Bad Faith Claims of Non-Disclosure Can Lead to Sanctions

In 2014 an appellate court in California in the case of Peake v. Underwood provides a lesson on why a real estate buyer should not base non-disclosure of defects claims on the hair-thin reasoning that the failure to disclose the extent to which home repairs were made when a physical inspection report shows the same type of defect existed at the property.

The Sellers had purchased a home in 2007 and were represented by a real estate agent in the transaction. The Sellers sold this home to Buyer about one year later and the Sellers were again represented by their previous agent. Buyer was represented by her own real estate agent.

Two years after they purchased the home, Buyer sued various parties including the Seller’s agent. Buyer alleged that “standing water was caused to wick into the foundation… causing the foundation and attached flooring structures to deteriorate.” Buyer alleged she “only became aware of the extent of the [water-intrusion] damage” after she purchased the home and the seller’s agent did not disclose this problem.

The crux of Buyer’s allegations were that Seller’s agent (I) had been aware of the unrepaired water damage and the deteriorated floor structure at the time of the sale but failed to disclose these facts, and (ii) knew or should have known, and failed to disclose, that the repairs performed on the property “were not proper and did not comply with applicable building standards and codes.” Buyer alleged that this failure meant that Seller’s agent had breached California’s statutorily required disclosure laws by failing to conduct a competent and diligent inspection pursuant to California Civil Code sections 1102 and 2079.

Not long after Buyer filed her complaint, the attorney for Seller’s agent sent Buyer’s attorney a series of communications explaining the legal and factual deficiencies of Buyer’s claims against Seller’s agent and encouraged the attorney to consult with a real estate standard-of-care expert. The attorney for Seller’s agent emphasized that the Seller’s agent had provided Buyer with all the information in his possession, including documents showing possible problems with the subflooring, and noted an agent’s statutory duties are limited to a visual inspection. Counsel for Seller’s agent reminded the attorney of his ongoing duty to reevaluate the merits of Buyer’s claim, and warned that if Buyer did not dismiss her claim, the Seller’s agent would seek sanctions from Buyer and the attorney under California Code of Civil Procedure section 128.7.

About one year after the complaint was filed, Seller’s agent served Buyer and her attorney with a section 128.7 sanctions motion. The Seller’s agent argued that the cited statutes under which Buyer sought liability (Civil Code sections 2079 and 1102) required that a real estate agent disclose only visible defects and the rotted subfloor problem was not visible on a reasonable inspection. He also argued that the statutes did not require a Seller’s agent or broker to independently verify a seller’s representations.

In support of his motion he submitted the three-page statutory transfer disclosure statement (TDS) provided to Buyer during escrow which indicated that the Seller’s were not aware of any “[f]looding, drainage or grading problems” on the property. This form clearly stated that the representations therein were made by the Sellers, not the Seller’s agent.

Second, the Seller’s agent submitted a copy of the Visual Inspection Checklist in which it stated “SEE DISCLOSURES ON DRAINAGE UPGRADES BY PREVIOUS OWNER.” This checklist form also noted a “SOFT SPOT IN SUBFLOOR IN ONE BEDROOM.” Finally, this form noted: “SEE PAST INSPECTION REPORTS, DRAINAGE UPGRADE REPORT AND WORK BY CIVIL ENGINEER, KENNETH DISCENZA [phone number] AND BOND CONSTRUCTION. DRAINAGE IMPROVEMENTS WERE PERFORMED IN TWO SEPARATE PROJECTS.”

Finally, the Seller’s agent submitted evidence that Buyer received the above-referenced inspection report from a prior sale of the property which disclosed substantial problems and decay in the subflooring of the home.

Given these facts, the court ruled that Buyer’s complaint was frivolous and that both Buyer and her attorney were aware of the utter lack of merit in the claims against the Seller’s agent. The court gave little to no significance to the allegation that it was not specifically conveyed to Buyer that all of the repairs (I.e., repairing the rotted subfloor structure) was not completed by the prior owners. The appellate court very quickly concluded that the fact that the subfloor is not visible and its exact condition is not reasonably ascertainable on visual inspection. Because of this, the broker is not charged with investigating this particular condition.

The court addressed Buyer’s claims that the Seller’s agent committed fraud by failing to disclose his knowledge regarding the subfloors’ unrepaired condition. It is well-settled law in California that where the seller’s knows of facts materially affecting the value or desirability of the real estate and also knows that such facts are not known to, or within the reach of the diligent attention and observation of the buyer, the seller’s agent is under a duty to disclose them to the buyer. A failure to do so can subject the seller’s agent to fraud claims.

The court noted that even assuming that the Seller’s agent knew more about the uncompleted repairs and the extent of the subfloor damage thanwas actually disclosed, Buyer herself was put on notice of the defective condition of the defective subfloor. Buyer had known about the property’s drainage problems and had received old pictures of rotted subflooring. These facts meant that Buyer was on notice to investigate whether there was any remaining repairs needed after the drainage issue was repaired. The court held that Buyer was not reasonable to conclude that because the drainage system was repaired that this also meant that the subflooring was repaired.

In the end, the trial court sanctioned Buyer and her attorney $60,000, the amount incurred by the Seller’s agent to defend himself in the action.

This case is a warning to eager plaintiffs and their attorneys that they will be charged with knowledge of defective conditions of the property disclosed in inspection reports issued years before the buyer purchases a house. The court found that Buyer’s argument that she relied on representations that the drainage was repaired as the functional equivalent of saying that the subfloor was repaired was simply untenable. In other words, they are two different defects and Buyer can’t claim that she was somehow lulled into believing all defects were repaired.

 

In the absence of a prior physical inspection report specifically mentioning some rotted subflooring, one wonders if all of the references to the drainage problems and repairing would also have supported the court’s finding that the complaint was frivolous. While the drainage problem caused the subfloor to rot, would a buyer be put on notice to investigate the subfloor if it only had prior knowledge of a previous drainage problem? That answer is not so clear and would involve other issues such as the sophistication of the buyer and the reasonableness of, for example, not hiring a home inspector. That is a case for another day.

This case is a good reminder to thoroughly take heed of any and all facts in any inspection report performed on the property because the facts therein can put a stake through the heart of claims of non-disclosure.

David S. Barrett is an attorney in Sacramento, California and his practice includes business and real estate litigation. Mr. Barrett has represented brokers, contractors, as well as real estate buyers and sellers. Mr. Barrett’s experience can be viewed in greater detail detail at [http://www.dsblawoffice.com].

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