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The Duty to Disclose: A Recent Case Explains Potential Liability for Constructive Fraud

Robert M. Tessier, Esq.

The California Court of Appeal has recently handed down another opinion warning of the perils of failing to disclose material information in a residential real estate transaction no matter how the information was acquired. The court in the case of Carl Michel v. Palos Verdes Network Group, Inc. finds that a broker may be responsible for negligent nondisclosure, even when the undisclosed information comes from an inspection performed by an agent while seeking the listing from the seller, but whose office later ends up representing the buyer.  The case is a cautionary tale regarding a broker’s responsibility to know what his agents are doing, and to insist upon full and complete disclosure of all facts known to all agents in the office who are directly, or indirectly, involved in the transaction, regardless of the source of that information.

 The Facts

An agent, Mike, working for the defendant broker, and in the hopes of obtaining a listing from his friend’s parents, inspects their home.  He takes notes of the property’s defects, including possible water leaks, cracked interior walls, and damage to the pool. He is unsuccessful in obtaining the listing, but keeps his notes of the inspection.

Six months later, Mike shows the same home to potential buyers.  These buyers are represented by another agent working under the same broker as Mike.  Mike gives a tour of the home to the buyers, but does not point out the defects he had noted in his inspection six months earlier.  The buyers mistakenly believe that Mike represents the seller when he gives the tour.  The seller is actually represented by another broker.

An offer is mistakenly sent by the buyers to Mike.  This misdirected offer is never answered.  A few weeks later, the buyers re-visit the property and submit a new offer to the correct agent.  Some, but not all, of the defects that Mike found are disclosed eventually to the buyer.

During the closing process, Mike is assigned the task of “transaction coordinator” by his broker (who represents the buyer).  Again, he does not reveal all of the defects he found in the inspection, and, therefore the buyers do not know the contents of Mike’s inspection notes before the sale is consummated. The transaction is completed and the buyers move in.

The Problem

At the first rain, cracks emerge in interior walls.  Thereafter, during a pool remodel, a soils engineer discovers significant instability and ground movement on the property that causes the house to tilt 3.5 inches from level.

The buyers meet with Mike the following year and are upset.  They tell him that the necessary repairs could cost half a million dollars.  At this meeting, Mike reveals that he had previously inspected the property and made a list of problems.  He gives the inspection notes to the buyers.  The buyers hire an attorney and sue on several theories.

The Claims Made Against the Broker

A.        Civil Code §2079

The buyers sued their own broker alleging a violation of Civil Code §2079. That code section states, in pertinent part, as follows:

“It is the duty of a real estate broker or salesperson...to a prospective purchaser of residential real property...to [inspect and disclose as more fully described by the statute]...if that broker has a written contract with the seller to find or obtain a buyer or is a broker who acts in cooperation with that broker to find and obtain a buyer.”

The buyers’ claim against their own broker under section 2079 was rejected by the court for two reasons.  First, the statute imposes a duty on the listing broker or salesperson, but not the buyer’s own broker or salesperson. Because Mike was an agent for the buyer’s broker and not the seller’s broker in the transaction, the statute does not apply to him.  Second, there was no signed contract between Mike and the sellers when he performed the undisclosed inspection.  The statute only applies to brokers or agents who have a written contract with the seller.

B.         Fraudulent Concealment

The buyers sued their own broker alleging a common law claim of fraudulent concealment.  To win, the buyers must show that their broker intentionally concealed facts with the intent to defraud them.  In this case, the buyers failed to produce evidence to the trial court sufficient to demonstrate that the broker intended to defraud them.  Mere non-disclosure is not sufficient evidence to find fraudulent concealment under the law.  In this case, the court found that there was not sufficient evidence to find that the broker intended to defraud the buyer, therefore, the broker prevailed on this theory.

C.        Negligent Non-disclosure

The most important part of the court’s holding concerns the buyers’ claims of negligent non-disclosure.  The trial court granted the broker’s non-suit claim on this theory.  On appeal, the court reversed this decision, and ordered a new trial to determine if there is evidence of the broker’s negligence in failing to disclose the contents of Mike’s notes to the buyer before the close of the transaction.

The law imposes a high duty on the broker.  It is well known that a broker has a fiduciary duty to his client. Cal. Civil Code § 2079.24.  This duty requires the highest good faith and undivided service and loyalty.  It is greater than the duty imposed under Civil Code §2079.  Therefore, even a reasonably competent broker may be found to have violated its fiduciary duty and be liable to its client.

One important duty is the duty to disclose material information.  A broker must provide its client all material information, no matter how it was obtained.  This would include the information Mike gathered at his inspection. 

The failure of a fiduciary to share material information is called constructive fraud.  This type of fraud differs from fraudulent concealment, because the actual intent to defraud need not be proven.  Thus, the buyers can establish constructive fraud by proving 1) the existence of the fiduciary relationship; 2) the information in the broker’s possession is material and 3) the broker failed to disclose the material information.  Clearly, a claim of constructive fraud is much easier to prove than a claim of common law fraudulent concealment because the buyer does not have to prove any fraudulent intent.  The buyers will get the opportunity to prove negligent nondisclosure when the case goes to trial once again.

The Implications

By law, brokers are charged with knowledge of all material information known to their agents.  Brokers are also held to the highest duty of loyalty and disclosure of all material information to their clients.  The problem in this case arose because the agent obtained the material information months earlier while unsuccessfully attempting to secure the listing from the seller, only later to be involved indirectly in the transaction on the buyer’s behalf.  How does a broker guard against a claim of negligent non-disclosure claim under such circumstances?

A system or database in place that cross-references all office listings by address probably would be insufficient to identify the problem in this case.  It is unlikely that Mike would have communicated an unsuccessful attempt at obtaining a listing to his broker, and his inspection in connection with the subject property before showing the property to the subsequent buyers. 

The Steps to Help Avoid This Result

There are some simple steps that may be taken to reduce the risk that a broker has negligently failed to disclose material information to his client. First, it is suggested that agents be instructed to include any contacts with property into a conflicts database or other system at the broker’s office to enable the office to identify any contact by its agents, even unsuccessful contacts, in which inspections are performed or information otherwise obtained about the property.

Second, a broker must ensure that all agents understand the full extent of the duty to disclose, and the liability for negligent non-disclosure, even if the information at issue was acquired through prior inspections, or any other source.  The court was well aware of the means by which Mike obtained the information in this case, but nevertheless reversed the trial court and will allow a jury to decide whether there has been negligent non-disclosure.

Third, at the first hint of a disgruntled or concerned buyer facing significant repair expense, a process needs to be in place to address the buyer’s concerns and facilitate a resolution of the dispute.  It is strongly suggested that the broker either himself or herself, a designated company representative with no direct ties to the transaction, or legal counsel be assigned the task of communicating with the concerned buyer.  It is unlikely that Mike’s post-sale contacts with the buyers aided the informal resolution of the dispute.

Fourth, the parties should take seriously the option of mediating any disputes in good faith pursuant to the contract.  Many real estate sales contracts now carry significant financial benefit to mediating before litigation ensues.  A skilled mediator can save time, money and aggravation in many real estate disputes.


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