Court: Purchaser’s Mistaken Belief About Property Is Unenforceable
Written by: Alan Nochumson
Prior to purchasing a commercial property, it is extremely important to perform due diligence which should go beyond reviewing the advertising and other promotional materials generated by the seller about the property.
The U.S. Court for the Eastern District of Pennsylvania in Schutter v. Herskowitz reaffirmed that principle when it concluded that a purchaser’s assumptions from such type of materials cannot be grounds for a lawsuit against the seller of the property if those assumptions were not actually directed by the seller to the buyer at the time the agreement of sale was entered into by the parties or even included as a term within the written agreement itself.
In late 2005, Stephen Schutter spoke with David Herskowitz, the owner of a hostel located in the Old City section of Philadelphia, about purchasing the hostel, according to the opinion.
Schutter, after reading a Washington Post article mentioning the hostel and information posted on the hostel’s website describing the hostel, believed that the hostel operated with a capacity of 70 beds, as stated in the opinion. However, Schutter never directly inquired into the hostel’s bed capacity nor did Herskowitz make any representations directly to him regarding the bed capacity.
Schutter decided to purchase the hostel with the understanding that the hostel was allowed to operate with 70 beds. Schutter then engaged a real estate broker to assist him in drafting the agreement of sale, among other things, the opinion said.
The agreement between Schutter and the real estate broker did not specify who was responsible to pay the real estate broker for his services and under what terms. However, their written agreement did mention that the transfer of the property was for a hostel with a 70-bed capacity. Herskowitz was not furnished with a copy of the agreement between Schutter and the real estate broker during while the agreement of sale was being drafted, according to the opinion.
The parties eventually executed the agreement of sale which was drafted by the real estate broker which did not condition the sale of the hotel on its bed capacity. In accordance with the terms of the agreement of sale, Schutter placed a deposit of $100,000 into an escrow account controlled by the real estate broker. However, soon after the agreement of sale was finalized, Schutter discovered that the hostel was only authorized for the use of 54, not 70, beds, according to the opinion.
Schutter promptly contacted Herskowitz and they both agreed to terminate the agreement of sale and for the real estate broker to return the escrowed funds back to Schutter.
The real estate broker then prepared a formal release which included, among other things, payment of $12,000 by Schutter to the real estate broker for services rendered. Because Schutter refused to sign the release, due to the inclusion of the real estate broker’s fee, the real estate broker did not return the $100,000 deposit back to Schutter. Schutter then filed suit not only against the real estate broker but also against Herskowitz.
At the summary judgment stage, the federal district court dealt with Schutter’s causes of action asserted against Herskowitz for fraudulent inducement to contract and fraudulent misrepresentation.
In the fraudulent inducement claim, Schutter alleged that Herskowitz made material misrepresentations to him regarding the bed capacity for the purpose of inducing him into entering into the real estate transaction. Similarly, in the fraud and misrepresentation claim, Schutter alleged that Herskowitz falsely induced him into tendering the escrow funds through false and fraudulent misrepresentations regarding the bed capacity.
Schutter, attempting to overcome summary judgment, claimed that Herskowitz represented that the hostel operated with a 70-bed capacity by advertising the property as a 70-bed hostel on the hostel’s website and through an article in the Washington Post posted on the website which referred to the hostel as including 70 beds.
The federal district court flatly rejected Schutter’s reliance on the Washington Post article because that article was written after, not before, the agreement of sale was signed by him. Regardless, the federal district court believed that the article was not a representation made by Herskowitz but rather a general circulation piece about youth hostels in the mid-Atlantic region.
Addressing the website content, the federal district court found that the brief description of the hostel, which did mention the 70-bed capacity, was not associated in any way with an offer to sell the property to Schutter and was referenced on the website for general information purposes only.
Relying on the parol evidence rule, the federal district court then placed down the proverbial hammer onto the fraudulent inducement claim.
In Pennsylvania, under the parol evidence rule, in the absence of fraud, accident or mistake, a plaintiff is precluded from offering evidence to explain or vary the terms of a written contract which includes an integration clause.
The federal district court emphasized that the agreement of sale contained an integration clause which expressly set forth that all of the terms agreed to by the parties were set out in the agreement itself and pointed to another portion of the agreement which specifically warned that any advertising or promotional activities made by Herskowitz was not a part of the agreement unless specifically acknowledged in the agreement itself.
In opposing the summary judgment motion, Schutter attempted to argue that, unlike the typical seller fraud situation, the fraudulent inducement claim did not arise from a physical characteristic of the property but as to the legality of the business operation. In other words, Schutter was upset that the hostel could not support the 70 beds to which he intended to operate.
The federal district court rejected Schutter’s attempt to widen the scope of the exception to the parol evidence rule. Instead, the federal district court, in strictly applying the parol evidence rule and thus reviewing the terms of the agreement of sale, did not find any provision in the agreement itself specifically addressing the number of permitted beds in the hostel.
Moreover, the federal district court noted that even Schutter did not allege that he believed that the 70-bed requirement was included within the four corners of the written agreement of sale. The federal district court implied that, had such an allegation been made by Schutter, the fraudulent inducement claim would have survived beyond the summary judgment stage.
The federal district court then addressed Schutter’s assertion that Herskowitz fraudulently and falsely induced him into entering the agreement through certain omissions regarding the bed capacity.
According to the “Restatement (Second) Torts,” a contracting party has a duty to disclose facts that are basic to the transaction if he knows that the other party is about to enter into the contract with a misunderstanding of those facts and, based on the relationship between the parties, the customs of trade or other objective circumstances, if those facts are reasonably expected to be disclosed.
The federal district court stated that a fact is considered a “basic” fact when that fact goes to the basis or the essence of the transaction and is an important part of the substance of what is being bargained for or dealt with.
Schutter alleged that the bed capacity was a basic fact that Herskowitz was obligated to disclose. In doing so, he, among other things, pointed out that Herskowitz agreed to terminate the agreement once he discovered that the bed capacity was not 70.
The federal district court was not persuaded that the bed capacity was a fact basic to the transaction and instead bluntly pointed to the inclusion of the integration clause in the agreement of sale, thereby dismissing the relevance of any conversations between the parties prior to the execution of the agreement or any conduct by the parties afterwards. According to the federal district court, under the agreement of sale, Schutter clearly assumed the risk of any legal limitations encumbering the property or its use.
LESSONS LEARNED
The federal district court’s ruling in Schutter illustrates why a potential purchaser must remain cautious prior to entering into an agreement of sale.
If Schutter had asked the right questions prior to its execution of the agreement, he would not have even had to retain the services of the real estate broker because he would have agreed to purchase the hostel in the first place and would thus not have tied up $100,000 of his money in the process.
Even if Schutter did not perform his due diligence as to the bed capacity of the hostel prior to agreeing to purchase the hostel, if that “basic” fact was important enough to him, he should have conditioned the purchase of the hostel on a 70-bed capacity, which he did not.
All is not lost for Schutter. In the lawsuit, he still maintains a cause of action against the real estate broker for breach of fiduciary duty. At worst, the $100,000 in escrow should be set off from the amount Schutter owes to the real estate broker, if any. The question remains, however, whether the federal district court will hold the real estate broker monetarily liable for refusing to return the escrowed funds to Schutter because of a pending payment dispute between them. The federal district court could very well impose a monetary judgment against the real estate broker and in favor of Schutter for punitive damages and lost profits suffered by Schutter if he can show that he was unable to enter into other profitable business ventures because he did not have access to the escrowed funds.
Reprinted with permission from the October 27, 2008 edition of The Legal Intelligencer © 2008 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.
