Chateau Royale Hotel/Motel: A Cautionary Tale Of Due Diligence

The Advertisment and Purchase

Paul Arena has a dream to open a five star hotel/motel in the heart of Fantasia Valley, approximately 50 kilometres north-east of Melbourne.

Paul stumbles across this advertisement, which appears in the Fantasia Valley News:

“A wonderful opportunity is just waiting to happen. Chateau Royale is a luxurious hotel consisting of 10 double bedrooms with spa ensuites, restaurant and living quarters for the owners. Situated at the heart of Fantasia Valley, this place is heaven on earth. It is for private sale only. Contact the vendor direct. Price is $7.5 million with terms negotiable.

David Gooroo Pty Ltd.”

Paul is very interested and excited at reading this advertisement. He meets with David Gooroo (director of David Gooroo Pty Ltd) on 1 March 2013. At this meeting, Paul explains to David that he is looking for a five star hotel/motel in the Fantasia Valley, where guests can stay in luxurious accommodation and wine and dine on local organic produce.

He informs David that he needs a hotel/motel complex that, with his hard work, will return him a profit of at least $30,000 per month.

David responds enthusiastically that Chateau Royale is a “real little goldmine” and that with hard work, will return at least twice the amount mentioned by Paul.

Paul likes what he hears and is anxious to view Chateau Royale straight away.

Both Paul and David meet the following day at the Chateau Royale and an inspection of the complex is undertaken by Paul. He loves it. He is impressed with the architectural features of the complex and the magnificent rolling hills and organic vegetable garden and vineyard surrounding it.

Paul is also impressed with the private living quarters as well as the 10 double bedrooms with spa ensuites and the tastefulness with which the rooms have been decorated. Paul is even more impressed when David informs him that he (David) did most of the decorations himself and that four of the double bedrooms are only 2 years old.

David realises that Paul is very impressed with the physical beauty of the entire hotel/motel complex. He is moved to tell Paul that “it is a great business as well”.

When Paul enquires as to the takings from this “great business”, David informs Paul that he is “making about $25,000 per month” but adds that “not much effort in promoting the business” had been made over the last 12 – 18 months. David in fact reiterates that the business can earn significantly more with proper promotion. David would have been happy to show Paul the “book of accounts” regarding the business, but unfortunately, they are no longer available due to a large fire at the office of David’s accountant.

Paul is very excited at the whole prospect of a business venture in the Fantasia Valley. Soon after the meeting with David, he researches the tourist industry in the Fantasia Valley via the internet and gathers information from the Department of Tourism, the Major Project Office and the Fantasia Valley Shire Council. He carefully makes the necessary calculations and concludes that the complex could easily achieve the targeted profit of $30,000 per month.

Initial Impressions and Expected Profits

Paul and David enter into a contract for the sale and purchase of Chateau Royale for the sum of $6.5 million. The date of the contract is 2 April 2013 with final settlement occurring on 2 July 2013 whereupon Paul took possession of the complex and settlement monies paid.

Paul’s bubble was about to burst. Shortly after taking possession, Paul notices a vile, nauseating smell wafting over the Chateau Royale at least one or two days per week. On each occasion that this occurs, at least one set of guests make a complaint and leave.

Upon enquires, Paul learns that there is a large abattoir only 2 kilometres from the complex, and that when there is a northerly wind, the smell from the abattoir travels in the direction of the Chateau Royale.

But problems for Paul don’t end there. He receives a visit from the Fantasia Valley Shire Council’s building inspector. He informs Paul that unless the “4 double bedrooms” are demolished within 7 days, Paul will be fined $1000 per day for the period that those 4 double bedrooms remain erected.

It seems that the council had refused to grant David a “satisfactory” completion certificate for the works carried out at the complex. Apparently, the building of the 4 double bedrooms had been carried out without David obtaining the necessary permits and in any event, the work did not comply with proper building standards and is contrary to uniform building regulations that applied to works of that type.

Paul is horrified at this news. The building inspector is extremely surprised that David did not mention to Paul that there was no completion certificate issued. The building inspector informs Paul that this issue about the buildings “was common knowledge” in the Fantasia Valley.

It will cost Paul $750,000 to demolish the existing 4 double bedrooms and construct new ones in accordance with relevant regulations.

Paul continues to run the business whilst the demolishment takes place. He struggles to make $5000 per month, a long way from the $25,000 per month David promised Paul that the business would make.

Extremely outraged by what has occurred, Paul contacts David demanding answers to all these problems. Paul exclaims:

“You cheating liar. Why didn’t you tell me that there was no satisfactory completion certificate with respect to those 4 bedrooms? I thought it was a 10 room hotel and then I find out that the capacity is almost half that! All up, I’m making a profit of about $5000 per month, whereas you told me you were making a profit of $25,000. You must have been lying, as it simply would not be possible to have made that much. And that abattoir! Why didn’t you tell me about that? My guests have been leaving in droves because of the smell."

David responds coolly, telling Paul that he had told him the hotel made about $25,000 a month, which it did.

“But of course that is the gross sum, and after payment of tax and overheads, the profit comes to about $4,500. Any fool with a basic knowledge of business would understand that”.

Unforeseen Challenges

Soon after this conversation, another council inspector comes to Chateau Royale to carry out a routine test of the soil. The results reveal that the soil has an unacceptable level of lead, making it impossible for Paul to maintain an organic vegetable garden.

Identify, explain/discuss and decide eight (8) issues that affect the rights and obligations of the parties in the factual scenario above.

Paul Arena wanted to buy a hotel in the heart of Fantasia Valley of Melbourne. David had an offer of selling his luxurious hotel consisting of 10 double bedrooms with spa ensuites, restaurant and living quarters for the owners situated at the heart of Fantasia Valley. David had given an advertisement for sale of his hotel describing it as a place as heaven on earth. Paul after reading the advertisement wanted to buy the hotel from David. Paul stated that he wanted to generate a return of $30,000 per month from the hotel. David made a claim that Paul would reap twice the return mentioned by Paul. He stated the hotel to be a gold mine. Paul and David went for the inspection of the hotel and impressed by its architecture and the magnificent rolling hills and organic vegetable garden and vineyard surrounding it, he purchases the hotel from David for a sum of $6.5 million. When Paul started with the business of the hotel he discovered that the hotel had to suffer from certain nauseating smell for two days in a week. Due to this many of its customers left the hotel. This affected the hotel business of Paul. Paul also later was called by the council who informed him that four double bed rooms of the hotel were not constructed in the right legal manner due to which the required satisfactory completion certificate has not been granted to the hotel. As Paul was ignorant of this fact, he discovered that he will have to demolish the existing four bedrooms of the hotel which are wrongly constructed and will have to construct them in the right manner which will cost him $750000 in order to demolish the existing 4 double bedrooms and construct new ones in accordance with relevant regulations.

The issue in the case of David Goroo v Paul Arena is the right and obligations of the parties in this case. The contract between Paul and David is made for the sale and purchase of Chateau Royale for the sum of $6.5 million. First it is necessary to understand as to what is a contract. A contract comes into existence when one party makes an offer and the other party accepts the offer made (The Law Handbook, 2013). This is a bilateral contract between both the parties to enter into a contract and undertake to do acts in accordance with the terms of contract they have entered into. The offer was made by David to Paul for sale of his hotel and Paul accepted David’s offer at $6.5 million. This makes a contract come into existence.

Council Issues and Legal Regulations

It can be clearly stated that for a contract to come into existence there needs to be a common intention to enter into a contract. This shall lead to a legally binding agreement between the parties. David had given an offer to sell his luxurious hotel stating the consideration amount for the same. Paul had an intention to buy the hotel and enter into a binding agreement with David.

The rights and obligations of the parties to contract are determined by the terms of contract which may be express or implied and this may be written or oral. Sometimes the terms might also be determined by the statute. It is essential to consider both pre-contractual obligations and post-contractual obligations.

There is a written agreement between the parties where one party (David) has stated that the hotel gives a net return of not less than $4500 per month. David as per the contract did not commit $30,000 income to be taken at home. This he claimed in pre-contractual claims. He states that he shall not be responsible if Paul did not understand that the net income is after deducting all allowances and taxes. But David had not informed Paul about the foul smell that comes in the hotel due to large abattoir only 2 kilometers from the complex and that when there is a northerly wind, the smell from the abattoir travels in the direction of the Chateau Royale.

David also did not inform Paul about the refusal of satisfactory completion certificate for the works carried out at the complex. David has not obtained the required permit and has not complied by the proper building standards which are contrary to the uniform building regulations.

1. There has to be an intention to create legal relations between people so as to make them legally binding under the terms of contract. David and Paul once have entered into a contract they are legally bound by its terms and can be enforced for the same.
2. Whenever a contract comes into existence there needs to be a free consent by the parties. Consent may be affected by mistake, false representations, duress and undue influence. In this case David has made a false representation to Paul by not telling about the foul smell and not obtaining the permission of proper building standards. False statement should be such that it affects the parties in contract.
3. The doctrine of Equitable Estoppel also applies here. Estoppel has been conducted during the pre-contractual negotiations.

Waltons Stores (Interstate) Ltd v Maher

For equitable estoppel to apply there must be unconscionable conduct by one party on the basis that a contract or promise will be performed and the other party has relied on such assumption or promise made which has cause loss to that party.

Assumptions for Estoppel

There has to be clear and unambiguous assumption by one party that a contract will come into existence or that the promise shall be fulfilled. Same was stated in the case of Thompson v Palmer.

It is necessary for estoppel to be justified that the party claiming estoppel must have acted in reliance upon the assumption made.

In the case of Australian Securities Commission v Marlborough Goldmines Ltd

The parties’ reliance upon an assumption must be reasonable.

Next requirement for estoppel to be justified by one party is that the other party who has committed estoppel must have an intention to induce the first party to act in reliance of assumptions made by it. Last assumption is that the detriment must be suffered by the plaintiff.

Gobblers Inc Pty Ltd v Stevens

There must be a link between the assumption or expectation created and the detriment suffered. There needs to be a failure on the part of the party who has made the assumption and the other party acting on the same have suffered.

Loss of Revenue and Unmet Expectations

In this case David made an assumption that the hotel is very luxurious of 10 double bedrooms with spa ensuites, restaurant and living quarters for the owners. He knew the needs of Paul of return of profit of at least $30,000 per month. He induced Paul by telling that there are 10 bed rooms where in fact there were only 6 bed rooms which were legally constructed. He never mentioned about the four bedrooms which were illegal and were not under the required permit license. Though the net takings were mentioned in the contract, David told Paul that his taking from the business is never less than $25,000 per month and that the hotel is a gold mine where he would reap twice the amount he is aiming at. He induced him so that Paul buys his loss making hotel business. Due to belief on the statements and assumptions made by David Paul entered in a contract with David and paid him $6.5 million. There is a clear application of doctrine of equitable estoppel in this case.

Before entering a contract there are various statements which are said by one party to induce the other party to come to an agreement (The Law Handbook, 2013). There can be a dispute as to which statement should be considered to be part of the contract and which is to be considered as just a pre-contract talk and not being a part of the contract. Generally the parties are bound by the terms of the contract and not by any other statements made during the talks for getting into a contract. In the case of David and Paul the court shall look at the intentions of the parties to consider whether the statement should be considered to be part of the contract or not. David’s statement to Paul that he is “making about $25,000 per month” but adds that “not much effort in promoting the business” had been made over the last 12 – 18 months and that in fact the business can earn significantly more with proper promotion. David would have been happy to show Paul the “book of accounts” regarding the business, but unfortunately, they are no longer available due to a large fire at the office of David’s accountant. This is a false statement made by David to Paul to induce him to buy his unprofitable hotel business. The court can clearly see the intentions of David behind selling his hotel to Paul and pass the judgment.

When the agreement is put into writing such that all the terms are stated on it forms a contract between the parties. The general rule is that it is applicable in a contract between parties that both the parties are bound by the terms of contract once they have signed on it. This shall be irrespective of whether the parties to contract have understood the terms or not. The only exception to the general rule is mistakes to the nature of documents or if any false statements are made in the contract.

Confrontation with David

The contract contains different terms which may be said or might be in written form in the contract. The more important out of them are the conditions to the contract and the less important ones are the warranties to the contract. Conditions hold an important position in the contract in such a way that if the condition in a contract is not fulfilled then the other party has the option of not entering into a contract. Even if the condition is applied falsely or there is breach of a condition, the other party shall be entitled to look over it seriously and treat the contract as void or even rescind the contract.

In case of a warranty made in the contract is not applied it shall make the party eligible for compensation for the damages suffered. The contract shall be binding on the parties and shall not be affected by non-fulfillment of the warranty. In this case, the terms , ‘Erected on the said parcel of land is a hotel/motel complex fully operational and conducted for the purpose of providing “a stress free” environment for guests; The hotel/motel comprises 10 double bedrooms with spa ensuites, restaurant and living quarters for the owner; Any construction works carried out by the vendor at the Chateau Royale have been carried out in accordance with local planning laws and building regulations of Fantasia Valley Shire Council’.

All these statements are conditions of the contract which makes Paul to enter into a contract with David and buy his hotel. None of the above statements have been fulfilled by David; the construction work of four bed rooms at Chateau Royale is not in accordance with the building standards norms and after obtaining the necessary permits. Therefore, in reality there are only six bedrooms which are available to Paul in the Hotel and for rest four rooms he will have to demolish the existing rooms and construct new ones in accordance with relevant regulations. This will cost $7,50,000 to Paul. Moreover, the guests in the hotel are not living in a stress free environment because of the nauseating smell wafting over the Chateau Royale at least one or two days per week. This event occurs at least twice in a week when one set of guests make a complaint and leave. This creates additional loss to Paul other than bad reputation to the business. These are conditions of the contract and non-compliance of the same shall give liberty to Paul to rescind the contract and claim for damages.

   In few cases there is a possibility that any such term or clause is included which excludes the responsibility of a person in the performance of a contract. It excludes the responsibility of the person in the contract so that the person cannot be held for any non-performance or breach. It is called an exclusion clause or an exemption clause. In this case David has applied an exclusion clause in the contract by inserting in the contract that, ‘The vendor shall not be liable for any loss or damage suffered by the purchaser as a result of the breach or otherwise of this written agreement.

Importance of Due Diligence

The purchaser further releases and forever discharges the vendor from any claims, suits, demands or any other form of legal action whatsoever with respect to this written agreement.’

In this David has clearly stated to take no responsibility in case of any losses or damages that will by suffered by Paul. As David already knew that he is doing wrong business by conveying things which are at default and not in such a position as stated by him he has made such an exemption clause in the contract. This is illegal and void.

The term in a contract is said to be unfair when it causes significant imbalance in the rights and obligations arising out of the contract or to protect the interest of the supplier or to cause harm to the other party. Though there is a valid contract between Paul and David but it consists of unfair contract terms which are in favor of David and against Paul. David after giving wrong facts about his hotel and delivering property not regularized properly to Paul has included such terms which will not make him responsible for any damages or losses suffered by Paul. This is unfair and illegal.

As a legal advisor to Paul, I would advise him to go to the court and prove as per the contract that there is false representation made by David to let his hotel property be sold to him and earn money out of it. He has made false representation to Paul by claiming the property to be properly licensed under the government regulations and having a stress free environment for the guests. If the court is satisfied that Paul has suffered losses due to fake promises and statements made by David it shall regard the contract as void and unenforceable. In such a situation Paul shall be reimbursed for full amount for all the damages suffered by Paul.

As Paul has suffered loss by believing on the assumptions made by David he can apply for remedy for equitable estoppel where a minimum equity shall be entitled to Paul so that there is justice between the parties to contract.

The remedy should be proportionate to the unconscionability. This would mean to compensate the reliance loss rather than expectation loss.

The court shall give remedy to Paul looking at the losses suffered by him and the evil done by David.

Conclusion

All the conditions in the contract are false and clearly state that they were constructed in a way so as to mislead Paul. The court shall look at the merits of the case and give its judgments. The court after considering the seriousness of the consequences suffered by Paul and understanding the intentions of David to make false statements shall determine whether it is a condition or a warranty which has been breached. Paul shall get justice where he shall be entitled to either end the contract or claim the whole amount paid by him with all the damages suffered. It is clearly stated in law that no person can induce the other person to get into a contract with him based on false representations. Such a contract shall be void and shall not be legal. The court retains all the remedies and rights for the innocent party. Paul has valid ground for termination of contract as there is breach of essential terms. The hotel business is not reaping the profits determined by Paul and only adding to the expenses and losses. The contract has been entered in such a manner by David so as to dispose of his loss making hotel business to Paul and go away with all the liabilities associated with it. It is against rules of law and the court after determining the intentions of the parties in the deal shall pass its orders. I, as a legal advisor would conclude the case to be in favor of Paul who has been misled and represented by false statements in order to get him in the deal for purchase of David’s hotel. Paul has enough proofs to prove his innocence. The court shall look at all the evidences and conclude the case in favor of Paul. Though the contract between David and Paul is valid but it is based on unfair terms where the only sufferer is Paul who has been duped with high claims made by David which were actually not true and were only claimed so as to decive Paul to buy David’s hotel which makes the whole contract void.

Reference:

The Law Handbook, Elements of a contract’, (June 2013)