FOR BROKERS: Risk Management

Dual agency
Seller disclosure
Loan and investment fraud
Unauthorized practice of law
Saying you’re sorry works, too

BY ROBERT FREEDMAN

Erect barriers to legal liability

When one of his clients was hit with a complaint alleging misrepresentation during a home sale transaction, attorney David Scott weighed in with a simple piece of advice that made the difference in how the lawsuit ended: Check your files and all your desk drawers for written records verifying what you disclosed.

So, when the sales associate produced a cover sheet showing that he had, as claimed, faxed the homebuyer information on the house’s water supply, the judge closed the case in favor of the associate. “The judge said to the buyer, ‘You may not have received the information, but the sales associate sent it, and here’s the proof he fulfilled his duty,’” says Scott, whose practice is in Nashville. “You’d be surprised how many cases turn on proof that a simple document was sent.”

Allegations of misrepresentation, including failures to disclose, have long been the No. 1 complaint against real estate sales associates, say attorneys who represent associates in professional liability cases.

Probably 90 percent of liability cases against associates involve misrepresentation, and 90 percent of those charge negligent misrepresentation, says Paul Stephen Drayna, an attorney in Seattle. Negligent misrepresentation occurs when sales associates say something they believe to be true based on what the client, often the seller, says—the water heater is five years old, for example—but the statement turns out to be false.

Although courts overwhelmingly tend to decide in favor of sales associates in these cases—probably 80 percent to 85 percent of the time, says Drayna, based on the cases he’s handled—the complaints keep coming. That’s because unhappy parties to a transaction, usually buyers who’ve discovered a problem with the house after purchase, don’t feel satisfied until they’ve sought damages. “Many times, all the person really wants to do is vent,” says Drayna.

Despite your odds of success, prevention is key because defending yourself, even in cases you ultimately win, costs time and money and can lead to increases in your errors & omissions insurance premiums.

What’s more, to avoid the costs and uncertainty of a trial, E&O insurers even prefer to settle lawsuits your associates are likely to win. But settlement can negatively affect your professional reputation and even attract more lawsuits. “Some brokers feel that if you settle a claim, even if it’s frivolous, you encourage more frivolous lawsuits,” says Drayna.
Consider four top risk-management issues that attorneys suggest you advise your associates about.

1. Dual agency. A big portion of misrepresentation claims come out of dual agency transactions, says Drayna, who makes this claim based on his experience rather than any hard statistics. Problems tend to arise when sales associates, acting as the listing agent, attract a buyer and propose to represent the buyer in addition to the seller.

Even assuming appropriate disclosures are made, if buyers discover something wrong with the house after purchase, they’re more likely to file a complaint than if they had separate representation, says Drayna. That’s because they’re more likely to question whether they were represented adequately.

Dual agency is permitted with appropriate disclosure in all states but three—Colorado, Florida, and Kansas—according to the Real Estate Agency Annual Report for2003, prepared for NAR Government Affairs by the Legal Research Center Inc. But Drayna calls it “a lightning rod.”

Risk reducer: Associates should limit dual agency to instances in which they have an established relationship with both parties rather than with just one of them, Drayna recommends.

2. Seller disclosure. Having sellers disclose the condition of their property on a standardized form—a requirement in New York and some 30 other states—can give sales associates a false sense of security, says Richard Evans, an attorney in Rochester, New York.

In Evans’ state, the form tells buyers they’re not to rely on the disclosures as an affirmative representation of the actual condition of the property, he says. Instead, they’re to verify conditions on their own with the help of professionals, such as a home inspector.

Even with that disclaimer, unhappy buyers are filing claims alleging the listing agent and even the buyer’s agent in some cases should have known the seller disclosure was inaccurate, says Evans. In court, judges often rule in favor of the buyers, he says.

“Buyers are coming in saying, ‘Why didn’t you point out this property condition to me?’” says Evans. “And judges are saying, ‘If the condition’s discovered, you’re liable.’ The seller disclosure form isn’t stopping disgruntled claims.”

NAR supports the use of seller disclosure forms as a tool for associates to help reduce, but not necessarily eliminate, their liability.

Risk reducer: Make sure your associates tell buyers upfront that the form reflects property condition only to the best of the seller’s knowledge, the disclosures aren’t to be relied on, and to inform themselves by hiring an inspector, says Evans.

3. Loan and investment fraud. Your associates can get caught up in such fraud unwittingly if they’re not careful about when it’s OK, and when it isn’t OK, to meet certain demands by vendors or other parties to a transaction, says Steve Willoughby, president of Steve Willoughby Seminars in Casper, Wyo.

Your associates should be wary if a mortgage broker asks them to rewrite a purchase agreement to mischaracterize the nature of a purchase to obtain more favorable loan terms than they otherwise could, says Willoughby, whose company hosts seminars on risk management and other topics for real estate professionals in Idaho, South Dakota, and Wyoming.

Drayna warns of characterizing the purchase of an income-producing property, such as a bed-and-breakfast or a boarding house, as a residential purchase. One scenario he’s aware of involved a boarding house near a university that, at the mortgage broker’s suggestion, was characterized as a duplex. And indeed, from the outside, the property looked like a duplex because that’s what it was originally developed as.

Lenders typically make financing available on better terms for residential purchases than for income-producing properties. Or they might not make a loan at all on an income-producing property. If the practitioner writes up the purchase agreement as a residential purchase knowing the deal is being mischaracterized by the mortgage broker or loan officer, the practitioner could be found to have committed loan fraud.

The same concerns about mischaracterization apply if associates help investors who ask to be listed as owner-occupants in the loan documents, says Willoughby.

Risk reducer: Anytime you’re asked to mischaracterize the nature of the purchase, that should be a red flag to you that you risk committing fraud and should refuse to do that, says Drayna. Associates should get as much in writing as possible—that the buyer intends to occupy the property, for example. If the buyer doesn’t intend to occupy and won’t say that in writing, then you don’t want to work with the person. “Typically you don’t find out about loan fraud until after the owner defaults and people start reviewing files,” says Willoughby. “If you have everything in writing, you’re protected.”

4. Unauthorized practice of law. Alert your associates to be cautious of requests by the buyer or seller to append unique language to a standard purchase agreement. “Any time your associates find themselves putting pen to a blank piece of paper, rather than just filling in blanks or checking boxes in a contract, that should be a red flag they could be engaging in the unauthorized practice of law,” says Drayna.

In one case Drayna is familiar with, a buyer of a property occupied by a tenant wanted a clause written into the purchase agreement that he could terminate the agreement if, among other things, the seller couldn’t evict the tenant in time for the closing.

Risk reducer: If there’s no legal language in your company’s collection of standard forms referencing what the buyer or seller wants in the contract—and in Drayna’s example there wasn’t—the most prudent course of action is for the associate to advise the buyer or seller to hire a lawyer to draft language, says Drayna.

Saying you’re sorry works, too

Whatever situation your associates find themselves in, they can’t go wrong asking for advice from you, other experienced brokers, an attorney, or the legal hotline hosted by their state association of REALTORS®, if one is offered. In many cases, commonsense advice such as keeping a good paper trail is all they need.

And sometimes saying “I’m sorry” works wonders. In one case Drayna was involved in, in which the plaintiff sought both damages and an apology, the sales associate didn’t believe he’d done anything wrong and couldn’t be coaxed into issuing an apology. Yet that was the main thing the plaintiff wanted, Drayna says.

Given the power of an apology to defuse a tense situation, make it part of your standard practice to wield it when a conversation is heated. If someone calls your associate and alleges he made a mistake, you might avoid a lawsuit simply by finding out the facts, saying you’re sorry for the problem and, even if you don’t believe your associate did anything wrong, taking accountability and searching for a resolution,” he says. That could include refunding a commission or relisting a property at a reduced rate,” he says.

Such a proactive response might not only forestall a lawsuit, it might help you keep a client.

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