FROM SEA TO SHINING SEA

A few months ago I received a call from a potential client. He explained that he and his wife were under contract to purchase a home from another couple but had just been told that the seller was not going to be able to close because they needed to bring money to the closing and didn’t have it. It was a few days before closing.

As a courtesy (and in the name of due diligence) I agreed to speak with his realtor. In sum, the buyers’ realtor told me that he was just informed by the listing agent that the seller would not be able to pay off their lender so they could not close, as planned. He also told me that he was “reminded” by the listing agent that there was about a month delay in securing the buyers’ financing because the buyers had (arguably) dragged their feet through the process. He guessed that the listing broker was suggesting that the need for “short sale” approval was the buyers fault.

Last week I spoke with a realtor who was concerned for one of her buyers because a late-breaking title report revealed significant judgments against the sellers as a result of unpaid income and real estate taxes. She explained that the anticipated net proceeds would not cover these obligations and inquired as to whether or not we were now in a “short sale” situation. If so, her buyers were not only going to be delayed in moving into their new home but so was another family which had plans to move into her clients’ property.

These conversations caused me to remember a recent case in which a California Court considered whether a broker had a duty to inform a buyer that the property had loans exceeding the purchase price amount and so a short sale would likely be needed to close the transaction. In that case, the buyers entered into an agreement to purchase a home for $749,000. The broker had listed the property in a range of $749-$799,000, and the listing noted that the seller was “motivated”. None of the information exchanged between the parties mentioned that the property had three liens totaling $1,141,000 and so the only way that the transaction could proceed at the agreed upon price was through a short sale or through a deposit of the additional funds into escrow by the buyers.

After entering into the purchase agreement, the buyers sold their current home. Following that transaction, the buyers allegedly learned for the first time that the new property was subject to the three liens and none of the lien holders would release their liens. Therefore, the only was the transaction could proceed would be if the buyers deposited $392,000 into escrow, which they were unwilling to do.

The buyers brought a lawsuit against the broker and the brokerage alleging negligence and negligent misrepresentation for their failure to disclose that the property could not be sold at the list price. The buyers alleged that the broker knew that the property was subject to the liens and had attempted to arrange a short sale with the lenders. The trial court dismissed the lawsuit, and the buyers appealed.

The Court of Appeal of the State of California, Fourth Appellate Division, reinstated the buyers’ lawsuit and sent the case back to the trial court for further proceedings. The court considered whether a real estate licensee has a duty to disclose the necessity of a short sale when the agreed-upon purchase price falls below the lien amounts. The buyers argued that the broker knew there was a substantial risk that the transaction would not close and the buyers should have been told this fact. The broker argued that she had a duty to keep her client’s financial information confidential and so could not disclose the need for a short sale.

California law requires real estate licensees to disclose all material facts affecting the value or desirability of a property that are known to them. While most of the defects that require disclosure are physical defects on the property, there are cases in California where courts held that disclosure of other matters was required, such as a murder on the property or potential zoning problems.

Even though this case did not involve a buyer who purchased property with an undisclosed defect, the buyers here argued that a licensee has a duty to disclose to them that the seller would not be able to convey title at closing for the agreed upon price, allowing the buyers to make an informed decision on whether to proceed with the closing.

The Court ruled that the broker should have informed the buyers about the necessity of a short sale. The Court stated that if a licensee is aware that the amount of liens on the property exceed the sale price so that either a short sale is required or an escrow deposit by the buyers, then the licensee has a duty to disclose this situation to the buyers so the buyers can further evaluate whether they want to proceed with the transaction.

The Court rejected the broker’s arguments against establishing a disclosure duty. First, the Court refused to input knowledge of the liens to the buyers, even though the liens were public record. The Court stated that it is not customary to undertake a title search when making a purchase offer, as the title search is not conducted until after escrow has opened.

Next, the broker argued that it was prohibited by both California law and the NAR Code of Ethics (“Code”) from disclosing the seller’s confidential information. Since the liens were in the public record, the California law was not implicated because this was not confidential information. The Court did state that a licensee would not have a duty to disclose the balances owed on the liens, but the existence of the liens and possibility of a short sale is not confidential information. Looking at the Code, Standard of Practice 1-9 states that a “Realtor® shall not knowingly…reveal confidential information of clients…unless client consents after full disclosure.” The Court noted that while this arguably may establish a higher duty than California law, the Code also states that it defers to state law and so the Court’s ruling that the broker had a duty to disclose would trump the requirements in the Code.

Based on the Court’s conclusion that the broker would have a duty to disclose the necessity for a short sale if known, the Court sent the case back to the trial court for further proceedings.

With this backdrop, I return to the two phone calls I received about property here in New Jersey. Who is accountable in the first instance? The listing realtor who, it appears, “hedged her bets” with the hope of a timely closing? Or the buyer whose supposed delay had unexpected consequences? And, in the second situation, what happens if the sellers don’t have the money to pay off the tax liens? They were surely known to the sellers and sellers’ agent but the buyers discovered them only after receiving the title report just days before closing. They could have been uncovered earlier. But should they have been? And, if so, by whom?

Well, it seems, one thing is certain. From sea (California) to shining sea (NJ) the potential for at least some of the blame will be directed at the realtors. You must, therefore, avoid getting “egg on your face” by obtaining all pertinent financial information from the seller at the outset to determine whether this issue will affect the way you handle the transaction. It would also be prudent to monitor any transaction with this potential problem as the listing progresses.

-Dan Posternock

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