The Seller Hid Property Defects. Claims in a Commercial Real Estate Deal

Why the disclosure statute does not help a commercial buyer

Texas has a seller's disclosure notice requirement, but it is narrow. Property Code § 5.008 requires the notice from a seller of residential real property comprising not more than one dwelling unit. An office building, a retail center, a warehouse, raw land or an apartment complex is outside it. There is no commercial equivalent. A commercial buyer who finds a hidden problem after closing is therefore in the world of common-law and statutory fraud, where the questions are what the seller said, what the seller knew, what the seller had a duty to say, and what the contract says about reliance.

The four claims a commercial buyer can bring

Common-law fraud

The seller made a material false representation, knew it was false or made it recklessly, intended the buyer to rely on it, and the buyer did rely and was injured. A rent roll that lists a tenant who had already given notice, a statement that the roof was replaced in a year it was not, or an environmental questionnaire that denies known contamination are all representations. The elements and proof are covered in how to prove fraud in a Texas business dispute.

Fraud by nondisclosure

Silence is fraud only when the seller had a duty to speak. Texas recognizes that duty when the seller knows the buyer is ignorant of a material fact and does not have an equal opportunity to discover it, when the seller voluntarily discloses part of the truth and leaves a misleading impression, when a later discovery makes an earlier statement false, and when the parties have a confidential relationship. A seller who hands over a clean inspection report while sitting on a newer one that found a foundation problem fits the partial-disclosure category. The doctrine is explained in when silence becomes fraud in Texas.

Negligent misrepresentation

The seller supplied false information in the course of a transaction without exercising reasonable care, and the buyer suffered pecuniary loss from justifiable reliance. This claim does not require intent, but damages are limited to out-of-pocket loss, not the benefit of the bargain.

Statutory fraud under § 27.01

Business and Commerce Code § 27.01 is written for real estate and stock transactions. It defines fraud as a false representation of a past or existing material fact made to induce a person to enter a contract and relied on, or a false promise to perform made with no intention of performing. The buyer need not prove the seller knew the statement was false to recover actual damages. If the seller had actual awareness of the falsity, the statute adds exemplary damages, and a person who knew of another's false statement, stayed silent and benefited from it is also liable for exemplary damages. Section 27.01(e) awards the defrauded party reasonable attorney's fees, expert witness fees, deposition costs and court costs, which the common-law claims do not. The statute is examined in statutory fraud in real estate and stock transactions.

The as-is clause: the seller's main defense

Nearly every commercial purchase agreement sells the property as is, where is, with all faults, and states that the buyer is relying on its own inspection and not on any representation by the seller. In Prudential Insurance Co. of America v. Jefferson Associates, Ltd. (1995), a case about the sale of an Austin office building later found to contain asbestos, the Texas Supreme Court held that a valid as-is agreement negates causation: a buyer who agrees to buy as is has agreed to make its own appraisal of the bargain and accept the risk of being wrong, so it cannot later claim the seller's conduct caused its loss. The Court then described when the clause does not control:

• Fraudulent inducement into the clause. A buyer is not bound by an as-is agreement it was induced to make because of a fraudulent representation or concealment of information by the seller. The buyer must show the misrepresentation led it to accept the as-is term, not merely that a misrepresentation occurred.
• Obstruction of inspection. A seller who impairs or prevents the buyer's inspection cannot rely on the buyer's agreement to inspect for itself.
• The totality of the circumstances. The clause must be an important part of the basis of the bargain between parties of relatively equal bargaining position, not boilerplate imposed on an unsophisticated party. A negotiated commercial contract between represented parties will usually meet this standard.

A related point concerns merger clauses. In Italian Cowboy Partners, Ltd. v. Prudential Insurance Co. of America (2011) the Supreme Court held that a standard merger clause, stating that the written agreement is the entire agreement and that no representations were made except those in it, does not by itself disclaim reliance and so does not bar a fraudulent inducement claim. Only clear language in which the buyer disclaims reliance on the seller's representations has that effect. Whether the contract contains a true reliance disclaimer, as opposed to a merger clause or a bare as-is sale, is the first thing a litigator reads.

What the outcome turns on

• Knowledge. Fraud requires proof the seller knew. Repair invoices, insurance claims, prior inspection reports, tenant complaints, emails with the property manager and city notices are where that proof lives, and they are obtained in discovery.
• What the buyer could have found. Nondisclosure claims fail when the defect was reasonably discoverable by the inspection the buyer agreed to perform. A roof problem visible from the parking lot is treated differently from a buried tank.
• The contract's reliance language. A clear disclaimer of reliance between sophisticated parties, with counsel, is enforced; a merger clause alone is not.
• Damages. Out-of-pocket damages (price paid less value received) or benefit-of-the-bargain damages (value as represented less value received), plus repair costs in appropriate cases. Section 27.01 adds fees and, with actual awareness, exemplary damages.

Deadlines

Fraud claims, including statutory fraud under § 27.01, must be filed within four years after the cause of action accrues under Civil Practice and Remedies Code § 16.004(a)(4). Texas applies the discovery rule to fraud, so the period generally runs from when the buyer knew or reasonably should have known of the wrongful act and the injury, but a buyer who waits to investigate a known problem risks the argument that it should have known sooner. Negligent misrepresentation has a shorter two-year period. The deadlines are covered in the deadline to sue for fraud in Texas.

Where the claim is filed

A fraud claim over a Dallas-Fort Worth property is filed in the district court of the county where the property sits or where the defendant resides, unless the contract requires arbitration or selects another forum. Claims against the seller's broker or an inspector may be joined. The Texas Deceptive Trade Practices Act is generally unavailable to a business buyer in a large commercial transaction because of the statute's exclusions for large transactions and large businesses, so § 27.01 usually carries the fee-shifting role.

Example

Suppose a Dallas investor buys a 1980s office building for $9 million under a contract that sells the property as is and includes a clause stating the buyer is not relying on any statement by the seller outside the contract. The contract's exhibits include a seller representation that the seller has received no written notice of any violation of law affecting the property. Eight months after closing the city issues a repair order for the fire sprinkler system and references two earlier notices sent to the seller in the year before the sale. Discovery produces the notices and an internal email in which the seller's asset manager wrote that the sprinkler issue should wait until after the sale. The as-is and non-reliance language does not protect the seller: the false statement was a representation inside the contract, and the seller had actual awareness that it was false. The buyer's claims for breach of the contractual representation and statutory fraud under § 27.01 proceed, with repair costs, diminished value, exemplary damages and attorney's fees in play. Had the contract contained no such representation and the city notices been discoverable through an open-records request the buyer never made, the as-is clause would likely have ended the case.

What to do when the defect appears

1. Preserve everything from the deal: the contract and exhibits, the data room contents, the seller's answers to due-diligence questions, inspection reports and broker emails.
2. Document the defect with dated photographs, contractor reports and any city or lender correspondence, and get a repair estimate.
3. Do not alter or demolish the affected area before it is inspected and photographed; the seller will argue spoliation.
4. Ask the city, the fire marshal and the prior property manager for records of complaints or notices before the sale.
5. Have a litigator read the reliance and as-is language and the contract's representations before any demand goes out.

Tina Wysk represents buyers and sellers in commercial real estate fraud and nondisclosure disputes in Dallas-Fort Worth. The firm's real estate litigation practice covers post-closing claims, as-is defenses and the related claims against brokers and inspectors.