Hello everybody. It has been many years since I have discussed the liability of a seller for misrepresenting the lot size of an apartment building to a buyer. For new readers and those who may have forgotten the law, permit me to again address the issue.
First, let me pose a common question, and answer it as well: DOES SIZE MATTER? It does if it pertains to LOT SIZE.
Imagine that the seller informs the buyer’s broker that the apartment complex sits on one acre of land. The broker then relays that information to the buyer, who, believing that property owners are honest and knowledgeable, relies on the information when purchasing the property for $5,000,000.
Imagine further that the property was only three-quarters of an acre, but still had a fair market value of $5,000,000. Finally, assume that if the property consisted of a full acre, it would have been worth an additional $500,000, that is: $5,500,000.
Shortly following the close of escrow, the buyer discovers from his surveyor that the property was one-quarter acre less than that represented to him by his broker and by the seller.
What are the liabilities of the seller and broker for the misrepresentations and the remedies available to the buyer for the erroneous statements?
As we will see, the broker’s exposure is significantly greater than the seller’s exposure, even though both may have been acting in good faith.
Out-Of-Pocket Rule
Absent a fiduciary relationship between a buyer and the seller (ordinarily there is none), the measure of damages to a deceived buyer is determined by the “out-of-pocket” rule. The out-of-pocket rule provides that a buyer is entitled to recover a monetary amount equal to the difference between the contract price he pays and the lesser market value, if any, of the property he receives.
In the preceding hypothetical, the buyer paid 5 million dollars and received, in exchange, property smaller in size then he anticipated, but nevertheless still worth 5 million dollars. Since the buyer did not pay more for the property than its market value, he is said not to be “out-of-pocket” any money. In other words, he simply exchanged his personal property (i.e. money) for the seller’s real property of equal value.
Under that scenario, the buyer has not been damaged.
On the other hand, if the buyer contracted to buy the property for $5.1 million, but the property was only worth $5 million, he would be entitled to a $100,000 rebate from the seller because the buyer is “out-of-pocket” $100,000.
Since a seller is not the fiduciary of a buyer (i.e. a seller owes no duty of loyalty to a buyer), the buyer’s damages are measured by the out-of-pocket rule.
The out-of-pocket rule is subject to certain qualifications under Civil Code Section 3343, such that even if the buyer does not pay more for the property than its market value, the buyer may still recover certain other limited consequential amounts, such as money attributable to loss of enjoyment or provable loss of profits, if any.
Benefit of the Bargain Rule
The “benefit of the bargain” rule, rather than the out-of-pocket rule, applies if a fiduciary relationship exists between the buyer and some other party. In the foregoing hypothetical, the buyer’s broker has a fiduciary duty to the buyer. As a fiduciary, the broker had the obligation to reveal to the buyer that he (the broker) had not verified the information which he learned from the seller concerning the acreage.
In the above example, the broker innocently misrepresented the size of the property, but because he is the buyer’s fiduciary, his exposure is measured by the “benefit of the bargain” rule rather than the more limited “out-of-pocket” rule.
The benefit of the bargain rule provides that the buyer is entitled to recover from his broker the difference between the contract amount the buyer paid for the property and what the higher market value of the property would have been had it been as represented. In other words, since the property would have been worth $5,500,000 if it contained five acres (as the broker represented), the buyer is entitled to receive from the broker $500,000. That $500,000 represents what would be the buyer’s benefit of the bargain had he received what he was told he would receive, i.e.: a full acre of land.
Here’s a sobering case: In Salahutdin v. Valley of California, Inc. 24 Cal.App.4th 555, the buyer’s real estate salesperson employed by the buyer’s broker made false representations about the size of the property and concealed his failure to adequately investigate or disclose the true facts. The court found that not only had the agent breached his fiduciary duty of care, he also committed constructive fraud by representing that the property was more than one acre in size and that it could be subdivided where, in fact, the property was less than one acre and therefore could not be subdivided.
How much less? Just a tiny bit! The land actually contained .998 acres. But since it was less than one acre, subdivision was not allowed ─ a costly mistake.
The fair market value of the property, had it been as represented by the agent, would have been $1,100,000. But, because the value in its actual condition was only $925,000, the court awarded the buyer $175,000, plus interest at the legal rate of 10% per annum from the date of entry of the judgment until paid.
Punitive damages were not discussed in the case. However, the United States Supreme Court has determined that punitive damages for fraud may be awarded in single-digit multiples of the compensatory damages. That could be a sizeable amount of money.
Note to Attorneys: Lawyers wishing to research the differences between the out-of-pocket rule and the benefit of the bargain rule should review Civil Code Sections 1709, 3333 and 3343 and the annotations thereto. Counsel wishing to research significant cases discussing punitive damages should review State Farm v. Campbell (2003) 538 U.S. 408 and Simon v. San Paolo (2005) 35 Cal.4th 1159.
Rescission
In the event of a serious misrepresentation of the lot size, the buyer, upon learning of the error, may attempt to rescind (i.e., cancel and unwind) the transaction. That means that the buyer must reconvey the property to the seller, and the seller must refund the buyer’s purchase price.
As a practical matter, rescission is rarely a workable remedy. That is because the seller, by the time of the rescission, probably spent a good deal of the proceeds he received from the buyer, and/or used a substantial portion of the money to pay off the seller’s mortgage at the close of escrow.
Conversely, the buyer is likely to have taken out a loan from an institutional lender and used it as a portion of his down payment. The buyer’s lender would have to be fully repaid and its deed of trust removed as a lien against the property in order for the rescission to be effectuated.
Because of these financial complexities, not to mention the fact that the brokers would have to refund their commissions, rescission is a rare remedy.
Recommendations
To avoid the problems discussed in this article, here is what I recommend:
1) A seller should be careful not to make any factual representation about his property which the seller has not confirmed to be true.
2) Subject to number three below, a buyer’s broker should not pass along to the buyer material information he hears from the seller (or from the seller’s broker) unless the buyer’s broker has independently verified the data.
3) If the broker does not verify the information, the buyer’s broker should, at a minimum, advise the buyer that the broker has not verified the data that he was passing along, and that the broker was simply transmitting the information provided by the seller, cautioning that it may or may not be accurate.
4) When a buyer receives information from a seller or the seller’s broker which, if untrue, would materially affect the value or desirability of the property, the buyer should independently verify the data.
5) When a buyer receives information from his broker, which, if untrue, would materially affect the value or desirability of the property, the buyer should inquire of his broker as to whether the broker has verified the information.
Real estate brokers are regulated by the California Department of Real Estate and are held to high standards of ethical conduct. Sellers are not. Most misrepresentations by a party’s broker are due to innocent mistakes, such as inadvertence in verifying given information, rather than intentional deception. With respect to representations that are material to the buyer’s decision to purchase an apartment building, the buyer should verify the information on his own, or at least query his broker as to whether his broker has confirmed the accuracy of the data.
Manager Law Update
In the January, 2014 issue of this magazine, I presented a detailed discussion of the new 2014 wage, hour and rent laws applicable to resident managers. At the time that I authored the article, two sets of numbers had not yet been announced by the California Industrial Welfare Commission or the California Labor Commissioner. Nevertheless, I estimated in the article that the maximum rent, commencing July 1, 2014, a landlord could charge his resident manager(s) who was required to live on the property as a condition of employment would be $508.37 or $751.79 per month depending on whether the landlord employed a single manager or a couple. The IWC has now announced the exact numbers. They are $508.38 per month for a single manager and $752.02 per month for a couple. Thus, those numbers supersede and replace the ones I estimated in my January column.
Those two new amounts are also applicable to the maximum rent credit that can be applied to offset the minimum wages the landlord would otherwise owe to the individual or couple managers.
I will provide a detailed update on these new amounts in the July 2014 issue of this AOA magazine, as that is when the new figures will take effect. Have a good March.
Dale Alberstone is a prominent litigation and transactional real estate attorney who has specialized in real property law for the past 37 years. He has been appointed to periodically serve as a judge pro tem of the Los Angeles Superior Court and is a former arbitrator for the American Arbitration Association. He also testifies as an expert witness for and against other attorneys who have been accused of legal malpractice.
Mr. Alberstone has been awarded an AV rating from Mardindale-Hubbell. An AV rating reflects an attorney who has reached the heights of professional excellence and is recognized for the highest levels of skill and integrity. You may Google “Dale S. Alberstone” for further background.
The foregoing article was authored on February 3, 2014. It is intended as a general overview of the law and may not apply to the reader’s particular case. Readers are cautioned to consult an advisor of their own selection with respect to any particular situation. Address correspondence to Dale S. Alberstone, Esq., ALBERSTONE & ALBERSTONE, 1900 Avenue of the Stars, Suite 650, Los Angeles, California 90067. Phone: (310) 277-7300.