Legal Update

LISTING AGENT HAS LEGAL DUTY TO DISCLOSE SHORT SALE STATUS TO BUYER

  • November 1st, 2010
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When a real estate agent is aware that the amount of existing mortgage liens exceeds the sales price of a residential property, such that the property can only be sold by short sale, the agent has a duty to disclose this state of affairs to the buyer, so that the buyer can inquire further and evaluate whether to risk entering into a transaction with a substantial risk of failure.  Holmes v. Summer (2010) 188 CA4th 1510.

FACTS:   Sieglinde Summer, a real estate broker with Beneficial Services, Inc. (listing agent) listed a property for sale in Huntington Beach, CA on the multiple listing service for a price of $749,000 to $799,000.  The listing did not indicate that the property was encumbered by three deeds of trust totaling $1,141,000.  Phil and Jenille Holmes (buyer) offered to purchase the property for $700,000, free and clear of all liens and encumbrances, other than their new purchase money loan.  The listing agent prepared a counter offer on the seller’s behalf, with a sale price of $749,000 and close of escrow to occur in 30 days.  The buyer accepted the counter offer.

After selling their own house in an effort to be able to pay for the purchase of the new property, the buyer learned that the seller could not complete the transaction without the lenders’ agreement to discount the debt on the property by a total $392,000.  The buyer sued the listing agent for negligence, negligent misrepresentation, and deceit (fraud) based on misrepresentation and a failure to disclose.  The trial court dismissed the buyer’s case and the buyer appealed.  The issue to be decided by the appellate court was whether the listing agent owed a duty of disclosure to the buyer.

On appeal, the buyer argued that the listing agent knew the property could not be sold free and clear for $749,000, unless at least two or more lenders agreed to discount the debt by $392,000 or the seller put up at least that amount in cash into escrow in order to pay off the lenders.  The listing agent argued that they were precluded from disclosing the financial issues affecting the transaction, based on their belief that it would have meant disclosing the seller’s confidential financial information or strategy in determining the sales price.

DECISION:  The Court of Appeal reversed the trial court’s judgment, holding that a real estate broker who lists a property that is so overencumbered that it can only be sold by short sale or if the seller deposits a substantial sum of cash into escrow, the broker must disclose this state of affairs to the buyer.  In reaching this conclusion, the court cited the general rule that a broker can be liable for nondisclosure of any fact that materially affects the value or desirability of the property which is not known or easily observable to the buyer.  Because the listing agent was aware of the magnitude of the debt and should have known the buyer was not aware of it, the listing agent had a duty to disclose the problem.  The court stated that this duty would further the purpose of protecting buyers from harm and providing them with sufficient information to enable them to choose whether to enter into the transaction.

When the real estate professionals involved in the purchase and sale of a residential property do not disclose to the buyer that the property is so greatly overencumbered that it is almost certain clear title cannot be conveyed for the agreed upon price, the transaction is doomed to fail. Not only is the buyer stung, but the marketplace is disrupted and the stream of commerce is impeded. When properties made unsellable by their debt load are listed for sale without appropriate disclosures and sales fall through, purchasers become leery of the marketplace.

ANALYSIS:  The logic of this decision makes sense. It is certainly a material fact worthy of disclosure that the seller may be unable to perform despite the seller’s acceptance of the price offered by the buyer.  The fact that the seller’s property is overencumbered is not confidential financial information which can be hidden from the buyer.   

However, in most residential property sales today where the property is “underwater”, competent listing agents include a “short sale contingency” in the contract which allows the seller to cancel without breach if their lenders refuse to approve the short sale on terms acceptable to the seller.  It also serves as a disclosure to the buyer that the sale is subject to lender approval and may not close.

Apparently there was no such contingency in the Holmes purchase contract.  Although not addressed in the appellate opinion, the absence of such a contingency subjects the seller to liability to the buyer for breach of contract when the seller cannot perform as promised.   It is likely that the unpublished story behind this case is that the seller was also liable to the buyer and the seller probably also sued his agent for negligence in failing to include the short sale contingency in the contract. 

Listing agents should disclose the short sale status of the property offered for sale by including a short sale contingency in the purchase contract.  

Complete text of the opinion at:

http://www.courtinfo.ca.gov/opinions/documents/G041906.PDF

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This case was recently decided and is subject to change by further appellate court review.  You should consult legal counsel to evaluate this legal precedent in the context of your specific facts.  The distribution of Legal Update does not by itself create an attorney-client relationship with the reader.