Duty To Disclose Defects In Arizona Real Property Transactions

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The seller of real property must disclose to the buyer any fact concerning the property that materially affects the value of the property. In determining whether a matter is material, Arizona courts have indicated that a matter is material if it is one to which a reasonable person would attach importance in purchasing the property in question.

Most defects in a home are considered to be “latent” defects. So what is a latent defect? A latent defect is defined as “[a] hidden or concealed defect. One which would not be discovered by reasonable and customary observation or inspection…” Black’s Law Dictionary 611 (Abridged 6th ed. 1991).

Anyone selling real property in Arizona must provide the buyer with a Seller Property Disclosure Statement (“SPDS”). Any latent defects that are material must be disclosed by the seller in the SPDS. Where a seller of real property knows of facts materially affecting the value of the property that are not readily observable and are not known to the buyer, the seller is under a duty to disclose those facts to the buyer. Hill v. Jones, 151 Ariz. 81, 725 P.2d 1115 (App. 1986).

Many sellers mistakenly believe that when they sell a property “as is“, they no longer have any duty to disclose any defects to the buyer. However, the existence of an “as is” provision in a purchase contract generally operates as a waiver of breach of warranty claims, not tort claims. Further, the duty to disclose latent defects arises out of an implied covenant of good faith and fair dealing.

Arizona law implies a covenant of good faith and fair dealing in every contract so that neither party will act to impair the right of the other to receive the benefits which flow from their agreement or contractual relationship. Arizona courts have held that in keeping with the covenant of good faith and fair dealing, a seller must disclose latent defects in property that are known to the seller, notwithstanding the existence of a burden-shifting “as is” clause or disclaimer of warranties. This applies to sellers of commercial property as well as residential property.

In S Development Company v. Pima Capital Management Co., 355 Ariz. Adv. Rep. 24 (August 30, 2001), the Arizona Court of Appeals held that an “as is” clause will not necessarily insulate a commercial real property seller from liability to the buyer, for property defects known to the seller and not disclosed to the buyer.

In that case, the seller failed to disclose the extensive use of flexible polybutylene pipe within the plumbing systems of two apartment buildings. The buyers – seasoned real estate agents who had retained legal counsel and other experts to assist them in the transaction – sued, alleging fraud and negligent nondisclosure. The seller attempted to defend based on a standard disclaimer of warranties that included an “as is” clause. A jury awarded the buyers substantial damages, and the Court of Appeals affirmed.

The Court rejected the seller’s argument that the “as is” clause relieved the sellers of any duty to alert the buyers to the defective plumbing, where the plumbing defect was known to the seller, was “basic to the transaction,” and was a latent defect which the buyers did not discover (and had no opportunity to discover) during the due diligence period. Under these circumstances, the Court held that the seller was under a duty to disclose the defective plumbing, and that its breach of that duty at a minimum violated the covenant of good faith and fair dealing implied in the contract, even though the contract contained an “as-is” clause.

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