The Riskiest Business
Property condition disclosure is a major legal risk for brokers today, according to findings from NAR’s new Legal Scan analysis.
OCTOBER 2011 | BY G.M. FILISKO
The more things change, the more they stay the same. At least that seems to be true in the world of real estate litigation.
Turmoil in real estate markets has brought new legal challenges to brokers, including a greater likelihood of disputes surrounding property condition disclosures and commission payments. Yet agency—a broad topic that includes dual agency, buyer representation, and fiduciary duty dilemmas, among other things—continues to be an area of high risk, according to the 2011 NATIONAL ASSOCIATION OF REALTORS® Legal Scan, a biennial study that’s based on interviews with real estate commissioners and brokers, a review of cases, and a close analysis of recently enacted state statutes. The report seeks to identify current and emerging legal issues and risks.
“The day-to-day reality is that every transaction is tougher today than five years ago,” says David Howell, executive vice president and chief information officer at McEnearney Associates Inc. in McLean, Va. “You have to be at the top of your game more than ever to avoid disputes.”
WAIT! More Legal Challenges
The 2011 NATIONAL ASSOCIATION OF REALTORS® Legal Scan highlights additional legal challenges for brokers. They include:
Affiliated business arrangements. The Real Estate Settlement Procedures Act wasn’t the top area of concern for Legal Scan respondents, yet almost 64 percent said RESPA issues were the source of a “moderate or higher” number of current disputes. “The issue comes up most when affiliated business arrangements aren’t properly disclosed,” says David Howell, executive vice president and chief information officer at McEnearney Associates Inc. in McLean, Va. “If there’s an affiliated business arrangement, you have to disclose that to your client.”
Fair housing. Respondents ranked four fair-housing issues—race, national-origin discrimination, sexual-orientation discrimination (not included in federal fair-housing law but often prohibited by state statute or municipal ordinances), and advertising and target marketing—as the sources of a moderate number of disputes. In addition, two fair-housing cases are among the Legal Scan’s 10 largest verdicts.
In a Florida case, McClandon v. Heathrow Land Co., an African American woman attempted to sell her unbuilt lot, which was part of a home owners association. She won a $2.4 million verdict against the HOA for refusing to approve the sale based on a build-within-two-years rule after the HOA failed to enforce the same rule against white owners.
In Teen Challenge v. Metropolitan Government of Nashville & Davidson County, a local government amended its zoning code and denied a building permit to prevent a Christian substance abuse center from opening a rehab facility. A jury found the government’s actions violated religious and disability protections and awarded plaintiffs $967,995.
Deceptive trade practices. Nearly 60 percent of Legal Scan respondents identified deceptive trade practices and consumer protection statutes as a source of a moderate level of current disputes. There have been nearly 100 new deceptive trade practices and fraud cases since the 2009 Legal Scan; in 75 percent of those cases, the real estate practitioner prevailed. Still, three of the Legal Scan’s 10 largest verdicts involved state deceptive trade practice laws, including the highest verdict, $2.7 million.
In that case, SJW Property Commerce v. Southwest Pinnacle Properties, brokers who were hired to find shopping center tenants were found to have defrauded the center’s developer by competing against the developer in the purchase of another property, with the intent to sell the property to another of the broker’s clients.
The Law of Distress
A hefty 68 percent of Legal Scan respondents ranked property condition disclosure among their top three current legal issues. The most significant development in this area is the emergence of disputes arising from distressed sales.
“The typical scenario is that right before or after a closing, something gets discovered that the buyers felt should have been disclosed,” says Bill Wright, broker-owner at the seven-office RE/MAX Executive Realty in Franklin, Mass. “All our [distressed] sales are as-is with no warranties, but there still needs to be full disclosure of any known material defects.”
In Massachusetts, sellers aren’t required to complete property condition disclosure forms, and some sellers, on the advice of their attorney, refuse to do so, Wright says. Nonetheless, his company now requires sellers to complete the form before his company will list their home on the market.
“Listings are hard to come by, without a doubt,” Wright says. “But when I’ve had to make a phone call to the seller, I’ve always been successful in getting that disclosure form. If someone refuses to fill one out, I see red flags.”
Distressed property disputes aren’t limited to property condition issues, says Dax Watson, a real estate lawyer at Mack, Drucker & Watson in Phoenix. “What we’re seeing—and my guess is it’s the trend going forward—is a large number of complaints arising out of how sales associates handle distressed properties.”
Watson says he’s seen two common types of problems arising from short sales, resulting in lawsuits:
Frustrated sellers. “The listing agent negotiates with the bank but isn’t successful at getting the sale closed, and that becomes the sales associate’s fault,” Watson says. “Sometimes it’s because the associate wasn’t paying attention to the foreclosure sale date or other deadlines. But, even if they do nothing wrong, if they don’t finalize the transaction, salespeople are going to get blamed.”
Giving legal or tax advice. Never advise sellers on issues outside of your expertise. “Short sale sellers will ask, ‘Is the bank or Uncle Sam going to come after me because this sale isn’t going to cover my mortgage?’ ” Watson says. “If salespeople answer that question, that’s a violation of their license. And if they get it wrong, that’s bad. We a see a lot of litigation related to that.”
To help real estate practitioners in their state reduce their risk of being sued, a team of Arizona lawyers, regulators, and REALTORS® created a short sale advisory form. It lists government resources and Web sites on short sales and expressly states that salespeople can’t give legal or tax advice. The form also urges sellers to consult a lawyer or accountant.
“Some sellers aren’t going to take that advice,” says Watson. “At least sales associates have given them that disclosure.”
But even with the form, Watson says, real estate professionals dealing in distressed property sales have a hard time avoiding discussions of law. In a short sale, legal issues seem to permeate the deal, says Delphine Adams, an attorney at Dickenson, Peatman & Fogarty in Santa Rosa, Calif., who defends brokers and sales associates in litigation.
“Sellers will ask: ‘Can we do a short sale instead of a foreclosure? What’s involved in a foreclosure? How long will it take?’ ” Adams says. “I tell sales associates that they are there to collect information, provide comps, and list and market the property. When it comes to sellers’ best option, they have to seek legal counsel. Salespeople can’t let their desire to help get in the way of their common sense.”
Watson remains concerned about future legal challenges arising from short sales. “People are in a position of stress, and even if we see a successful closing, they may come back and say, ‘You should have gotten me a better deal,’” he says. “I do worry about that.”
Good Ol’ Agency Still Causing Trouble
With the exception of property condition disclosure, Legal Scan respondents ranked agency issues in their top three legal issues more than any other topic.
“When it comes to dual and buyer agency, disclosure is a concept that sales associates are continually lax in dealing with,” says Ron Hardgrove, director of real estate for the Illinois Department of Financial and Professional Regulation, Division of Professional Regulation in Springfield. “Sales associates have trouble saying, ‘This is who I am and what I do, and it’s a value to you.’ ”
Practitioners are supposed to disclose agency relationships at their first substantive contact with customers. But consumers complain that they were never told about dual agency or about agency relationships in general, Hardgrove says. “Salespeople fumble that, but not necessarily with intent to deceive,” he says.
Sylvia Golden Norris, a real estate lawyer in Sarasota, Fla., says her clients also struggle with agency. “A large part of my practice is handling agency representation cases for big insurance carriers,” Norris says. “When we discuss the claims we’re seeing, agency is always high up there, and breach of fiduciary duty comes into play.”
She says that she doesn’t think licensees really understand what a fiduciary duty is and perhaps are unclear about the breadth of responsibility owed to clients.
“Know your obligations; remember whom you represent, what you’re allowed to do, and what you’re not allowed to do; and put it all in writing so everybody’s clear,” she says.
Here are two scenarios that illustrate fiduciary breaches arising from not following basic training for dual agency:
Not staying true to the sellers. A salesperson acting as a dual agent agrees to return the earnest money check to buyers who promise to wire the funds into the brokerage account. As the transaction nears closing, the funds are still missing in action. “From an agency perspective, the sales associate is between a rock and a hard place,” Howell says. “The salesperson wanted to accommodate the buyers’ interest but didn’t protect sellers’ interest or do what the contract called for.”
Dealing with multiple offers. A salesperson presents an offer to the sellers, who begin negotiating with the potential buyers. A second, higher offer comes in, and the salesperson fails to notify the first buyers, instead presenting the second offer to the sellers, who accept it. “In the last month, I’ve had five of these same issues,” says Stacy Berman, branch manager at Long & Foster, REALTORS®, in Washington, D.C. “The listing agent forgets one crucial step. It’s a breach of the listing agent’s fiduciary duty to the sellers, who could get a higher price through negotiations.” That scenario generated one of the 10 largest damages awards in the Legal Scan. In a Louisiana case, Markovich v. Prudential Gardner, REALTORS®, a salesperson accepted a second offer while a counteroffer from another buyer was pending without informing the original buyer, his salesperson, or the seller about the second offer. The salesperson’s breach of his fiduciary duty cost him nearly $745,000.
Daniel Villazon, a lawyer in Celebration, Fla., who represents brokers and sales associates before the Florida Real Estate Commission, where he was once employed, has also seen blatant breaches of fiduciary duty.
Salespeople who are also members of an investment company, he says, commonly represent sellers in a short sale. “The investment company buys the property and flips it,” Villazon says. “The salesperson knows there’s someone who’ll pay a higher price, and he’s taking the property at the lower price for himself. The law’s pretty clear. Salespeople must present all offers to the sellers, and they have a fiduciary duty to get the best price for the sellers.”
Agency issues can overlap with distressed sale issues. “Sales associates don’t understand they’re fiduciaries of lenders when they’re representing lenders in REO sales,” Adams says. “They owe lenders the duties they owe individual buyers or sellers. They must communicate, put things in writing, and keep on top of disclosures required of lenders.”
Who Gets the Commission?
Commission disputes, including procuring cause, are another significant source of current disputes, according to 44 percent of Legal Scan respondents. “I’ve never seen so many commission disputes,” Villazon says of the current environment.
The most common disputes involve procuring-cause battles in which buyers see a property with one salesperson and make an offer through another salesperson or directly with the seller. To demonstrate that they are the procuring cause of the sale and are entitled to a commission, practitioners must show that they initiated an unbroken chain of events that resulted in the deal between the buyer and the seller.
There’s a simple way to keep disputes from happening, Villazon says. “You’d be amazed how many salespeople I ask, ‘Do you have a buyer representation agreement?’ and they don’t,” he says.
Wright attributes the increase in commission disputes to salespeople sending buyers to open houses unaccompanied. “The buyers don’t sign in at the open house and indicate they’re working with another salesperson,” Wright says. “We strongly urge buyers’ representatives to e-mail the listing agent and say their buyers will be coming to the open house.”
In addition, sales associates sometimes fail to ask potential buyers basic questions that would alleviate the problem, Norris says. Under the REALTORS® Code of Ethics, salespeople should ask buyers if they’re already represented by someone or if they’ve worked with another salesperson before, she says.
New Laws in Town
Perhaps the biggest lesson to be learned from the latest Legal Scan is that staying out of legal trouble requires brokers to be vigilant about the laws that govern their business.
“We’re still in an economic crisis, and our government is going to try to find solutions, which could have a huge impact on how properties are bought and sold,” says Watson. “Pay attention to the laws that are coming into play.”