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Short Sale Disclosure Ruling Raises Other Questions

Posted By: Admin DreamingCode

Suppose you had a listing and that, because of some fact about either the seller(s) or the property, you believed that any transaction would stand a greater than normal chance of failing to close. (Yes, I've had one of those too.) Would you have a duty to disclose those circumstances to a prospective buyer even before they entered into contract? Apparently, "yes", if you do business in California's 4th Appellate District.

A very recent appellate decision (Holmes v. Summer) raises troublesome questions for real estate agents and brokers. Even if one agrees with the outcome in this particular case, the principles and reasons invoked could lead to problematic results in future situations.

Phil and Jenille Holmes (Buyers) entered into a contract to purchase a property listed by Seiglinde Summer and Beneficial Services, Inc. (Brokers). The buyers saw the listing on the MLS website where it was listed for sale at $749,000 – $799,000. A purchase price of $749,000 was agreed upon. According to the court records, "Unbeknownst to the buyers, the property was subject to a first trust deed in the amount of $695,000, a second deed of trust in the amount of $196,000, and a third deed of trust in the amount of $250,000, for a total debt of $1,141,000, and the lenders had not agreed to accept less than the amounts due under the loans in order to release their deeds of trust. According to the buyers, after they signed the deal with the seller, they sold their existing home in order to enable them to complete the purchase of the seller's property. Only then did they learn that the seller could not convey clear title because the property was overencumbered." The buyers, of course, filed a law suit. However, they filed it against the brokers rather than against the seller. The brokers then filed a demurrer, essentially a motion to dismiss the suit even if the factual allegations of the buyers were true. "They argued that the lawsuit was a disguised effort to require the brokers to guarantee the seller's performance. They also asserted that if the seller decided to sell the property at a loss, such that it would have to come up with cash to close the transaction, but then changed its mind, that was a business decision for which the broker could not be held liable."

The court agreed with the broker's demurrer, so the sellers filed an amended complaint. At the second hearing the trial court expressed the same sentiment as at the first. "I think you've got a great lawsuit against the seller of the property, but the seller of the property is not a named defendant in this case. I'm guessing that the seller, because the seller is upside down in this, is basically judgment proof. And so you're searching around for a deep pocket. The deep pocket is the brokerage. But the brokerage appears… under the circumstances to have done nothing that breached any duty to your client, certainly did not engage in the fraud that you allege. Basically, I think the ruling in sum is that you picked the wrong target here." It then upheld the demurrer to the amended complaint.

But the appellate court disagreed with the trial court. It reversed the trial court decision, holding that the brokers did, indeed, have a duty of disclosure to the buyers.

The discussion in the appellate decision is, to say the least, wide-ranging. A multitude of issues is discussed and numerous opinions and interpretations are rendered. Many of them have the characteristics of being both questionable and of having the potential for troublesome applications in future situations.

The court wrote, "…the brokers contend that to impose a duty upon them in this instance would be to fashion a rule that brokers are required to divine when sellers may breach their agreements and to disclose their forecast to the buyer." "Not at all," the court said. "Rather, the rule we articulate in this case is simply that when a real estate agent or broker is aware that the amount of existing monetary liens and encumbrances exceeds the sales price of a residential property, so as to require either the cooperation of the lender in a short sale or the ability of the seller to put a substantial amount of cash into the escrow … the agent or broker has a duty to disclose this state of affairs to the buyer…"

Now, I can imagine a number of people nodding their heads in agreement. Certainly, it is commonplace – though not universal – to disclose that a property will be a short sale. (That is more for the purpose of warning people that they are in for a long and frustrating experience than it is to inform them of the likelihood of failure.) But consider this: suppose that the agent has reason to believe that the seller is going to bring in the cash to close. Then would it be necessary to disclose that the property is currently upside down?

The appellate court opinion has nothing to say on the matter of whether the seller had the ability and the intention to make up the difference. We do know this: the first offer (for $700,000) had a sixty day escrow, and the seller's counter offer shortened it to thirty days. That would at least suggest that the seller was not intending to wait for the lenders to give short sale approval.

If the court had said that the brokers had a duty to disclose if they had good reason to believe that the seller couldn't or wouldn't cure the shortfall, that might be reasonable. But, in the absence of such knowledge, the broker is, indeed, being asked "to divine" that the seller is likely to breach the agreement.

Anyone who has been in the business for a while has had the experience of having a seller and/or a buyer breach an agreement. Usually this is a surprise, and a disappointing one at that. If an agent had a reason to think it likely that a breach would happen, maybe the agent would have a duty to disclose that to the other party. But, if the agent thought it were likely, the agent probably wouldn't be in the transaction anyway.
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Written by Bob Hunt

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