Commercial Real Estate Purchases and Environmental Issues – Buyer Beware?

Traditionally, Canadian common law as adopted from England places the obligation on purchasers of real property to complete due diligence and satisfy themselves as to the state of the property purchased. This general rule, caveat emptor or “let the buyer beware”, was limited only by latent title defects or fraudulent statements or acts of concealment by the vendor.

As environmental issues become more prevalent and costly, it is important for purchasers of real estate to consider whether caveat emptor applies in the traditional sense to contamination or other environmental issues. Is contamination a latent defect? Is there some other rule which can make a vendor liable for such damage, even years after a property has been purchased?

In this article we discuss general rules applicable to liability for environmental damage in commercial real estate transactions. Importantly, we note a trend towards imposing additional obligations on vendors to disclose environmental damage, particularly if such damage is potentially hazardous.

The article ends with tips for purchasers to maximize their protection and potential remedies against a vendor of real property with environmental issues.

Caveat Emptor, Warranties & Merger

Caveat emptor is a common law doctrine which impacts the sale of real property in Canada. It provides generally that a buyer must beware and that there are typically no implied warranties from the vendor that real property is fit for use.

This doctrine is rationalized by the fact that the purchaser, if it so chooses, may either negotiate express warranties from the vendor, or complete its own due diligence. If it chooses not to, it is appropriate for the purchaser to bear the risk of buying something unfit for its use.[1] This doctrine is, however, limited by fraud or concealment. If the vendor actively conceals a defect from the purchaser then the starting point of “buyer beware” no longer applies and the vendor should be held liable.

The doctrine has also been limited in the case of residential property where the purchaser is buying a home from a builder-vendor and the house is not completed at the time of purchase. It is easy to see why caveat emptor should not apply to this scenario. How could the purchaser reasonably discover a major defect in the house prior to purchase if the house is not actually completed? In such a case, the courts will usually imply a warranty of reasonable fitness for use as a residence and the purchaser will have recourse against the vendor if the home is uninhabitable.

Historically, the courts have, however, been reluctant to imply similar warranties into purchases of completed homes or properties not used for residential purposes. In such circumstances, the purchaser will need to negotiate express warranties into the purchase agreement to protect itself. But even where the parties create express warranties there is a risk of “merger”.

A real property transaction can conceptually be viewed as including two stages: (i) the executory stage and (ii) the conveyance of the property. The executory stage exists from the time of signature of a purchase agreement until the actual transfer of the property. This is a “contractual” concept governed by the purchase and sale agreement. The actual transfer, however, is a “conveyance” and is governed by property law concepts.

Traditionally, the purchase agreement would “merge” at the time of closing such that warranties or representations could not be relied on once the conveyance had occurred. This concept, however, has also become more limited in the modern era.

As stated by the Supreme Court, the rule of merger “is not applicable to independent covenants or collateral stipulations in an agreement of sale not intended by the parties to be incorporated in the conveyance.”[2] In that case, the conveyance is only a part performance of the purchase agreement; certain of the obligations of the parties will continue under the contract.

To determine whether a covenant or warranty merged with conveyance, the courts will look to the intention of the parties. The question of intention is one of fact[3] and will thus depend on the circumstances of each case.

The best evidence of the parties’ intention will be a survival clause or some other express language in the agreement itself. Otherwise, the courts will be forced to consider the actions of the parties and their reasonable expectations. If there is no proof of a common intention to merge the warranty at the conveyance, there will be no merger.[4] The purchaser will be able to continue to rely on the warranties of the vendor after the transaction has concluded.

Application to Environmental Damage

As mentioned above, absent the special case of the builder-vendor selling an incomplete home, there will generally be no implied warranties of fitness for use. The parties will need to rely on those warranties expressly given by the vendor.

In commercial transactions, it is becoming standard to include robust environmental clauses into a purchase agreement. Often there will be significant due diligence conditions, allowing the purchaser to complete testing or obtain environmental reports. There will often also be express warranties given, for example that there are no known hazardous substances on the property.

It is important where one is relying on such a warranty provision that a survival clause also be included. Otherwise, the purchaser bears the risk of a court finding that the warranty merged on conveyance leaving the purchaser unable to rely on that clause if it discovers contamination issues in the future.

Where, instead, the environmental clauses are framed as conditions or simple due diligence abilities, these will typically not survive the transfer of the property. Conditions are presumably either completed or waived before closing occurs. And if the purchaser relies on its own due diligence, it will generally not have recourse against the vendor for the purchaser’s own failure to discover an environmental issue.

Absent a breach of an express warranty then, are there any other potential remedies available to the purchaser? Maybe.

There are three causes of action which may be available to the purchaser. These are: (i) fraudulent misrepresentation, (ii) breach of a duty of disclosure, and (iii) breach of a duty to warn. These causes of action are where we have seen a significant trend toward increased vendor liability over the last couple decades.

 The Trend Towards Vendor Liability

The traditional formulation of fraudulent misrepresentation requires that the purchaser prove that “the vendor has made a false representation either (i) knowingly, or (ii) without belief in its truth, or (iii) recklessly, careless whether it be true or false.”[5] Traditionally this did not apply where the vendor merely remained silent so long as there was no act of concealment of the truth.

Thus, if the vendor was aware of environmental issues but simply failed to disclose them, while still allowing the purchaser to complete their reasonable due diligence, this remedy would not be available to the purchaser.

A duty of disclosure, on the other hand, if found to exist in the circumstances, will be breached where the vendor remains silent in the face of an obligation to provide the purchaser with relevant information. Traditionally, a duty of disclosure only applied to latent title defects, meaning defects which could not be found upon reasonable inspection of the land.[6] This would typically not apply to issues with the physical quality of the land, instead caveat emptor applied.

The last and least-used remedy is a breach of the duty to warn. This cause of action has seen less use in the real property context, being more typically applied to product liability cases, and its ambit is not well defined. That being said, its most common formulation requires that a vendor warn a purchaser of hazardous conditions which may foreseeably cause harm to person or property. It would typically then not apply where the purchaser has merely suffered economic damage.

Despite the theoretical restrictions with fraudulent misrepresentation not applying to mere silence, and the duty of disclosure and duty to warn not typically applying to physical defects with land, the courts have recently begun extending some or all of these concepts to create an obligation on vendors to notify purchasers of known contamination issues with real property.

The seminal case often cited by later decisions as authority for such an obligation is McGrath v. MacLean,[7] an Ontario Court of Appeal decision. While the case itself did not turn on these issues, the majority reasons spoke at length on the legal principles applicable to a vendor’s duties in relation to physical issues with land.

The Court questioned whether a “vendor, having knowledge of a latent defect in the lands being purchased rendering the lands unfit for habitation, [is] under a duty to make such a disclosure” and whether failing to do so gives rise to a cause of action in damages.[8] The majority concluded as follows:

I am prepared to assume that, in an appropriate case, a vendor may be liable to a purchaser with respect to premises which are not new if he knows of a latent defect which renders the premises unfit for habitation. But … in such a case it is incumbent upon the purchaser to establish that the latent defect was known to the vendor, or that the circumstances were such that it could be said that the vendor was guilty of concealment or a reckless disregard of the truth or falsity of any representations made by him.

… Similarly, I am prepared to assume that there is a duty on the vendor to disclose a latent defect which renders the premises dangerous in themselves, or that the circumstances are such as to disclose the likelihood of such danger, e.g., the premises being sold being subject to radioactivity.[9]

This case has since been followed by courts in many other jurisdictions, including Alberta. It can be seen as either extending the fraudulent misrepresentation cause of action to situations of silence of the vendor,[10] extending the duty of disclosure to physical latent defects,[11] or applying the duty to warn to real property transactions.[12]

For example, a 2007 Alberta Court of King's bench decision stated the “new” rule as follows:

I find that there is ample support for the proposition that a vendor who has knowledge of, or who is unaware of latent defects on his property but for his own recklessness, has a duty to disclose them during the sale of that property. The cases also indicate that silence as to the existence of those defects amounts to a misrepresentation such that the principle of caveat emptor will not apply.[13]

Regardless of how it is theorized, the impact is that a vendor should be wary of remaining silent in the face of known physical defects with property, including environmental damage. While this area of the law is still somewhat unsettled,[14] the courts appear to be increasingly prepared to place liability on the vendor for physical defects with real property.

This is particularly so where the environmental issues render the property dangerous. The above quote from the Alberta Court of King's Bench also suggests that even actual knowledge will not always be necessary; recklessness as to the truth on the part of the vendor can be enough to find liability.

That being said, if a physical defect in land is not inherently dangerous and does not impact the purchaser’s intended use of the property, it remains unlikely that a court would hold the vendor liable for non-disclosure. Vendor liability in such circumstances would stretch even the most generous reading of the McGrath decision.

Takeaways

Canadian common law has moved towards increased vendor liability in real estate transactions. This impacts commercial real estate transactions where environmental damage may be an issue. While historically physical defects like environmental damage, unless fraudulently concealed, would not create liability for the vendor, this appears to no longer be the case. Now, the courts often consider non-disclosure of dangerous physical defects to be an exception to the general rule of caveat emptor.

While this is generally favourable for purchasers of real property, there is still risk due to the unsettled nature of the law. For example, it is unclear whether environmental damage that causes only economic harm will be excepted from caveat emptor. Similarly, if the purchaser is unable to prove vendor knowledge of the defect, a court may be reluctant to find vendor recklessness as to the truth about the environmental condition of the land.

The best way to protect oneself from future discovery of environmental defects with purchased property therefore remains careful drafting of covenant and warranty provisions in a purchase agreement. Standard form agreements should generally be avoided.

From the purchaser’s perspective, clauses surrounding the environmental state of the property should be imposed as warranties, not as conditions, and should explicitly be made to survive the conveyancing of the property. These warranties should also be drafted broadly and should set out specific remedies, such as the rescission of the contract or payment of damages.

If you are considering purchasing real property which may be impacted by environmental damage, or are already in the unhappy position of having discovered environmental issues post-closing, our environmental team is available to help.

Please contact Sean Parker or Lydia Roseman for assistance.