By Jones Osborn II

Contracts for the sale of real property often contain an "as is" clause. This is widely thought to mean that the buyer accepts the property with any and all faults. If there is a defect in the property it is the buyer's problem.

This is not entirely true, however. A recent decision of the Arizona Court of Appeals has made it clear that there are important limitations on the effectiveness of the typical "as is" clause. In the Pima Capital case, the Court held that an "as is" clause did not protect the seller of commercial property against a claim based on the existence of polybutylene pipe (which is inherently defective and eventually leaks) where the pipe was hidden from view inside the walls and where the seller's agent knew of the problem.

What Does It Mean? Based on Pima Capital, the law in Arizona appears to be as follows, at least for commercial properties (including multi-family):

1. An "as is" clause is effective in releasing the seller from responsibility where the defect can be discovered by a reasonable inspection, even if the seller knows of the defect and remains silent.

2. The "as is" clause does not relieve the seller of responsibility for a defect known to the seller if the defect is hidden and cannot be discovered by a reasonable inspection.

3. If the seller's agent (such as a property manager or broker) or employee knows of the defect, the seller is deemed to know of the defect, regardless of whether the seller has actual knowledge.

4. An "as is" clause is effective only for claims based on contract, and not for claims based in tort (such as fraud); however, it might be possible to draft the clause so as to cover some tort claims.

Criticism. One can argue that the Pima Capital case is good law on the grounds that a seller should always be required to disclose hidden defects, regardless of what the contract says. After all, why should the law sanction fraud?

The answer is that there are good reasons for giving the buyer and seller the freedom to agree to an "as is" clause, particularly in sales of commercial property where the buyer and seller are experienced in business. The freedom to agree to an "as is" clause should not be stripped away because there may be situations where the Court does not like the result.

For example:

1. The seller may want a "clean deal" free of the risk of future litigation. He may not want to risk a lawsuit over whether he did or did not have knowledge of a defect. There may be a dispute as to whether the seller actually had knowledge, or appreciated the significance of knowledge he did have, or properly disclosed it to the buyer, or whether the defect is apparent or hidden. The seller may want to protect himself against having to spend thousands of dollars fighting over these issues in court.

2. The seller may want to avoid the risk that the knowledge of third parties will be imputed to him, as in the Pima Capital case. Under that decision, the seller can be held liable even if he had no knowledge of the defect, if his property manager, broker, employee, or contractor knew of the defect and didn't tell him.

3. The buyer may have agreed to the "as is" clause because he was not particularly concerned about defects at the time of the purchase; for example, where he intends to substantially remodel or demolish the building. The buyer got what he bargained for and should not be allowed to recover a windfall because of the defect.

4. The price may have been reduced in consideration for the "as is" clause, or the seller may have been unwilling to sell without the "as is" clause. It would be unfair for the courts to then impose duties on the seller that the buyer gave up for valuable consideration.

A Sample Clause. It is not clear whether the Pima Capital decision will be reversed or modified. Nevertheless, based on the principles laid down in that case, it may be possible to draft an "as is" clause that is effective in most situations. Such a clause might be worded as follows:

Buyer agrees that except for the express warranties and representations set forth herein, Buyer is purchasing the Property "as is," in its present condition, with all faults. Buyer agrees to purchase the Property subject to all defects, whether hidden or apparent, and whether known or unknown to Seller. Buyer acknowledges that the Property is not new construction and that there may be items needing maintenance, repair or replacement, and that equipment or components in current working order may soon require replacement or repair. Buyer acknowledges that it is Buyer's duty to inspect the Property and Buyer has full authority to do so, as long as Seller's representatives are present and all damage is properly repaired. Seller makes no representation or warranty as to the condition, zoning, size, value, or suitability of the Property for any particular purpose, and Seller shall have no duty to disclose known defects to Buyer, regardless of whether such defects are apparent or hidden. Buyer hereby waives any claims against Buyer based on the condition of the property, whether hidden or apparent, and whether such claims might be based on contract or tort, including but not limited to claims based on negligence or fraud. This paragraph was specifically bargained for and is reflected in the purchase price.

Conclusion. It is not known how effective the foregoing clause might be in providing protection to the seller. However, it does attempt to comply with the reasoning of Pima Capital, and will probably furnish as much protection as the law allows. It almost certainly will not provide protection against outright misrepresentation or fraud or even against remaining silent when there is a duty to speak; for example, when the seller owes a fiduciary duty to the buyer or when a direct question about the defect is asked. The "as is" clause is not a license to commit fraud, but if properly drafted it can offer protection against many other kinds of claims.

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The case referred to above is The S Development Company, et al v. Pima Capital Management Co., et al, Arizona Court of Appeals, Division One, 1 CA-CV 000347, Filed 8/30/01.