The Due Diligence Process:
Commissioner’s Rule R4-28-1101B states: A licensee participating in a real estate transaction shall disclose in writing to all other parties any information the licensee possesses that materially or adversely affects the consideration to be paid by any party to the transaction, including:
A. Any information that the seller or lessor is or may be unable to perform;
B. Any information that the buyer or lessee is, or may be, unable to perform;
C. Any material defect existing in the property being transferred; and
D. The existence of a lien or encumbrance on the property being transferred.
The broker, who makes the decisions on which E & O insurer will insure the company, will need to consult with the E & O provider and perhaps consider providing a model for how they assist a client in conducting due diligence in a transaction. Here is a simple process that will substantially reduce the agent’s (and broker’s) risk of having to confront a messy and annoying legal issue. After all, an agent’s time is much more productive in developing business, making listing presentations, showing properties to qualified buyers, presenting offers, and closing escrows. Agents and brokers often already have enough to do without having to extinguish a legal fire. The real estate industry is always seeking the “magic pill” to solve all of its problems and this is no exception. As one might guess there is no such thing, but there is a suggested communication process that can minimize these risks.
This process applies in dealing with either a buyer or seller and can be applied systematically to creating that “paper trail” that becomes essential when an agent may be put into the position of having to defend themselves against an accusation of misrepresentation or misconduct. Most often, if the agent receives an accusatory letter from a lawyer, they will do everything possible to make it as intimidating as possible and it may even read like complete fiction. Unfortunately, judges and juries historically have sided with the non-professional when it’s simply a matter of the agent’s or broker’s word against the consumer. The best way to overcome this is for the agent to have probative evidence that they did their due diligence. Below is the format to follow that will best ensure this. A broker should review this process in detail with each of their agents.
- Whether the agent is representing the buyer or the seller, the best way to go on record as having done this is for the agent to ask the seller to fill out the SELLER PROPERTY DISCLOSURE STATEMENT (SPDS form). While the seller must disclose all known material facts on their property, they are not required to provide the buyer a SPDS. Many sellers feel that they may make themselves more vulnerable to potential litigation if they fill it out and give it to the buyer. Even if the seller ends up not doing this, it is important that the agent is on record as having asked them to do it. While there are exceptions, a seller, especially owner-occupied sellers, should be willing to do this. If they’re not, the agent may want to reconsider taking the listing. Many brokers require their salespeople to reject the listing if this is the case. If the agent is representing the buyer, they have usually already asked for the SPDS in the offer. Some brokers ask executors or lenders, who may have never seen the property to add comments on the last page of the SPDS that they have not seen the property and therefore are unable to answer the questions on it. The SPDS also functions effectively as a job description for an inspector or for the inspectors.
- A broker will need to distinguish with the salesperson the differences between performing an inspection and an observation of the premises. Whether the agent is working with a buyer or seller, they will most likely have a chance to observe the premises and most often there will be visible clues as to some possible underlying problems. The agent should remember that they are NOT doing an inspection as this will be done by a qualified state-certified professional, but should the agent notice “red flags” such as stains in the ceilings, cracks on the floors and walls, little tunnels, uneven floors, or algae growth in the pool, etc, they should make a note of them here. Since the agent is not doing an inspection, they can apply something called the “Tool & Tuxedo” rule that means that if getting access to an area requires the use of a tool (screwdriver, ladder) or would soil the hypothetical tuxedo or evening gown they are wearing, they don’t check that area out. It is “inaccessible for observation”.
One possible red flag that often gets misinterpreted has to do with the issue of stigmatized property. ARS 32-2156A states the following: No criminal, civil or administrative action may be brought against a transferor or lessor of real property or a licensee for failing to disclose that the property being transferred or leased is or has been: 1. The site of a natural death, suicide or homicide or any other crime classified as a felony. 2. Owned or occupied by a person exposed to the human immune deficiency virus (HIV) or diagnosed as having the acquired immune deficiency syndrome (AIDS) or any other disease that is not known to be transmitted through the common occupancy of real estate. 3. Located in the vicinity of a sex offender. This law provides that an agent is not required to disclose these facts but with one exception, the law does not prohibit a buyer’s agent from disclosing them to their client. The broker will need to identify and develop policies where the salespersons may encounter a seller whose property was the site of a homicide and demands this fact be kept confidential. This is especially important in dual agency transactions. The only fact that an agent is forbidden from disclosing is whether the property was occupied by a person with the HIV or AIDS virus. Both the State and Federal Fair Housing Laws prohibit this disclosure. Another “red flag” that may be overlooked by agents due to a misinterpretation of this law is if the seller feels that a house is inhabited by paranormal beings. This law will not protect the agent should the agent fail to disclose this to a buyer. The disclosure would be on the order of “Seller has indicated that the property is inhabited by paranormal beings” or “has a reputation of being haunted”.
- After the agent has noted the “red flags”, they should point them out to their seller or buyer. They should advise them that these are things they noticed in their casual viewing of the property and let them know that there might have been some other visible “red flags” that they may have missed and there were areas where they were not able to observe because they were inaccessible. The agent should also advise the seller or buyer that they are not a qualified inspector.
- The agent should advise the buyer or seller that since they have noticed these red flags, that it would be in the seller’s or buyer’s best interests to have these checked by a qualified professional to determine the underlying conditions and what measures are needed to correct them. A broker will need to monitor who the salespeople recommend to the sellers and buyers. This is also where it may be advisable for the agent to recommend that the seller offer a home warranty plan to the seller to make their home more marketable. The seller should also be alerted to the possibility of having multiple inspections. A general home inspector may recommend that the seller gets an air conditioning technician to look at the unit rather than pry it open themselves and examine the components.
It is important for an agent to have a written record of having this communication as part of their paper trail, which could even be a letter to the client with a copy of the transaction file. It might be wise for the broker to actually require this documentation be made a part of the transaction files. Also, the agent should not forget to advise their seller or buyer that they should consult with any qualified professionals to seek competent advice and to check out any other sources of important consumer information.
Again, a broker is required to systematize a process for disclosure for their agents. Every communication regarding a property or transaction should be documented with the following:
A. Time and date of the conversation.
B. Location of conversation or if it was by phone.
C. The parties to the conversation.
D. The subject or subjects of the conversation.
E. What was discussed and resolved? (Basically a recap of the conversation)
F. The duration of the conversation – beginning and ending time.
After the agent memorializes these facts, this recap should be sent by e-mail to all parties as a recap of the conversation for the records with a return request that the parties have received the e-mail. The agent should then make a hard copy of the e-mail communication for both their files and their broker’s file. While the retention requirements for the broker don’t include these documents, a broker should include these records along with any SPDS(s) that were a part of the transaction, the READE form used in the transaction, and the CONSENT TO LIMITED REPRESENTATION, if applicable to the transaction.