The Pitfalls of Failing to Disclose in Real Estate: a CRES Risk Management Video Webinar

paperwork on a desk with two people pointing at it with pens

The majority of real estate E&O lawsuits are a result of failures to disclose. In this webinar, attorney Mark Carlson from Carlson Law Group and Dave Miller, Regional Vice President with Fidelity National Home Warranty, discuss the pitfalls of failing to disclose. 

Whether it’s a simple mistake or an intentional failure to disclose, you can find yourself in hot water if a buyer discovers major property issues after the transaction is complete. Real estate agents must be extra diligent to avoid legal issues. 

This comprehensive and informative webinar covers:

  • What agents should watch out for when inspecting properties 
  • If something looks wrong, why you should ask about it
  • Dealing with properties that have termite and rodent issues
  • Working in a ‘hot market’ and the dangers of submitting non-contingent offers 
  • Working as a buyer’s agent or seller’s agent for flipped properties 
  • The concept of ‘interviewing’ sellers
  • Why getting sellers to fill in their own disclosure forms is crucial
  • Negligent non-disclosure vs intentional misrepresentation 
  • Inspection periods where there are multiple offers

Watch the full webinar (or read the transcript below):

Laura Prouse: Thank you for joining us today for the Pitfalls of Failing to Disclose. CRES Insurance Services welcomes attorney Mark Carlson from the Carlson Law Group. Mark has been defending real estate professionals since 1993 and has worked with CRES for over 20 years as a founding member of our legal panel. Along with Mark, we have Dave Miller, regional vice president with Fidelity National Home Warranty. Dave manages the CRES Advantage Home Warranty Plan. (CRES E&O customers can give their sellers a Fidelity Home Warranty that includes Seller’s E&O coverage.)  

Failing to Disclose – Water Intrusion and Mold

Dave Miller: Mark, I was talking to Laura yesterday, and she said it’s estimated about 70% of the E&O lawsuits out there are a result of a party failing to disclose. So, what’s the most common disclosure lawsuit against real estate professionals for failing to disclose?

Mark Carlson: I would say the 70% estimate on lawsuits arising out of sales transactions, setting property management aside, is probably low. The majority of our cases have always been just forgetting to disclose something or concealing something that’s pertinent about the property. Disclosure issues are always present and are always the large majority of the lawsuits we see.

Dave Miller: Regarding water intrusion, and we see a lot of this with mold, too, what are the responsibilities of the sellers to disclose these, and what type of nondisclosure issue is most likely to result in a lawsuit?

Mark Carlson: There’s nothing like water intrusion to guarantee a lawsuit. People will put up with a lot of different things, but when there’s water coming into the house, that’s when people are almost guaranteed to file a lawsuit.

It’s difficult for agents because a lot of times, there isn’t a whole lot of evidence of water intrusion. It only happens when it rains. Unless you happen to be there when there’s rainfall, it’s hard for an agent to know. But being careful about:

  • Asking questions like, “Have you repainted recently?”
  • Looking for signs of stains and pointing them out, rather than just glossing over them
  • Looking at windowsills, bottoms of balcony doors, ceilings

All that is really important. You’ve got to be extra diligent. If it looks wrong, you should ask about it, so the transaction doesn’t close with an undisclosed water intrusion problem somewhere.

Termites and Rodents

Dave Miller: How about wood destroying pests and rodents? What should agents do to handle those properly?

Mark Carlson: The biggest issue right now is termite issues, it’s been since 2002 that the California or CAR Residential Purchase Agreement has made reference to section one, section two items, but we still see people holding on to that concept and forcing the seller to pay for section one (termite inspection) items.

And it’s been almost three years now that the WPA, the Wood Destroying Pest Addendum, has been removed from the list of forms, but people are still putting it in the additional terms, seller to pay for section one items. And it’s so dangerous, because you don’t know what’s going to be discovered once you ultimately do the inspection. Even if you say, “I’m a smart agent, I’m going to do the inspection before I list the property,” the purchase agreement says the buyers have the right to do their own termite inspection. So even if the sellers get their own, then if the buyer comes in and gets another one, and the recommended repairs are different, there’s going to be a dispute.

Another issue that I don’t think agents consider is the regulations that pest control operators have to follow. Oone of those regulations involves evidence of active infestation that goes into an inaccessible area. The pest control operator is obligated to stop and say, “Hey, you need to open this area up.” And then the operator is obligated to come back and do a re-inspection.

Who pays for all that, and who pays to put the property back together? When you just write in, on the other terms, seller to pay section one items, you’re exposing the parties to uncertainty as to cost for something that you know the pest control operator may have to do.

In California, CAR has been trying to get brokers and agents to handle pest issues like any other request for repair. And it really is the better way to do it. It lets the market dictate who’s obligated to incur those expenses. In a hot market, the seller’s probably going to say, “I’m not doing anything.” In a soft market, the buyers are going to say, “If it’s not perfect, I’m not buying.” And that really is the way that it should go.

With respect to rodents, that’s a separate license for pest control operators. When there’s evidence of rodent infestation, I’ve seen lots of situations where people just ignore it. And then if a house in the attic or crawlspace is infested by rodents, it’s so difficult to get that remedied. That’s something to really pay attention to, if somebody calls out that there might be a rodent problem.

The Risks of Non-Contingent Offers

Dave Miller:  In a competitive, hot real estate market, we’re seeing multiple offers over asking. Talk about buyers’ agents recommending that buyers make non-contingent offers, and the risk. What’s your advice, and how do buyers and buyers’ agents navigate through that?

Mark Carlson: Agents have this idea that having a non-contingent quick close is most desirable to all sellers. In reality, the sellers mostly just want a high purchase price. In a hot market, when you have multiple offers, if somebody goes through inspections and then cancels, you’ve got multiple other buyers waiting in the lanes.

It’s a less common circumstance where a seller really needs to close quickly and making a non-contingent offer is the best solution for the seller. So, then you’ve got to figure out, how do I deal with this? There are a couple of things that I like to recommend. First, get some inspections done prior to listing, and then deliver the home inspection report and other inspection reports before any of the offers come in.

Another strategy that I’ve heard when you have multiple offers is to say to all the potential buyers, “We’re going to make a decision five days from now.” And within those five days, you all can agree to hire a home inspector and come in and inspect, or you can all get your own home inspectors. But within that five days, you can do the inspection and then decide whether you want to make the offer five days from now. So at least the buyers or the sellers have the protection of the buyer getting an inspection period.

And a non-contingent offer can actually create problems for the seller and potentially both listing and buyer’s agents. Buyers are going to say, “Yeah, I got into this house and there’s a whole bunch of problems. And my agent told me, or the listing agent told me or told my agent, if you want to be considered, you’ve got to be non-contingent. So, I was forced to, even though I didn’t want to.” So, it creates additional risk to the seller. Sellers may want to say, “Okay, I’m accepting you, buyer number four, but in my counter to you, I’m going to give you an inspection period of whatever number of days,” and I think that would be the best way to deal with it as a seller, to encourage the buyer to get an inspection.

We’ve also had non-contingent offers where the HOA says, “The seller is two years in arrears on dues,” and there’s not enough money in the deal to pay the dues. So now the buyers are left with either having to pay the dues or canceling, because it wasn’t anything they could have figured out prior to accepting or making a non-contingent offer.

Property Flips

Dave Miller: Let’s talk about flip properties. We’ll start with agents representing sellers on the transaction that maybe never lived there. It’s an investment property, and they flipped it. Or maybe they did some renovations themselves. What should real estate agents be looking for when they represent sellers on a flipped property?

Mark Carlson: The risks are different if you’re selling or listing with respect to flip properties. What I’ve seen often on the listing side is that an agent will be asked to come in and evaluate a property prior to the flip. So maybe the agent represented the buyer when they acquired the property. And then the argument is, well, you saw how bad everything was, and you should have disclosed that there was this problem or that problem. But frequently, the agent isn’t paying that much attention to problems, thinking that all those issues are going to be remedied in the course of the flip.

And it’s the reality that people buying properties to flip and resell aren’t using fixtures and finishes and doing things as though they were living in the property. They’re trying to keep costs to a minimum. And not necessarily to say that it’s done with mal intent, but the flipper’s mentality usually is, “well, it’s working, so I’m not going to do something I don’t have to do.” Whereas if you were living there, you might pay the extra money to correct a small issue.

For a listing agent, be careful about how much time is spent. I had one case where it was an eight month remodel, and the listing agent was on the property numerous times during the course of the construction. And that was a real difficult situation, because there was a lot of innuendo that the listing agent should have known that the repairs weren’t being done properly.

If you’re on the selling side, it’s the reverse. Now you’ve got a buyer who’s expecting a perfectly remodeled home, and then discovers there were corners cut here and there. From a buyer’s agent’s perspective, you want to be even more diligent about inspections to make sure the work was done properly. A lot of times work is done without permits. I see that buyers don’t go and pull permits, even though they know it’s a flip. And that’s a big problem after the deal. The buyers say, “Well, why didn’t you ever tell me to go pull permits?” Or maybe there’s an oral recommendation, but not a written recommendation to the buyer. But you need to be direct about it: “Listen, this is a flip. Work was done. You’re going to be a fool if you don’t go pull permits prior to close.”

How to Interview Your Potential Sellers to Reduce Your Risk

Dave Miller: As a busy agent in a hot market, you may find yourself running from listing appointment to listing appointment. But the questions you ask (or don’t ask) in the listing interview could potentially get yourself in trouble, and those sellers could take down your career.

What can agents do to verify that what the seller is saying about the property and its condition is true?

Mark Carlson: The concept of interviewing the seller is really important, as experienced agents will all get a sixth sense about their clients. And I can’t tell you how many lawsuits I’ve had where the agents will say, “Gee, I knew they were a problem right from the beginning.” And sometimes it’s about the listings you don’t take versus trying to take every single listing.

A couple of things you can do to vet the seller more carefully:

  1. Go over the disclosures with them as they’re filling them out. Don’t write the answers yourself, because then it looks like you’re the one that provided the information. Go over the seller property questionnaire with the seller as they’re filling it out, telling them, “Here’s what this means. Have you had any of those problems?” And then listen to the response. If they waffle or, “Oh, yeah, maybe, but it was no big deal,” then you’re able to ask more questions and follow up. If you think there’s an issue they’re trying to hide, hopefully in that process it’ll become more apparent.
  • With the transfer disclosure, it’s better practice for agents on both sides, buyers and sellers, to go over the documents paragraph by paragraph. You don’t have to read it to them, but at least say, “Here’s what this is talking about. You have an inspection period. Here’s what it means.” That way the clients get professional service, and the agents have the opportunity to try to get a feel for whether there’s something that isn’t being disclosed properly.

Dave Miller:  What are some of the typical things that sellers fail to disclose?

Mark Carlson: In the majority of the nondisclosure cases, there’s some physical defect in the house. And maybe a little more than half the sellers say, “I never had that problem when I was here.” Or, “I just forgot about that. We did that repair 20 years ago, and I just forgot.” And then for whatever reason, it resurfaces after closing. There is a small portion of the cases where the sellers knew they had a problem, and they were just trying to get rid of the problem and pass it on to somebody else.

Dave Miller: What’s the difference between just simply failing to disclose (whoops, I just missed that) versus I intentionally failed to disclose that? Laura tells us that fraud is not covered under an E&O policy. Do you have to at least open the claim to determine if it was fraudulent, or was it just a whoops, I forgot? What’s the difference between those two?

Mark Carlson: The element is intent. A negligent nondisclosure is where you make an intentional misrepresentation of fact, knowing it to be false. And then the fact caused, or the issue caused damage to the buyer or to the plaintiff.  The buyers relied on that to their detriment and caused them damage. So it’s really a matter of proving that the person making the representation knew it was false and intended to cause the other side to rely on the misrepresentation.

Concealment is the same way. I knew something, I had a duty to disclose it, and I intentionally failed to disclose, to get the other party to act in a particular way. Concealment is more difficult when you’re trying to prove “you knew it and didn’t tell me, because you wanted me to rely.”

Dave Miller: What if I’m listing your property, and I know as the listing agent that something you’re saying is not truthful? Do I walk away from the listing, knowing that you’re failing to disclose something that even I know about, maybe because you told me, and you put on the form that it was something different?

Mark Carlson: The seller’s obligation to disclose arises out of the contract. There are contractual obligations to make disclosure. For example, in California, civil code section 1102, which is where the TDS comes from, imposes duties upon the seller to make disclosures. An agent’s obligation to make disclosures arises out of California civil code section 2079. So, there’s a separate, distinct statutory obligation to make disclosure that the agents have, apart from the seller.

If you know something as an agent and the seller doesn’t disclose it, you still have to disclose it. And if the seller says, “Well, don’t disclose it,” then you have two choices. You either say, “Well, I can’t do that,” and then try to convince the sellers that they’re not acting properly. Or just give up the listing and say, “I can’t complete a transaction, if you’re going to tell me not to disclose something that I’m statutorily obligated to disclose.”

Laura Prouse: Thank you, Mark. Thank you Dave. As always, very, very informative. Looking forward to our next Risk Management webinar.

This blog/website is made available by CRES Insurance Services for educational purposes to give you general information and understanding of legal risks and insurance options, not to provide specific legal advice. This blog/website should not be used as a substitute for competent legal advice from a licensed professional attorney in your state. Claims examples are for illustrative purposes only. Read your policy for a complete description of what is covered and excluded.

Originally Published November 3, 2020

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