Defect Must Be Latent to Defeat As-Is Lease

Facts: The state health department forced a frozen yogurt shop tenant to suspend its operations until the waste water system for its space in a strip mall complied with state requirements. The tenant, who was unaware that its water system was inadequate, complained to the owner, who asserted that it was the tenant’s responsibility to bring the system into compliance at its own cost.

According to the owner, because the tenant’s lease specified that the tenant took its space “as is,” the owner was protected from having to make repairs or upgrades to old systems, including the water system—unless the complained-of problem was a “latent” defect—that is, a problem that couldn’t have been discovered prior to the lease with a reasonable inspection.

The tenant sued the owner for fraud, claiming that the owner knew that the water system wasn’t adequate before signing the lease, and made fraudulent representations that the space was previously approved by the appropriate municipal entities concerning all of the food tenants in the center. The tenant claimed that upon reviewing an additional engineering study, it was ascertained that not only were the existing waste water and sanitary systems for its store unapproved and inadequate, most of these pre-existing systems were inadequate throughout the entire shopping center inclusive of five other food establishments and a dry cleaner.

The tenant claimed that, despite an "as is" clause in its lease agreement, the owner had a primary and independent duty to notify and advise the health department of any proposed change, use, and occupancy by a new tenant in a timely manner, and was also duty bound to advise all prospective tenants about potential deficiencies in the sewer and water systems existing at the premises. The tenant claimed that it suffered damages by relying on the owner’s false representations. The owner asked the court to dismiss the case.

Decision: A New York appeals court dismissed the tenant’s claims.

Reasoning: The court reviewed the portion of the lease that pertained to defects in the space. Under the lease, the tenant agreed that it had “inspected the building and the demised premises and is thoroughly acquainted with their condition and agrees to take the same, including without limitation all electrical, plumbing, ventilation, fire and other building systems, if any existing, in their ‘as-is’ condition on the date possession is tendered, and acknowledges that the taking of possession of the demised premises by tenant shall be conclusive evidence that the said premises, and the building of which the same form a part, were in satisfactory condition at the time such possession was so taken, except as to latent defects” [italics added]. The court stated that the issue here was whether the deficiencies in the water system are, in fact, "latent" defects.

While the tenant asserted that the owner was duty bound to advise it regarding any potential deficiencies in the sewer and water systems, New York State courts have consistently held that, in addition to establishing the elements of a cause of action for fraud, in order to recover damages for fraudulent concealment, the tenant must also establish the existence of a fiduciary or confidential relationship between the parties that would impose a duty upon the owner to disclose, and the owner failed to do so. The court noted that, in this case, it’s clear that no such relationship existed between these parties. It dismissed the fraud claim.

Furthermore, the court said that it couldn’t accept the deficiency in the water-septic system as a "latent defect." “A latent defect is one that is hidden or concealed which a reasonable customer inspection would not reveal,” the court stressed. But here, the deficiency was identifiable independently by a municipal agency, and, therefore, the tenant could’ve discovered it as well.

• The Yogurt Factory NY, Inc. v. S.G.M. Holding Corp., March 2014