June 2022

• A waiver-of-reliance clause is standard language in most commercial real estate purchase agreements.
• The waiver clause solidifies that buyer is not relying on the representations of seller when purchasing the property but is doing its own due diligence.
• If worded properly, a waiver of reliance clause may nullify any fraud or fraudulent inducement claims that the buyer could have.

Commercial real estate purchase agreements can be very long and detailed. They contain a lot of information and clauses. The ones we draft for our clients are often 30-40 pages long and have a lot of brilliant lawyer-speak in them. And while that can be irritating, the language is often essential for us to protect our client’s interest and help them navigate purchases and sales and minimize risk.

One of the areas we often use to minimize risk is a waiver of reliance (“WOR”) section. This section came up recently for us when one party sued another for fraud after the purchase. The arguments from the buyer were much less effective because of the WOR clause.

But how do you determine whether a WOR clause is effective? This is what we will be discussing this week and how it can be beneficial to you.

What is a Waiver of Reliance Clause and What does It Cover?

When a buyer is purchasing commercial real estate, it generally relies on its own due diligence to determine whether the acquisition is a good one for it. The buyer needs to request the documents and information it wants from the seller and then do its own analysis to determine whether it wants to acquire the property. It should not rely on what the seller is telling it about the property.

A WOR clause basically codifies this position in writing in the purchase agreement. It generally states that the buyer is not relying on any representations the seller has made and it is doing its own due diligence and analysis of the project. Because it is doing its own due diligence, the buyer cannot blame the seller if something goes wrong after purchase.

But a WOR clause may have even more power than that. If drafted properly, it may nullify the possibility of a suit for fraud. But to do this, it must be written in accordance with the Texas Supreme Court guidelines.

Determining Whether a WOR Clause is Effective Against Fraud Claims

It is black-letter Texas law that proof of reliance is an essential element of fraud and fraudulent inducement claims. That’s why a WOR clause may be so important in nullifying a fraud or fraudulent inducement claim. If the parties’ intent is clear and specific, a WOR clause may disclaim reliance on certain representations, thereby negating reliance-based claims like fraud and fraudulent inducement.

To determine whether a WOR clause is sufficient to nullify a fraud or fraudulent inducement claim, the Texas Supreme Court has instituted a two-step analysis. First, the Court determines whether the parties to the contract used clear and unequivocal language. Second, the Court evaluates the circumstances surrounding the contract’s formation to determine whether the disclaimer is binding. A court will then also use a five factor analysis to evaluate the circumstances around a contract’s formation. This includes determining whether:

• The terms of the contract were negotiated or boilerplate;
• the parties specifically discussed the topic of the later dispute during negotiations;
• the complaining party was represented by counsel;
• the transaction was arm’s length; and
• the parties were knowledgeable in business matters.

Assuming that the language of the WOR clause and the circumstances surrounding the contract show that two sophisticated parties freely entered into the agreement, then the buyer may very well have waived any fraud or fraudulent inducement claims it could have against the seller.

Its extremely important, therefore, to understand what waiver language is included in your purchase agreement and the full extent to what you may be waiving.

• With the federal reserve raising interest rates, property owners may look to alternative methods of financing.
• If these methods have early prepayment penalties, one way to avoid those is to defease the loan when selling the underlying property.
• By tying an investment payout to the loan payments, a property owner can sell a property and avoid a prepayment penalty.

When real estate folks get together in a group, there are a limited number of topics we all talk about. Especially if there are things going on in the country that greatly impact the real estate world.

That’s a long way of saying that lately all anyone wants to talk about is rising interest rates. And I reckon I will specifically write about that soon. But the fed has raised rates this year and will continue to do so.

As interest rates increase, investors and developers are looking to alternate types of financing. Indeed, I was just having a conversation with my good friend Matt Counts about the life insurance lenders that he works with and all the options he provides his clients. And these and other lending vehicles can be great. But the loans often come with prepayment penalties.

So what does an owner do if it wants to sell its property that has a loan with a large prepayment penalty on it? We are going to talk about one of the options this week.

Options for Dealing with a Prepayment Penalty

Maybe the most common, easiest way to deal with a loan with a large prepayment penalty is to just have the new buyer assume the loan. And with a rising interest rate market like we are in, this may not be a bad option. The loan may well have better terms than the buyer could get in the market.

But there is also another option. The seller can defease the current loan.

What is Defeasance?

Defeasance is the process of repaying a commercial real estate loan by switching the payment to something more stable and government-backed, typically a US Treasury Bond. This is usually done to assist in refinancing the real estate or selling it. This switch does not change how much is owed, and the principal and interest must be paid in full to the lender.

Essentially with the proceeds from the real estate sale, the Seller buys a security that will pay out the exact same amount, at the same time, as the current note on the property. Thus each month, the security issues a coupon that makes the payment on the outstanding loan.

How does Defeasance Work?

As described above, defeasance is a prepayment plan for an outstanding loan. The Seller invests in a security through a special defeasance company. And then the defeasance company makes sure the security pays out directly to the loanholder.

As we talked about above, one of the main benefits for borrowers is to circumvent the prepayment penalties of the underlying loan. Defeasance does this through “the purchase of Treasury bonds with maturities equal to the remaining term of the loan, with coupon rates that provide the necessary income to offset the contracted periodic interest and principal payments”. The potential downside is this could leave the owner vulnerable to interest rate rise. The owner may have to pay more for the defeasement security if rates are higher than they were when the original loan was purchased.

Obviously a Seller has to pay for the defeasance security. That reduces the amount of the sale proceeds going to it. But that defeasement fee for the security can be much lower than a prepayment penalty. Thus defeassnce can be a great way to avoid large prepayment penalties. And, as a result, make unique loan structures more attractive when initially purchasing a property.