Brokers: Duty to Disclose Debt

By Alvin Arnold

A California appellate court held that a residential broker owed a duty to disclose to possible buyers the substantial risk that the seller could not transfer title free and clear of liens. [Holmes v. Summer, 188 Cal. App. 4th 1510, 116 Cal. Rptr. 3d 419 (4th Dist. 2010)].

The case involved a short sale, i.e., one in which the value of the home was less than the outstanding mortgage. Siegland Summer, a broker, listed a home for sale on a multiple listing service for a price of $749,000 to $799,000. The listing noted the seller was a motivated one and that Summer would receive a 3% commission. Summer showed the property to Holmes, making no mention of any encumbrances on the property that might affect the ability of the seller to sell at the advertised price.

After some negotiation, Holmes agreed to pay $749,000. Summer did not disclose that the property was subject to three trust deeds totaling $1.41 million. After learning of this, Holmes then began their action for negligence, negligent misrepresentation and deceit. Holmes also alleged that Summer was seeking to arrange a "short sale" which would have required the lenders to accept less money than was owed to them in order to retire the debt against the property. In addition, Holmes asserted that during escrow, the lenders refused to discount the loans and demanded full payment before they would release their liens against the property. The trial ruled in favor of Summer and dismissed the action. Holmes appealed.

The issue before the Appellate Court was whether the complaint alleges facts sufficient to state a cause of action, assuming the truth of the pleaded facts. The fundamental issue here, said the court, was whether the broker owed a duty of disclosure to the buyers. The broker represented that the property could be bought for $749,000 and even negotiated a sale at that price, while knowing the property was encumbered with over $1 million in debt. Thus, the property could not be sold at the stated price unless either two or more lenders agreed to discount the debt on the property or the seller put $392,000 in cash into an escrow account in order to pay off the loans. Furthermore, the seller had to gain the cooperation of two or more lenders. Holmes argued that considering the discrepancy between price and debt, the brokers were obligated to disclose the facts.

Summers, on the other hand, argued she was precluded from disclosing the financial issues affecting the transaction, since this would have required them to disclose the seller's confidential financial information or its strategy in determining the price at which they would be willing to sell.

The court stated the general rule in California as follows: "It is now settled that where the seller knows of facts materially affecting the value or desirability of the property that is known or accessible only to him and also knows that such facts are not known or within the reach of the diligent attention and observation of the buyer, the seller is under a duty to disclose them to the buyer."

Here, according to the buyers, the monetary liens affected both the value and the desirability of the property. Because the broker knew of the debt and should have known that the buyers were not aware of the same, the she had a duty to disclose the problem. Here, the complaint asserted four theories of liability: (1) deceit based on misrepresentation; (2) deceit based on failure to disclose; (3) negligent misrepresentation; and (4) negligence. Said the court, a properly pleaded cause of action on any one of those theories would suffice to save off a demurrer. The court reversed the judgment of the trial court.

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