The Upside of Being Upfront: New Case Illustrates the Benefits of Disclosing Defects

August 28, 2014Article

We have written before about the importance of disclosing potentially negative facts, and that doing so can help protect a broker from liability. A new case from the California Court of Appeal illustrates that, even if disclosure is not required by law, providing all available information about possible problems can earn a broker both a relatively quick dismissal of litigation and an award of attorney fees.

In Peake v. Underwood, Joanne Peake purchased a house from Marviel and Deanna Underwood. After the purchase, Peake alleged that she learned that the subfloor was rotting when her son’s foot went through the floor.

Peake filed a lawsuit against the Underwoods and their real estate agent Paul Ferrell, alleging that they failed to disclose the deteriorating subfloor. After Peake dismissed her suit against the Underwoods, she pursued her claims against Ferrell.

Peake alleged that Ferrell owed her an affirmative duty under California law “to fully and completely disclose all known material defects, failures and deficiencies.” She alleged that Ferrell breached this duty by failing to “conduct a competent and diligent inspection” and “disclose information about the true condition of the [residence] including water damage” that Ferrell knew or should have known.

After filing the lawsuit, Ferrell’s counsel sent Peake several emails explaining that Peake’s claims were legally and factually deficient because Ferrell, the seller’s agent, did not owe Peake an affirmative duty to disclose unseen defects. Ferrell’s counsel warned that Ferrell would seek sanctions if Peake did not dismiss her claims. Despite these warnings, Peake proceeded with the lawsuit.

Ferrell’s counsel filed a motion for sanctions against Peake. Ferrell submitted evidence showing that, although the Underwoods represented they were not aware of any issues with the subflooring, only they, and not Farrell, made this representation. Ferrell also submitted evidence showing that he had disclosed to Peake a “soft spot” in the subflooring. Finally, Ferrell submitted evidence showing that (1) he had provided Peake with reports detailing decay in the subflooring, and (2) Peake was aware during escrow that the house had drainage issues.

Ferrell’s motion for sanctions gave Peake one last opportunity under California law—known as a “safe harbor” period—to dismiss her claims. She refused to do so.

The trial court agreed with Ferrell that Peake’s claims were factually and legally frivolous. The court found that Ferrell supplied Peake with reports revealing the decayed subflooring, and that he did not owe any additional inspection disclosure duties under California law. The court also found that Peake’s continued pursuit of her claims against Ferrell was in “bad faith.” As a result, the trial court dismissed Peake’s claims against Ferrell and ordered Peake and her attorney to pay Ferrell $60,000 as reimbursement for his attorney fees.

Peake and her attorney filed an appeal challenging the sanctions, arguing that Ferrell should have “red-flagged” the subflooring issue.

The appellate court rejected this argument and affirmed the trial court. The court held that, under California law, Ferrell was only required to disclose visible defects, and that the defects in the subflooring were not visible. The court further noted that Ferrell went beyond these duties by disclosing problems with the subflooring to Peake.

This case underscores two important principles. First, under California law, a seller’s agent’s duties to the buyer are limited to disclosing visible or known defects. Second, even though a seller’s agent’s duties are limited, going beyond the bare minimum by affirmatively disclosing possible non-visible defects can have important benefits if litigation ensues. Ferrell probably would have eventually prevailed if he had stayed silent about the rotted subflooring. But by affirmatively disclosing the defect, he earned himself a quick dismissal of the case, along with reimbursement of his attorney fees.