What Is a Caveat?
The term caveat refers to a notice, warning, or word of caution provided to an individual or entity before they take action. The term, which means "let him beware" in Latin, has a range of usages that are common in finance and law. When someone adds a caveat to a contract or a legal situation, they effectively add a warning that the other party should be alerted to the possibility of a dangerous or undesirable circumstance if they proceed any further.
- A caveat is a notice, warning, or word of caution provided to an individual or entity before they take action.
- By including a caveat as part of an agreement, one party warns the other of the possibility of a dangerous or undesirable circumstance if they proceed any further.
- The most common usage of the term is as a caveat emptor, which states that a buyer should exert caution and cannot recover damages when they purchase an inferior product.
As mentioned above, a caveat is a caution or warning that one party gives to another entity before they enter into an agreement. Anyone can include caveats as part of an agreement or a contract. They generally advise a party that there may be an undesirable outcome or situation that may stem from any action they take, or it may be a condition that is attached to a pending agreement.
For instance, an employment contract may include a caveat or condition that a potential new hire must pass a drug test before being hired. Or they may include a non-compete agreement, which prevents the employee from working with a competitor for a certain length of time after their employment is terminated.
Caveats or warnings are commonly found in law and finance. For example:
- They serve as documents presented to legal or public officials to suspend proceedings until another, opposing party has their say.
- They allow individuals or other entities to stake claims on property. Nothing can be done with the property including title registration until the caveat is cleared.
- They were also used in the past by parties who objected to the appointment of an estate's executor and by individuals who wanted to block a patent from being granted to someone else.
They are also common in financial contracts. Real estate deals almost always include caveats of some sort. For instance, these contracts may include conditions that state that the buyer or seller must beware of certain circumstances before they go ahead with a deal. As long as the contract is accepted, the legal applicability of these concepts can determine civil and criminal liability.
Understanding how caveats work in any contract you negotiate will help you determine your rights.
Types of Caveats
The most common usage of the term is as a caveat emptor. This term means that a buyer should exert caution and cannot recover damages when they purchase an inferior product. In some jurisdictions, consumer protection laws allow buyers to receive refunds or exchanges when they purchase goods that do not live up to their expectations.
Many transactions between businesses treat the two as equals, however, and provide no protection to the buyer unless they can prove that the seller committed fraud.
Caveat venditor puts the burden on the seller to investigate potential flaws in the goods or services to be sold and to meet all legal requirements related to the transaction. Failure to do so can make a contract unenforceable. Caveat lector warns the reader to beware of what may be written, while caveat auditor warns the listener to beware of what he may hear.
Example of Caveat
The widespread sales of securities backed by pools of mortgages that were bundled and sold by investment banks were among the factors that fuelled the financial crisis. The securities were backed by multiple tranches of residential mortgages of differing credit quality, and the securities were known to include sub-prime mortgages. Many of the securities quickly became worthless as the housing market collapsed.
The packaging of these securities, which were given investment-grade ratings by the credit rating agencies, was done under the caveat emptor concept. The concept was central to the business model as the purchasers of the securities were considered sophisticated investors who should be able to evaluate their worth. While that has made successful criminal prosecutions difficult, it has not been a protection against civil charges.
The U.S. Securities and Exchange Commission (SEC) and the Department of Justice have charged many of the country's largest financial institutions with defrauding investors because they lied about the quality of the underlying mortgages.