Legal Briefs

Broker Beware of Changes in Buyer Beware

Anyone involved in the commercial real estate business even 20 years ago knows that a basic tenet of doing business historically has been caveat emptor—let the buyer beware. Simply stated, this doctrine puts the burden of evaluating the quality and value of a property on the real estate buyer.

Although caveat emptor does not protect the seller or broker who has committed fraud, for the most part, it has not required a seller or broker to volunteer information, even when it might be extremely material to a purchaser’s informed decision-making process.

Recent decades have seen severe inroads into the doctrine of caveat emptor in residential real estate. Federal, state, and/or local laws now require sellers, and often brokers, to disclose myriad matters, from the existence of lead paint to the location of airplane flight paths—and residential real estate contracts approved by local real estate boards are rife with disclosure.

Indeed, in the residential real estate business, the game has changed from buyer beware to seller beware, and disclosure of even minute matters or remote risks often is viewed as the best insurance against potential lawsuits. Although commercial real estate has been less prone to such actions, recent cases indicate this may be changing.

Legal Precedents
In a 1992 Alabama case, Real Estate Financing v. Resolution Trust Corp., Investment Group Mortgage Co. had represented a subsidiary of the Resolution Trust Corp. (RTC) in the sale of a pool of mortgages in 1988. The broker’s offering package contained what was determined to be an innocent, but important, error: the anticipated servicing fees that the purchaser could expect to earn were described as net of mortgage insurance costs, when indeed, the numbers were gross figures, thereby materially overstating anticipated servicing income.

The purchaser was experienced in mortgage pools and its executive vice president had six years of experience in buying, selling, and analyzing mortgage portfolios. Nevertheless, the error was not discovered until after the purchase contract had been signed. The RTC and the broker argued that there was no fraud—merely an innocent mistake—and that as a sophisticated purchaser, the plaintiff could not have placed "justifiable reliance" on the information given.

However, interpreting Alabama’s unintentional fraud law, the U.S. Court of Appeals for the Eleventh Circuit found that although there was not intentional fraud, under the standard for "justifiable reliance," the "plaintiff, given the particular facts of his knowledge, understanding, and present ability to fully understand the nature of the subject transaction and its ramifications, has not justifiably relied on the defendant’s representation if that representation is one so patently and obviously false that he must have closed his eyes to avoid discovery of the truth."

The U.S. District Court for the Middle District of Alabama, true to the concept of caveat emptor, had found that a party "closes its eyes" whenever it fails to investigate the veracity of any representation. The Eleventh Circuit, however, ruled that whereas the old standard placed burden on the buyer, the "new standard of justifiable reliance places a burden on the party making the statement—the burden of knowing the truthfulness of a statement" and that instead of "let the buyer beware," the standard is becoming "let the liar beware."

In a 1998 California case, In Re King Street Investments, Inc., Jim and Alice Porsche, their daughter, and a friend had loaned $138,000 to Craig Pilgrim in 1992, which increased a previous $87,500 loan made a year earlier to acquire a parcel of commercial land in Lafayette, California. The mortgage broker’s agent originally gave the lenders a third-party appraisal for the property showing a value of $205,000 and later advised the lenders to accept a deed in lieu of foreclosure when the borrower defaulted, because the property was "worth a lot more than [they had] invested in it." Traditionally, statements about value cannot be relied upon to show fraud or misrepresentation. But the U.S. Bankruptcy Appellate Panel of the Ninth Circuit Court of Appeals not only found such action to be constructive fraud, but also found that the broker had a fiduciary duty to investigate material facts and to verify information (or disclose the lack of verification). Stretching the concept to the limit, the court (apparently swayed in part by the fact that the broker did not affirmatively suggest to the clients that they get an attorney or appraisal specialist) noted that the "reliance element is relaxed in constructive fraud" so that reasonable reliance is assumed "absent clear evidence of lack of reliance."

In Florida’s 1991 case, Sun Bank, N.A. v. E.F. Hutton & Co., Inc., the Eleventh Circuit ruled against a stockbroker and others for overstating to a lender the net worth of a commercial borrower, saying that a recipient of a false misrepresentation may rely on it unless its "falsity is subjectively known or obvious to" the recipient.

In Texas, the demise of caveat emptor has been brought about by statute. In Henry S. Miller Co. v. Bynum, the Texas Court of Appeals in 1990 found that a commercial leasing agent violated the state’s Deceptive Trade Practice Act by telling a prospective tenant that the shopping center in which the tenant ultimately leased space was "first class" and "almost fully occupied." On appeal, the court found that the statute applied to the broker’s statements, whether or not the broker knew of their falsity and without regard to whether the tenant easily could have ascertained the truth or falsity of those statements.

But many—and perhaps most—jurisdictions have not yet abandoned caveat emptor. In New York, for example, in the 1993 case Simms v. Biondo, the plaintiffs purchased a development parcel on Shelter Island. After defaulting on their commercial loan, they brought suit, alleging that the broker misrepresented the property’s value. The U.S. District Court for the Eastern District noted that not only were the representations of value not actionable under a fraud or misrepresentation theory, but that caveat emptor applies in real estate transactions in particular, and a buyer "has a duty to satisfy himself" as to the bargained-for price absent a scheme of deception.

Broker Beware
Despite the prevailing continuance of caveat emptor, developments in California, Florida, and other jurisdictions make it clear that not only must the buyer beware, but increasingly, so also must the commercial real estate broker beware.

Samuel H. Weissbard, JD, and Camellia K. Schuk, JD

Samuel H. Weissbard, JD, is senior counsel and Camellia K. Schuk, JD, is an associate in the Irvine, Calif., office of Cox, Castle, & Nicholson, LLP. Contact them at (949) 260-4600 or sweissbard@ccnlaw.com and cschuk@ccnlaw.com.The discussion of legal issues in this column is for informational purposes only. Results may vary depending on state laws and individual circumstances.

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