Daily Development for Thursday, December 14, 2000

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

BROKERS; DISCLOSURE; BUYER'S BROKER: Buyer's broker has duty to disclose adverse financial information concerning buyer because buyer also has such a duty under concept of good faith and fair dealing.

Lombardo v. Albu,2000 WL 1819807, No. Cv.9900316PR (Ariz. 12/13/2000)

This Arizona Supreme Court decision just came to me "over the transom" from an Arizona practitioner. I have no doubt that it will appear in the computer services in a day or two. It reverses a case reported on DIRT as the Daily Development for January 4, 2000 (on the DIRT Website: http://cctr.umkc.edu/dept/dirt/ That case (same name) appears at 4 P.3d 395 (Ariz. App. 1999).

A couple were attempting to purchase a house through a broker. The buyer wife confided to her broker that her husband was in bankruptcy and had several pending income tax liens, but that they were hoping that the financing would go through in her name alone. The broker did not disclose this information. The seller was also in financial difficulties concerning the house. A contract agreement was reached, but fell through when the buyer was unable to obtain financing. Thereafter, the seller, unable to sell the house, lost it through foreclosure.

The seller sued the buyer's broker, among others, and the trial court granted summary judgment to the buyer's broker on the grounds that the broker had a duty of loyalty to her client not to disclose information. On appeal the Arizona Court of Appeals affirmed the trial court, commenting that the information in question was available to the seller through a credit check, a demand for loan preapproval, or other devices, and thus was not "latent" information. Consequently, the court concluded, the buyer had no duty to disclose it. Although a broker may have a greater duty than the buyer to disclose information, the court of appeals concluded that the broker also had a duty of loyalty to the broker's own client the buyer that precluded disclosure when the seller could have obtained the information could have been obtained in other ways. In the Court of Appeals decision, a dissenter pointed out that the Arizona Real Estate Commission had set specific standards of care for brokers requiring the disclosure of adverse financial information, and that the standards do not limit such disclosure duty to latent facts. The majority of the Court of Appeals dismissed this argument by saying that the professional duties of a broker, enforceable by disciplinary action by the Real Estate Commission, do not set the standard of care in misrepresentation actions. It voiced a concern that to impose such a duty in tort would make it difficult for a broker to know what was relevant information and what was not, perhaps causing a broker to compromise the interests of the broker's own client. The editor criticized the decision on the grounds that it seemed logical that the professional standards of the Real Estate Commission ought to be the tort standard of care as well.

On appeal to the Arizona Supreme Court, held: Reversed.

The Arizona Supreme Court goes far beyond the position taken by the editor in criticizing the case, finding that there is a general duty at common law for both the buyer and the agent to disclose adverse financial information concerning the buyer's ability to purchase even when that information is available to the seller in some other way. It also concludes that the Real Estate Commission's standards restate the common law and in any event can form the basis for the statement of a common law duty. It therefore declines consider whether there is any private remedy based specifically upon a violation of the Commissioner's standards.

The court cites the Restatement of Torts and Restatement of Contracts to reach the conclusion that a buyer has a duty to disclose adverse financial information concerning its ability to perform. It points to the implied duty of good faith and fair dealing in the contract itself, but of course the duty of disclosure that the court talks about would arise in the pre contract stage, so it is difficult to know what significance the court places on the good faith and fair dealing duty. The editor concludes that the court is *not* expressly concluding that there is a duty of good faith and fair dealing during negotiations. But, as the quote below indicates, it is coming very close.

The court notes that there is a duty of the seller to disclose to buyer, prior to contract, defects in the property, citing a case involving termite damage. It comments that this is not a "one way street," and that the buyer has a similar duty on issues as significant to the seller as the buyer's ability to perform.

"The buyer cannot present himself as a ready, willing and able buyer if he knows that there is a significant risk that the deal will never close because of his inability to perform. This would violate the buyer's duty to deal fairly under the contract and the legal dutyies imposed by Restatement (Second) of Contracts Section 161 (1981) and Restatment (Second) of Torts Sec. 552 (1977)"

The court concludes that where the buyer has such duties, then the buyer's agent cannot argue that the duty of loyalty to the buyer precludes a duty on the part of the agent to disclose as well, since nondisclosure is tortious, and the agent does not have the duty to facilitate a tort.

Comment 1: Egads!! Pandora's box is open in Arizona, and brokers and sellers should head for cover wherever they can find it (the editor recommends the legislature.) This court does not state the recognized common law disclosure duty of parties to in real estate transactions. The critical difference is the question of latent defect. The court has made the standard for disclosure materiality, and not latency. Whether the Restatement also has done so (as the court asserts), is somewhat problematic. I have set forth the text of the Restatement Sections below:

Restatement Contracts (Second) s 161. WHEN NONDISCLOSURE IS EQUIVALENT TO AN ASSERTION

A person's nondisclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only:

(a) where he knows that disclosure of the fact is necessary to prevent some previous assertion from being a misrepresentation or from being fraudulent or material.

(b) where he knows that disclosure of the fact would correct a mistake of the other party as to a basic assumption on which that party is making the contract and if nondisclosure of the fact amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing.

(c) where he knows that disclosure of the fact would correct a mistake of the other party as to the contents or effect of a writing, evidencing or embodying an agreement in whole or in part.

(d) where the other person is entitled to know the fact because of a relation of trust and confidence between them.

Restatement (Torts) s 551. LIABILITY FOR NONDISCLOSURE:

(1) One who fails to disclose to another a fact that he knows may justifiably induce the other to act or refrain from acting in a business transaction is subject to the same liability to the other as though he had represented the nonexistence of the matter that he has failed to disclose, if, but only if, he is under a duty to the other to exercise reasonable care to disclose the matter in question.

(2) One party to a business transaction is under a duty to exercise reasonable care to disclose to the other before the transaction is consummated,

(a) matters known to him that the other is entitled to know because of a fiduciary or other similar relation of trust and confidence between them; and (b) matters known to him that he knows to be necessary to prevent his partial or ambiguous statement of the facts from being misleading; and (c) subsequently acquired information that he knows will make untrue or misleading a previous representation that when made was true or believed to be so; and (d) the falsity of a representation not made with the expectation that it would be acted upon, if he subsequently learns that the other is about to act in reliance upon it in a transaction with him; and (e) facts basic to the transaction, if he knows that the other is about to enter into it under a mistake as to them, and that the other, because of the relationship between them, the customs of the trade or other objective circumstances, would reasonably expect a disclosure of those facts.

Comment 2: The language of the Restatement of Torts is not nearly so difficult as the Restatement of Contracts, as it requires that the relationship between the parties, the customs of the trade or other objective circumstances would lead the other side to expect disclosure. The Restatement of Contracts talks about clearing up misconceptions and duties of fair dealing whatever that means. Commonly, of course, parties to real estate transactions expect to be permitted to make their own inspection, and where that is not enough, they can and do demand warranties or representations from the other side. The common law and trade practice are clear that the other side generally has no duty to volunteer information that can be ascertained or demanded through the process that usually is followed in real estate contract negotiations.

Comment 3: The Restatement of Contracts, on the other hand, does not look to trade practice, but makes its own. This is not the first time that the editor has noted that practitioners should be cautious about assuming that Restatements are in fact what the title suggests. In fact, the title appears to be a misrepresentation itself according to the standards set out in the Restatement sections above, since the term "Restatement" suggests, at least to the average observer, that something is being said which has already been said, and is just being organized and clarified. But in fact in many cases unprecedented new rules and duties are developed in these Restatements. Or, as in this case, rules stated in relatively narrow contexts are applied more broadly.

Comment 4: In the good old days, brokers had a real duty to see to it that parties to a transaction were treated fairly. If a broker was aware that a party was laboring under a misconception, the broker typically would correct that misconception. That duty, in the editor's judgment, would have superceded any duty of confidentiality to the buyer, and the broker should have so informed the buyer. But in the instant case both broker and buyer have an affirmative duty to inform the seller of anything material. Since, of course, they can't really know what's material, they better tell everything they know. Same with the seller's duty to the buyer, which in fact is being implemented in many NAR supported statutes being enacted around the country.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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