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For many years, most real estate brokers have taken comfort in certain California appellate decisions holding that the duty to disclose material facts may not extend to matters of public record. 

But just this month, the California Court of Appeal for the 4th District issued a unanimous opinion that appears to limit this rule in the case of Holmes v. Summer (October 6, 2010).  The decision seems disturbing both in its conclusion and in its internal reasoning process, but prudent brokers should definitely proceed cautiously with this new development in mind.

The case involved a lawsuit by some would-be-buyers of certain residential property (although the rule announced does not seem to be limited to residential transactions, and logically it would extend to commercial ones as well).  Unbeknownst to the buyers, the sellers had listed the property for a sum well below the loan balance and although the sellers were attempting to negotiate a “short sale” with their lender, that transaction was never consummated.  As a result, the sellers were unable to deliver clear title unless the buyers contributed the loan shortfall amount and the buyers then sued for those damages.

The matter never went to trial but was tested only on the strength of the pleadings submitted by the buyers.  The trial Court held, among other things, that the fact that the loan was of public record and thus was constructively known to the buyers excused the duty of the brokers to disclose.  The Court of Appeal reversed the trial Court and held that a preliminary title report would not necessarily show the loan balance, and so once the brokers admitted that they knew the loan balance was higher than the sale price, a material fact in need of disclosure arose.

This new decision departs from the earlier rule and its reasoning process seems flawed (for example, once a Preliminary Title Report showed the original loan balance—presumably higher than a sale price—a buyer would seem to be on notice to inquire whether pay downs had brought the balance below the sale price).  Equally disturbing is the suggestion that brokers need to disclose circumstances relative to their own clients’ internal and private challenges to removing all conditions for a successful close.  In the Holmes case, the broker logically argued that such a rule unfairly made the broker a guarantor of the transaction and of the broker’s clients full performance.  The Court of Appeal rejected this, reasoning that if confidential information obtained from a client relative to a potential inability to perform is known to the broker, then the broker must obtain a waiver of confidentiality for purposes of disclosing or that broker proceeds at its peril.

Brokers, beware!

For further information, please contact William H. G. Norman, Chair of Cooper, White & Cooper’s Financial Crisis Group.

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