What is Caveat Emptor?
Caveat emptor is a Latin phrase that is translated as “let the buyer beware.” The phrase describes the concept in contract law that places the burden of due diligence on a buyer of a good or service. Caveat emptor is a fundamental principle in commerce and contractual relationships between a buyer and a seller.
According to the caveat emptor principle, a buyer is responsible for performing the necessary due diligence before the purchase to ensure that a good is not defective or that it suits his/her needs. If the buyer fails to perform the necessary actions, he or she will not be entitled to any remedies for the damage in case the purchased product showed significant defects.
Caveat emptor and information symmetry
The caveat emptor principle arises primarily from the asymmetry of the information between a purchaser and a seller. The information is asymmetric because the seller tends to possess more information regarding the product than the buyer. Therefore, the buyer assumes the risk of possible defects in the purchased product.
If there is no explicit warranty regarding the product’s quality, it is the buyer’s responsibility to gather all the information about the purchased product. At the same time, the seller must not misrepresent the product or provide the buyer with false information about the product.
Applications of buyer beware
Although the caveat emptor principle can be applied to the purchase of any good or service, nowadays, it is primarily applied to real estate transactions. Most consumer goods transactions in different jurisdictions are regulated by specifically designed acts, while the caveat emptor principle is losing its significance.
In addition, the financial services industry is a major exception from the caveat emptor principle. Regulators require sellers of financial products to disclose as much information as possible to the buyers. Generally, the seller of a financial product is required to provide relevant information about the product in a standardized form.
The caveat emptor principle does not apply when the seller provides false information to the buyer, or there is evidence of misrepresentation of the product.
Example of caveat emptor (buyer beware)
John purchases a house from Adam. Before the purchase, John asked the seller about the defects in the house. Adam told him that there was a leak in the bathroom upstairs, but it was fixed already. However, Adam also warned him that despite the repairs, a small leak could occur from time to time. John failed to inspect the bathroom properly but still decided to buy the house.
After three months, there was a big leak that damaged the floor in the bathroom and the ceiling in the dining room downstairs. John decided to go to the court to recover damages from Adam. However, the judge stated that John is not entitled to any remedies because the caveat emptor principle is applied. John did not perform thorough due diligence to ensure that the defect in the bathroom could not cause any damage in the future.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources: