Mr. and Mrs. Holmes saw a house listed for sale in Huntington Beach, California on the Realtors' Multiple Listing Service with an advertised price of $749,000 to $799,000. The listing indicated that the "seller was motivated." The Holmes made an offer, and after a counter-offer they agreed to purchase the home for $749,000 with a 30-day escrow.
In order to close on this purchase, the Holmes sold their house. What the Holmes did not know was that this was a short-sale involving three lenders and a total of $1,141,000 in loans. And, the lenders had refused to lower their payoffs to accommodate the short sale. Appearing that the property could not be transferred to them free and clear of all liens because the debt on the property far exceeded the agreed sales price, the Holmes filed suit against the real estate broker for failing to disclose this situation.
Because it seemed very unlikely that the seller's could satisfy any judgment, the Holmes did not include them as defendants in the case. The trial court found that the Holmes had a great case against the seller and it appears that they were only suing the broker to find a deep pocket. Thus the trial court dismissed the case without leave to amend the complaint.
Foreshadowing the opinion, the court of appeals stated in its first paragraph the following:
Particularly in these days of rampant foreclosures and short sales, the manner in which California’s licensed real estate brokers and salesmen conduct business is a matter of public interest and concern.” 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 and lenders preparing to extend credit to those purchasers waste valuable time in processing useless loans. In the presently downtrodden economy, it behooves us all for business transactions to come to fruition and for the members of the public to have confidence in real estate agents and brokers.
The court stated as a general rule that "where the seller knows of facts materially affecting the value or desirability of the property which are known or accessible only to him and also knows that such facts are not known to, or within the reach of the diligent attention and observation of the buyer, the seller is under a duty to disclose them to the buyer." Also, when the seller’s real estate agent or broker is also aware of such facts, “he or she is under the same duty of disclosure.”
A real estate agent is clearly under a duty to exercise reasonable care to protect those persons whom the agent is attempting to induce into entering a real estate transaction for the purpose of earning a commission. However, the brokers argued that this particular bit of information regarding the liens did not affect the value or desirability of the property; therefore they had no duty to disclose.
The court wasn't buying this argument. First, it found that only through disclosure of the short sale, and vast amount of debt on the property, before the sales contract was signed could the buyers "weigh the risks of entering into an agreement, and preparing their finances and related affairs to facilitate completion of the purchase, considering there was a significant possibility the transaction would fall through."
The brokers also argued that "a diligent buyer could have done a title search before making an offer on the property to avoid exactly the situation that occurred." To which the court stated:
This argument is unpersuasive for two reasons. First, even though a title search may have divulged the existence of recorded deeds of trust against the property, it would not likely have disclosed the current balances of the promissory notes secured by those deeds of trust, unless foreclosure proceedings had been commenced. Second, it is not typical in a residential purchase in California for a buyer to perform a title search on each property of interest before deciding whether to make an offer on one of them. Rather, it is more typically the case that a preliminary title report is provided to the buyer during escrow, so that the buyer can determine, before closing escrow, whether there are any title defects that are unacceptable to the buyer. Moreover, when a buyer makes an offer to purchase the property free and clear of all liens and encumbrances, and the seller agrees to sell on those terms, the seller impliedly represents that he or she expects to be in a position to deliver title free and clear.
The court ultimately found that the Holmes were able to state a cause of action against the brokers for failure to disclose the fact that this was a short sale with a very slim chance of being able to deliver clear title at the advertised price. It also found with respect to the Holmes' claimed damages that "it should be perfectly foreseeable to an experienced real estate agent or broker that one who is purchasing a $749,000 residence may need to sell an existing residence in order to make the move." Thus, the court of appeals reversed the trial court's dismissal.
This case is a good example of how short sales are so different from ordinary sales. Ordinarily, it would be of no concern to the buyers how much the sellers actually owes on their mortgages. But in a case like this, where the sale depends on the cooperation of the existing lenders to take less than the full amount due, the Realtor clearly has a duty to disclose that fact to the buyers. At least this is the rule in California - but it makes good sense and should be a lesson to Realtors across the country.
With the state of our current housing market, short sales are very common. Realtors who are offering homes for sale, with knowledge that a short sale will be required, should be aware of the process... and they should know that potential buyers will likely be selling their home once the contract is signed to prepare for the purchase. If the buyers do not know that there is a real possibility of the sale falling through they could suffer economic harm.
Realizing that many potential purchasers may refuse to even make an offer on a short sale property, given the uncertainty of the deal, it may be prudent to secure commitments from the lenders before advertising a certain price or entering into a contract. The alternative could be a costly legal battle, and a potential judgment for the would-be-buyers damages.