Wisconsin Lawyer
Vol. 75, No. 7, July
2002
Buyer's Pre-Closing Knowledge of Seller's Breach of Warranty
In most jurisdictions, a buyer is not required to rely on the
underlying truth of a warranted fact in a contract for the sale of a
business in order to maintain an action for a breach of an express
warranty against the seller - even if the buyer knew of the breach
before the sale closed. However, the issue is unsettled in
Wisconsin.
by
Robert J. Johannes & Thomas A.
Simonis
t is standard practice for attorneys to include
representations and warranties regarding various matters in contracts,
including agreements for the sale of businesses. Attorneys in all
practice areas include these representations and warranties to allocate
economic risks between the parties.
Frequently, one of the parties to the contract will learn, before the
sale closes, that a representation or warranty made by the other (for
example, the seller) is untrue. A buyer who knows of a material breach
often will complete the transaction without the parties amending the
contract or agreeing on the consequences of the breach, because the
buyer assumes that the contract terms will be enforced, and that the
seller will be responsible for any damages resulting from the breach. In
fact, many purchase agreements for business transactions contain a
specific provision providing that the buyer's knowledge of the breach is
not a bar to the buyer's recovery. Many business attorneys, relying upon
such a provision, counsel their clients accordingly. If a court or
arbitrator held that the buyer's pre-closing knowledge of a breach of a
warranty precluded a cause of action arising from that breach, the
client's reasonable expectations would be frustrated.
This article surveys the national trend as to the requirement of
reliance to maintain a claim for a breach of an express warranty;
examines the currently unsettled Wisconsin law on this issue; and notes
the relevant differences, under Wisconsin law, between a tort claim for
misrepresentation and a contract claim for breach of warranty. The
article concludes that, at least in negotiated transactions, reliance
should not be a required element for breach of express warranty or, at
least, that the type of reliance required is simply reliance on the
enforceability of the warranty rather than on the underlying truth of
the warranty.
The National Trend
The majority of jurisdictions that have considered whether reliance
is a required element of a cause of action for a breach of an express
warranty in a sale of a business have concluded that reliance is not
required.
Currently, the law in New York best represents the modern view of
this issue. In CBS v. Ziff-Davis, the New York Court of Appeals
held that reliance on the underlying truth of a warranted fact in a
contract for the sale of a business was not required in order to
maintain an action for a breach of an express warranty.1 Ziff-Davis involved a contract for the
sale of a privately held corporation to a corporate buyer. The contract
of sale contained express warranties by Ziff-Davis, the seller, as to
the truthfulness of financial information previously supplied by it.
After entering into the contract, the buyer, CBS, conducted its own
investigation into the financial status of Ziff-Davis. This
investigation led CBS to believe that the financial information
submitted by Ziff-Davis was untrue, and CBS informed Ziff-Davis of its
concerns. Ziff-Davis dismissed CBS's concerns and insisted that it
proceed with closing. CBS agreed to close after the parties came to a
mutual understanding that the closing would not waive any rights either
party had under the purchase agreement. After the deal was concluded,
CBS brought a suit for breach of warranty.
Ziff-Davis argued that reliance was a required element of a breach of
warranty claim and because CBS did not believe the warranted financial
statements, it could not have relied on them, rendering the warranty
unenforceable. The court of appeals rejected this argument. In its
decision, the court distinguished that an action for a breach of
warranty is no longer grounded in tort, but rather in contract. By
making this distinction, the court held that reliance on the underlying
truth of the warranted assertion was not required. Rather, the only
element of reliance needed to maintain the claim for breach of warranty
was the buyer's belief that it was purchasing the seller's promise as to
the warranted fact. In other words, the buyer was purchasing the
economic risk allocation that the parties had bargained for.2
Another New York case that clearly demonstrates the lack of a
reliance requirement is Ainger v. Michigan General Corp.3 In this case, the seller, a book publisher, placed
a warranty into the sales contract that it was "not involved in
litigation and has not been notified of any claims which could give rise
to litigation."4 After the sales contract
was formed, but before the deal closed, the buyer conducted its own
investigation and became aware of a copyright dispute between the
publisher and one of its authors. The buyer made its concerns known to
the seller and received reassurances that the warranties were true. The
parties closed the sale, and a dispute subsequently arose with the
author regarding ownership of the copyrights, eventually resulting in a
lawsuit between the seller and the buyer.
In a counterclaim to the lawsuit, the buyer alleged a breach of
warranty. The seller defended by arguing that the warranty was
unenforceable because the buyer knew of the potential litigation from
the copyright dispute; therefore, the buyer could not have relied on the
warranty. The court disagreed, holding that knowledge of the untruth of
a warranted assertion was not a bar to recovery for a breach of
warranty. "The problems of a reliance, and a right to rely, on the
representations do not appear when the action is grounded in warranty.
The warranty is as much a part of the contract as any other part, and
the right to damages on the breach depends on nothing more than the
breach of warranty."5
This view has been upheld in most jurisdictions that have considered
the reliance question. In the Seventh Circuit, cases in Indiana and
Illinois have held that reliance on the underlying truth of the
warranted assertion is not required to maintain a breach of express
warranty claim.6 These cases have held that
an express warranty is a contract term, and that an action for a breach
of an express warranty is a contract claim, not a tort claim. In
Indeck, for example, the court held that "[t]he right to
indemnification depends only on establishing that the warranty was
breached."7
While no Florida cases have dealt explicitly with the requirement of
reliance for a claim of breach of an express warranty, two federal
courts have held that, if faced with the issue, the "Florida Supreme
Court would embrace the modern view that express warranties are
bargained-for terms of a contractual agreement, any breach of which is
actionable notwithstanding proof of nonreliance at the time of closing
on the contract."8
Under Pennsylvania law a showing of reliance is not necessary to
maintain a breach of warranty action.9 In
Giuffrida, the court held that the line of cases requiring
reliance was "inconsistent with the commercial realities of these
complex purchase agreements negotiated over several months by
sophisticated parties."10 Further, the
court held that requiring reliance would inject uncertainty into
agreements because the enforceability of warranties would be subject to
a fact finder's determination, and that it would discourage due
diligence.11
Reliance on the truth of the warranted assertion also is not required
to maintain a breach of an express warranty claim in Connecticut,12 Montana,13
Massachusetts,14 and New Mexico.15
In only four states were cases found that still require reliance on
the underlying truth of the warranted assertion to recover for a breach
of an express warranty. These states are Kansas,16 Minnesota,17
Delaware,18 and California.19 These cases have been heavily criticized, and
they represent the view of a minority of jurisdictions.
Some courts have made distinctions that depend on whether the buyer
expressly reserved its right to claim a breach of warranty following the
closing for an untruth the buyer knew of before the closing, or whether
the buyer learned of the untruth from a source other than the
seller.20
These cases have held that the necessary reliance to establish a
claim for breach of express warranty is the mere reliance on the
warranty as a contract term, not reliance on the underlying truth of the
warranted assertion. However, these cases also have held that if the
seller discloses the untruth of a warranty, and the buyer closes with
knowledge of that untruth, then the buyer is foreclosed from later
asserting that breach because the buyer has waived its right to assert a
breach of warranty claim. On the other hand, if the buyer expressly
reserves its right to later claim a breach of warranty, then it may do
so because no such waiver exists.
Finally, these cases also hold that if the buyer learns of the
untruth other than from the seller, then the buyer's claim for breach of
warranty is not precluded, because it is not unreasonable to assume that
the buyer is purchasing the seller's warranty as insurance.21
In summary, while not every jurisdiction has considered the reliance
requirement, most jurisdictions considering the issue have held that
reliance on the underlying truth of the warranted assertion is not
required.
Unsettled Wisconsin Law
As one would expect, reliance on the truth of the assertion is a
required element of the tort of misrepresentation under Wisconsin
law.22
In Foss, the buyer entered into a contract for the purchase
of a commercial property. The contract contained a provision that the
"Seller warrants and represents to Buyer that Seller has no notice or
knowledge of any ... underground storage tanks" on the property.23 At closing, the buyer knew that there were two
underground storage tanks on the property, and the seller presented the
buyer with a letter stating that the property was sold "as is."24
Robert J.
Johannes, Univ. of Chicago, 1977, practices with Michael Best
& Friedrich LLP, Milwaukee.
Thomas A. Simonis, U.W.
1981, practices with Quarles & Brady LLP, Milwaukee.
The authors thank Michael E. Dahm, a second-year law student at
Harvard, and Ryan L. Van Den Elzen, a Notre Dame Law School graduate who
will join Quarles & Brady LLP as an associate in September, for
their research and writing assistance.
The buyer in Foss subsequently brought a claim against the
seller for the tort of misrepresentation, attempting to recover the
costs of removing the storage tanks and leaked fuel and lost rentals due
to construction delays. Importantly, the buyer did not bring a contract
claim for a breach of warranty. The court of appeals held that the buyer
could not maintain his tort claim, stating that "[t]o succeed on such a
tort claim ... [the buyer] must have believed the representation was
true and relied on it to his damage."25
The question still remains in Wisconsin whether reliance on the truth
of the warranted assertion is a required element of a contractual action
for breach of warranty.
Unlike the jurisdictions discussed above, Wisconsin courts have not
yet directly answered the question of whether a buyer's nonreliance on
the truth of a warranted assertion (specifically arising from its
pre-closing knowledge of the assertion's untruth) precludes a
contractual claim for breach of an express warranty. The cases
concerning the effect of the buyer's pre-closing knowledge that a
warranted fact is untrue reach varied and seemingly conflicting
conclusions. Furthermore, the secondary sources addressing this issue
reach different results.
In general, reliance is not required for a contract action. 26 Thus, if an express warranty is a contract term,
then a contract claim brought to enforce it should not require reliance.
However, in Wisconsin this appears not to be the case. The Wisconsin
Civil Jury Instruction on breach of an express warranty states that the
buyer's reliance is a required element of an express warranty.27 The jury instruction, however, does not explain
whether the requirement is reliance on the truth of the warranted
assertion or reliance on the bargained-for allocation of economic risk
demonstrated by the warranty (that is, reliance on the express warranty
as a term of the contract).
Almost a century ago, the Wisconsin Supreme Court considered the
requirement of reliance in a warranty action in Smith v.
Reed.28 The sales contract in issue
contained a representation (not characterized as a warranty) on which
the jury found the buyer did not rely. On appeal, the court held that
reliance was required to give a representation the effect of a warranty.
The court did not elaborate on whether the reliance required was on the
truth of the representation or on the enforceability of the
representation as a contract term. However, the court did state that "if
an express warranty had been given in express terms as
a part of the contract of sale, no proof of reliance thereon
would have been necessary."29 With this statement, the court seems to be saying that
incorporating the magic words of "express warranty" into a
representation can eliminate the need to demonstrate reliance.
Again, it is not clear what the court means by saying no reliance is
required. Does the court mean that the buyer is not required to
demonstrate reliance on the truth of the assertion or, more broadly,
that the buyer is not required to demonstrate reliance even on the
enforceability of the warranty? How does one reconcile the court's "no
reliance" statement with the current jury instruction? This question can
be resolved by interpreting the jury instruction to require reliance on
the enforceability of the express warranty as a contract term and the
statement in Smith as discounting the need for reliance on the
truth of the assertion.
Most Wisconsin cases addressing the requirement of reliance for a
breach of express warranty claim have dealt with situations in which a
buyer desired to treat a representation as an express warranty. Before
enactment of the UCC, courts consistently had followed the
Smith holding and required that reliance on the truth of the
assertion be shown in order to turn a representation into a
warranty.30 Although the UCC applies only
to sales of goods, its provisions often have been extended to other
contracts of sale.31
The current version of the UCC requires only that a seller's
affirmation of fact be "part of the basis of the bargain" for the
affirmation to be treated as a warranty.32
The Wisconsin Supreme Court has held that "the buyer's reliance on the
affirmation [is] not determinative as to whether the representation is a
basis of the bargain."33 Thus, the UCC
appears to eliminate the requirement of reliance on the truth of an
assertion for the assertion to be a warranty. As long as a warranty is
part of the basis of the bargain (that is, a negotiated term of the
contract), the warranty, and the bargained-for allocation of economic
risk that it represents, should be enforced regardless of the buyer's
pre-closing knowledge of the untruth of the warranted assertion (that
is, the buyer's nonreliance).
It is possible that a court might now go even farther, and hold that
the statement from Smith eliminating the need to show reliance
for an express warranty means not only an elimination of reliance on the
truth of the assertion made in the warranty, but also an elimination of
all reliance (including the reliance requirement to turn a
representation into a warranty). Given the national trend of eliminating
the reliance requirement, this result would not be surprising.
Furthermore, because of the economic loss doctrine in Wisconsin,
attempting to analyze contract-based claims in terms of tort concepts,
such as reliance, is both archaic and potentially destructive of the
goal of bringing certainty to the expectations of parties to a contract.
While historically a breach of warranty claim evolved from a tort claim,
the economic loss doctrine instructs us that contract disputes should
not be grounded at all in tort but in the privatized negotiations
embodied in contract.34
In any event, Wisconsin law does not expressly answer the question of
whether or what type of reliance is necessary to establish a breach of
express warranty claim. Regrettably, a paucity of decisions on this
issue exists, and the decisions that do exist often establish a forced
distinction between whether a warranted assertion is a mere
representation (requiring proof of reliance on the underlying truth of
the assertion) or whether it is an express warranty (which may not
require reliance on the underlying truth). The most likely result is
that no reliance on the underlying truth is required if an express
warranty is made.35
Conclusion
As a matter of policy, courts should hold that when the written terms
of a contract contain express warranties, the warranties represent the
bargained-for economic risk allocation agreed on by the parties; the
warranties are enforceable terms of the contract; and the buyer's
pre-closing knowledge of the untruth of a warranted assertion, however
such knowledge is obtained, does not preclude recovery for a breach of
warranty claim. If any reliance is required, reliance on the
enforceability of the contract and the warranties it contains should be
sufficient. Such a rule would bring Wisconsin into conformity with the
law of a majority of jurisdictions.
Lastly, when two sophisticated parties enter into a contract for the
sale of a business, there are several material factors regarding the
agreement that cannot be determined to an acceptable degree of
precision. An example of this is when both parties know that the company
being sold has or may have environmental damage on its property, but the
parties cannot agree on the potential costs of cleanup. In situations
similar to this, the parties often will negotiate a warranty, where the
seller will warrant that there is no environmental damage on the
property, even though both parties either know this is not true or are
uncertain.36 This warranty is purchased by
the buyer in order to shift the cost of cleanup to the seller. If the
warranty were not in the contract, then the buyer would reduce the
amount it is willing to pay for the company by its estimate of the
cleanup costs that it would be liable for. The warranty is a contract
term for which the buyer has paid consideration to the seller.
If a court subsequently determines that the warranty is not
enforceable because the buyer knew of its untruth or otherwise did not
rely upon it, the court upsets the bargain of the parties to allocate
the clean-up costs to the seller. This collides with the recognition,
cited with approval in Mackenzie v. Miller Brewing Co.,37 that contracts reflect the parties' bargain, and
nonenforcement of the bargain would not only "chill the formation of
contracts and reduce predictability," but also diminish the objective of
protect[ing] justifiable expectations and the security of
transactions.
Regardless of the unsettled state of Wisconsin law, the authors
believe that the following language (written from a buyer's
perspective), if included as an introduction to the representations and
warranties article of the contract of sale, should be sufficient to
ensure that all representations and warranties will be enforceable
without regard to any proof of reliance or fear that a seller will
successfully assert a waiver argument:
"In order to induce Buyer to enter into this Agreement, and to close
upon all transactions contemplated by this Agreement, Seller makes the
following representations and warranties to Buyer. Each Section of this
Article is considered by the parties to this Agreement to be, will be
treated as, and shall be effective and enforceable as an express
warranty, whether or not Buyer has relied on the truth of the warranted
fact. Buyer's knowledge of any inaccuracy or breach of any
representation and warranty, regardless of when, how or from what source
such knowledge is acquired, shall not be a waiver of such representation
and warranty or any of Buyer's rights under this Agreement with respect
to such breach. Buyer expressly reserves the right to assert any and all
claims for, or arising from, the breach of any representation and
warranty, regardless of any knowledge of such breach prior to closing.
Buyer has no duty to disclose to Seller any knowledge of any breach of
any representation and warranty, regardless of when, how or from what
source such knowledge is acquired."
Endnotes
1CBS Inc. v.
Ziff-Davis Pub. Co., 75 N.Y.2d 496 (1990). (For the purposes of
this article, an express warranty will be treated as a statement in a
contract of sale made by the seller, upon which the parties to the
contract expect the buyer to rely. This statement typically will be made
to warrant the truth of an assertion regarding the business to be
sold.)
2See Am.
Bar Ass'n, Model Stock Purchase Agreement with Commentary 189
(1995).
3Ainger v.
Michigan General Corp., 476 F. Supp. 1209 (S.D.N.Y. 1979),
aff'd, 632 F.2d 1025 (2d Cir. 1980).
4Id. at
1214.
5Id. at
1223 (quoting Glacier Gen. Assurance Co. v. Casualty Indem.
Exch., 435 F. Supp. 855, 860 (D. Mont. 1977)); see also
Am. Bar Ass'n, supra note 2, at 189 (discussing buyer's
knowledge of untruth of a warranted assertion before closing not being
bar to recovery).
6Pension
Benefit Guar. Corp. v. Ziffer, 1994 U.S. Dist. LEXIS 87 (N.D. Ill.
1994); Indeck N. Am. Power Fund, L.P. v. Norweb, P.L.C., 316
Ill. App. 3d 416 (2000); Shambaugh v. Lindsay, 445 N.E.2d 124
(Ind. Ct. App. 1983); Mowbray v. Waste Management Holdings
Inc., 189 F.R.D. 194 (D. Mass. 1999).
7Indeck,
316 Ill. App. 3d at 428.
8Southern
Broad. Group, LLC v. GEM Broad. Inc., 2001 U.S. Dist. LEXIS 7386,
*17 (M.D. Fla. 2001); see Lennar Homes Inc. v. Masonite Corp.,
32 F. Supp. 2d 396 (E.D. La. 1998).
9Giuffrida v.
American Family Brands Inc., 1998 U.S. Dist. LEXIS 5588 (E.D. Penn.
1998).
10Id.
at *15.
11Id.
at *16-17; see also Mackenzie v. Miller Brewing Co.,
2001 WI 23, ¶28, 241 Wis. 2d 700, 623 N.W.2d 739 (holding that the
law encourages contractual exchanges to foster predictable results).
12Pegasus
Mgmt. Co. v. Lyssa Inc., 995 F. Supp. 29 (D. Mass. 1998).
13Glacier
Gen. Assurance Co. v. Casualty Indem. Exch., 435 F. Supp. 855 (D.
Mont. 1977).
14Wechsler
v. Long Island Rehabilitation Ctr., 1996 Mass. Super. LEXIS 626
(1996); Richards v. Saveway Oil Co., 2 Mass. Ct. App. 514
(1974).
15C.R.
Anthony Co. v. Loretto Mall Partners, 112 N.M. 504 (1991).
16Land v.
Roper Corp., 531 F.2d 445 (10th Cir. 1976).
17Hendricks
v. Callahan, 972 F.2d 190 (8th Cir. 1992).
18Middleby
Corp. v. Hussmann Corp., 1992 U.S. Dist. LEXIS 13138 (N.D. Ill.
1992) (applying Delaware law).
19Kazerouni
v. De Satnick, 228 Cal. App. 3d 871 (1991).
20Rogath v.
Werner, 129 F.3d 261 (2d Cir. 1997); Galli v. Metz, 973
F.2d 145 (2d Cir. 1992); Southern Broad. Group, LLC v. GEM Broad.
Inc., 2001 U.S. Dist. LEXIS 7386 (M.D. Fla. 2001); Giuffrida v.
American Family Brands Inc., 1998 U.S. Dist. LEXIS 5588 (E.D. Penn.
1998).
21In the opinion
of the authors, this is a forced distinction. It is not clear why one
circumstance is treated as a purchase of insurance while another is
treated as a waiver of claims when the buyer's knowledge is the same and
the only difference is the source of that knowledge. In each situation,
one would expect the question to be decided by analyzing whether the
elements necessary to establish a waiver - a knowing relinquishment of a
right - exist. This distinction seems at odds with the treatment of
express warranties as contract terms, where proof of reliance generally
is not a required element for a cause of action for breach. Moreover,
distinguishing between sources of knowledge introduces a degree of
uncertainty into already complex transactions, making the source of
knowledge subject to a finding of fact before a court.
22See
Anderson v. Tri-State Home Improvement Co., 268 Wis. 455, 461, 67
N.W.2d 853, 858 (1955); Foss v. Madison Twentieth Century Theaters
Inc., 203 Wis. 2d 210, 218, 551 N.W.2d 862, 865 (Ct. App.
1996).
23Foss,
203 Wis. 2d 210, 214, 551 N.W.2d at 864.
24Id.
at 216, 551 N.W.2d at 864.
25Id.
at 218, 551 N.W.2d at 865.
26See
Wis JI-Civil § 3010 Agreement (1998). (This jury instruction states
that the three elements required for a contract to be binding are an
offer, an acceptance, and consideration.)
27Wis JI-Civil
§ 3220 Express Warranty: General (1998).
28Smith v.
Reed, 141 Wis. 483 (1910).
29Id.
at 487 (emphasis added).
30See
Borg v. Downing, 221 Wis. 463 (1936).
31See
Dittmann v. Nagel, 43 Wis. 2d 155 (1969) (UCC express warranty
principles extend to other areas of law).
32Wis. Stat.
§ 402.313 (1999-2000).
33Ewers v.
Eisenzopf, 88 Wis. 2d 482 (1979).
34See, e.g.,
Stoughton Trailers Inc. v. Henkel Corp., 965 F. Supp. 1227 (W.D.
Wis. 1997).
35While it is
not clear what is necessary to make a contractual assertion an express
warranty, it appears from Smith that the inclusion of the magic
words "express warranty" in the contract provision are, even if not
necessary, sufficient to make the provision an express warranty.
36Alternatively,
the parties could express their economic risk allocation in the form of
either an express purchase price adjustment mechanism or an explicit
indemnity. If either of these drafting methods were used, no issue of
buyer's reliance would arise and both would be given effect. The authors
believe that this same result is commonly intended, and should be given
equivalent effect, if the parties choose to express their risk
allocations via the drafting mechanism of representations and
warranties.
372001 WI 23,
¶28, 241 Wis. 2d 700.
Wisconsin
Lawyer