The return to the ring of “buyer beware” in Washington real estate transactions
April, 2007
In a recent one-two punch to the collective bellies of real estate buyers, the Washington courts have made it very clear that "Buyer Beware" is alive and well. Since the law many times tries to compensate a loss, this limitation to seller liability may very well create significant exposure for real estate brokers and agents.
The Body Blow – Hoel v. Rose
In Hoel v. Rose, 125 Wn. App 14, 105 P.2d 395 (2004), the Washington Court of Appeals held that a buyer of real estate was not entitled to recover from a seller based on a claim of negligent misrepresentation. The facts in this case were pretty simple.
In marketing materials and on the Internet, the seller represented the size of the property as 6.43 acres. The buyer became aware of the property through this marketing material. The buyer toured the property and the seller pointed out what she thought were accurate boundary markers which, in fact, were incorrect. The buyer later toured the property by himself but did not get a survey, measure the lot dimensions, or undertake any investigation or verification of the information provided concerning the boundaries or lot size prior to closing. The buyer did obtain a pre-closing appraisal containing a diagram of the property that differed significantly from what the seller had represented. The buyer then closed the sale.
After closing, the buyer obtained a survey that showed that the boundary markers initially pointed out by the seller were incorrect and that the actual size of the property was 5.04 acres. The buyer sued the seller for negligent misrepresentation and claimed damages for the loss in value represented by the acreage discrepancy.
Despite the seller admitting to a misrepresentation of the lot size, the court ruled in favor of the seller by finding that the buyer did not justifiably rely on the misrepresentation. Critical to the court's conclusion were the fact that:
- The buyer had full opportunity to inspect the property and there was nothing to prevent the buyer from confirming the accuracy of the seller's lot size representation
- Nothing material about the property was hidden from discovery by the buyer.
- The buyer, through the appraisal, had information that at least called into question the accuracy of the lot size representation and he did nothing to reconcile the conflict.
While the Hoel case was a direct hit to buyer rights for seller misrepresentation of property conditions, the big blow was just around the corner.
The Knockout Punch – Alejandre v. Bull
On March 1, 2007, the Washington Supreme Court held in Alejandre v. Bull (Docket No. 76274-1) that the Economic Loss Rule applies in the sale of real estate and bars a claim for negligent misrepresentation.
In Alejandre, the buyer and seller entered into a purchase and sale agreement ("PSA") for residential real estate. The PSA contained a representation by the seller that the property was served by a septic system and also her promise to have the septic tank pumped prior to closing. The PSA contained an Inspection Contingency that covered the septic system and provided that "[a]ll inspection(s) must be satisfactory to the Buyer, in the Buyer's sole discretion." In addition, prior to closing the seller provided the buyer with a Form 17 Disclosure Statement indicating that (a) the house had a septic tank system which was last pumped and last inspected in the fall 2000, (b) a broken line between house and septic tank had been replaced and (c) there were no defects in the operation of the septic system.
Also prior to closing, the buyer's lender required an inspection of the property. The inspection report indicated that the septic system appeared to function properly.
As it turns out, the year before the house was sold, the seller noticed soggy ground over the septic system. She hired a septic tank service company to pump the tank and to make a repair. She also applied for a connection to the city sewer, but abandoned the idea when she learned there was a $5,000 hook-up fee.
After closing, the buyers heard water gurgling and noticed a foul odor both inside and outside the home, which they believed came from the soggy ground around the septic tank. They subsequently hired the same septic company that had worked on the system for the seller and were told that he could pump the tank but could not fix the problem because the drain fields were not working. He also told them that he informed the seller that the drain field was not working and that the seller needed to connect to the city's sewer system. The buyer hired another company to connect to the city sewer system. During this work, that company discovered that the septic system was malfunctioning, thus allowing sludge from the septic tank to enter the drain field and plug it. The buyers then commenced a suit against the seller for both fraud and negligent misrepresentation.
The Economic Loss Rule
The very important discussion in this case revolves around whether the Economic Loss Rule applies to the sale of real estate. The Economic Loss Rule generally provides that where two parties enter into a contract and economic losses occur (as opposed to physical harm or personal injury), recovery is confined to the contract. Some of the reasons supporting the Rule:
- If tort and contract remedies were allowed to overlap, certainty and predictability in allocating risk in contracts would decrease and impede future business activity.
- If tort liability is expanded to include economic damages, parties to a contract would be exposed to liability in an indeterminate amount for an indeterminate time to an indeterminate class.
- A bright line distinction between the remedies offered in contract and tort with respect to economic damages encourages parties to negotiate toward the risk distribution that is desired or customary.
In determining whether to apply the Economic Loss Rule, the key inquiry is the nature of the loss and the manner in which it occurs. In other words, does the loss deal with economic injury (e.g. loss of bargain) or personal injury or injury to other property. If the loss is economic, and no exception applies, then the complaining party will be limited to contractual remedies, if any.
Application to a Real Estate Transaction
For the first time in Washington state, the Alejandre Court applied the Economic Loss Rule in the context of a real estate transaction.
Here, the claimed injury was for loss associated with the failed septic system. Like most post-closing property condition disputes, this one clearly involved economic loss. The buyer argued that the Economic Loss Rule should not apply in these situations where the specific risk was not "negotiated" between the parties. This argument was rejected because specific warranties can be negotiated and if not included in the contract, an assumption can be made that the purchase price reflects the lack of warranties (i.e. a lower price paid). The buyer also argued that the Economic Loss Rule should not apply in situations involving unsophisticated parties. Again, this argument was rejected because both the buyer and seller were on "essentially equal footing".
In a nutshell, since the buyer had no warranties regarding the septic system, they were out of luck even if they were able to prove the seller had negligently misrepresented the condition of the septic system.
Impact to Real Estate Professionals
With respect to post-closing property condition claims, Hoel gutted the negligent misrepresentation claim by focusing on the reliance aspect. Alejandre has now eliminated it. This means that unless a buyer has an express or implied warranty regarding a property condition, they will have no recourse against a seller unless they can prove fraud. And as we all know, proving fraud is very difficult. Commercial brokers should not take comfort that the Alejandre case involved a residential sale. The rule is not limited to residential sales and will impact commercial sales just the same.
As a result, there will be many buyers who encounter a post-closing loss and start looking for a pocket. Enter the real estate professional. While the liability of the seller is limited by the Economic Loss Rule, brokers and agents have statutory duties (many of which are non-waivable) under RCW 18.86 et. seq. Those duties include the duty to use reasonable care and skill, to disclose material facts and to advise their client to seek expert advice on matters relating to the transaction that are beyond the agent's expertise. In the past, many buyers were reluctant to sue their real estate professional. If that is the only way to obtain compensation for a loss, that reluctance will likely fade away.
So What Can You Do?
Buyers
Do as much pre-closing due diligence as you can (and can afford) and then get a comprehensive warranty concerning the property. This may be easier said than done, especially in seller markets. If you cannot negotiate warranties, price concessions may be the next best thing.
Sellers
Disclose what you know and don't provide warranties to the buyer. Not making misrepresentations doesn't hurt either.
Real Estate Professional
In order to not become the de facto insurer of the condition of the property, you must: (a) disclose to the buyer all "material facts" that you know about the property; (b) advise the buyer to seek services from one or more experts (other than you) for matters outside your expertise; and (c) advise the buyer to undertake commercially reasonable diligence and that absent express contractual warranties, they will likely take the property "as is" and subject to whatever hidden faults lie within.