Commercial real estate buyers who skimp on due diligence cannot shift liability for that mistake to their seller, according to a December 2021 opinion from the Alaska Supreme Court.
In Gavora, Inc. v. City of Fairbanks, the Court ruled unanimously that the seller of a Fairbanks shopping mall had no duty to disclose the environmental condition of the property to a buyer even when the seller knew of potential contamination. The buyer, the Court highlighted, purchased the property ‘As-Is.’
The opinion is a caution to real estate investors that they must undertake their own due diligence. After closing, ‘As-Is’ clauses offer strong protection to sellers from liability.
The buyer – Gavora, Inc. – was an experienced commercial real estate investor and tenant under a ground lease with the City of Fairbanks. In 2002, Gavora exercised an option to purchase and the City sold to Gavora. Seven (7) years later, the State of Alaska notified Gavora and the City that they were potentially liable for groundwater contamination from a dry cleaner at the property. In a subsequent enforcement action, the federal court found the City 55% and Gavora 45% liable.
Gavora sued the City in state court claiming misrepresentation, fraud, breach of contract, and breach of the implied covenant of good faith and fair dealing. Gavora also claimed that the City, in selling the property, breached a fiduciary duty to disclose the environmental contamination.
The City knew of potential contamination but never advised Gavora. Meanwhile, Gavora skipped environmental due diligence and did not obtain a Phase I environmental report before Closing.
Gavora argued that the purchase agreement’s “As-Is” clause did not absolve the City from liability, and that the City should have disclosed the risk of contamination. Gavora claimed the City had a fiduciary duty to disclose a known material fact during a business transaction, and failure to do so rendered the City liable as if it had affirmatively misrepresented the property’s condition.
The Court disagreed. Rejecting Gavora’s claim of a heightened disclosure duty, the Court held that no special relationship of trust or any fiduciary duty existed between buyer and seller. A duty to disclose information or to correct the other party’s mistaken belief could arise in a joint venture, but no duties exist “when parties to a real estate contract are represented by real estate professionals in an arm’s length commercial transaction that contains an ‘As-Is’ clause.”
Next, the court rejected any implied duty to disclose under the covenant of good faith and fair dealing, which is included in all Alaska contracts as a matter of law. The purpose of the covenant of good faith and fair dealing is to prevent “each party from doing anything that will injure the right of the other to receive the benefits of the agreement. But the covenant’s purpose is to effectuate the reasonable expectations of the parties, not to alter or add terms to the contract.” Importantly, the Court noted the covenant does not contain a duty to disclose in these circumstances: the covenant “will not create a duty where one does not exist.” According to the Court there is no “free-floating disclosure duty arising solely under an implied covenant.” This ruling follows established Alaska law, that an implied duty cannot overrule or contradict an express provision.