Sour Grapes: Seller’s Warranties Survive Closing in Sale of Winery

June 2015

Most real estate purchase agreements provide that the buyer will purchase the property in its AS-IS condition, subject to various representations and warranties made by the seller about the history and condition of the property. If the seller violates these representations and warranties, then the buyer may, among other options, sue the seller for damages. In some cases, however, upon the conclusion or closing of the sale transaction, the seller’s representations and warranties are deemed to “merge” with the deed. The effect of this merger doctrine is to extinguish at least some, if not all, of the seller’s representations and warranties that were contained in the purchase agreement, leaving the buyer without recourse post-closing. To prevent this result, buyers will often negotiate for the representations and warranties to survive the closing of the sale for a certain period of time (e.g., one year). There are also other situations that protect buyers even without an express survival period—this might be based on the parties’ intent, on ambiguity, or on whether the obligation is collateral to the deed. In these instances, the parties’ obligations survive and remain enforceable after the close of escrow.

On April 9, 2015, the California Court of Appeal for the First District ruled in Ram’s Gate Winery, LLC v. Joseph G. Roche, et al. that the merger doctrine did notextinguish the seller’s warranty to disclose conditions on the property material to its ownership or use, even though the warranty was not contained in the deed and even though the purchase agreement did not expressly state that the warranty would survive closing. By this ruling, the court limited the application of the merger doctrine to instances in which the parties clearly intend to have all of the contractual obligations extinguished by the deed.

Ram’s Gate bought property in Sonoma County with the intent to build a winery.  As part of the purchase and sale agreement, the seller agreed to disclose facts having a “material effect on the value of the ownership or use of the property,” including potentially hazardous seismic conditions. After escrow closed, Ram’s Gate discovered an active fault trace on the property that substantially increased the cost of development. Ram’s Gate sued the seller for breach of contract contending that the seller had knowledge of this active fault and failed to disclose such fact before closing. The seller, however, argued that the disclosure covenant and warranty “merged” into the deed and did not survive escrow, extinguishing any liability arising therefrom.

The trial court agreed with the seller that the merger doctrine terminated any liability of the seller arising from the disclosure obligation and dismissed Ram’s Gate’s breach of contract claim. On appeal, the appellate court reversed, holding there was a triable issue of fact as to whether the parties intended to have this duty of disclosure survive closing. In doing so, the court held that the merger doctrine did not extinguish the seller’s liabilities as a matter of law because the doctrine only applies to “circumstances where the contractual terms are inconsistent with the terms of the deed, or where the parties clearly intend to have all contractual obligations subsumed by the recitals of the recorded deed.”

The appellate court found that there was no obvious conflict between the terms of the purchase agreement and the terms of the deed. The court also found that even though several paragraphs of the purchase agreement expressly provided for such paragraphs’ survival, the fact that other paragraphs did not expressly provide for survival did not foreclose the possibility that these other paragraphs could also survive. Upon such finding, the court held that a declaration submitted by Ram’s Gate to the trial court stating that it believed the disclosure warranty continued after the close of escrow should have been considered by the trial court in determining the parties’ mutual intent. The appellate court reasoned that the merger doctrine, in its limited capacity, did not extinguish the seller’s disclosure warranties and liabilities, as there was a reasonable interpretation based upon the declaration that the purchase agreement’s disclosure obligations were intended to continue in force after the transfer of title.

The court also found that the collateral terms exception to the merger doctrine would apply because, if the alleged breach in fact occurred, equity would treat the disclosure warranty as a collateral promise. The collateral promise exception states that those obligations that are to be performed after the close of escrow or that are not related to the mechanics of transferring title remain enforceable after closing. The court stated the seller’s disclosure obligations were collateral to the sale transaction itself – not to the passage of title – and would therefore not be subject to the merger doctrine.

The court’s ruling in Ram’s Gate Winery, LLC v. Joseph G. Roche et al. should be taken as a warning to sellers to not rely on the merger doctrine as a shield to the sellers’ duties and liabilities under a purchase and sale agreement. Additionally, the decision should be treated as a reminder to buyers that it is good practice to expressly state which covenants and warranties the parties intend to survive the close of escrow.