DAVID J. WILLIS ATTORNEY
Copyright © 2018. All rights reserved worldwide.
Three Rules: Disclose, Disclose, Disclose
by David J. Willis, J.D., LL.M.
Sellers and buyers have different needs and motivations when it comes to the transfer of real estate. One area that is often an issue is property condition. Sellers typically want to make the transfer "as is" without warranties and with no obligation for repairs. They naturally want to avoid being on the hook for future liability. Buyers, on the other hand, have an interest in acquiring property that is in the best condition for the price. They also want full disclosure of adverse conditions, defects, and needed repairs, since it is not possible to perform an accurate cost/benefit analysis of the investment unless all costs are known.
TREC promulgates a Seller's Disclosure of Property Condition for use in residential real estate transactions (www.trec.state.tx.us/forms). This form (TREC OP-H) is filled out by the seller and attached to the TREC 1-4 contract. The form tracks section 5.008 of the Property Code which states:
5.008(a) A seller of residential real property comprising not more than one dwelling unit located in this state shall give to the purchaser of the property a written notice as prescribed by this section or a written notice substantially similar to the notice prescribed by this section which contains, at a minimum, all of the items in the notice prescribed by this section.
The purpose of the Seller's Disclosure is to make it clear what appliances, equipment, and features exist on the property; whether or not these items are working; if the seller knows of any defects or malfunctions in critical systems; if certain red-flag events like termite treatment, previous fires, or flooding have occurred; the need for repairs; and the existence of unpermitted additions, unpaid HOA fees, violations of deed restrictions, lawsuits, or conditions that "materially affect the health or safety of an individual." It should be "completed to the best of seller's belief and knowledge as of the date the notice is completed and signed by the seller." Prop. Code sec. 5.008(7)(d).
The Seller's Disclosure seeks to implement the core disclosure requirement in Texas, succinctly articulated in Myre v. Meletio, 307 S.W.3d 839, 843-44 (Tex. App.—Dallas 2010, pet. denied): "In the context of a real estate transaction, a seller is under a duty to disclose material facts that would not be discoverable by the exercise of ordinary care and diligence by the purchaser, or that a reasonable investigation and inquiry would not uncover. But a seller has no duty to disclose facts he does not know. Similarly, a seller is not liable for failing to disclose what he only should have known." Actual knowledge is thus required. A careless and neglectful seller who has not thoroughly acquainted himself with the condition of property he is selling may be off the hook—unless, of course, he encounters a skeptical jury that considers his conduct not just neglectful but dishonest.
Property Code section 5.008(e) provides that the requirement that a Seller’s Disclosure be provided does not apply to a transfer:
- pursuant to a court order or foreclosure sale;
- by a trustee in bankruptcy;
- to a mortgagee by a mortgagor or successor in interest or to a beneficiary of a deed of trust by a trustor or successor in interest (which would include deeds in lieu of foreclosure).
- by a lienholder who has either purchased at a foreclosure sale or a sale pursuant to a court order or accepted a deed in lieu of foreclosure;
- by a fiduciary in the course of an administration of a decedent's estate, guardianship, conservatorship, or trust;
- from one co-owner to one or more other co-owners;
- made to a spouse or to a person or persons in the lineal line of consanguinity of one or more of the transferors;
- between spouses incident to divorce, legal separation or a property settlement agreement;
- to or from a governmental entity;
- a new residence of not more than one dwelling unit that has not been occupied for residential purposes (this would include newly-built homes);
- of real property where the value of any dwelling does not exceed 5% of the value of the property (pure "tear-downs," in other words).
If the seller does not give the Seller's Disclosure as required, Property Code section 5.008(f) permits the buyer to "terminate the contract for any reason within seven days after receiving the notice." The statute does not address the legal consequences of the seller never giving the Seller's Disclosure at all. However, if the failure to give the notice is coupled with fraud or failure to disclose defects, then other laws and penalties may (and likely will) arise pursuant to the Deceptive Trade Practices Act and/or the Statutory Fraud Act (see below).
For commercial transactions, the Texas Association of Realtors has a Commercial Property Condition Statement that is an optional attachment to its standard commercial contracts. Its scope is broader than TREC's Seller's Disclosure since it addresses additional issues such as wetlands, underground storage tanks, toxic waste, and the like. Although the form is optional in commercial transactions, a careful buyer should always require that the seller provide it. Note that this and other TAR forms are available only to realtors.
Purpose of Disclosure Forms
The intent and purpose of both the residential and commercial disclosure forms is the same: to induce the seller to disclose material conditions, circumstances, and defects. For some reason, however, the drafters of these forms saw fit to insert a statement at the top to the effect that the contents of the form do not constitute a warranty by the seller. The TREC Seller's Disclosure states:
THIS NOTICE IS A DISCLOSURE OF SELLER'S KNOWLEDGE OF THE CONDITION OF THE PROPERTY AS OF THE DATE SIGNED BY SELLER AND IS NOT A SUBSTITUTE FOR ANY INSPECTIONS OR WARRANTIES THE PURCHASER MAY WISH TO OBTAIN. IT IS NOT A WARRANTY OF ANY KIND BY SELLER OR SELLER'S AGENTS.
The TAR Commercial Property Condition Statement reads:
THIS IS A DISCLOSURE OF THE SELLER'S KNOWLEDGE OF THE CONDITION OF THE PROPERTY AS OF THE DATE SIGNED. IT IS NOT A SUBSTITUTE FOR ANY INSPECTIONS OR WARRANTIES A BUYER OR TENANT MAY WISH TO OBTAIN. IT IS NOT A WARRANTY OF ANY KIND BY SELLER, SELLER'S AGENTS, OR ANY OTHER AGENT.
What is the point of these disclaimers? Is the seller making disclosures but then warning the buyer not to rely on them? Apparently so, which makes for a mixed message. This should be unsettling if not unsatisfactory from the buyer's point of view. A careful buyer should consider negotiating inclusion of a contract clause (perhaps contained in a special provisions addendum) which makes it clear that the seller is standing behind the truth of these disclosures. Buyers, commercial or residential, will want to minimize a seller's wiggle-room on the disclosure issue with a simple demand: tell me what you know. All of it.
Ongoing Duty to Disclose
The Seller's Disclosure does not in and of itself impose an ongoing duty to disclose matters that may come to the seller's attention after the form has been signed and delivered to the buyer. Bynum v. Prudential Residential Servs., 129 S.W.3d 781,795 (Tex. App.—Houston [1st Dist.] 2004, pet. denied). Although this may be strictly true as it relates to the promulgated form, it would be unwise for a seller to withhold material adverse information that is subsequently discovered. There are too many statutory and common law avenues for an aggrieved and angry buyer to pursue, most notably an action for deceptive trade practices.
The case of Comel v. Birdwell, 2014 WL 4347815 (Tex.App.—Eastland 2014) imposes a duty on the seller to update the Seller's Disclosure under certain stated circumstances, namely, if a confidential or fiduciary relationship exists; when the seller has already disclosed part of the issue (then the rest of it must be disclosed); when a prior representation by the seller would be untrue or misleading without further explanation; and in the case of partial disclosure when that partial disclosure creates a false impression in the mind of the buyer. Practice note: silence may be considered misleading!
Two additional important points. Firstly, inclusion of an "as is" clause in the contract does not relieve a seller of the obligation to disclose material facts (Ritchey v. Pinnell, 357 S.W.3d 410 (Tex.App.—Texarkana 2012, no pet.); and second, merely giving the buyer a copy of an expert report on a certain condition (termites, for example) does not eliminate the requirement that the seller disclose what he knows about that condition (Lawrence v. Kinser, Tex.App.—Dallas 2011, no pet. h.). The conclusion? The best rule for sellers, as stated elsewhere in this book, is to disclose, disclose, disclose.
Broker Liability for the Seller’s Disclosure
Accurately completing the Seller's Disclosure is the responsibility of the seller, preferably in the seller's own handwriting—a good way for the seller's broker to avoid liability, since the seller's broker does not ordinarily become liable for the seller's wrongdoing in this regard unless the broker has actual knowledge of a defect and the failure to disclose it. A broker "would have a duty to come forward only if he had any reason to believe that the seller's disclosures were false or inaccurate, and the only way he could be held liable for [the seller's] statement in the notice is if it were shown to be untrue." Sherman v. Elkowitz, 130 S.W.3d 316, 321 (Tex. App.—Houston [14th Dist.] 2004, no pet.).
As a related issue, a broker does not become liable for a defect or adverse condition (mold, for example) merely by transmitting a mold inspection report to the buyer. Merely handling and delivering such a report does not make the broker liable for its contents. Arlington Home Week Inc. v. Peek Environmental Consultants, Inc., 361 S.W.3d 773 (Tex.App.—Houston [14th Dist.] 2012).
Note that Article 1 of the National Association of Realtors Code of Ethics makes it clear that information about defects is not confidential. A broker has no obligation to become the accomplice of a dishonest seller. Disclosure of defects is in fact a duty for all members of the NAR.
The Deceptive Trade Practices-Consumer Protection Act (DTPA)
Have no doubt about it: the DTPA applies to real estate transactions. The cases consistently declare that real estate is a "consumer good" as that term is defined in the statute. See Chastain v. Koonce, 700 S.W.2d 579, 582 (Tex. 1985).
Business & Commerce Code section 17.46 declares that "false, misleading, or deceptive acts or practices in the conduct of any trade or business are hereby declared unlawful. . . ." Also expressly stated to be unlawful are misrepresenting the characteristics and uses of a particular item; representing that goods or services are of a particular quality and standard when they are not; advertising with intent not to sell as advertised; and failing to disclose information in an attempt to induce the consumer into buying.
"Mere puffing or opinion" expressed by a seller is carved out from most liability by DTPA cases. "Whether a representation is a warranty or merely an expression of [the seller's] opinion depends in part upon whether the seller asserts a fact of which the buyer is ignorant, or merely states an opinion or judgment on a matter on which the seller has no special knowledge and on which the buyer may be expected to have an opinion and exert his judgment." Also, a "general statement concerning a future event . . . should be looked at differently than a statement concerning a past or present event or condition." Humble Nat'l Bank v. DCV, Inc., 933 S.W.2d 224, 230 (Tex.App.—Houston [14th Dist.] 1996, writ denied).
Bottom line: affirmative misrepresentations or failure by a seller to disclose known material adverse conditions and defects are violations of the DTPA. The key question for a court that later looks at the case is whether or not the seller's misrepresentation or failure to disclose would have influenced an ordinary buyer's decision to buy or not buy.
Does it sound as though most any of the itemized grievances in the DTPA might form the basis of a lawsuit against a real estate investor? Count on it. But it does not end there when it comes to investor liability. Section 17.50 adds breach of warranty and "any unconscionable action or course of action by any person" to the list. "Any unconscionable action?" Seriously? Statutory language does not get any broader or more potentially damaging than that. Investor sellers beware: if you fail to disclose a material item, a jury can find that your action was "unconscionable" (an open-ended term by any definition) and award treble damages, attorney's fees, and court costs against you.
The Statutory Fraud Act (Tex. Bus. & Com. Code § 27.01) is another potential pitfall for sellers who fail to make full disclosure:
(a) Fraud in a transaction involving real estate or stock in a corporation or joint stock company consists of a
(1) false representation of a past or existing material fact, when the false representation is
(b) A person who makes a false representation or false promise commits the fraud described in Subsection (a) of this section and is liable to the person defrauded for actual damages.
(A) made to a person for the purpose of inducing that person to enter into a contract; and
(2) false promise to do an act, when the false promise is
(B) relied on by that person in entering into that contract; or
(B) made with the intention of not fulfilling it;
(C) made to a person for the purpose of inducing that person to enter into a contract; and
(D) relied on by that person in entering into that contract.
(c) A person who makes a false representation or false promise with actual awareness of the falsity thereof commits the fraud described in Subsection (a) of this section and is liable to the person defrauded for exemplary damages. Actual awareness may be inferred where objective manifestations indicate that a person acted with actual awareness.
(d) A person who (1) has actual awareness of the falsity of a representation or promise made by another person and (2) fails to disclose the falsity of the representation or promise to the person defrauded, and (3) benefits from the false representation or promise commits the fraud described in Subsection (a) of this section and is liable to the person defrauded for exemplary damages. Actual awareness may be inferred where objective manifestations indicate that a person acted with actual awareness.
(e) Any person who violates the provisions of this section shall be liable to the person defrauded for reasonable and necessary attorney's fees, expert witness fees, costs for copies of depositions, and costs of court.
The above language is tighter than that found in Prop. Code 5.008 or in the common law. The elements of statutory fraud under sec. 27.01(a) are the same as the elements of common law fraud, except that sec. 27.01(a) does not require proof of knowledge or recklessness as a prerequisite to the recovery of actual damages.
For greater clarity on what constitutes a misrepresentation, observe the language in Coldwell Banker Whiteside Associates v. Ryan Equity Partners, 181 S.W.3d 879, 888 (Tex. App.—Dallas 2006, no pet.): "A misrepresentation may consist of the concealment or nondisclosure of a material fact when there is a duty to disclose. The duty to disclose arises when one party knows that the other party is ignorant of the true facts and does not have an equal opportunity to discover the truth. A fact is material if it would likely affect the conduct of a reasonable person concerning the transaction in question."
Exemplary or punitive damages are available to plaintiffs who prevail. A plaintiff is entitled to recover exemplary damages in cases of statutory fraud if the false representation is made with actual awareness of the falsity of the representation. Hines v. Hash, 843 S.W.2d 464 (Tex. 1992).
Real estate brokers are liable under the DTPA only for intentional fraud.
The Statutory Fraud Act does not preclude a deceived buyer from filing suit on grounds of common-law fraud as well. In other words, the two causes of action can be pursued side-by-side. Any competent plaintiffs' attorney will include as many causes of action as possible in his lawsuit against a nondisclosing seller. This is known as the "shotgun approach" and is designed to insure that, when the dust settles, at least some lines of attack will have found their mark.
Additional Liability for Real Estate License Holders
Agents and brokers who are also sellers need to be especially concerned about failing to make full disclosure. Unlike unlicensed real estate investors, license holders are subject to the Real Estate License Act ("RELA," found in Occupations Code section 1101.652), the five canons of professional ethics and conduct (Texas Administrative Code chapter 531), and the rules of the Texas Real Estate Commission (Texas Administrative Code chapters 531-543—go to www.trec.texas.gov for a copy).
TREC rules state that a broker or sales agent is a fiduciary, meaning that the license holder must place the interests of his or her principal above their own. This manifests in a variety of specific duties to disclose, inform, and perform at a knowledgeable and professional level. The rules also make it clear that a license holder has a duty of honesty and fair dealing with regard to everyone, not just clients.
TREC may revoke or suspend the license of a broker or sales agent if the license holder is convicted of any offense involving fraud or engages in misrepresentation, dishonesty, or untrustworthy behavior. RELA section 1101.652(b)(3) provides that a license holder may be sanctioned for making "a material misrepresentation to a potential buyer concerning a significant defect, including a latent structural defect." Section 1101.652(b)(4) specifically adds failure to disclose a significant defect to the list. Accordingly, investors who have a real estate license have a heightened level of duty and potential liability.
Suppose a broker fails to disclose an important personal fact—for instance, that she is the mother of the seller. Does this void the earnest money contract? Probably not, although the broker may be vulnerable to sanctions by TREC. Goldman v. Olmstead 414 S.W.3d 346 (Tex.App.—Dallas 2013, pet. denied).
Note that Goldman will likely not prevent a creative plaintiffs' attorney from alleging that the license holder acted in conspiracy with the seller. Result? The broker must expend time and resources to defend against this charge. In the long run, license holders are always better off pursuing a policy of full disclosure that continues throughout the course of the transaction.
“As Is” Transactions
It is important to observe that the TREC 1-4 contract contains an optional "as is" clause, and the transaction becomes "as is" if the box at paragraph 7D(1) is checked. Problem is, not all "as is" clauses are equally thorough and effective. See chapter 1 for an example of solid "as is" language that a seller could use in a special provisions addendum to the contract.
Here is the central question: Is it lawful to transfer property without disclosing material defects if the contract states that the transaction is "as is?" In other words, does use of the words "as is" or similar phraseology relieve the seller of the obligation to disclose? The answer, as is true in many areas of the law, is it depends—but probably not. And the risks involved in attempting to do so are significant.
The foundational case in this area is Prudential Insurance Co. v. Jefferson Associates Ltd., 896 S.W.2d 156 (Tex. 1995), which upheld "as is" clauses in certain narrow circumstances. Two things are critical if such a clause is to be upheld: the specific wording and whether or not the buyer obtained an inspection. Also, in evaluating an "as is" transaction, courts look not just at these two factors but at the totality of the circumstances. Note that if the buyer consults an attorney before agreeing to an "as is" clause then a court is more likely to find the clause enforceable. Courts dislike situations where the parties are unequally informed of their rights. For this reason, it is more likely that an "as is" provision will be upheld in a commercial rather than a residential transaction since commercial buyers are presumed to be more sophisticated.
In 2007, the Dallas Court of Appeals said the following with regard to "as is" transactions involving residences: "The nature of the transaction and the totality of the circumstances surrounding the agreement must be considered. Where the 'as is' clause is an important part of the basis of the bargain, not an incidental or 'boilerplate' provision, and is entered into by parties of relatively equal bargaining position, a buyer's affirmative agreement that he is not relying on the representations of the seller should be given effect." Kupchynsky v. Nardiello, 230 S.W.3d 685, 690 (Tex. App.—Dallas 2007, pet. denied).
The commercial landlord-tenant case of Italian Cowboy Partners, Ltd. v. Prudential Insurance Co. of America, 341 S.W.3d 323 (Tex. 2011), involved lease of a restaurant with a history of chronic sewage odor. The landlord's manager, who knew of the problem, fraudulently induced the tenant into a lease by orally declaring that the premises were in "perfect condition." Even though Italian Cowboy is a commercial lease case, it is likely that a similar theory of liability would be applied against a seller of residential property who made such false statements.
The 2014 case of Harstan, Ltd. v. Kim, 441 S.W.3d 791, 796-97 (Tex.App.—El Paso 2014, no pet.) states: "Courts assess the validity of an 'as is' agreement in light of three factors: (1) the sophistication of the parties; (2) the terms of the 'as is' agreement; and (3) whether there was a knowing misrepresentation or concealment of a known fact." Evaluation of these factors in a specific case can result in a court declaring an "as is" clause invalid as a matter of law.
Willful Concealment and Fraudulent Inducement
The general take-away from this discussion is that an "as is" clause will not protect a seller in a case of willful concealment, and it will certainly be no protection if the seller engages in fraudulent inducement. Ritchy v. Pinnell, 357 S.W.3d 410 (Tex. App.—Texarkana 2012, no pet.).
Example? A seller knows that there is foundation settlement because of cracks in the sheetrock and floor tile. So the seller positions a picture over the wall crack and a rug over the cracked tile (willful concealment) and then goes on to tell the prospective buyer that there are no serious defects in the condition of the house (fraudulent inducement).
Determined "As Is" Sellers
What if a real estate investor is determined to sell "as is" and minimize any duty to disclose? In the residential context, of course, this is difficult because the Seller's Disclosure is usually a required document. In commercial transactions, however, the situation is more fluid. Note, however, that an "as is" clause designed to comply with the standards of the Italian Cowboy case was upheld in Dragon Fish, LLC v. Santikos Legacy, Ltd., 383 S.W.3d 175 (Tex. App.—San Antonio 2012, no pet.), so a well-drafted "as is" clause is most definitely effective in Texas. The best person to draft such a clause in an attorney familiar with the case law.
Paragraph 7.D of the TREC 1-4 contract states that " 'As Is' means the present condition of the Property with any and all defects and without warranty except for the warranties of title and the warranties in this contract." While useful, this definition may not go far enough to satisfy a cautious seller. Furthermore, it does not commit the buyer to signing a deed containing an "as is" provision. A better strategy would be to include a more muscular "as is" clause as part of a comprehensive special provisions addendum to the contract.
"As Is" Clauses in the Deed
An "as is" clause should also be included in the warranty deed to the buyer in order to leave no doubt as to the intent of the parties (The wording is somewhat different since we are dealing with a deed here and not a contract). The buyer should then be required to sign and acknowledge the warranty deed, leaving no doubt as to the buyer's consent to and agreement with the "as is" clause.
To summarize, the optimal "as is" scenario for a seller would be to (1) make full disclosure of defects and adverse conditions; (2) avoid making any statements relating to property condition, value, or potential use, even those that could be considered sales puffing; (3) include effective "as is" clauses in both the earnest money contract and the warranty deed which are clear, conspicuous (bold and capitalized), and unequivocal; and (4) require that the buyer sign and acknowledge the warranty deed in order to expressly accept the property in its present state (This has the effect of making the deed a contract as well as a conveyance). Since most buyer lawsuits are based on allegations of fraud, following these guidelines will provide maximum protection for the seller.
The practical question, of course, is whether or not a buyer will be willing to accept such strict "as is" language. As is true with many contract terms, it may come down to price.
Is there a less onerous "as is" clause with which a buyer might feel comfortable? Yes, and it would probably consist of only the first paragraph of the above sample provision.
"As Is" in the Real World
Generally speaking, an "as is" clause (both in the earnest money contract and the warranty deed) is an extremely valuable, even essential, tool for the cautious seller, but it should not be used as a means of avoiding disclosure of defects or adverse conditions. No one, especially juries, likes a liar—whether the lie is by commission or omission. The best advice an attorney can give a seller is disclose, disclose, disclose, whether or not the contract contains an "as is" clause. If an "as is" clause is going to be included in a contract or deed, it should be in bold and all caps. The seller should get a real estate attorney to draft it so that it specifically fits the circumstances. The "as is" clauses contained in this article are offered as general formulations only.
Investor clients often ask, "Can they sue me if . . . ?" For lots of reasons, this is the wrong question, since anyone can sue anyone for anything and incur little or no liability for doing so, at least in this country. The better approach—since lawsuits are so very expensive—is to deter suits in the first place by being open and above-board. And when threatened with a lawsuit, the best practice is usually to immediately offer to engage in a pre-suit mediation.
Buyers confronted by a seller who insists on an "as is" clause while attempting to avoid disclosure should be suspicious. In such a situation, the best course of action for the buyer may be to walk away. Not every deal can or should be made. On the other hand, a tough "as is" clause may not be a problem for the buyer so long as he or she conducts thorough due diligence within the available time frame. Having said that, whenever a seller wants to include an "as is" clause in a sales contract, the buyer should respond by asking that a provision be included to the effect that such a clause does not relieve the seller of the obligation to disclose known material conditions and defects. If the seller balks at this, then it may be time for a prudent investor to look elsewhere for a deal.
Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.
Copyright ©2018 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.