Closing Escrow and Opening Claims

Real estate is an industry that truly understands the meaning of highs and lows. When the market is strong, deals are waiting to be made on every corner (literally), revenue growth is abundant, inventory is low, and multiple-offer competition is fierce. When the market is weak or recessed, revenue streams dry up, prices flatten, and, at the worst of times, inventory is abundant. Regardless of the market conditions, real estate brokers and agents face a constant threat of legal liability, and the market's direction can influence the nature and number of the claims that arise.

As claims and litigation professionals, we can better serve our clients and insureds by understanding the types of claims that can arise and what needs to be done to successfully prepare defenses. Likely causes of actions include the following claims:

Failing to Disclose a Property Defect – Real estate agents have a duty to disclose anything that materially affects the property. Something materially affects a property if it impacts the value or desirability of the home. Defects can include construction issues, improvements without permits, leaks, cracking, noise, or nuisances. Even if the real estate agent did not personally know about the defect, they can still be sued if they represent a party who knew the defect existed.

Breach of Fiduciary Duty – The most common type of lawsuit brought against real estate agents are for breach of duty. If an agent does not act in the best interest of her client, she can be sued. For example, if an agent receives five offers on a home sale ranging in price, but lies and tells the client she only received one for the cheapest amount, then she can be sued for breach of duty.

Negligence – Agents can be sued for negligence if they fail to exercise due care toward others that a reasonable or prudent person would do under the same or similar circumstances. Clients often make claims that real estate agents knew or should have known something but failed to take the right action.

Fraud – If a real estate agent intentionally uses false information or makes false representations about the condition of the property in order to gain an advantage during a real estate transaction, then they can be sued.

Giving Legal Advice – Real estate agents have general knowledge about real estate transactions and may even have a peripheral understanding of real estate law for the state in which they reside, but they are not authorized to give legal advice. Many agents don’t understand this and give unsolicited legal advice to the detriment of their clients.

Breach of Contract – Real estate agents who did not perform under the terms of the contract can be sued for breach of contract. One of the most common breach of contract claims is for failing to comply within the timeframe stated in the contract. Breach of contract claims are often filed with claims of negligence, breach of duty, and fraud.

Personal injury – If someone is injured during a showing (slipping and falling on the newly washed floor, falling through non-code compliant stairs, etc.), then they can file suit against a real estate agent.

A single real estate transaction could result in a lawsuit that encompasses all of the aforementioned causes of action. To illustrate the point, the following hypothetical is based on an actual case that was litigated in California in recent years.

A Flip That's A Flop

Sally is a licensed local real estate agent who hasn't quite found her stride in a highly competitive local market. Luckily, she keeps her ear hustle game strong during floor time and hears about a potential pocket listing for the worst house in the best neighborhood in town. Not only are her eavesdropping skills on point, but also she's been watching a lot of HGTV and knows that she and her contractor husband Bill are the next Tarek & Christina. Sally approaches the potential seller directly and makes an offer sight unseen that includes a waiver of her commission. She's thrilled when her offer is accepted and she and Bill waste no time starting the remodel.

As is often the case with first-time flippers, Sally and Bill are in way over their heads. This property requires more than just a face lift. For starters, when the old flooring is pulled up, Bill notices a large crack in the slab foundation that runs through two rooms. He knows this could be the sign of a bigger problem, but decides that he will just cover it with some of the new wide plank white oak floors that everyone loves and not worry Sally about what is quickly becoming a money pit. Bill and Sally also notice that the floor in one of the upstairs bedrooms has some flex to it, and several of the outlet plate covers have black burn marks on them. Sally has her furniture stager place the bed in the area where the floor heaves to conceal the issue from potential buyers and replaces the outlet plate covers.

Sally and Bill, wearing their owner hats, fill out the property disclosure and fail to disclose the problems they discovered during the remodel. The open house was a smashing success and resulted in multiple offers over asking price. Of course, Sally and Bill took the highest offer and the shortest escrow. Based on Sally's representations in the property condition disclosure and Sally's relationship with the buyer's agent Barb, the buyers did not perform any inspections. The property closed and the buyers moved in.

Shortly after moving in, the newly installed wood floor begins to lift, plugs on the second floor trip the breaker every time they are used, and a the buyer fell through portion of the floor in the second story bedroom and ruptured two vertebrae, which necessitated spinal fusion surgery.

The Analysis

Let's take a look at the potential claims against the parties to this transaction and some practical tips for mitigating the risks associated with a real estate transaction. As a preliminary step, real estate agents and brokers should regularly refresh their understanding of the laws that apply to the transactions with which they are involved. To the extent that educational programming is provided and required, efforts to track compliance should be instituted in order to ensure that the agents in the field are properly trained and monitored.

Appropriate policies, procedures, and protocols should be delineated to guide agents through the transaction to confirm that the right questions are asked and the right steps are taken to avoid problematic transactions such as the owner/agent flip. If agents are also acting as owners and contractors, the potential exposure increases exponentially while the insurance coverage remains flat or goes away entirely.

Make sure that your agents watch their open houses carefully. If you have a property with a sunken living room or dark basement staircase with odd depth stairs, post a sign or make a practice of standing near the area that could give rise to a personal injury.

The reality of lawsuit avoidance in its entirety is nearly impossible. Most of us reading this article would have far less to do if it was that simple. Despite the challenges, these cases are defensible when your insured clients, claims professionals, and attorneys understand where the risks lie and actively try to mitigate those risks.