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Three cautionary tales of real estate agents successfully sued

By Tim O'Dwyer - posted Tuesday, 17 January 2012


Tale one (from New Zealand)

Consumer advocate Neil Jenman says treacherous "bird-dog" real estate agents, who locate deals for investors and speculators while still charging their sellers commission, should be busted "big time" – as ultimately happened to the agent in this first tale.

Warrenand Rose West's New Zealand home had been on the market for some time, but they received only one low offer despite reducing their price. Then they became motivated, if not desperate, sellers when they contracted to buy another home subject to selling their own. Their "window of opportunity for an advantageous sale" (as one judge subsequently put it) was limited, if they were to proceed with that purchase. So they quickly sold for $2.75 million, even though they felt their home was worth about $3 million.

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Five years, one court hearing and two legal appeals later Wests' selling agent, KiwiRealty,was ordered to pay them almost $1million for damages, interest, costs and refund of commission.

Wests had discovered, to their dismay, that within six months their buyer, Dave Dagg, on-sold through KiwiRealty to an overseas buyer for $3.555million. Admittedly Dagg made some improvements, conducted an aggressive international sales campaign in a rising market, but Wests felt betrayed.

They then sued KiwiRealty after dismally discovering further that its saleslady Jenny Spink had not revealed while handling their sale, that she knew Dagg often purchased properties to resell at a profit. Nor did she disclose KiwiRealty's ongoing "bird-dog" relationship with Dagg and, in particular, its involvement in several of his previous wheeler-dealing purchases and resales.

When Wests had asked Spink what she knew of Dagg, she said he had the means to buy but then lead these folk to believe he was purchasing their property for his own home. "He is looking for a place closer to his office", Spink deceptively explained.

The trial judge found that KiwiRealty failed to disclose material information to its clients. Such failure was misleading and deceptive, and consequently contrary to the Fair Trading Act and in breach of the Common Law fiduciary duties imposed on agents. Moreover, KiwiRealty's past Dagg dealings and the expectation of acting for him again (including re-selling this property) created a discloseable conflict of interest. Wests were awarded substantial damages and a commission refund of $67,000.

KiwiRealty's boss told a newspaper he was "floored" by the decision, would appeal and protested: "We believe we sold the property at the prevailing market price and do not believe we can be held responsible for what someone subsequently was prepared to pay for it".

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This was hardly the point and on appeal KiwiRealty was held liable again, although Wests' damages were reduced. Both sides appealed further - the agent against the liability findings and the sellers against their lower damages.

The final Appeal Court affirmed this "canvassing" agent's liability for disloyalty to its trusting clients, and re-instated damages to the difference between the then market value of Wests' home ($3.25million on a valuer's evidence) and Dagg's $2.75 million purchase price.

The Court highlighted the consequences when agents breach their fiduciary duties to clients.

Firstly commission will be forfeited, as it was here, if not earned "by good faith performance". When agents betray the trust reposed in them, the court explained, notions of "equity and conscience" apply. Hence forfeiture of commission is "a real deterrent to betrayal".

Secondly disloyal agents face being liable for "equitable" damages, and will be allowed "a narrow escape route for liability" only if clients' losses had occurred in any event without any breach of duty. Once a client suffers loss as a result of a fiduciary breach affecting the sale price, the measure of damages is the difference between that price and market value – as it was here.

Clients are entitled, the judgement continued, to the "single-minded loyalty' of their agents who must act in good faith; must not profit out of their trust; must not place themselves where their duties and own interests may conflict; and must not act for their own or a third person's benefit without clients' "informed consent". Failure to disclose material facts, objectively likely to impact on sellers' judgements, is a breach of agents' "duty of loyalty".

While Wests knowingly under-sold, KiwiRealty's culpable disloyalty concerned significant information about their prospective buyer. This undisclosed information would have been material to Wests' attitude to Dagg's offer and the possibility of attracting better offers from non-dealers genuinely wanting their house as a family home.

Tale two (from the United States)

"When agents negotiating a residential sale do not disclose that a property is so greatly over-unencumbered clear title almost certainly cannot be conveyed for the agreed price, the transaction is doomed to fail. The buyer is stung, and the market is disrupted. When properties made unsellable by their debt load are listed for sale without appropriate disclosures, and sales fall through, buyers become leery of the market while lenders extending those buyers credit waste valuable time processing useless loans."

These opening remarks by a Californian Appeal Court summed up the wider ramifications of the case before it where "stung" buyers, Josh & Kate Potter, were suing agent, Sally Fox.

Russ Mantan listed his home with Fox who then multi-listed it for sale at $799,000. After Potters saw the home on the internet they arranged an inspection with Fox. Potters liked the property, offered $700,000, Mantan counter-offered $749,000, Potters accepted and a contract was signed.

Unbeknownst to Potters, the property was encumbered by three mortgages: $695,000 was owing on the first, $196,000 on the second and $250,000 on the third – making a total debt of $1,141,000. The counter-offer did not mention these mortgages or that this was $392,000 less than the mortgage debt. Because Fox was aware the property was "over-encumbered" she later attempted to arrange a "short sale" whereby Mantan's lenders might accept lesser payments at settlement. However none of the mortgagees would agree to this. Meanwhile Potters sold their existing home so they could complete this purchase.

Since Manton could not settle without full mortgage releases, the contract fell over. Potters were considerably out of pocket, and sued Fox for damages alleging negligent misrepresentation and failure to disclose.

When the matter came to court, the Judge told Potters: "You've got a great lawsuit against your seller".

No matter that debt-ridden Mantan was, in the Judge's words, "basically judgment-proof".

Fox was not liable, as she had not breached any duty to disclose. Potters appealed.

The Appeal Court noted how Fox knew that any sale at $749,000 was doomed unless the lenders discounted their debts by $392,000, or Mantan found the cash. This was not "chump change," remarked the Court, for any lenders to forego or for any seller to "cough up."

Potters' case was that the magnitude of the mortgage debt affected both the property's value and desirability. Because Fox knew how much was owing (which they could not find out), she not only owed them a duty of disclosure but also, by her silence, effectively misrepresented the non-existence of impediments to the transfer of clear title.

Fox's lawyers argued that making this disclosure meant revealing confidential information. Moreover, the agent's duty to disclose material facts did not extend to financial information when the seller had agreed to sell free of monetary liens and encumbrances.

"The latter viewpoint misses the big picture," stated the Court judgement. Although a buyer may be harmed acquiring a property with undisclosed physical defects, a buyer may also be harmed by contracting when settlement is highly unlikely.

The main purpose of pre-contract disclosure, the judgement continued, is to protect buyers from "unethical" agents and sellers while ensuring sufficient accurate information is provided to make an informed decision to purchase: "An agent must exercise reasonable care to protect persons the agent is attempting to induce into entering a transaction for the purpose of earning a commission."

When an agent knows that mortgage debts exceed the sale price (requiring mortgagees' "shortsale" cooperation or the seller's making up the difference), the agent is obliged to disclose these circumstances so the buyer can inquire further before entering into a highly risky transaction.

Although the confidentiality duty to the seller must take into account the disclosure duty to the buyer, the Court saw a clear solution to any conflict between these duties: "Obtain the seller's permission to disclose relevant confidential information before the buyer enters into a contract." Any agent who proceeds without that consent does so "at the peril of liability should the transaction go awry due to the undisclosed risks involved."

The Court ruled for Potters, and found Fox breached her obligation "to disclose there was a substantial risk the seller could not transfer free and clear title."

Aussie agents beware, because the same legal principles apply here. In recent years more than a few buyers across Australia have similarly had purchases come unstuck because their sellers sold for less than what they owed. No local agents have been successfully sued yet but the time will come – especially if buyers are significantly disadvantaged and the agents knew about the extent of their seller clients' indebtedness.

And the final tale (from West Australia)

After architect Henry Thomas established his property development consulting business he heard of favourable development prospects in a distant coastal town. He soon visited there and met estate agent Ken Miller (whom he would later successfully sue for big bucks). Henry told Miller he was looking for a property suitable for unit development, and became interested in one which Miller showed him.

Before any contract was signed, Miller wrote a letter to assist Henry in obtaining finance.

With some 20 years local real estate market experience, Miller's letter described an almost "crisis situation in town with demand for quality units and town houses out-stripping supply." Henry did not proceed further because he could not secure finance.

On Henry's next visit, six months later, Miller showed him another property where the zoning permitted development up to four residential units. During a site inspection, Miller told Henry of a "huge void" at the top end of the market. He often got enquiries, he said, for "luxury top of the range units for investment and retirement", but none were available. There was always a shortage of quality units, he explained.

Pointing out this particular property's excellent views, Miller then suggested that Henry might prefer to build three larger high quality units there, rather than the maximum four. If three such units were built, he continued, they would fetch between $250,000 and $280,000 each. (OK, this all happened some years back when prices were much lower.) Needless to say, Miller had his beady eyes not only on the commission he would make on the sale of this property, but also on future multiple sales commissions when he sold the completed units after ensuring he got himself engaged for that purpose.

Henry took the bait and, after preparing sketches and preliminary profitability calculations, submitted an offer to purchase this property subject to finance.

After this offer was accepted, Miller agreed to write another letter to help with Henry's finance application. He began: "Having studied the plans for the three unit development, I am very excited with this project and predict a very enthusiastic market reception".

He again described a "large void" in the local market and said he was "constantly frustrated" by being unable to satisfy buyer demand for "quality units in prestige locations". Naturally enough, he was "delighted" to be responsible for selling this project (always his main game), was confident of complete success and his marketing plan would see all units sold within six months at prices from $250,000 to $280,000. This letter, together with a feasibility study, was attached to Henry's (subsequently successful) finance application.

The project did not proceed smoothly, with planning and engineering problems significantly increasing construction costs. Henry then had difficulties getting an increase in his overdraft. The consequent delays led to Henry's incurring substantial interest and bank charges.

By the time the units were completed the local property market had slowed dramatically. Miller commenced a marketing program, later described as "singularly unsuccessful", although the lack of sales was not attributable to the units themselves. They were well-designed, well-constructed and well-finished. An initial asking price of $295,000, agreed upon jointly by Henry and Miller, was a serious mistake which probably crueled the opening sales campaign.

Various unsuccessful campaigns were mounted to sell the units but, eventually, Henry's bank pressured him to go to auction. After one unit was knocked down for $175,000 and the other two sold soon after for $185,000 each, Henry sued Miller (all the way to the High Court) for damages for having breached Section 52 of the Trade Practices Act. Henry claimed the mega-amount he was worse off by embarking on the development.

Miller's pre-contract remarks were held to be misleading, deceptive and totally baseless. There had been no unsatisfied demand for quality units, no demand for units in the price range, no shortage of quality units in prestige locations and no "void". Miller had not undertaken any market research, and could not substantiate his representations.

However Henry had relied not only on Miller's misrepresentations but also on his own flawed feasibility study. If selling prices or costs had been accurately estimated, the result would have revealed a potentially unprofitable project which Henry would not have pursued without a sufficient margin of profit to justify the risk.

Was Miller still liable in these circumstances? Although the Trade Practices Act has been since amended in this regard, the High Court ultimately ruled that Miller could not escape or discount his liability on account of Henry's contributory negligence.

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(Each of these true stories – but with fictitious names used – first appeared in Tim O’Dwyer’s Real Estate Escapes column in Australian Property Invester Magazine.)



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About the Author

Tim O’Dwyer is a Queensland Solicitor. See Tim’s real estate writings at: www.australianrealestateblog.com.au.

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