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Effect of "As Is" Clauses in Real Property Contracts

"As is" language will not protect a seller from tort claims based on nondisclosure of significant latent defects known to the seller

The Arizona Court of Appeals has recently held that an "as is" clause will not necessarily insulate a commercial real property seller from liability to the buyer, for property defects known to the seller and not disclosed to the buyer.

In S Development Company v. Pima Capital Management Co., 355 Ariz. Adv. Rep. 24 (August 30, 2001), the seller failed to disclose the extensive use of flexible polybutylene pipe (a type of tubing that apparently fails and leaks when transporting warm water under normal water pressure) within the plumbing systems of two apartment buildings. The buyers – seasoned real estate agents who had retained legal counsel and other experts to assist them in the transaction – sued two years after the closing, alleging fraud and negligent nondisclosure, and the seller attempted to defend based on a standard disclaimer of warranties that included an "as is" clause. A jury awarded the buyers $3,690,000 in damages, and the Court of Appeals affirmed.

The Court rejected the seller’s argument that the "as is" clause relieved the seller of any duty to alert the buyers to the defective plumbing, where the plumbing defect was known to the seller, was "basic to the transaction", and was a latent defect which the buyers did not discover (and had no opportunity to discover) during the due diligence period. Under these circumstances, the Court held that the seller was under a duty to disclose the defective plumbing, and that its breach of that duty at a minimum violated the covenant of good faith and fair dealing implied in the contract, even though the contract contained an "as-is" clause.

The case arose on somewhat unusual facts. Not only was the defective pipe "buried six inches inside the walls" of the two buildings, but the seller had expressly refused to permit the buyers to inspect inside the walls of either building, and "all visible plumbing was copper piping." The Court admonished that "preventing a party from conducting an inspection effectively turns what may be a patent defect into an undiscoverable-in-fact latent defect."

The S Development case thus extends to commercial real estate transactions between sophisticated parties the general rule, well-known in the consumer world, that "as is" language will not protect a seller from tort claims based on nondisclosure of significant latent defects known to the seller. If it is left to stand, the decision will significantly impact the conduct of commercial real estate transactions in Arizona, including those conducted between sophisticated buyers and sellers. Commercial real estate clients are strongly urged to review their contract language and their due diligence practices in light of this decision.