DAVID J. WILLIS ATTORNEY
Copyright © 2014. All rights reserved worldwide.
Three Rules: Disclose, Disclose, Disclose
by David J. Willis, J.D., LL.M.
Sellers and buyers have different needs and motivations when it comes to the transfer of real estate. One area that is often an issue is property condition. Sellers typically want to make the transfer "as is" without warranties and with no obligation for repairs. Buyers, on the other hand, have an interest in acquiring property that is in the best condition for the price. They also want full disclosure of adverse conditions, defects, and needed repairs.
TREC promulgates a Seller’s Disclosure of Property Condition for use in residential real estate transactions (www.trec.state.tx.us/forms). This form (TREC OP-H dated 10-23-13) is filled out by the seller and attached to the TREC 1-4 contract. The form tracks section 5.008 of the Property Code which states:
5.008(a) A seller of residential real property comprising not more than one dwelling unit located in this state shall give to the purchaser of the property a written notice as prescribed by this section or a written notice substantially similar to the notice prescribed the his section which contains, at a minimum, all of the items in the notice prescribed this section.
The purpose of the Seller’s Disclosure is to make it clear what appliances, equipment, and features exist on the property; whether or not these items are working; if the seller knows of any defects or malfunctions in critical systems; if certain red-flag events like termite treatment, previous fires, or flooding have occurred; the need for repairs; and the existence of unpermitted additions, unpaid HOA fees, violations of deed restrictions, lawsuits, or conditions that "materially affect the health or safety of an individual."
Property Code section 5.008(e) provides that the requirement that a Seller’s Disclosure be provided does not apply to a transfer:
- pursuant to a court order or foreclosure sale;
- by a trustee in bankruptcy;
- pursuant to a deed in lieu of foreclosure;
- by a lienholder who has either purchased at a foreclosure sale or a sale pursuant to a court order or accepted a deed in lieu of foreclosure;
- by a fiduciary in the course of an administration of a decedent’s estate, guardianship, conservatorship, or trust;
- from one co-owner to one or more other co-owners;
- made to a spouse or to a person or persons in the lineal line of consanguinity of one or more of the transferors;
- between spouses incident to divorce, legal separation or a property settlement agreement;
- to or from a governmental entity;
- a new residence of not more than one dwelling unit that has not been occupied for residential purposes;
- of real property where the value of any dwelling does not exceed 5% of the value of the property.
If the seller does not give the Seller’s Disclosure as required, Property Code section 5.008(f) permits the buyer to "terminate the contract for any reason within seven days after receiving the notice." However, if the failure to give the notice is coupled with fraud or failure to disclose defects, then other penalties may arise pursuant to the Deceptive Trade Practices Act and/or the Statutory Fraud Act.
For commercial transactions, the Texas Association of Realtors has a Commercial Property Condition Statement that is an optional attachment to its standard commercial contracts. Its scope is broader than TREC’s Seller’s Disclosure since it addresses additional issues such as wetlands, underground storage tanks, toxic waste, and the like. Although the form is optional in commercial transactions, a careful buyer should always require that the seller provide it. Note that this and other TAR forms are available only to realtors.
Purpose of Disclosure Forms
The intent and purpose of both the residential and commercial disclosure forms is the same: to induce the seller to disclose material conditions, circumstances, and defects. For some reason, however, the drafters of these forms saw fit to insert a statement at the top to the effect that the contents of the form do not constitute a warranty by the seller. The TREC Seller’s Disclosure states:
THIS NOTICE IS A DISCLOSURE OF SELLER’S KNOWLEDGE OF THE CONDITION OF THE PROPERTY AS OF THE DATE SIGNED BY SELLER AND IS NOT A SUBSTITUTE FOR ANY INSPECTIONS OR WARRANTIES THE PURCHASER MAY WISH TO OBTAIN. IT IS NOT A WARRANTY OF ANY KIND BY SELLER OR SELLER’S AGENTS.
The TAR Commercial Property Condition Statement reads:
THIS IS A DISCLOSURE OF THE SELLER’S KNOWLEDGE OF THE CONDITION OF THE PROPERTY AS OF THE DATE SIGNED. IT IS NOT A SUBSTITUTE FOR ANY INSPECTIONS OR WARRANTIES A BUYER OR TENANT MAY WISH TO OBTAIN. IT IS NOT A WARRANTY OF ANY KIND BY SELLER, SELLER’S AGENTS, OR ANY OTHER AGENT.
What is the point of these disclaimers? Is the seller making disclosures but then warning the buyer not to rely on them? Apparently so. At best, this is ambivalent legal drafting. It should be unsettling if not unsatisfactory from the buyer’s point of view. A careful buyer may consider negotiating inclusion of a clause which makes it clear that the seller is standing behind the truth of these disclosures. Buyers, commercial or residential, should seek to deny a seller any wiggle-room on the disclosure issue.
Ongoing Duty to Disclose
The Seller’s Disclosure does not in and of itself impose an ongoing duty to disclose matters that may come to the seller’s attention after the form has been signed and delivered to the buyer. Bynum v. Prudential Residential Servs., 129 S.W.3d 781,795 (Tex. App.–Houston [1st Dist.] 2004, pet. denied). Although this may be strictly true as it relates to the form, it would be unwise for a seller to withhold material adverse information that is subsequently discovered. There are too many statutory and common law avenues for an aggrieved buyer to pursue. Note that Article 1 of the National Association of Realtors Code of Ethics makes it clear that information about defects is not confidential. Disclosure of defects is in fact a duty for all members of the NAR.
Broker Liability for the Seller’s Disclosure
Accurately completing the Seller’s Disclosure is the responsibility of the seller, preferably in the seller’s own handwriting. The seller’s broker does not ordinarily become liable for the seller’s wrongdoing in this regard. A broker "would have a duty to come forward only if he had any reason to believe that the seller’s disclosures were false or inaccurate, and the only way he could be held liable for [the seller’s] statement in the notice is if it were shown to be untrue." Sherman v. Elkowitz, 130 S.W.3d 316, 321 (Tex. App.–Houston [14th Dist.] 2004, no pet.).
The Deceptive Trade Practices-Consumer Protection Act (DTPA)
Have no doubt about it: The DTPA applies to real estate transactions. The cases consistently declare that real estate is a consumer good within the meaning of the statute. See Chastain v. Koonce, 700 S.W.2d 579, 582 (Tex. 1985).
Business & Commerce Code section 17.46 declares that "false, misleading, or deceptive acts or practices in the conduct of any trade or business are hereby declared unlawful. . . ." Also expressly stated to be unlawful are misrepresenting the characteristics and uses of a particular item; representing that goods or services are of a particular quality and standard when they are not; advertising with intent not to sell as advertised; and failing to disclose information in an attempt to induce the consumer into buying.
Bottom line: failure by a seller to disclose material adverse conditions and defects is a violation of the DTPA.
Does it sound as though any of these complaints might form the basis of a lawsuit against a real estate investor? Count on it. But it does not end there. Section 17.50 adds breach of warranty and "any unconscionable action or course of action by any person" to the list. "Any unconscionable action?" Seriously? Statutory language does not get any broader or more potentially damaging than that. Investor sellers beware: If you fail to disclose a material item, a jury can find that your action was "unconscionable" (an open-ended term by any definition) and award treble damages, attorney’s fees, and court costs against you.
The Statutory Fraud Act (Tex. Bus. & Com. Code § 27.01) is another potential pitfall for sellers who fail to make full disclosure:
(a) Fraud in a transaction involving real estate or stock in a corporation or joint stock company consists of a
(1) false representation of a past or existing material fact, when the false representation is
(b) A person who makes a false representation or false promise commits the fraud described in Subsection (a) of this section and is liable to the person defrauded for actual damages.
(c) A person who makes a false representation or false promise with actual awareness of the falsity thereof commits the fraud described in Subsection (a) of this section and is liable to the person defrauded for exemplary damages. Actual awareness may be inferred where objective manifestations indicate that a person acted with actual awareness.
(d) A person who (1) has actual awareness of the falsity of a representation or promise made by another person and (2) fails to disclose the falsity of the representation or promise to the person defrauded, and (3) benefits from the false representation or promise commits the fraud described in Subsection (a) of this section and is liable to the person defrauded for exemplary damages. Actual awareness may be inferred where objective manifestations indicate that a person acted with actual awareness.
(e) Any person who violates the provisions of this section shall be liable to the person defrauded for reasonable and necessary attorney’s fees, expert witness fees, costs for copies of depositions, and costs of court.
(A) made to a person for the purpose of inducing that person to enter into a contract; and
(2) false promise to do an act, when the false promise is
(B) relied on by that person in entering into that contract; or
(B) made with the intention of not fulfilling it;
(C) made to a person for the purpose of inducing that person to enter into a contract; and
(D) relied on by that person in entering into that contract.
Observe the language in Coldwell Banker Whiteside Associates v. Ryan Equity Partners, 181 S.W.3d 879, 888 (Tex. App.–Dallas 2006, no pet.): "A misrepresentation may consist of the concealment or nondisclosure of a material fact when there is a duty to disclose. The duty to disclose arises when one party know that the other party is ignorant of the true facts and does not have an equal opportunity to discover the truth. A fact is material if it would likely affect the conduct of a reasonable person concerning the transaction in question." That is very straightforward language, as far as court opinions go.
Exemplary or punitive damages are available to plaintiffs who prevail. A plaintiff is entitled to recover exemplary damages in cases of statutory fraud if the false representation is made with actual awareness of the falsity of the representation. Hines v. Hash, 843 S.W.2d 464 (Tex. 1992).
The Statutory Fraud Act does not preclude a deceived buyer from filing suit on grounds of common-law fraud as well. In other words, the two causes of action can be pursued side-by-side. What is the difference? Read Trinity Indus. v. Ashland, Inc., 53 S.W.3d 852, 867 (Tex. App.–Austin 2001, pet. denied): "The elements of statutory fraud under section 27.01 . . . are essentially identical to the elements of common law fraud except that section 27.01 does not require proof of knowledge or recklessness as a prerequisite to the recovery of actual damages."
Any competent plaintiffs’ attorney will include as many causes of action as possible in his lawsuit against a nondisclosing seller. This is known as the "shotgun approach" and is designed to insure that, when the dust settles, at least some lines of attack will have found their mark.
Additional Liability for Real Estate Licensees
Agents and brokers who are also sellers need to be especially concerned about failing to make full disclosure. The Real Estate License Act ("RELA," found in Occupations Code section 1101.652), allows TREC to revoke or suspend the license of a broker or salesperson if the licensee is convicted of any offense involving fraud or engages in misrepresentation, dishonesty, or untrustworthy behavior. RELA section 1101.652(b)(3) provides that a licensee may be sanctioned for making "a material misrepresentation to a potential buyer concerning a significant defect, including a latent structural defect." Section 1101.652(b)(4) specifically adds failure to disclose a significant defect to the list. Accordingly, investors who have a real estate license have a heightened level of potential liability.
Suppose a broker fails to disclose an important item – for instance, that she is the mother of the seller. Does this void the earnest money contract? No, although the broker may be vulnerable to sanctions by TREC. Goldman v. Olmstead 414 S.W.3d 346 (Tex.App.–Dallas 2013, pet. denied).
Note that Goldman will likely not prevent a creative plaintiffs’ attorney from alleging that the licensee acted in conspiracy with the seller. Result? The broker must expend time and resources to defend against this charge. In the long run, licensees are always better off pursuing a policy of full disclosure that continues throughout the course of the transaction.
“As Is” Transactions
It is important to observe that the TREC 1-4 contract contains an optional "as is" clause, and the transaction becomes "as is" if the box at paragraph 7D(1) is checked. Problem is, not all "as is" clauses are equally thorough and effective (see below).
Here is the central question: Is it lawful to transfer property without disclosing material defects if the contract states that the transaction is "as is?" In other words, does use of the words "as is" or similar phraseology relieve the seller of the obligation to disclose? The answer, as is true in many areas of the law, is it depends–but probably not. And the risks involved in attempting to do so are significant.
The foundational case in this area is Prudential Insurance Co. v. Jefferson Associates Ltd., 896 S.W.2d 156 (Tex. 1995), which upheld "as is" clauses in certain narrow circumstances. Two things are critical if such a clause is to be upheld: the specific wording and whether or not the buyer obtained an inspection. Also, in evaluating an "as is" transaction, courts look not just at these two factors but at the totality of the circumstances. Note that if the buyer consults an attorney before agreeing to an "as is" clause then a court is more likely to find the clause enforceable. Courts dislike situations where the parties are unequally informed of their rights. For this reason, it is more likely that an "as is" provision will be upheld in a commercial rather than a residential transaction since commercial buyers are presumed to be more sophisticated.
In 2007, the Dallas Court of Appeals said the following with regard to "as is" transactions involving residences: "The nature of the transaction and the totality of the circumstances surrounding the agreement must be considered. Where the ‘as is’ clause is an important part of the basis of the bargain, not an incidental or ‘boilerplate’ provision, and is entered into by parties of relatively equal bargaining position, a buyer’s affirmative agreement that he is not relying on the representations of the seller should be given effect." Kupchynsky v. Nardiello, 230 S.W.3d 685, 690 (Tex. App.–Dallas 2007, pet. denied).
The commercial landlord-tenant case of Italian Cowboy Partners, Ltd. v. Prudential Insurance Co. of America, 341 S.W.3d 323 (Tex. 2011), involved lease of a restaurant with a history of chronic sewage odor. The landlord’s manager, who knew of the problem, fraudulently induced the tenant into a lease by orally declaring that the premises were in "perfect condition." Even though Italian Cowboy is a commercial lease case, it is likely that a similar theory of liability would be applied against a seller of residential property who made such false statements.
Willful Concealment and Fraudulent Inducement
The general take-away from this discussion is that an "as is" clause will not protect a seller in a case of willful concealment, and it will certainly be no protection if the seller engages in fraudulent inducement. Ritchy v. Pinnell, 357 S.W.3d 410 (Tex. App.–Texarkana 2012, no pet.).
Example? A seller knows that there is foundation settlement because of cracks in the sheetrock and floor tile. So the seller positions a picture over the wall crack and a rug over the cracked tile (willful concealment) and then goes on to tell the prospective buyer that there are no serious defects in the condition of the house (fraudulent inducement).
Determined "As Is" Sellers
What if a real estate investor is determined to sell "as is" and minimize any duty to disclose? In the residential context, of course, this is difficult because the Seller’s Disclosure is a required document. In commercial transactions, however, the situation is more fluid. Note, however, that an "as is" clause designed to comply with the standards of the Italian Cowboy case was upheld in Dragon Fish, LLC v. Santikos Legacy, Ltd., 383 S.W.3d 175 (Tex. App.–San Antonio 2012, no pet.), so a well-drafted "as is" clause is most definitely effective in Texas.
Paragraph 7.D of the TREC 1-4 contract states that "As Is" means the present condition of the Property with any and all defects and without warranty except for the warranties of title and the warranties in this contract." While useful, this definition may not go far enough to satisfy a cautious seller. A more effective seller-oriented "as is" clause would be:
SELLER SELLS AND BUYER UNCONDITIONALLY ACCEPTS THE PROPERTY "AS IS," IN ITS PRESENT CONDITION, WITH ALL DEFECTS, KNOWN OR UNKNOWN, PATENT OR LATENT, AND WITHOUT REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED. SELLER HAS NO OBLIGATION TO DISCLOSE MATERIAL FACTS INCLUDING DEFECTS OR ADVERSE CONDITIONS. BUYER AGREES. BUYER RELIES SOLELY ON BUYER’S INSPECTIONS AND OTHER DUE DILIGENCE IN EVALUATING PROPERTY CONDITION. ANY PRIOR ORAL OR WRITTEN STATEMENTS CONCERNING CONDITION OF THE PROPERTY, WHETHER MADE BY SELLER, SELLER’S AGENTS, OR THIRD PARTIES, ARE EXPRESSLY DISCLAIMED. NO REPAIRS, REMEDIATION, OR TREATMENT WHATSOEVER ARE REQUIRED TO BE PERFORMED BY SELLER. THIS "AS IS" CLAUSE IS A MATERIAL TERM BUT FOR WHICH THE SELLER WOULD NOT HAVE AGREED TO SELL THE PROPERTY TO BUYER. THE CONSIDERATION PAID FOR THE PROPERTY REFLECTS THE "AS IS" NATURE OF THIS CONVEYANCE. PROVISIONS OF THIS "AS IS" CLAUSE SHALL SURVIVE CLOSING AND SHALL NOT MERGE. IF BUYER IS UNCERTAIN ABOUT THE MEANING AND EFFECT OF THIS "AS IS" CLAUSE, THEN BUYER SHOULD CONSULT AN ATTORNEY. BUYER’S INITIALS: ________________.
The optimal "as is" scenario for a seller would involve (1) an effective "as is" clause in both the earnest money contract and the warranty deed, and this clause should be clear, unequivocal, and conspicuous (bold and capitalized); (2) language that goes farther than merely stating that the transaction is "as is" by clearly rejecting any duty of disclosure on the part of the seller; (3) neither the seller nor his broker making any assurances or promises (oral or written) relating to property value, use, or condition; and (4) the buyer signing the warranty deed.
The practical question, of course, is whether or not a buyer will be willing to accept such strict "as is" language. As is true with many contract terms, it may come down to price.
Is there a less onerous "as is" clause with which a buyer might feel comfortable? Yes, and it would probably consist of only the first sentence of the above provision.
"As Is" in the Real World
Generally speaking, "as is" transactions as a means of avoiding seller disclosure are problematic at best and should be avoided. No one, especially juries, likes a liar–whether the lie is by commission or omission. The best advice an attorney can give a seller is disclose, disclose, disclose. If an "as is" clause is going to be included in a contract, it should be in bold and all caps. The seller should get a real estate attorney to draft it.
Investor clients often ask, "Can they sue me if . . . ?" For lots of reasons, this is the wrong question, since anyone can sue anyone for anything and incur little or no liability for doing so, at least in this country. The better approach–since lawsuits are so very expensive–is to deter suits in the first place by being open and above-board.
Buyers confronted by a seller who insists on an "as is" clause while attempting to avoid disclosure should be suspicious. In such a situation, the best course of action for the buyer may be to walk away. Not every deal can or should be made. On the other hand, an "as is" clause combined with full disclosure by the seller may not be a problem so long as the buyer realizes that the he or she bears full responsibility for due diligence and should thoroughly inspect the property. Whenever a seller wants to include an "as is" clause in a sales contract, the buyer should respond by including a provision to the effect that such a clause does not relieve the seller of the obligation to disclose material conditions and defects. If the seller balks, then it may be time for an investor to look elsewhere for a deal.
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.
Copyright © 2014 by David J. Willis. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.