Agent Disclosures and “Reasonable Diligence” - Lawsuit that Started it All

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Editor’s Note: Ever wonder about the legal precedents that underlie modern day disclosure and due diligence practices of real estate agents/brokers?  Read on to learn more about a landmark litigation case that changed the agent/broker liability landscape.

 

Agent Disclosures and “Reasonable Diligence” – Lawsuit that Started it All
by Isaac Peck, Editor

If you’ve been a real estate agent longer than a day, you’re familiar with the variety of disclosure paperwork that is shuffled back and forth between the buyer and seller during a property sales transaction.

And it’s not just the seller who is expected to disclose information about the property.

Though state law varies on the specifics, generally real estate agents have a duty to disclose known defects about a property to potential buyers (and face significant civil liability if they don’t!) AND they are often held liable for failure to disclose “reasonably discoverable defects.” In California, for example, a Realtor typically fills out the Agent Visual Inspection Disclosure (AVID) form which is designed so the agent can disclose the “material facts affecting the value or desirability” of the subject property.

While such disclosures are now commonplace–with many states having passed laws that require agents to disclose obvious material defects and hold them accountable for defects they should have known about through “reasonable diligence” –it wasn’t always like this.

Which begs the question: Where did our modern-day disclosure and investigation requirements come from?

Easton v. Strassberger
One of the most defining cases on this issue is Easton v. Strassberger, a lawsuit decided by the California Court of Appeals back in 1984.

Here’s a look at the history of the case and how it shaped the regulatory and legal environment that agents operate in today.

In 1976, the Strassburgers solicited the services of a real estate brokerage, Valley Realty, to help sell their home to Leticia Easton, the buyer in the transaction, for $170,000.

However, shortly after moving into the home in summer of 1976, the parcel of land that Easton’s new home was built on experienced massive slides, with parts of the driveway being destroyed and the foundation being so damaged that the walls of the home cracked and the doorways warped. This occurred, according to the experts, because a portion of the property was “fill” that had not been properly engineered and compacted.

The result was that although the home had appraised for $170,000 just a few months prior, new estimates placed the property’s value at just $20,000, with the cost to repair the damage and avoid recurrence upwards of $213,000.

Not surprisingly in December 1976, less than six months after moving in, Easton sued the Strassburgers and the real estate agents involved in the transaction for fraudulent concealment, intentional misrepresentation, and negligent misrepresentation.

Prior Knowledge
Unbeknownst to both Easton and the seller’s agents, the Strassburgers knew that there were serious soil issues affecting the property. There had been a minor slide in 1973 involving about 10 to 12 feet of the filled slope, and another major slide in 1975 where the fill dropped eight to 10 feet in a circular shape 50 to 60 feet across. However, the Strassburgers did not disclose this to their agents (or the buyer) or that corrective action had been taken.

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Judgement & Appeal
Easton’s original case was tried in front of a jury that awarded her $197,000 in damages, to be paid from the parties as follows: five percent from the seller’s brokerage, 65% from the sellers, and the remainder to be paid by the builders.

However, unwilling to accept liability in the matter (and perhaps worried about the precedent that would be set), the seller’s brokerage, Valley Realty, appealed the matter to the California Court of Appeals. Valley Realty made a variety of arguments, but perhaps most important was their contention that as a broker, they were “only obliged to disclose known facts and [had] no duty to disclose facts which ‘should’ be known to [them] ‘through reasonable diligence.’”

In other words, Valley Realty agreed that they were bound to disclose known facts, but objected to the idea that they were responsible for “conducting due diligence on the property,” which may or may not have identified the soil issues that caused the massive earth movements which nearly destroyed the home.

As the California Court of Appeals wrote, the court then had to decide whether “the broker’s duty of due care in a residential real estate transaction includes a duty to conduct a reasonably competent and diligent inspection of property he has listed for sale in order to discover defects for the benefit of the buyer.”

Broker Due Diligence Established
Ultimately, the court found that the brokers’ duty to disclose material facts includes “the affirmative duty to conduct a reasonably competent and diligent inspection of the residential property listed for sale and to disclose to prospective purchasers all facts materially affecting the value or desirability of the property that such an investigation would reveal.”

In its decision, the court noted that the National Association of Realtors (NAR) Code of Ethics (at that time), said that its members “had an affirmative obligation to discover adverse factors that a reasonably competent and diligent investigation would disclose.” The court reasoned that failure to hold a real estate broker responsible for “reasonably discoverable defects” would set a bad precedent and reward brokers for their ignorance.

The court made a passionate argument for its position, writing:
“If a broker were required to disclose only known defects, but not also those that are reasonably discoverable, he would be shielded by his ignorance of that which he holds himself out to know. Such a construction would not only reward the unskilled broker for his own incompetence…If given legal force, the theory that a seller’s broker cannot be held accountable for what he does not know but could discover without great difficulty would inevitably produce a disincentive for a seller’s broker to make a diligent inspection.”

The court also made clear that it expects more than a casual viewing of the property by an agent or broker, writing that because agents are held out to the public as professionals with “superior knowledge, skills and experience” in the field of real estate, they are expected the exercise their expertise and “should have been alert to the signs of soils problems.” As such, the court agreed with the original jury’s conclusion that a “reasonably diligent and competent inspection of the property would have included something more than a casual visual inspection and a general inquiry of the owners.”

Consequently, Valley Realtors was held liable for its failure to disclose a “reasonably discoverable defect” and the liability of the real estate agent/broker shifted substantially.

Note that NAR’s current requirement now reads: REALTORS® shall only be obligated to discover and disclose adverse factors reasonably apparent to someone with expertise in those areas required by their real estate licensing authority. Article 2 does not impose upon the REALTOR® the obligation of expertise in other professional or technical disciplines.)

Buyer Beware No Longer
Prior to this case, real estate had long operated on a doctrine of “caveat emptor,” which means buyer beware, and there was little recourse for buyers who purchased a home and later discovered major defects.

While state laws and legal precedents vary by state, the far-reaching effects of the Easton v. Strassberger decision in California should not be underestimated. The questions raised and the precedent established in California had a sweeping effect on agent practices, liability, and case law across the country.

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Home Inspection Connection
Additionally, many cite Easton v. Strassberger as the catalyst that propelled the home inspection profession into existence (for more, see History of Home Inspection). There were some home inspectors in operation throughout the 1960s and 1970s, but it was not commonplace to order a home inspection prior to purchasing a property. However, this case not only increased the responsibility and liability of real estate agents, but also led to the realization that agents and brokers could (1) better serve their clients and (2) reduce their new liability, by referring independent home inspectors to provide a complete and thorough inspection of the property.

In this way, agents realized that they could manage the new liability placed on them, due to the Easton v. Strassberger case, by encouraging the buyer to hire an independent home inspector, who most likely was much more competent and qualified to inspect the property for defects.

One year after the case was decided by the California Court of Appeals, Texas became the first state to regulate home inspectors and pass a home inspection licensing law. Other states followed and now more than 30 states have home inspector licensing laws, with many of the remaining states exploring options on how to regulate the profession.

So, if you have ever wondered how home inspectors came to be involved in over 90% of real estate transactions in the United States, now you know!

Lowering Liability and Managing Risk
In the face of potential lawsuits against agents for “what they should have known,” encouraging the buyer to hire a home inspector is an easy and highly recommended way to lower an agent’s liability and avoid lawsuits, according to David Brauner, Senior Broker at OREP.org, a leading provider of E&O insurance for real estate agents and brokers nationwide.

“When we look at claims against agents and brokers, failing to have a home inspection on a property definitely increases the chances of a lawsuit down the road,” Brauner said. “In fact, our insurance carrier has identified this as a key risk management factor to the point where if you don’t get a home inspection on your transactions (or get a signed home inspection waiver), you will actually pay a slightly higher premium due to the increased risk of claims,” said Brauner.

Other tips from OREP E&O’s risk management materials for agents include:
1. Physically inspect the property yourself to uncover any defects.
2. Ask the seller directly if any hidden defects exist and make a note of the date/time of the conversation.
3. Notify the seller of any defects you uncover and give them the opportunity to remedy them.
4. Make full disclosure to the potential buyer and seller of any discovered defects which might affect value.

This should all be done in addition to the home inspection. If the buyer decides against hiring a professional home inspector as part of the due diligence process, then the buyer should be asked to sign a home inspection waiver form, which should be saved in the agent’s file, OREP advises.

Another way to make sure your business is protected is to carry E&O insurance. At OREP, agents can purchase an annual policy that covers them for all transactions throughout the year for a very affordable rate. Premiums begin at $350 for $300,000 Aggregate Limits. Premiums vary by state and other underwriting factors. Visit OREP.org to learn more or call toll-free 888-347-5273.

>> Get a Fast E&O Insurance Quote (No-Obligation)

About the Author
Isaac Peck is the Editor of Working RE magazine and the Vice President at OREP.org, a leading provider of E&O insurance for real estate professionals in 50 states. He received his master’s degree in accounting at San Diego State University. He can be contacted at isaac@orep.org or (888) 347-5273.

 

About Working RE
Working RE is a national publication serving real estate agents and brokers, appraisers and home inspectors. WRE is published by the Organization of Real Estate Professionals (OREP), providing E&O insurance to real estate agents/brokers, appraisers and home inspectors for over 19 years.

 

We’re always listening: Send your story submission/idea to the Editor: isaac@orep.org

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