What Happens If a Real Estate Agent Fails to Disclose Property Defects?

As mortgage rates remain historically low and more people buy homes, it’s important that agents know their responsibilities to buyers in disclosing property defects. Non-disclosures are common — from not disclosing a previous history of carpenter ants to “forgetting” that an oil tank is under the property — it happens all the time. Virtual home touring, which is done more and more frequently, often compounds the risk of property defects going undisclosed. Long-distance buyers rely even more on their real estate agents to be their eyes, ears, and even nose. (Can you smell the pig farm located a mile away?)

Litigation often results when a home buyer is not informed in writing of a material defect in the residence. Defects are material if they affect the value or safety of the home; for example, structural weaknesses in the floor covered by carpet, lack of access to the public sewer system, location within a flood zone, or an undisclosed feature — say a “closed” underground heating oil storage tank.

Non-Disclosure: Misrepresentation & Concealment

Before looking at real cases, it’s important to understand an agent’s legal duties.

State laws on the subject may vary, but in general, making an inaccurate statement in a real estate disclosure, even without intending to do so, can lead to lawsuits and state disciplinary actions. Even an innocent transposition error, such as writing that the roof is 13 years old when it’s actually been in place for 31 years, will be alleged to be misrepresentation in the complaint filed by the buyer/plaintiff. Concealment is failing to report a material defect; misrepresentation is reporting incorrect information regarding a defect or potential defect. Either is a basis for a lawsuit alleging negligence and fraud.

The seller, seller’s agent, and buyer’s agents have duties to disclose material defects to the buyer.

• The seller must disclose all known and openly obvious defects, or else they risk the sales contract being rescinded (i.e., voided) and being held liable for the buyer’s consequential damages.
• Under California law, the seller’s agent has higher responsibilities and owes a fiduciary duty to both seller and buyer. This elevated standard exists because the seller’s agent is in the best position to arrange for needed inspections for pests, structural issues, and building code compliance.
• The buyer’s agent owes no duty to the seller or seller’s agent and has no duty to personally inspect the house beyond what a visual inspection reveals but has a fiduciary duty to the buyer to disclose to the buyer all material defects known to the agent.

When an agent has a “fiduciary” duty, this means the agent has an obligation of faithfulness (sometimes called “fidelity”) in favor of the person to whom the duty is owed. Faithfulness means putting the client’s interests ahead of the agent’s. Other fiduciary duties require disclosing all material information and protecting the client’s confidential information.

In every transaction involving an agent — property, insurance, or talent, for example — there is a potential for conflicts of interest. When both seller and buyer are represented by agents who are employed by the same brokerage firm, the potential for a conflict is greater. Some states require that a separate disclosure must be made to both parties and approved by them in writing. Even when the seller’s and buyer’s agents have no business relationship, both have an economic interest in closing sales: no sale means no commission. Agents should not give in to the temptation to omit or downplay a material defect in a property for fear that it will be a deal-killer. Losing a sale is less costly than defending against a lawsuit or a regulatory or ethics grievance.

Of Chipmunks, Maps, & Water

How do these legal principles affect real estate agents’ daily lives? Here are three interesting cases. (The names have been changed.)

1. The Map: Arthur bought a house with acreage in Northern California, consisting of two adjoining parcels. The county’s Map Act required that parcels be consolidated before they were sold in a single transaction, but that didn’t happen. According to Arthur, his agent never told him about the Map Act issue. After the sale, Arthur sued the seller, Beth. In turn, Beth filed a third-party complaint against Arthur’s agent, in addition to her own agents.
2. Water Damage: Ben and Carol bought a large house in a semi-rural area from a seller, who obtained title to the house through Carol’s father’s family trust after he passed away. The seller did not disclose to Ben and Carol that the water source to their house was not from the main municipal water system but on a parallel irrigation system, making the water non-potable. The couple had to use bottled water for drinking and cooking. Ben and Carol sued the seller, seller’s agent, and later added their own buyers’ agent to the lawsuit.
3. Chip or Dale? Howard, an urbanite, wanted to buy a second house near Lake Tahoe for respite from big city life and for ski trips. He found a real estate agent in the area, Theresa, who was employed by the same brokerage firm as Constance, whose client owned a high-end log house on acreage. After Constance posted the property on the brokerage firm’s white board, Theresa notified Howard, who visited the house one time and quickly purchased it. But all was not well in paradise. After returning to the house, Howard smelled something amiss. He sued, claiming the house was infested by chipmunks (though none were seen) and that the insulation between the logs and the walls was soaked with chipmunk urine, making the house uninhabitable.

These are not everyday claims, but they illustrate some of the defects that don’t appear on most standard disclosure checklists. (In 40 years of legal practice, I have not seen a chipmunk urine disclosure form, though “infestations” are routinely listed.) In each instance, the buyer sued everyone in sight (agents, inspectors, and sellers), alleging negligence, fraud, and statutory violations, and seeking damages in the mid-six-figures.

These unusual disclosure scenarios follow the same rules as the more typical hidden-defect claims. Assuming that the agents knew the alleged conditions existed, lawsuits could have been avoided by including the defects in certified letters, emails that provide proof of delivery, or including the defect in the “other” category on the standard disclosure form.

In a rising housing market, buyers may overlook or excuse small undisclosed defects. No house is perfect, after all. In a declining market, the same buyers may be more likely to conclude that material facts were withheld by their agents. “I may have made a bad decision,” becomes “I bought a bad house from an unscrupulous broker.”

Takeaway Tips

Here are three takeaways to help agents avoid litigation landmines in residential real estate disclosures:

1. Agents should know and understand the duties imposed on them under the law of each state in which they practice. The California Department of Real Estate has a clearly written brochure on this subject, as do other state regulatory bodies.
2. If there is any question as to whether a known defect should be disclosed, agents should always err on the side of disclosing it– and describing it accurately.
3. Real estate agents can’t disclose what they don’t know. Visual inspections are essential to protect home buyers. If they are performed with reasonable care, inspections can protect the agents, too.

Yes, the times and the market are changing. That does not mean we can be any less vigilant in discovering and disclosing defects, including unseen chipmunks.

Want to learn more about how E&O insurance can help you protect your career — and even your business? Call us at 855-209-2555 to speak with one of our licensed agents today!

Image courtesy of iStock.com/DNY59

Last updated on Jul 24, 2024.
Originally published on Feb 05, 2021.

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