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Agents: When You Do A Short Sale, Are You Required By Law To Disclose The Risk The Seller Could Not Convey Title? One Court said You Are.
Posted by: Kenny Tan
October 21, 2010

Since the real estate market began its decline and the collapse of the subprime market in 2007 and the ensuing and unrelenting recession which has lingered for several years, lenders have started foreclosing on many homes throughout the nation.

In the process, the market is flooded with properties that are on the market because the owners face foreclosure, and in an effort to avoid suffering a significant impact on their credit rating, many has opted for short sale -- a process whereby the lender would take a big discount from the loans in order to allow the properties to be sold in the open market due to the decline in property values. Many such homes are "upside-down"- the owners owe more money to the bank than what they are worth.

It seems lately there are more and more properties going through short sale and newer agents who are going through this cycle for the first time in their career as licensees are learning how to handle a short sale.

When it comes to disclosures, are short sales any different than the normal sales? 

"Yes,", says one California Court of Appeal. Recently the 4th District sent a very important and strong message to all licensees in the case of Holmes v. Summer published in early October 2010.

In that decision, the 4th district held that listing agents have a duty to disclose to the the buyers -- even if they're in a fiduciary relationship to them --- that there is a significant risk that the escrow would not close because the seller may have to put up with funds of his own to close the escrow and the risk is big that that may not happen. In that case, the buyers relied on the nondisclosure of this fact and sold their home in anticipation of the completion of the sale, and therefore stated a claim against the brokers for nondisclosure -- despite the fact that public records might have revealed that possibility anyway from the deeds of trust that had been recorded.

You would think that if the listing agent had indicated to the buyers that this is a short sale that that would be sufficient disclosure under the law -- it is unclear if the buyers were even told it was a short sale though. However, the court of appeal reversed the demurrer sustained by the trial court where the issue revolved around the question of whether, as alleged, did the complaint state a claim for fraud -- Was the listing agent under an affirmative duty to make the disclosure? If the answer is yes, doesn't it now become important for the CAR to forthwith publish new disclosure forms for short sale situations.

More importantly, for attorneys especially, the effect of this case may be to water down the defense available to licensees in nondisclosure cases based on constructive notice of public records. The principle set forth in this new precedent can now applied to other areas such as illegal or nonpermitted construction. These may be public records which are available to the buyers but it behooves agents to disclose them and not risk being sued for fraudulent nondisclosure -- or even negligence - by the buyers. 

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