Daily Development for
Tuesday, January 6, 1998

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

ESCROW; NEGLIGENCE; WAIVER: California court upholds hold harmless clause releasing escrow company from its own active negligence in connection with "custom tailored" release agreement relating to accomodation services.

Rooz v. Kimmel, 64 Cal. Rptr. 2d 177 (Cal. App. 1997)

The story behind this case is another fascinating saga of the eighties. Impatient readers may jump three paragraphs to get to the gist of the holding. R and K appear both to be real estate wheeler dealers in a red hot commercial real estate market in the San Francisco area. They agreed that they would do a 1031 exchange of buildings in K's building in San Mateo for R's in Berkeley. As part of the deal, K gave to R a $465,000 note, with a ten year term and zero interest, on the Berkeley building. (The facts don't indicate whether the note was non recourse by its terms, but it appears in any event to be a purchase money mortgage, and therefore automatically non recourse under California law.) The parties agreed that K could move the note to a different property if K were to sell the Berkeley property, but that the new security had to have an equity, following the attachment of the K-R deed of trust, of 20% of its value. Within a few months, K in fact decided to sell the Berkeley property and proposed that the note be moved to another property K was acquiring, but on which K had not yet closed - the San Francisco property. At the time, the San Francisco property had an appraised value of $2.975 million although K was buying it for $1.5 million. (This was the 80's, remember). There was a loan on the property of $975,000. As the court reports the facts, at about this time R and K suddenly realized that the note on the Berkeley building was in the wrong amount, and apparently agreed together to increase it to $515,000, and to transfer this obligation to the San Francisco property. Unfortunately, K was not going to be able to close on the San Francisco property until shortly after K was scheduled to close on the sale of the Berkeley building. At that time R was planning to be in Hungary. The parties arranged with the escrow officer in the sale of the Berkeley building to release R's lien on the Berkeley building but to hold the $515,000 note and deed of trust on the San Francisco property and to record them when K took title to that property. [Note that a better practice might have been to record immediately against "K's title to be" and then to rerecord after K took title - assuming that one was dumb enough to do all this at all - ed.]

The escrow company apparently was willing to be of service in carrying out this delayed recording, but was properly concerned about its potential exposure as a fiduciary when it was not otherwise in control of the closing on the new property. Therefore, it apparently drew up (or had drawn up) a special indemnity agreement that set forth all the details of this specific transaction, stated that it normally would not record documents over which it had not exercised general control and which it had not examined for conformity, and that R recognized that it would not undertake to perform this recording service but for the fact that R was executing the instand agreement, which indemnified and held harmless the escrow company.

Thereafter K closed on the sale of the Berkeley property and the escrow reconveyed R's deed of trust to facilitate that closing as planned. Two days later, K acquired title to the San Francisco property. Despite the fact that her unequivocal escrow instructions instructed the escrow agent to record the R deed of trust upon K's acquisition of title in the San Francisco property, and despite the fact that the agent's contract relationship with K had ended when K had closed on the sale of the Berkeley property and the agent took the $515,000 note and deed of trust as agent for R, the agent contacted K and asked permission prior to recording the note and deed of trust. K withheld permission, indicating that he had not yet "completed financing arrangements." (The escrow agent did notify R's local attorney in fact, who notified R, but remember that R was in Hungary and didn't manage to intervent in time.)

You guessed it. K loaded up the San Francisco property with additional liens. The 80's ended, and the San Francisco property was foreclosed in a foreclosure sale on senior liens that wiped out R without a cent of return. R sues both K and the escrow company for the loss of the $515,000 lien (apparently there was no direct recourse against K, perhaps because of the purchase money feature, or perhaps because of the loan terms themselves.)

The trial court found that the escrow company had been negligent in withholding the recording contrary to its instructions, but upheld the "hold harmless" provision and left R with a damage claim against K. R appeals.

On appeal: held: affirmed (as to the escrow liability issue).

There were two interesting issues. California authority originally had held that provisions holding a party harmless for its own negligence had to be very specific in character in order to apply to "active negligence." The indeminifaction agreement here did not reach that standard of specificity. In fact, the hold harmless agreement does not mention negligence at all. But the court held that new authority justifies courts in looking at the overall document to ascertain whether the release of liability would fairly carry out the intention of the parties based upon all the circumstances. In this commercial arrangement, the court held that the language, although not a model for drafters in this regard, sufficiently addressed the issue of release for the actions in question.

The second issue dealt with established California authority that had held that indemnification and hold harmless agreements relating to an escrow company's own negligence were void as against public policy. The court turned to the underlying authority that had been relied upon in the decisions concerning escrow companies and pointed out that an important element in all the cases was the fact that the party executing the indemnification agreement had, in essence, signed a "contract of adhesion," generally required in order for the party to obtain a critical service not otherwise generally available.

In this case, however, the court pointed to the specific recitals in the agreement that R executed to demonstrate that this was anything but a contract of adhesion. The escrow company was performing special services, not its normal services, and doing so only as an accomodation, without separate consideration. The agreement stated specifically that the escrow company would not provide these services except that R was releasing it from liability. R signed this "custom tailored" agreement.

Comment 1: Although the court does point out that the hold harmless clause could have been clearer as regards negligence, the attorney who drafted the clause was smart enough to realize that this was uncharted territory and, under such circumstances, elaborate explanatory recitals might be valuable to demonstrate the intent of the parties and their understanding of the factual background. It appears that the court relied upon this language to justify setting aside specific anti-escrow authority. The lawyer wise enough to insert that language added value to the client's transaction, and gets the DIRT "play of the day."

Comment 2: The court elected not to take extrinsic evidence, and relied solely on the language of the document. It might be interesting to know who presented all of these documents to R, and with what representations. Note that no one is suing a broker here, or any lawyer. Perhaps R really was a "cowboy" wheeling and dealing without professional advice. If so, then perhaps R got what he deserved.

Comment 3: In another part of the case, the court holds that the trial court erred in limiting R's recovery against K to the present value of the 0%, ten year note on the Berkeley property. Instead, the court holds that the new $515,000 note, not the earlier note, was the obligation that existed at the time that K acted to deprive R of priority. Further, the deed of trust securing that note had a "due on sale clause" that was triggered when the San Francisco property was foreclosed by the first lienholder. At that time, had R been properly secured, R would have been covered for the complete amount of the $515,000 lien, and that was the amount which K now had to pay.

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 Stacy Walter at the ABA. (312) 988 5260 or stacywalter@staff.abanet.org

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. The same is true of all commentary provided by contributors to the DIRT list. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA. Parties posting messages to DIRT are posting to a source that is readily accessible by members of the general public, and should take that fact into account in evaluating confidentiality issues.