Nash Law Firm, PLLC
By: Stephen J. Nash
Short sales involve more risk and more work for everyone involved and we can now add one more potential risk - the threat of a lawsuit by the buyer for the failure to properly disclose the fact that a house is upside down.
I know what you are thinking - no problem, I put on the MLS that this is a short sale transaction. That, however, may not be enough.
Facts of the Case
The broker listed the property for $749,000.00 to $799,000.00. There was no mention in the listing that there were 3 mortgages in the total amount of $1,140,000.00 against the property. A purchase agreement was entered into for $749,000.00. The buyer sold their home in anticipation of closing on their purchase but the sellers lenders refused to agree to the short sale and the deal fell through.
The buyers then brought a lawsuit against the listing broker. The listing broker responded that they were not responsible for the performance of the seller, that if the buyer has a claim it should be against the seller directly.
The buyer argued that the listing broker knew that the seller was massively upside down, that the risk of the seller failing to obtain a short sale approval was great, and they had a duty to convey this information to the buyers. The buyer argued that the listing broker by listing the property for significantly less than what is owed implied that the sellers would be able to perform even though they knew there was significant likelihood that they could not (either by getting a short sale approval or by funding the deficiency).
The Court Decision
The court found in favor of the buyer. First, they found that it was not necessary to include the seller in the lawsuit. Second, they found that by holding out the property for sale at a price that was significantly lower than what is actually owed, was misleading because the buyer had no way of knowing how upside down the seller was and had a right to rely on the implied representation of the listing broker.
How Will the Decision Be Applied?
How broad or narrow the decision will become is up for debate since we do not have a lot of facts to go by. It seems clear from the decision that merely stating that the transaction is subject to a short sale would not be enough since, under the courts logic, the fact that you are listing the property implies that you can get the short sale approval or that the sellers can fund the difference. Since short sales are always at the whim of a lender/s, the only safe course of action would be to set out the amounts owed on each debt to that the potential buyer could see how great the potential deficiency is.
The problem with this approach is that whether a short sale is approved or not often has to do with factors that have nothing to do with the specifics of the transaction -
- the lender may have insurance that pays better than any short sale,
- the lender may agree to the short sale price but not the release language,
- a local lender may look at a short sale differently than a national lender,
- some lenders are easier to deal with the others,
- does the lender control the decision or the investors
Does the listing agent need to disclose any information that they have that may indicate a problem in achieving a successful short sale? Where will the line be drawn?
The only thing that seems certain is that any information the listing agent actually is aware of that may doom the short sale should be disclosed based upon this decision.
How Does This Apply to a Minnesota Listing Agent/Broker?
The case in question is a California case that is not binding in a Minnesota court. The concern is that the case decision was heavily influenced by the court's awareness of the foreclosure/mortgage/short sale problems that people are routinely running into. While we like to think that our judges are not influenced by what is happening in the world when they make a decision, the fact is they are and always have been. Judges read the same papers that everyone else does, see the same television reports as everyone else does, and live in the same neighborhoods that everyone else does. How can they not be influenced? On top of every else, state judges have to run for elections. Do you really believe that a judge will not take note of the anger and frustration of people who are dealing with the lending and real estate problems that are wide spread?
The judge who wrote the California decision was very upfront about awareness of the troubles facing the real estate world and started the decision as follows:
"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. [Citations.]' (Wilson v. Lewis (1980) 106 Cal.App.3d 802, 805-806.) When the real estate professionals involved in the purchase and sale of a residential property do not disclose to the buyer that the property is so greatly over-encumbered that it is almost certain clear title cannot be conveyed for the agreed upon price, the transaction is doomed to fail. Not only is the buyer stung, but the marketplace is disrupted and the stream of commerce is impeded. When properties made unsellable by their debt load are listed for sale without appropriate disclosures and sales fall through, purchasers become leery of the marketplace and lenders preparing to extend credit to those purchasers waste valuable time in processing useless loans. In the presently downtrodden economy, it behooves us all for business transactions to come to fruition and for the members of the public to have confidence in real estate agents and brokers."
While it seems hard to believe that a Minnesota court would arrive at the same decision, my guess is that a California attorney would have said the same thing about the California courts prior to this decision.
At a minimum, purchase agreements should be contingent upon the type of short sale approval needed to close the transaction. If the seller will not accept a short sale approval without a release of the underlying debt, that should be stated. If you know that the seller will not cooperate in trying to obtain the short sale approval, strongly consider not representing them. They will waste your time and if the short sale falls through due to the sellers lack of cooperation and you had reason to know that they would not cooperate, you may have opened yourself up to a lawsuit like the California case.
A tougher decision is a short sale where the seller is making a "strategic" default. This makes a short sale approval much less likely. Does this require the listing agent/broker disclose this fact?
Another tough decision is where the servicer for the first lender is notorious for not providing in writing the borrower with a waiver of the lenders right to sue the borrower for any deficiency. The borrower will not agree to a short sale approval that does not contain the waiver but we know that that particular lender/servicer won't give it. Do we have to disclose this information?
Just another risk for real estate agents/brokers working on short sale transactions that are already chock full of risk. Hopefully, the California decision will not get traction and will not show up in Minnesota but nobody should ignore the possibility. A old saying in law is that bad facts make for bad law. The idea is that if you get a case that has facts that will push the buttons of a judge (either because what is happening in the world or because the facts in the particular case are so compelling) may result in a decision that never would have happened at any other time. Unfortunately, the case creates a ruling that is precedent for future cases without such compelling facts. An example of this is the decision by the US Supreme Court that upheld the imprisoning of US citizens of Japanese decent in World War II.
We cannot always predict when such a decision will occur, but given the turmoil in the world, the longer our economic and real estate problems linger and fester, the more likely we will see cases such as the California one that will shock everyone.