The Court of Appeal in Holmes v. Summer (2010) 188 Cal.App.4th 510} added to real estate broker’s duty to disclose in residential real estate transactions – known title defects and encumbrances.

In this case the buyers entered into a contract  purchased a home in Huntington Beach for $749,000, which they believed to be free and clear of all liens and encumbrances.  However, in fact the property was subject to three deeds of trust, with a total debt of over $1.1 million.  Neither the seller nor the listing agent advertised the home as a short sale.

Relying on the contract, the buyers listed their home for sale and incurred other damages.  When the buyers discovered the fact that the house was way under water when they received the preliminary title report during escrow. The buyer realized that clean title would not pass at the price negotiated by the parties.   Although the buyers were able to cancel the transaction, they demanded that listing agent reimburse their damages.  As to be expected, the broker refused.

The buyers sued the seller’s brokers for failing to disclose the fact that the property was in below deep water.  Although the trial court dismissed the case, the court of appeal reversed and  held that while the liens were public record, the amount of the encumbrance was not necessarily obvious and the $392,000 shortfall was serious enough to make the property undesirable. The court holding was an extension of the duty of both sellers and seller’s brokers to disclose facts that materially affect the value or desirability of the property, when those facts are unknown to a reasonably diligent buyer.

The brokers argued that the buyers were not diligent, and should have done a title search before making an offer on the property. The court dismissed this argument for two reasons. First, while a title search may have disclosed the three deeds of trust, it likely would not have disclosed the $1.1 million total balance on those deeds. Second, the court said that it is not typical for a residential purchase for the buyer to perform a title search; rather, a preliminary title report is usually provided to the buyer.

The brokers also argued that disclosure in this case would have violated their duty of confidentiality to the seller. The court noted that disclosure of the current loan balances may invade the seller’s personal and confidential financial information. However, the existence of the three deeds of trust was “a matter of public record.” The brokers knew that the deeds made it almost impossible for the seller to deliver title free and clear. This, the court held, was what the brokers had a duty to disclose.

With its holding, the court leaves real estate brokers with a delicate responsibility. Where a seller agrees to deliver title free and clear of all liens and encumbrances, the seller’s broker now has a duty to disclose to the potential buyer that liens and encumbrances do in fact exist on the property, even if those liens are a matter of public record. However, the broker cannot disclose the amount of those liens. Rather, the seller’s broker only has a duty to disclose that the existence of liens may make it impossible for the seller to deliver title free and clear.

The case arguably has implications outside of the context of recorded defects.  For instance, should the seller’s broker disclose that a view property in fact does not have any legal view protections?