By Glen C. Hansen

In Holmes v. Summer (2010) 188 Cal.App.4th 1510, the Court of Appeal for the Fourth Appellate District held that when a real estate agent or broker for a seller is aware that the amount of existing monetary liens and encumbrances exceeds the sales price of a residential property, so as to require either the cooperation of the lender in a short sale or the ability of the seller to put a substantial amount of cash into the escrow in order to obtain the release of the monetary liens and encumbrances affecting title, the agent or broker has a duty to disclose this state of affairs to the buyer, so that the buyer can inquire further and evaluate whether to risk entering into a transaction with a substantial risk of failure.

In Holmes, the buyers and the seller agreed to the purchase and sale of a residential real property for the price of $749,000. Unbeknownst to the buyers, the property was subject to a first deed of trust in the amount of $695,000, a second deed of trust in the amount of $196,000 and a third deed of trust in the amount of $250,000, for a total debt of $1,141,000, and the lenders had not agreed to accept less than the amounts due under the loans in order to release their deeds of trust. The seller’s brokers were aware of that situation, but never disclosed it to the buyers. According to the buyers, after they signed the deal with the seller, they sold their existing home in order to enable them to complete the purchase of the seller’s property. Only then did they learn that the seller could not convey clear title because the property was over-encumbered.

Buyers brought a damages action against the seller’s brokers for negligence, negligent misrepresentation and deceit — based on both misrepresentation and the failure to disclose. The trial court sustained the brokers’ demurrer without leave to amend. The buyers appealed and the Court of Appeal reversed. The Holmes court held that the buyers sufficiently stated claims under those causes of action because the brokers had a duty to disclose to the buyers the information about the over-encumbered title. The court employed several rationales in reaching that holding, including the following:

  • First, the court found that the undisclosed information materially affected the value or desirability of the property because (a) “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”; and (b) imposing a duty to disclose information “alerting the buyers that the sale was at high risk of failure” would protect buyers from harm and provide them with sufficient information to enable them to wisely choose whether to enter into the transaction.
  • Second, even if the buyer had constructive notice of the existence of the deeds of trust on the property, this does not eliminate all of the duties of disclosure on the part of a seller or its agents.
  • Third, the confidentiality provisions of Civil Code section 2079.16 did not prevent the brokers from disclosing the information here because the brokers had a duty to act fairly towards the buyers, and fairness under the circumstances dictated disclosing that either lender approval or a substantial seller payment was required to close escrow.
  • Fourth, even if the information here involved “confidential information” of the seller that the brokers believed they could not disclose under Standard of Practice 1-9 of the Code of Ethics and Standards of Practice of the National Association of Realtors, the brokers should have sought the seller’s permission to disclose the information to the buyer. “In a case such as the one before us, where the seller’s financial situation is so precarious, if the seller is unwilling to consent to the disclosure of confidential information, and the real estate agent or broker nonetheless chooses to undertake representation of the seller, he or she does so at the peril of liability in the event the transaction goes awry due to the undisclosed risks involved.”

The only wiggle room that the court offered the brokers in this case is that the duty to disclose may not apply if “the brokers had reason to believe that the seller had at least $392,000 in cash available to close escrow.” That fact was not before the court in the context of the demurrer. However, that wiggle room may, in reality, be nonexistent. In a case such as this, the brokers’ knowledge of the existence of the significant liens on the seller’s property is probably sufficient grounds for the brokers to reasonably doubt that the seller has such cash reserves available to close escrow.

The Holmes decision stands as a strong reminder that courts will be vigilant in ensuring that real estate brokers and agents carry out their duties of care, honesty, good faith and fair dealing and disclosure to other parties in the transaction. As the court warned: “Particularly in these days of rampant foreclosures and short sales, [t]he manner in which California’s licensed real estate brokers and salesmen conduct business is a matter of public interest and concern.”

Glen C. Hansen is a senior associate at Abbott & Kindermann, LLP. For questions relating to this article or any other California land use, real estate, environmental and/or planning issues contact Abbott & Kindermann, LLP at (916) 456-9595.

The information presented in this article should not be construed to be formal legal advice by Abbott & Kindermann, LLP, nor the formation of a lawyer/client relationship. Because of the changing nature of this area of the law and the importance of individual facts, readers are encouraged to seek independent counsel for advice regarding their individual legal issues.