing. Sometimes, the contract includes a seller covenant to provide updated information as the seller learns of it.
Covenants that Don’t Survive the Closing. Covenants are future-oriented. Many covenants in a real estate contract are designed to keep the buyer updated and to preserve the status quo until the closing. But some covenants anticipate post-closing actions, such as reallocating utility costs after actual bills arrive.
But, under the merger doctrine, a real estate purchase contract isn’t enforceable after the closing, because it merges into the deed. Many contracts will state that certain covenants will “survive the closing.” The better approach is to include post-closing covenants in a separate contract the parties sign at closing.
When musicians buy a violin, they usually sign the purchase agreement at the point of sale. Plus, the merger doctrine doesn’t apply to purchases of violins. Musicians rarely make a huge investment on due diligence for a violin, and they rarely have a large nonrefundable deposit before the purchase. So, the differences between representations, warranties, and covenants may not be important.
Real estate contracts usually are signed weeks or months before the closing, and both parties may incur commercial real estate due diligence, lender, and legal expenses before the closing. It’s important that parties to real estate contracts pay close attention to whether statements are past, present, and future based. Plus, the parties and their attorneys should be sure that they have remedies should a representation, warranty, or covenant be breached.
© 2019 by Elizabeth A. Whitman
Any references clients and their legal situations have been modified to protect client confidentiality
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