Duties of A Home Buyer's Agent -- The Recent N.Y. Times Article

A couple of weeks ago I was interviewed by a reporter from the New York Times who was writing a story about an unusual case pending in San Diego. The case concerns a buyer who is suing her agent because he allegedly misled her about the value of a house she and her husband purchased.

I expressed the general view that far more claims concerning the purchase of residential real estate will be asserted in the present declining market than are asserted in an appreciating market. But I opined that there will probably not be a wave of cases alleging that buyers' agents misled buyers as to property values during the recent boom years in the residential market. Value is in the eye of the beholder and information about home sales is publicly available.

The article ran in the New York Times on January 22, 2008 and included one of statements that I made to the author. To read the article, click here.

There are many reasons that a buyer's agent can be sued -- most claims arise from a misrepresentation or non-disclosure about the physical condition of real property. But it is certainly possible that an agent can misrepresent the value of a home, and whether this is actionable will depend on the facts of the case. As the authors of a leading real estate treatise have poetically concluded, “The kind and number of intentional misrepresentations reflected in the reported decisions are as plentiful as grains of sand on the beach.” 1 Miller & Starr, California Real Estate (3d ed. ) p. 436.

The law in this area is well settled but is worth briefly summarizing. A buyer's agent has a fiduciary duty to disclose material facts to the buyer. This includes a duty to disclose reasonably obtainable material information, which may require the agent to investigate facts not yet known to the agent. [See Leko v. Cornerstone Bldg. Inspection Service (2001) 86 Cal. App. 4th 1109, 1115–1116—this includes the obligation to discover and disclose material defects in property.]

The broker's fiduciary duty to disclose material facts about the property arises upon creation of the principal-broker relationship—before the purchase contract is entered into.
Exxess Electronixx v. Heger Realty Corp. (1998) 64 Cal. App. 4th 698, 711.

When transmitting material information from the seller (or others) to the buyer, the buyer's broker must either verify the accuracy of the information or disclose to the buyer that the information has not been verified. Salahutdin v. Valley of Calif., Inc. (1994) 24 Cal. App. 4th 555, 562–563 & fn. 3. A buyer's broker who accepts material information from others as being true and transmits it to the buyer without verification or disclosing to the buyer that it has not been verified breaches his or her duty and may be liable to the buyer for negligent misrepresentation or “constructive fraud.” Id.

On the other hand, the “buyer's agent is not required to verify information received from the seller and passed on to the buyer if the buyer understands the agent is merely passing on unverified information.” Pagano v. Krohn (1997) 60 Cal. App. 4th 1, 11; see Assilzadeh v. California Fed'l Bank (2000) 82 Cal. App. 4th 399, 417.

Knowledge of these rules and a spirit of full disclosure will help keep real estate agents out of trouble.

Agent for Home Equity Purchaser is No Longer Required to be Bonded

Even a well intentioned law may be declared void for vagueness if the reader is left in a fog. A recent case in point involves the bonding requirement in the Cal. Home Equity Sales Contract Act.

According to the Court of Appeal, "The Home Equity Sales Contract Act (Civ. Code, section 1695 et seq . . .) was enacted to protect homeowners faced with mortgage foreclosure proceedings from being victimized by person employing oral and written representations, intimidation, and other unreasonable commercial practices to induce homeowners to sell their homes for a fraction of their fair market value and lose the equity in their homes. (citations omitted)." Schweitzer v. Westminster Investments, Inc. (12/13/2007) 157 Cal. App. 4th 1195.

The Home Equity Sales Contract Act ("HESCA") contains a number of protections for sellers in foreclosure. As discussed in my February 20, 2007 post ["Buyers (and Agents) Beware If the Seller is Upside Down"): "There is another interesting protection for equity sellers. If an equity buyer is represented by an agent, the agent must have a bond from an admitted insurer in an amount equal to twice the fair market value of the property. But no insurer admitted in California offers such a bond, so agents should avoid representing equity buyers." The Court of Appeal has recently eliminated the requirement of a bond. The reason -- that bonding subsection of the law was so vague that a person of ordinary intelligence would have to guess what it requires.

In Schweitzer, the trial court held that a deed transferring the property to an equity purchaser was voidable because the purchaser's representative did not have the bond required by Civil Code section 1695.17. The code section requires proof that the purchaser's agent/representative is "bonded by an admitted surety in an amount equal to twice the fair market value of the real property which is the subject of the contract." The Court of Appeal reversed, holding that the requirement of a bond was void for vagueness and unenforceable.

That language, reasoned the Court of Appeal, ". . . provided no guidance on the amount, the obligee, the beneficiaries, the terms or conditions of the bond, the delivery and acceptance requirements, or the enforcement mechanisms of the required bond." However, the rest of the HESCA is enforceable because the statute had a "severability" provision specifying that if any provision of the Act is declared unconstitutional the remainder shall not be affected (section 1695.11) if it is "grammatically, functionally and volitionally separable." Under the remaining provisions, the equity purchase contract was enforceable.

Schweitzer v. Westminster teaches us 3 lessons: a statute, like a contract, should be complete and written so that a person of ordinary intelligence does not have to guess what it requires; the remainder of the HESCA survives intact, including the requirement that a purchaser's representative be licensed by the Department of Real Estate; and, "Buyers (and Agents) Should Still Beware If the Seller is Upside Down."

Real Estate Appraisers -- Decline in Home Prices Exposes Inflated Appraisals

In a surging real estate market, the "rising tide lifts all boats." The rapid appreciation of home prices makes it less likely that a buyer will complain about problems with his purchase that are discovered after the close of escrow. But for every high tide there is a low tide that exposes rocks below the surface and barnacles on grounded ships.

A down cycle in the real estate market also exposes a variety of reasons for the artificial inflation in prices: lax loan underwriting, fudged loan applications, rampant speculation, "creative" financing, a secondary market for sub prime loans, and inflated appraisals. The last of these problems is the subject of this post.

Since the savings and loan debacle in the 1980's, the federal government has regulated real estate appraisers who prepare appraisals for loans by federally insured institutions. For example, California established an apparatus for licensing real estate appraisers in 1989.

Appraisers can be liable for negligence or negligent misrepresentation to lenders or buyers who rely on inflated appraisals that have not been prepared in accordance with the standard of care. Based on anecdotal evidence in my litigation practice, the licensing of real estate appraisers appeared to result in the decline of lawsuits against appraisers after 1989. I handled a number of such cases for a mortgage company and a S&L before 1989, but none in the 1990's after licensing became mandatory.

Unfortunately, the recent decline in the housing market has again exposed problems caused inflated residential real estate appraisals. So two months ago, the California Legislature made it illegal to pressure an appraiser to reach a inflated opinion of value. And a new California law effective January 1, 2008 has substantially increased the educational requirements for certified appraisers.

How does "the market" pressure appraisers to inflate appraisals? Will the new laws have any effect on the appraisal industry? How widespread is the problem of inflated appraisals? A recent article in the Los Angeles Times tackles these questions. To read the article, click here.

Nontraditional Mortgage Products -- The Slippery Slope Became an Avalanche

On December 28, 2006, in my second post on this Blog, I wrote about the foreseeable and serious problems that would result from the boom in "creative" financing (sub prime loans, loans made with no down payment, ARM loans with low teaser rates that would reset in 2007 & 2008). I called the post, "'Creative'" Financing -- The Slippery Slope in 2007." This became the biggest economic and real estate story of 2007, as the slide turned into an avalanche.

But this blog is not about economics or predicting the future. So what really changed in the area of real estate law as a result of the creative financing fiasco?

As discussed in my last post, borrowers who negotiate a loan reduction or lose their homes to foreclosure will not be required to pay federal income taxes on phantom income.

The California Legislature has enacted a new law to warn borrowers about "nontraditional mortgage products." After January 1, 2008, Senate Bill 385 will require additional written disclosures for nontraditional mortgage products (e.g., loans that negatively amortize or bear interest only). The additional disclosures must be made in both disclosure statements and advertising. A violation of the new law may be a crime. Unfortunately, a mortgage broker cannot determine the content of the additional disclosures by reading SB 385 itself. Rather, the mortgage broker is referred to various guidelines and regulations to learn what he must disclose. SB 385 also broadens the definition of a real estate broker for lenders. This is significant because it is a crime in California to act as a real estate broker without a license. To read the highlights of SB 385, see Business & Professions Code section 10240.3 and Financial Code sections 215.5 and 22171.

In an apparent attempt to curb mortgage fraud, in California effective January 1, 2008, a notary public who acknowledges a document must certify under penalty of perjury under the laws of the State of California that the facts acknowledged by the notary are true and correct, including that the signer has presented documentary proof that he is who he says he is. (It is no longer good enough for a notary to state that they personally know the signer.) Civil Code section 1189.

That's about it. The other laws regulating brokers, lenders and borrowers are pretty much the same. And there are no new laws against financial institutions, lenders and borrowers from "creatively" finding new ways to lose money.

U.S. Mortgage Relief Act

Until yesterday, debt that was forgiven in a foreclosure or as part of a loan workout was classed as income. For example, a homeowner who negotiated a short sale with her lender was required to recognize as income the amount of the loan that was forgiven.
That changed when President George W. Bush signed the Mortgage Forgiveness Debt Relief Act into law.

The measure will eliminate income taxes for many homeowners who must restructure their mortgages as they face foreclosure. The new law relieves a homeowner of the burden of paying additional income taxes if his lender has reduced the original loan amount to make it easier to continue making the mortgage payments. The law is a response to the rising waive of foreclosures and the re-setting of interest rates in 2008 on as many as 1.8 million mortgages.

DISCLOSURES IN THE SALE OF RESIDENTIAL REAL ESTATE -- No Fairytale Endings

Let's imagine that you were interested in purchasing house in Beverly Hills -- just for fun, let's call it the Hansel and Gretel house. Let's also imagine that you found a local broker to represent you in the negotiations with the seller. In our fairytale, the broker had competed unsuccessfully for the listing on the house and in the process learned that it required significant structural repairs. After the house was put on the market, your broker fails to tell you about all of the problems with the house he previously learned about. You do not learn of the structural problems until after the close of escrow. Can this story have a happy ending for the non-disclosing broker?

The Court of Appeal recently answered "no" in Michel v. Moore & Associates, Inc. (2007) 156 Cal. App. 4th 756. In that case a real estate agent, Larry Kirkpatrick of Moore & Associates, conducted a walk through of a house in the hopes of getting a listing. In the process, the agent Kirkpatrick took notes about problems with the house that would have to be disclosed by a listing broker to a buyer, including symptoms of structural problems (cracks in the pool, sliding doors that don't close properly, hardwood floors that are separating and damaged stucco). After another broker got the listing, Kirkpatrick showed the house to the eventual buyer. The buyer learned from the Transfer Disclosure Statement that there were interior cracks, but did not learn the other information contained in Kirkpatrick's notes.

Following the close of escrow and significant rains, further cracking appeared in the interior walls of the house. The buyer conducted an investigation and discovered the floor was out of level and there was a major soil instability problem. The buyer sued Moore & Associates.

At trial the jury returned a verdict in favor of Moore & Associates on the grounds that Kirkpatrick did not fail in his duty under Civil Code section 2079 to conduct reasonably competent inspection and did not fraudulently conceal any facts.

The Court of Appeal reversed, holding that Moore & Associates owed a fiduciary duty to the buyer that is broader than the more limited, non-fiduciary duty under Civil Code section 2079. Under the broker's fiduciary duty, he must inform the buyer of all information in his possession that is material to the buyer's interests, regardless of how the information is obtained. The failure to make such disclosure is actionable as "constructive fraud," which is easier to prove than actual fraud because the latter requires proof of intent to defraud.

The moral to our fairytale -- when in doubt, disclose. Non-disclosure cases are quite common in residential real estate transactions. I have handled a number of them in my law practice, including a six week trial of a case involving a crack in a closet. It is up to the seller to tell the broker everything that it is material about the house, but the buyer's broker also has a duty disclose all material, adverse information about the property.

The '07 Wildfires -- A Helping Handbook

The recent wildfires have wreaked havoc on the lives of many families in Southern California. As a public service to those families, the Los Angeles County Bar Association and Morrison & Forester have published a "Helping Handbook" available on line. This handbook contains a compendium of California and Federal real estate and insurance law that will assist wildfire victims in the recovery process.

To read the Helping Handbook, click here.

Trade Secrets and Commercial Real Estate

Real estate and business litigation are first cousins. This fact is illustrated by the recent Court of Appeal opinion in San Jose Construction v. S.B.C.C., Inc. -- an action by one commercial construction company against another for misappropriation of trade secrets.

Plaintiff's former employee, a project manager, took confidential documents with him to his new job with a competitor. The documents were a compilation of information about the "design build" of more than a dozen projects that plaintiff used to emerge as the successful bidder on the projects. Using the confidential information, the former project manager sought to have the developers shift to his new employer.

The case contains a helpful summary of the law of trade secrets and unfair competition in CA. As in many trade secret cases, the defendant tried to "slice and dice" the information by claiming each bit of information by itself was not confidential. The plaintiff argued that it was the compilation of information (much like a secret recipe) that made it a trade secret. The Court of Appeal agreed by holding that plaintiff raised a triable issue of fact in opposition to defendant's motion for summary adjudication.

Trade secret cases are not uncommon in the real estate industry. Over the years, I have litigated cases involving proprietary building techniques used for factory built housing, customer lists in the mortgage business, and processes for originating specialized loans for multi-family housing.

GOLF TIPS FROM THE CAL. SUPREME COURT

In a recent case arising from an errant tee shot at Rancho Park Golf Course, Shin v. Ahn, the California Supreme Court opined about the benefits and risks of golf. One obvious lesson can be gleaned from the case: don't stand if front of a recreational golfer who is teeing off!

You may wonder how this case found its way into a blog about California real estate law. The case turns on the Court's extension of the legal doctrine of primary assumption of the risk. Where this doctrine is applied, the defendant must be guilty of conduct more serious than negligence -- recklessness. The doctrine is a branch of the law of premises liability and has bearing upon the liability of property owners/landlords to third persons/ tenants on their property. For example, primary assumption of the risk may apply if a worker at an apartment building is injured while he is engaged in work that is considered dangerous.

IS YOUR OPTION CONTRACT WORTH THE PAPER IT IS WRITTEN ON?

When I was a child, the Quaker Oats Company promoted the sale of its Puffed Wheat breakfast cereal by including a Deed for a square inch of land in the Klondike in each box. As a proud land owner at the age of 6, I thought about building a house on the top of a pole firmly planted in my inch of land in the Yukon Territory. However, I recently learned that all of us kids lost their land in the Klondike in 1965 for the non-payment of $37.20 in property taxes by Quaker Oats.

As the California Court of Appeal has just reminded us, sometimes a real estate contract is not worth the paper that it is written on. In Patel v. Liebermensch, the Court of Appeal held that an option contract to purchase real estate is unenforceable unless it contains all of the essential terms of a contract to purchase real property. In Patel, the buyer was not entitled to specific performance of the option contract because the parties had not agreed to the length of the escrow. The Court of Appeal concluded that the trial court had no basis for supplying additional terms that the parties had not agreed to. [Note, the Court of Appeal was reversed by the CA Supreme Court on 12/22/2008; see, January 2, 2009 post.]

The Patel case is a reminder that an option contract must be drafted with the same level of specificity as a purchase contract itself, and all of the essential terms must be included. If you are interested in finding a Los Angeles area real estate lawyer to help you with an option contract or another type of real estate contract, feel free to contact the author of this Blog. If you are interested in buying land in the Klondike, I suggest you consult with a real estate broker in Dawson City or Whitehorse.

BETWEEN A ROCK & A HARD PLACE -- Using A Short Sale to Avoid Foreclosure

In my December 28, 2006 post, I discussed some of the anticipated problems from the "boom" in subprime mortgages and other creative lending practices during recent years. I entitled the post, "'Creative' Financing -- The Slippery Slope in 2007."

It didn't take a crystal ball last December to predict the fall-out from adjustable rate home loans that facilitated the purchase of homes for unprecedented prices with lax underwriting and no money down. It was also apparent this would problem would create weighty issues in California real estate law during 2007 and beyond.

With the prices of homes declining in many areas, some borrowers are between a rock and a hard place. How does the owner of a home with no equity get out from under the loan without suffering a foreclosure and the resulting damage to his or her credit rating?

One strategy is a "short sale." A short sale requires the seller to first negotiate with the lender to reduce the balance of the loan subject to the sale of the property to a third party. For example, let's say the seller bought the house for $550,000 with a non-recourse loan of $500,000; the house is now worth $450,000; the seller persuades the lender to reduce the balance of the loan to $450,000 and sells the house for $454,000, with $450,000 going to the lender and the $4,000 used to pay a portion of the closing costs. The lender doesn't have to deal with the house as an "REO" (real estate owned by the lender); and the seller avoids the negative impact of a foreclosure and is no longer obligated to the lender after the sale is completed.

But there may be negative tax consequences to a short sale. Under the current tax law, the seller may have to recognize "phantom income" from the "cancellation of debt" in the amount of the loan reduction ($50,000). Any reader who wants to employ this strategy should consult with an accountant about the tax consequences of a short sale and to determine if an exemption from the payment of income tax on the cancellation of debt is available.

P.S. On August 31, 2007, President Bush proposed legislation to temporarily eliminate the recognition of income when the lender forgives a portion of the debt. Stay tuned! The Congress may move the boulder that is one of the impediments to short sale.

ILLEGAL REAL ESTATE CONTRACTS

Several years ago I tried an unlawful detainer case that the commercial tenants defended on the basis that their lease was void because it had been negotiated and signed by a unlicensed property manager. The court agreed that the Lease was void, but the tenants lost the case because they had no right to possession without a lease.

Illegality issues can arise in a number of other real estate cases: an unlicensed broker cannot recover a real estate commission; an unlicensed contractor may not be entitled to payment; and a contract for the sale of unsubdivided parcels of the land may be unenforceable.

This last issue was the subject of Black Hill Investments, Inc. v. Albertson's, Inc. (2007) 146 Cal.App.4th 883. In that case, a buyer was able to cancel a purchase agreement because the seller, Albertson's, Inc., failed to include the proper language in the contract. While it is generally illegal to sell parcels that have not been subdivided, there is an exception under Government Code section 66499.30(e) which permits the sale of an unsubdivided parcel when the contract is expressly conditioned on the recordation of a subdivision map. The contract in question allowed Albertson's Inc. to cancel the sale if the subdivision map was not recorded, but did not make the obligation of the buyer to purchase the parcel conditional upon the recordation of the map. Even though the subdivision map was recorded before the buyer canceled, the Court of Appeal determined the contract was void from its inception and could not be revived by the recordation of the map.

In entering into contracts for the sale of unsubdivided land, as well as other real estate contracts, the parties should take care to include the proper language and to confirm that the status of the parties will not render the contract void from its inception.