California Appeals Court Fires Warning Shot At R/E Agents Failing To Disclose That Property Is So Greatly Encumbered That Short Sale Is Doomed To Fail

A recent ruling by a California appellate court hammered real estate agents for failing to disclose to a home purchaser that the property was so overencumbered with mortgages that there was little likelihood that a desired short sale transaction would successfully close at the agreed-upon purchase price.

The court "kindly" commences its ruling with the following excerpt, which essentially serves as the shortened, "CliffsNotes" (aka Cliff Notes) version of the situation involved.

• Particularly in these days of rampant foreclosures and short sales, "[t]he manner in which California's licensed real estate brokers and salesmen conduct business is a matter of public interest and concern. [Citations.]" (Wilson v. Lewis (1980) 106 Cal.App.3d 802, 805-806.)

• When the real estate professionals involved in the purchase and sale of a residential property do not disclose to the buyer that the property is so greatly overencumbered that it is almost certain clear title cannot be conveyed for the agreed upon price, the transaction is doomed to fail.

• Not only is the buyer stung, but the marketplace is disrupted and the stream of commerce is impeded. When properties made unsellable by their debt load are listed for sale without appropriate disclosures and sales fall through, purchasers become leery of the marketplace and lenders preparing to extend credit to those purchasers waste valuable time in processing useless loans. In the presently downtrodden economy, it behooves us all for business transactions to come to fruition and for the members of the public to have confidence in real estate agents and brokers.

• The case before us presents the interesting question of whether the real estate brokers representing a seller of residential real property are under an obligation to the buyers of that property to disclose that it is overencumbered and cannot in fact be sold to them at the agreed upon purchase price unless either the lenders agree to short sales or the seller deposits a whopping $392,000 in cash into escrow to cover the shortfall.

• Here, the buyers and the seller agreed to the purchase and sale of a residential real property for the price of $749,000. Unbeknownst to the buyers, the property was subject to a first deed of trust in the amount of $695,000, a second deed of trust in the amount of $196,000 and a third deed of trust in the amount of $250,000, for a total debt of $1,141,000, and the lenders had not agreed to accept less than the amounts due under the loans in order to release their deeds of trust.

• According to the buyers, after they signed the deal with the seller, they sold their existing home in order to enable them to complete the purchase of the seller's property. Only then did they learn that the seller could not convey clear title because the property was overencumbered.

• In a lawsuit against the seller's brokers, the trial court sustained a demurrer without leave to amend, holding that the brokers owed no duty of disclosure to the buyers. The buyers appeal. We reverse, holding that, under the facts of this case, the brokers were obligated to disclose to the buyers that there was a substantial risk that the seller could not transfer title free and clear of monetary liens and encumbrances.

For the rest of the ruling, see Holmes v. Summer, No. G041906 (Cal. App. 4th Dist., Div. 3, October 6, 2010) (go here for .doc version; when links expire, try here).