Is a buyer agent's duty to a buyer to discover latent defects higher than a subagent's duty of reasonable care?

I. As subagents, cooperating brokers do not owe fiduciary duties to a buyer.

During the early 1990s the National Association of REALTORS® abandoned what had been the bedrock of its professional standards and multiple listing policies: the legal relationship between a listing broker and a cooperating broker is presumptively a subagency relationship unless the cooperating broker had created an express agency relationship with the buyer. Under traditional common law, a "subagent" is an "agent of an agent." The subagent owes fiduciary duties to the primary agent who delegated authority to the subagent and to the primary agent's principal. In a real estate brokerage context, a subagency relationship between a listing broker and the cooperating broker results in the cooperating broker owing fiduciary duties to the listing broker and to the listing broker's client, the seller. The buyer is not "represented" to the extent that being "represented" means having an agent that has assumed fiduciary obligations to the buyer.

II. If a cooperating broker is a subagent, both the listing broker and seller can be held vicariously liable for the cooperating broker's errors or omissions.

While a buyer is not "represented" if a subagency relationship exists between a listing broker and a cooperating broker, a buyer could hold both a listing broker and a seller vicariously liable for any tortuous acts or omissions committed by a cooperating broker. This would not be true if the cooperating broker is the buyer's fiduciary agent.

Under traditional common law, a principal is vicariously or strictly liable for the actual damages caused by the torts of an agent committed in the course of the agent's performance of duties for the principal. A cooperating broker acting as a subagent has two principals, the listing broker and the seller. These two principals are liable to the buyer if the cooperating broker commits a tort that causes damage to the buyer, such as misrepresenting a material fact, or knowingly failing to disclose a material fact. Both of these examples constitute either negligent or intentional misrepresentation under the common or statutory laws of nearly every state.

Thus, an "unrepresented" buyer potentially has three entities to sue if a cooperating broker materially misrepresents the condition of a property: the cooperating broker for his own tortious conduct; and the listing broker and the seller who are vicariously liable for the torts of their subagent. On the other hand, if the cooperating broker is the buyer's agent, the listing broker and the seller do not assume any vicarious liability for the cooperating broker's conduct.

III. Agents of the seller do not owe the buyer a fiduciary duty to promote the buyer's interest.

As agents of the seller, the cooperating broker and listing broker do not owe the buyer any fiduciary duties of undivided loyalty to promote the best interests of the buyer. They merely owe the buyer a duty to conduct themselves in a reasonable manner so as not to cause harm to the buyer's interests. This is the same "duty of reasonable care" that the common law of torts imposes upon all persons in our society to conduct themselves in a manner that does not expose others to unreasonable risks of harm to their person or property.

There is well developed common and statutory law in most states that defines when a real estate broker or agent representing a seller is liable to a buyer under a theory of negligent misrepresentation or fraud for misrepresenting or failing to disclose a material condition of the property. In most states, a broker may, without assuming liability, repeat to a buyer any representations made by a seller about the property so long as the broker does not have reason to believe that the seller's representations are not accurate. Also, it is the law in most states that brokers are not liable to buyers for failing to disclose a material defect in a property unless there is evidence to show that the broker knew of the undisclosed defect prior to the buyer's execution of a sales contract.

In many states, brokers do not even have a duty to conduct an inspection of a property to discover defects prior to offering the property for sale to the public. Many states also exclude from the torts of fraud or negligent misrepresentation any misrepresentations or omissions about matters of law (zoning requirements), facts that are on the public record (tax assessments or recorded easements), statements about events that will occur in the future (income projections) or expressions of opinion (estimates of market value or appraisals).

Under the law of torts, and particularly the law of negligence liability, all persons owe a duty not only to act reasonably to protect others from harm, but also to act reasonably to protect one's own person or property. As a result, real estate buyers have a duty to themselves to take reasonable steps to protect the safety and integrity of their own real estate investments. Therefore, when a real estate broker is sued for tortious conduct, the broker is entitled to raise affirmative defenses of the plaintiff's own contributory negligence or assumption of the risk.

IV. A fiduciary owes a higher duty of care to a client than merely to avoid causing the client harm.

The fiduciary duties that agents owe principals are, however, much higher than the duty of reasonable care not to cause harm that the common law of torts imposes in general on all persons. Fiduciaries are instead obligated to take affirmative measures to advance their principals' interests to the exclusion of all other interests, including the agents own interests.

The following hypothetical real estate transaction illustrates the difference between the duties owed by a fiduciary to his principal and the lesser duties of persons dealing at "arms length." A listing broker lists an older house for sale, and the seller tells him that the basement leaks water after rainstorms. The listing broker does not know, and the seller does not reveal, the cause of the leakage. A young couple who have never owned a home are interested in the house because it is in their child's elementary school district. The young couple are represented by a buyer's agent.

The listing broker discloses, as he must, to the buyers and their agent that the basement leaks after rainstorms. The listing broker does not, however, speculate or opine to the buyers or their agent about the cause of the water infiltration, which could be clogged gutters, a malfunctioning sump pump, poor exterior drainage, or a serious structural defect in the foundation.

The buyers' agent, upon receipt of the listing broker's disclosure about the leaking basement, simply tells the buyers that "basements in older houses often leak." The young couple buys the house because it is the only house in their price range that is within walking distance of their child's elementary school. Two months later, the buyers decide to replace the paneling on the basement walls. Behind the paneling is a large crack in the foundation wall one foot above the floor. A structural engineer determines that the house was built over an underground stream. The underground water flow has destabilized the foundation causing it to crack. The cost of minimum repairs necessary to prevent further foundation damage equals thirty percent (30%) of the purchase price.

The buyers sue the seller and listing agent for fraud due to failing to disclose the structural damage to the foundation. They also sue their agent for fraud and breach of fiduciary duty.

After pretrial discovery, all defendants move for summary judgment. The court dismisses the buyers' claims against the seller because the buyers could not adduce any evidence that the seller knew of the structural damage. On the other hand, the seller introduced evidence that the basement walls were paneled when he bought the house three years earlier.

The court also granted the listing broker's summary judgment motion. The court noted that the listing broker told the buyers that the basement leaked water. The court held that, as the seller's agent, the listing broker simply owed the buyers a duty to disclose known material defects, which the broker did when he disclosed the water leak in the basement. The listing broker did not owe any duty to investigate the source of the leak for the benefit of the buyer.

The court refused to grant the summary judgment motion of the buyers' agent. However, the court did dismiss the buyers' fraud claim against the buyers' agent because the buyers could not produce any evidence that the buyers' agent knew of the preexisting structural damage. But the court allowed the buyers to proceed with their breach of fiduciary duty claim. The court rejected the agent's reliance on the numerous cases holding that a broker is not liable for failure to disclose defects in a house unless the agent has actual knowledge of the defects. The court observed that the cases cited by the broker were all tort cases decided on a theory of negligent misrepresentation or fraud. None of the cited cases involved claims by a buyer against a buyer's agent for breach of fiduciary duty.

Despite the fact that the inspection could not have revealed the structural damage, which was hidden by the basement paneling, the court deemed irrelevant the agent's claim that he conducted a careful visual inspection of the property as required by law. The court stated that the agent's potential breach of fiduciary duty was not his failure to conduct an adequate visual inspection. Rather, it was the agent's failure to give adequate advice and counsel to the buyers once the buyers and the buyers' agent learned that the basement leaked.

The court noted that the buyers' agent owed the buyers a higher duty than merely to disclose known defects. The buyers' agent owed the buyers a fiduciary duty to promote their best interests. Upon learning of a condition that could be a symptom of a more serious defect, a reasonably competent buyers' agent acting consistently with his fiduciary duty would have advised the buyers to secure a third party professional's report diagnosing the cause of the leakage, and the cost to correct it, before binding themselves to close the transaction. Depending on the content of the report, the buyers' agent might also be obligated to advise the buyers not to buy the property because of the potential risk of a serious defect requiring significant sums to repair.

The buyers' agent in this case could not document that he gave any advice and counsel to his buyer clients other than to observe that "basements in older houses often leak." Accordingly, the court allowed the buyers to proceed with their breach of fiduciary duty claim against the buyers' agent. The court directed that the case be tried on the issue of whether the broker satisfied his duty to counsel the buyers about the potential significance of the water leakage in the basement of the property.

This hypothetical transaction is meant to illustrate how buyers' agents may be acting at their peril if they assume that they need only observe the same standards as listing brokers and sellers with regard to the disclosure of material defects in a property. At least one court has held, however, that this peril may be more than hypothetical.

V. California court of appeals holds that buyers' claims against their agent will be judged under a fiduciary duty standard rather than negligence standard.

A California appellate court held in the Spring of 1998 that claims by buyer clients against their real estate agents should be measured against a fiduciary standard rather than a negligence or fraud standard. The specific issue before the appellate court was the appropriate statute of limitations that would be applied to the buyers' claims against a buyers' agent for damages suffered when they purchased a home with an easement that was more intrusive than represented, and with acreage substantially less than represented.

The buyers were represented exclusively by a real estate broker in their acquisition of the property at issue, which closed in 1988. In September of 1992, the buyers sued their broker as well as the listing broker and seller for damages as a result of the misrepresented easement and acreage. The seller and listing broker settled the buyers' claims before trial. The buyers later filed an amended complaint against their agent asserting negligence, negligent misrepresentation and breach of fiduciary duty.

The agent defended on the ground that the buyers' claims were barred by the limitations period in the California statute that obligates listing and cooperating brokers to conduct a visual inspection of marketed property for the benefit of potential purchasers. That statute requires that claims be brought within two years after the buyers take possession of the property. However, the California statute of limitations applicable to claims for breach of fiduciary provided that the limitation period runs from the time the plaintiff discovered, or should have discovered, the breach of duty. In the case at hand, the buyers' claims would not be time barred if the limitation period ran from the date they "discovered" the misrepresentations rather than the date of closing.

The court of appeals held that the statute of limitations applicable to breaches of fiduciary duty applied to the buyers' claims, rather than the limitations period in the statute imposing a duty to inspect property offered for sale. The court concluded that the fiduciary duty of a real estate broker exclusively representing a buyer to investigate facts and counsel a buyer client is independent of any duty imposed by the statutory or common law of California upon listing and cooperating brokers to conduct a reasonable visual inspection of property for the benefit of a buyer.

The court observed that the California statute requiring the visual inspection of property by listing and cooperating brokers expressly excludes any duty to investigate public records, building permits, title records, or areas of the property that are reasonably and normally inaccessible to an inspection. The court noted that the inspection contemplated in the California inspection statute is a non–fiduciary duty imposed upon real estate brokers for the benefit of unrepresented buyers. According to the court, a fiduciary duty is "substantially more extensive."

Quoting from a previous decision that outlined the scope of a real estate broker's fiduciary duties, the court of appeals stated that "[t]he broker as a fiduciary . . . is expected to perform necessary research and investigate in order to know those important matters that will affect the principal's decision, and he has a duty to counsel and advise the principal regarding the propriety and ramifications of the decision." The court declared that this fiduciary duty includes a duty to investigate public records and advise the client of the significance of the information discovered, which is a duty expressly excluded from the scope of the California statute requiring a visual inspection of property.

The court of appeals also rejected the buyer agent's claim that the use of the term "cooperating broker" in the inspection statute is evidence of the legislature's intent to limit a buyers' agent's responsibility to a client to the relatively minimal inspection defined in the statute. The court held that a "cooperating broker" means a broker acting in "cooperation with" the seller's broker. It does not mean a broker exclusively representing a buyer in the buyer's search for appropriate property to purchase.

This case can be found at 63 Cal.App. 4th 18, 73 Cal. Reptr. 2d 784 (4th Dist. 1998).

VI. Conclusion.

The organized real estate industry's rush to repudiate subagency relationships in favor of buyer agency status for so–called "cooperating brokers" may have the unintended consequence of greatly expanding the duties and liabilities of cooperating brokers. This potential for expanded liability for cooperating brokers is most severe in claims by buyers arising from undisclosed negative attributes of the acquired property, which represent the vast majority of all claims asserted against real estate brokers and agents. When both listing and cooperating brokers represented the seller, both brokers' liability to buyers for undisclosed defects was defined by traditional standards of fraud and negligence. Yet, as the California court of appeals made clear, fiduciary duties owed to buyers are much higher.

These fiduciary duties can encompass a duty to conduct affirmative investigations of public records and other information sources, and to counsel and advise a client about the actual or potential significance of facts discovered by an investigation, as well as facts that are disclosed by the seller or listing broker. As the California court of appeals further held, cases and statutes defining the non–fiduciary duties of real estate brokers to buyers will not necessarily be applicable to agents assuming fiduciary duties to buyer clients. The precise scope of a broker's fiduciary duty to investigate a transaction, and counsel a buyer client, is yet to be defined in the statutory and case law of most jurisdictions. Accordingly, real estate brokers, in consultation with their attorneys, should consider the scope of the fiduciary liability of buyers' agents when deciding upon the appropriate agency policy to adopt for their firm.

Please note that the comments and opinions contained herein are not to be construed to be legal advice by the author, Victor O. Schinnerer & Company, Inc., or the Schinnerer errors and omissions insurance program.

This information is made available to you for your risk management program. No action should be based on this information without appropriate advice from legal counsel and a review of currently applicable statutory and case law.

This article from the Risk Management Reporter, October 1998, was written by Robert D. Butters of the law firm of Arnstein & Lehr, which concentrates in the representation and defense of real estate brokers and agents