California law requires real estate brokers and agents involved in the sale of residential real estate to disclose facts materially affecting the value or desirability of the property. In a recent case, Holmes v. Summer, the California Court of Appeal held that this obligation includes an obligation to disclose that the debt on the property so far exceeds the value of the property that it is unlikely that the property can be sold for the agreed upon purchase price.
The Holmes case arose from a transaction in which the buyers agreed to purchase a residence for $749,000. Unknown to them, the property was encumbered by three deeds of trust securing debt totaling $1,141,000. The seller and the seller’s real estate broker did not disclose that the property was so over encumbered. The buyers sold their existing home to enable them to complete the purchase. Only after selling their home did the buyers learn that the seller could not convey clear title because the encumbrances exceeded the purchase price. The buyers sued the seller’s real estate broker for failure to disclose the excessive encumbrances.
The court noted prior decisions found that real estate professionals were obligated to disclose matters beyond physical defects. For example, prior case law found an obligation to disclose neighborhood nuisances, a murder on the property, and conditions to the close of escrow.
The court also explained the policy rationale for holding real estate professionals liable for nondisclosure of encumbrances exceeding the sales price. If excessive liens are not disclosed, buyers become leery of the real estate market and real estate lenders waste resources processing loan applications for sales that will not close. Particularly in a down economy, the public benefits from having confidence that real estate transactions will close under the agreed terms.