Business

Bad Faith Nondisclosure Statements May Result in Penalties

In 2014, a California appellate court in the case of Peake v. undergrowth provides a lesson on why a real estate buyer should not base non-disclosure of defects claims on the bald reasoning that non-disclosure of the measure those who had home repairs made when a physical inspection report shows that the same type of defect existed in the property.

The Sellers had purchased a home in 2007 and were represented by a real estate agent in the transaction. The Sellers sold this home to the Buyer approximately one year later and the Sellers were once again represented by their previous agent. The buyer was represented by his own real estate agent.

Two years after purchasing the home, the Buyer sued multiple parties, including the Seller’s agent. The buyer alleged that “standing water was caused to seep into the foundation…causing the foundation and attached floor structures to deteriorate.” The buyer claimed that “he only realized the extent of the [water-intrusion] damage” after she bought the house and the seller’s agent did not disclose this problem.

The crux of Buyer’s allegations was that Seller’s agent (I) was aware of the unrepaired water damage and deteriorated floor structure at the time of sale, but did not disclose these facts, and (ii) knew or should have known, and not to disclose that the repairs made to the property “were not adequate and did not meet applicable building codes and standards.” Buyer alleged that this failure meant that Seller’s agent had violated disclosure laws required by California law by failing to conduct a competent and diligent inspection pursuant to California Civil Code sections 1102 and 2079.

Not long after Buyer filed her complaint, Seller’s agent’s attorney sent Buyer’s attorney a series of communications explaining the factual and legal deficiencies of Buyer’s claims against Seller’s agent and encouraged the attorney to consult with an expert in real estate standards of care. Seller’s agent’s attorney emphasized that Seller’s agent had provided Buyer with all information in his possession, including documents showing possible subfloor problems, noting that an agent’s legal duties are limited to a visual inspection . Seller’s agent’s attorney reminded the attorney of their continuing duty to reassess the merits of Buyer’s claim and warned that if Buyer did not dismiss Buyer’s claim, Seller’s agent would seek sanctions from Buyer and attorney under Section 128.7 of the United States Code. California Civil Procedure.

Approximately one year after the lawsuit was filed, Seller’s agent served Buyer and her attorney with a motion for sanctions pursuant to section 128.7. Seller’s agent argued that the cited statutes under which Buyer sought liability (Civil Code sections 2079 and 1102) required that a real estate agent reveal only visible defects and that the rotted subfloor problem was not visible on reasonable inspection. He also argued that the statutes did not require the seller’s agent or broker to independently verify the seller’s representations.

In support of his motion, he submitted the three-page legal transfer disclosure statement (TDS) provided to Buyer during escrow stating that Seller was not aware of any “[f]flooding, drainage or grading problems” at the property. This form clearly states that the representations therein were made by the Sellers, not the Seller’s agent.

Second, the Seller’s agent submitted a copy of the Visual Inspection Checklist stating “SEE INFORMATION ON DRAIN UPDATES BY PREVIOUS OWNER”. This checklist form also noted a “WEAK POINT IN A ROOM’S SUBFLOOR.” Finally, this form noted: “SEE PREVIOUS INSPECTION REPORTS, DRAIN UPDATE REPORT AND CIVIL ENGINEER WORK, KENNETH DISCENZA [phone number] AND CONSTRUCTION BONDS. THE DRAINAGE IMPROVEMENTS WERE DONE IN TWO SEPARATE PROJECTS.”

Finally, Seller’s agent presented evidence that Buyer received the aforementioned inspection report from a previous sale of the property that revealed substantial problems and deterioration in the subfloor of the home.

Given these facts, the court ruled that Buyer’s claim was frivolous and that both Buyer and her attorney were aware of the complete lack of merit of the claims against Seller’s agent. The court gave little or no weight to the allegation that it was not specifically conveyed to Buyer that the previous owners did not complete all repairs (ie, repair of rotten subfloor structure). The appellate court quickly concluded that the fact that the subfloor is not visible and its exact condition cannot reasonably be determined by visual inspection. Because of this, the broker is not charged with investigating this particular condition.

The court addressed Buyer’s claims that Seller’s agent committed fraud by not disclosing his knowledge of the unrepaired condition of the subfloors. It is a well-established law in California that when the seller knows facts that materially affect the value or desirability of real property and also knows that such facts are not known to, or within reach of the buyer’s diligent attention and observation, the seller’s agent has a duty to disclose them to the buyer. Failure to do so may subject the seller’s agent to claims of fraud.

The court noted that even assuming Seller’s agent knew more about the incomplete repairs and the extent of subfloor damage than was actually disclosed, Buyer herself was notified of the subfloor’s defective condition. The buyer was aware of the property’s drainage problems and had received old photographs of rotted subfloors. These facts meant that the Buyer was aware to investigate if there were any necessary repairs left after the drainage problem was fixed. The court held that Buyer was unreasonable in concluding that because the drainage system was repaired, this also meant that the subfloor was repaired.

In the end, the court of first instance fined the Buyer and her attorney $60,000, an amount incurred by the Seller’s agent to defend himself in the action.

This case is a warning to anxious plaintiffs and their attorneys that they will be charged with knowledge of defective property conditions revealed in inspection reports issued years before the buyer purchased a home. The court found that Buyer’s recounted argument about representations that the drain was repaired as the functional equivalent of saying the subfloor was repaired was simply untenable. In other words, they are two different defects and Buyer cannot claim that it was somehow led to believe that all defects were repaired.

In the absence of a previous physical inspection report specifically mentioning some rotten subfloors, one wonders if all the references to drainage and repair problems would also have supported the court’s conclusion that the complaint was frivolous. Even though the drainage problem caused the subfloor to rot, would a buyer be advised to investigate the subfloor if he or she only had prior knowledge of a previous drainage problem? That answer is not so clear cut and would involve other issues such as the sophistication of the buyer and the reasonableness of, say, not hiring a home inspector. That is a case for another day.

This case is a good reminder to pay close attention to each and every fact in any inspection report made on the property because the facts in it can go to the heart of non-disclosure claims.