“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.”

When an appellate opinion opens with these words, California real estate agents and brokers should take careful note of that opinion. The opinion in the recent case of Holmes v. Summer, 188 Cal. App. 4th 1510 (2010), began with the above quote and ended with selling brokers owing greater duties to buyers of residential property.

It is commonly understood that when a seller of real property knows of facts materially and adversely affecting the value or desirability of that property, which facts are not reasonably discoverable by the buyer, the seller has a duty to disclose those facts to the buyer. Lingsch v. Savage, 213 Cal. App. 2d 729 (1963). It is also well known that when the seller’s broker is also aware of such facts, the broker also has an independent duty of disclosure to the buyer. Supra. In Holmes, however, the selling broker’s duty was expanded to include facts relating to a potential “impediment” to the seller’s ability to convey lien-free title to the property. The potential impediment, according the court in Holmes, was debt secured by the property that far exceeded the sales price.

Factual Context

A seller listed residential property for sale with a broker at a price of $749,000 to $799,000. The property was subject to recorded liens totaling approximately $1,141,000. After some negotiations, the seller and a buyer agreed upon a purchase price of $749,000 with a 30-day closing. During the escrow period, in order to be in a position to close its purchase, the buyer sold its existing home. Also during the escrow period, the seller, with the assistance of the broker, attempted to negotiate a short sale agreement with the existing lenders. The existing lenders refused to accept discounted payoffs to facilitate the short sale. Unable to fund the approximately $392,000 shortfall necessary to close the sale, the seller breached the purchase agreement.

Legal Context

The buyer filed an action against the broker for negligence, negligent misrepresentation and deceit based upon the broker’s failure to disclose the existing encumbrances against the property and their potential impact upon the seller’s ability to complete the sale. The seller was not named as a party to the action presumably because the seller had limited or no assets. The trial court sustained the broker’s demurrer without leave to amend, finding that the broker owed no duty of disclosure to the buyer. On appeal, the trial court’s ruling was reversed. The appellate court found that the broker was obligated to disclose to the buyer that there was a substantial risk that the seller could not transfer title free and clear of the existing monetary liens.

The Appellate Court’s Analysis and Holding

Before the appellate court, the broker argued that the duty of disclosure was limited to matters affecting the value of the property or its desirability and that the amount of debt secured by the property was unrelated to those matters. The broker also argued that to require the broker to disclose the amount of the debt would require the broker to disclose information confidential to the seller. Finally, the broker argued that because the debts secured by the property were matters of public record, a diligent buyer could have discovered the existence of the relevant information. The appellate court rejected all of the broker’s arguments.

The court reiterated that the purpose of the duty of disclosure articulated in Lingsch v. Savage, supra, is to protect the buyer from an unethical seller and broker and assure that the buyer is provided with sufficient accurate information to make an informed decision whether or not to purchase. Citing only a single case (Wilson v. Lewis, 106 Cal. App 3d 802 (1980), dealing with disclosure of inspection conditions and dates of deposit) for the proposition that the duty of disclosure extends beyond the value or desirability of the property, the court extended the duty of disclosure to what it described as an “impediment” to the seller’s ability to complete the transaction as agreed, reasoning that disclosure of such an impediment was consistent with purpose of the duty of disclosure. Based upon the recording of the deeds of trust securing the existing loans, the court rejected the proposition that disclosure would violate any duty of confidentiality owed by the broker to the seller. Interestingly and somewhat inconsistently, the court went on to find that the recorded information alone was insufficient to inform the buyer of the current balances of the loan and would not, in the ordinary course, be discovered until well into the escrow process when a title report was obtained. Holmes, supra, at 1527.

The court summarized its holding as follows:

“When a seller’s real estate agent or broker is aware that the existing amount of debt on the residential real property being sold far exceeds the sale price for the property, such that either the lender’s consent to a substantial discount of the debt will be required or the seller will have to put a considerable amount of cash into the escrow in order to be able to clear the debt and convey title free and clear, there is a duty on that agent or broker to disclose the state of affairs to the buyer so the buyer can make an informed choice whether or not to enter into a transaction that has a considerable risk of failure.”

Unresolved Questions

The Holmes case raises a plethora of potential issues and concerns for real estate agents and brokers:

  • What is the threshold for the disclosure obligation to kick in? What does “far exceeds” mean? What is a “substantial discount”? What constitutes a “considerable amount” of cash?
  • Exactly what is the extent of the required disclosure – current principal balances and/or status of lender negotiations with the property owner?
  • What other types of closing “impediments” could be required to be disclosed?
  • Will the holding be limited to residential property sales, or will it be applicable to commercial transactions as well? Is there any public policy or practical concern that should cause commercial transactions to be treated differently? (Note that the court bolstered its holding by citing to a commercial real property case, Jacobs v. Freeman, 104 Cal. App. 3d 177 (1980).)  

Only time will tell how this decision will play out. In the interim, brokers need to proceed cautiously and to work closely with their sellers to make sure that all material information relating to potential sale “impediments” is fully disclosed, in addition to the customary disclosures relating to the desirability or utility of the property. This requirement may add an additional layer of complexity to the relationship between the broker and its seller.