The rule of “caveat emptor” (“buyer beware”) was abolished in residential real estate transactions in Arizona some years ago by an Arizona court decision. The Arizona Department of Real Estate also adopted a rule many years ago effectively doing away with “buyer beware” as to real estate brokers and salespersons. A new case decision by Division One of the Arizona Court of Appeals will do the same in commercial real estate transactions if it is allowed to stand by the Arizona Supreme Court.

The rule that replaced “buyer beware” in residential real estate sales is, by now, fairly familiar to real estate professionals: the seller of a residence must disclose to the buyer any fact concerning the property that materially affects the value of the property. The regulations of the Arizona Department of Real Estate place the same obligation on real estate brokers and salespersons in all transactions, residential or commercial. The only exception to those rules is that neither the seller nor a broker or salesperson is required to disclose that the property has been the site of a death or crime, has been owned or occupied by a person infected with the HIV virus, or is located in the vicinity of a sex offender.

In commercial real estate sales, however, the “buyer beware” rule still governed the duties of the seller of the property. The seller was under no obligation to reveal to the buyer any facts about the property. The seller’s only obligations were to not misrepresent or actively conceal material facts concerning the property. Typically, contracts for sale of commercial property contain provisions giving the buyer the opportunity and the obligation to investigate all material facts concerning the property. Those contracts typically also provide that the seller is making no representations as to the condition of the property and if the buyer elects to proceed with the purchase after having the opportunity to investigate, the buyer is proceeding at his own risk. Stated another way, the buyer under those typical contracts is deemed to purchase the property “as-is.”

The new decision of Division One of the Arizona Court of Appeals does not completely abolish the “buyer beware” rule, but does impose the requirement that the seller of commercial real estate either disclose to the buyer all known “latent” defects, that is, defects that are not readily discoverable by reasonable investigation, or give the buyer appropriate opportunity to discover any such defects. “Buyer beware” is still the rule if any defects in the property are “patent,” that is, readily discoverable by reasonable investigation by the buyer, or if the buyer is given appropriate opportunity to discover “latent” defects. The Court of Appeals summarized its new rule as follows:

Simply stated, in the face of an “as is” sale, the rule of caveat emptor continues to apply and the vendor may be insulated from liability for nondisclosure of facts basic to the transaction if the facts at issue are patent, or if the purchaser has been given an appropriate opportunity to discover latent defects. If the vendor fails to disclose a known latent defect or fails to give appropriate opportunity to discover latent defects, caveat emptor does not apply and the vendor must disclose the defect or, at a minimum, be subject to tort liability for nondisclosure.

The less obvious practical effect of this new rule in commercial real estate sales will be to significantly increase the risk to the seller if the buyer files a lawsuit after the sale claiming that a material defect was not disclosed. Even though the Court said that “buyer beware” is still the rule if the defect is readily discoverable or the buyer is given appropriate opportunity to discover the defect, the buyer will be entitled to have a jury decide whether the defect was readily discoverable or whether buyer was given appropriate opportunity to discover the defect. In the case decided by the Court, the buyer discovered after the sale that the plumbing in the building was defective. Although the contract specifically provided for an inspection of the property by the buyer, the Court said that it was up to the jury to decide whether the buyer actually had an adequate opportunity to discover that the building had defective plumbing. The Court put it like this:

All of the issues raised with regard to the “as is” clauses are questions of fact for the jury. It is for the jury to determine if the defective plumbing was a fact basic to the transaction, whether a defect is latent or patent, whether the appellants knew about the defective plumbing, whether the appellees undertook a reasonable inspection, and whether the appellants did not give the appellees equal opportunity to discover the defect. Viewing the evidence in the light most favorable to upholding the jury’s verdict, we conclude that reasonable minds could differ on the inferences to be drawn from the evidence. The appellants were not entitled to judgment as a matter of law merely because the purchase contracts contained “as is” clauses.

A decision by the Arizona Court of Appeals can of course be overruled by the Arizona Supreme Court. Unless and until that happens, however, the decision of the Court of Appeals is the law in Arizona. The likely result of this decision is that sellers of commercial real estate will want to expand the opportunity given to prospective buyers to inspect the property prior to purchase. Sellers will also have to consider the risk that a condition that could be considered a defect may not be revealed by the buyer’s inspection, in which case the seller has a duty to disclose the condition. Sellers and their representatives will no longer be able to rely on the standard buyer’s inspection and “as is” contract provisions to relieve them of potential liability for undiscovered defects in commercial property.