Daily Development for Wednesday, August 3, 1999

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

CONSTRUCTION; APPRAISALS: A home purchaser is a third party beneficiary of agreement between purchaser's lender and an appraisal company the lender has retained to supervise construction draws, and purchaser can recover consequential and circumstantial damages when appraiser negligently monitors payments.

Vogan v. Hays Appraisal Associates, 588 N.W.2d 420 (Iowa 1999).

An appraisal company failed to monitor properly the progress of construction of plaintiff home purchaser's new home, and consequently triggered funds to be improperly released by the lender to the contractor, who later defaulted. The appraisal company, however, had not contracted with home purchaser but with the purchaser's lender. The lender was covered by its mortgage loan agreement with home purchaser, and thus was not pursuing appraiser for damages.

The Iowa Supreme Court, relying on Tredrea v. Anesthesia & Analgesia, P.C., 584 N.W.2d 276 (Iowa 1998), stated that "a third-party who is not a promisee and who gave no consideration has an enforceable right by reason of a contract made by two others . . . if the promised performance will be of pecuniary benefit to the [the third-party] and the contract is so expressed as to give the promisor reason to know that such benefit is contemplated by the promisee as one of the motivating causes of his making the contract."

The court found that where appraiser's performance was to have been of pecuniary benefit to borrowers, and the inspection reports issued by appraiser naming borrowers as home purchasers gave appraiser reason to know that lender's purpose in contracting for periodic inspection reports was to provide protection for money the borrowers had invested in the project, then the borrowers/home purchasers were third-party beneficiaries to the contract between the construction lender and the appraiser.

Finally, the court found that recovery by the borrowers/home purchasers from appraiser of sums advanced to contractor by the construction lender that were based upon the appraiser's faulty progress reports, was not beyond the appraiser's contemplation at the time it entered into the contract to provide the lender with progress reports, and thus recovery from the appraiser does not violate the rule of Hadley v. Baxendale, even though, due to cost over-runs, substantially more funds were advanced to the contractor then the amount of the original construction loan.

Comment: Obviously the case really is not a real estate case, but a contract law case in a real estate setting. Nevertheless, it is useful to contemplate the principles at work here, as in modern real estate transactions situations arise frequently in which a party expecting a benefit from one party is thwarted because that party expected to transfer the benefit is disserved by a third party.

Note that in this case the appraiser and the lender did not intend to confer a benefit on the purchaser through their contract. The purpose of the appraiser's work was to protect the bank's interest. To find liability here is a substantial dismantling of privity concepts and expands the potential liability of many service providers. Of course there was a close relationship in this case between the purposes of the contract between the appraiser and the lender and the benefit to the buyer. But the difference between this case and a myriad of other cases is only one of degree, and not of character.

How far can we go? If a closing agent botches a closing, thus leading to other pending sales being cancelled, is the agent liable not only to the parties to its closing, but to those suffering losses in the series of other pending sales? What about brokers or others who would derive fees from those closings? What if a home inspector negligently gives a bad inspection report, indicating flaws that really are not present, leading to cancellation of a sale agreement. Assume that the seller can recover, even though the inspector's contract is with the purported buyer. Can others suffering losses as a consequence of the blown sale also recover? Brokers? Pending sales (assuming the inspector knew or should have known of them?)

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