Does Seller’s Real Estate Agent Have A Duty To Purchaser?

A recent Michigan Court of Appeals decision, Alfieri et al. v. Bertorelli et al., dated October 18, 2011 re-visits the issue of whether a real estate agent has a duty to disclose environmental information to a prospective purchaser in the absence of privity.

The take-away in this and similar cases is that the result is often dependent upon the specific facts presented, and even then, according to the Property Investment in New Zealand the result may vary depending upon the law of the state at issue. For example, New York strongly adheres to the doctrine of caveat emptor, which imposes no liability on a seller (let alone the seller’s agent)  for failing to disclose information regarding the premises in an arms length transaction, unless there is some conduct on the part of the seller which constitutes active concealment.  In New York, the purchaser of contaminated property would arguably have a difficult time, in the absence of some affirmative misrepresentation and a showing of reasonable reliance, holding seller’s agent liable.

Although the Alfieri case is based on Michigan, not New York, law, its holding is instructive. Alfieri arose out of plaintiffs’ purchase of a condominium unit in what had once been an abandoned factory. The factory had been contaminated with trichloroethylene, and in the process of converting it into condominiums, a vapor barrier was installed. Nonetheless, the former factory property was never properly decontaminated. However, plaintiffs were led to believe that the contamination had been cleaned up. In part, plaintiffs relied upon a sales brochure, prepared by Coldwell Banker, the seller’s agent, indicating that the site had been decontaminated. The plaintiffs purchased the condominium without conducting any independent diligence of their own and only learned following the closing that the property was seriously contaminated.

In rejecting Coldwell Banker’s motion for summary judgment, the Michigan court discussed two of plaintiffs’ theories of recovery – silent fraud and negligent misrepresentation. The court explained that common law fraud or fraudulent misrepresentation involves: (1) a defendant making a false representation of material fact with the intention that a plaintiff would rely on it; (2) the defendant either knowing at the time that the representation was false or making it with reckless disregard for its accuracy; and (3) plaintiff actually relying on the representation and suffering damage as a result. Silent fraud is essentially the same, except that it is based on a defendant suppressing a material fact that he or she was legally obligated to disclose, rather than making an affirmative misrepresentation. A silent fraud may be a misleadingly incomplete response to the purchaser’s inquiry concerning a particular concern.

The court did not accept seller’s agent’s argument that Michigan jurisprudence did not impose upon the seller’s agent a duty of disclosure, in contrast to the duty imposed on the sellers themselves. The court held that a duty of disclosure may be imposed on seller’s agent to disclose newly acquired information that is recognized by the agent as rendering a prior affirmative statement untrue or misleading. In this case, there was evidence that the plaintiffs made direct inquiries of defendants about the condition of the property. The Michigan Department of Environmental Quality provided information to the seller which suggested that the sales brochure contained inaccurate and misleading information. What is troubling about the court’s holding is that the agent for the seller prepared the sales brochure on the basis of information obtained from the client. Did the agent have reason to believe that the contents of the sales brochure were not true until the plaintiffs filed suit? The decision does not provide a clear answer. However, the court apparently believed that there was a sufficiently genuine issue of material fact to deny the agent’s motion for summary judgment.

Can Phase I Reports Hurt Your Client?

In an article titled, “How Phase I Reports Can Hurt Your Clients,” (ALI-ABA Practical Real Estate Lawyer, Vol. 27, No. 6, November 2011), environmental guru Larry Schnapf cautions purchasers of property that an ill-conceived Phase I report may result in their losing CERCLA ability protection or expose them to misrepresentation claims.  The article’s primary concern is that a Phase I report may not necessarily assist a purchaser in establishing a CERCLA:  1) third-party defense; 2) innocent landowner defense; or 3) bona fide prospective purchaser defense, the requirements for each of which are set forth in the statute. 

To qualify for CERCLA liability protection, a property owner or operator must, among other things, demonstrate that it investigated the past use and ownership of the property consistent with the requirement of the EPA “All Appropriate Inquiries” (“AAI”) rule and exercised appropriate care with respect to contamination at the property.  In an earlier article, “The New ‘All Appropriate Inquiries’ Rule,” (ALI-ABA Practical Real Estate Lawyer, January 2007), Schnapf observes that ASTM’s standard practice for environmental site assessments (ASTM E1527-00) may be inconsistent with the statutory criteria set forth in Small Business Liability Relief and Brownfields Revitalization Act of 2002 (the “2002 Brownfields Amendments”) and spurred EPA to develop the AAI rule.  Thereafter, ASTM worked with EPA to revise E1527-00 to ensure that a revised standard would satisfy the requirements of the AAI rule. When EPA issued the final AAI rule, which became effective November 1, 2006, the agency announced that E1527-05 was now consistent with the final rule so that environmental site assessments consistent with the ASTM standard could be considered compliant with the rule.  Do pitfalls remain?

Schnapf cautions that the absence of a “recognized environmental condition” (“REC”) in a Phase I may not guarantee that there is no “business environmental risk” (“BER”).  For example, over the years, some Phase I reports have come to include environmental issues (e.g., asbestos, lead-based paints, radon mold) that do not fall within the definition of an REC because they do not involve releases of hazardous substances, although they could still be of concern to a property owner, tenant or lender.

  In Bank of New York Mellon Trust Company et al. v. Morgan Stanley Mortgage Capital Inc. (MSMCI), 2011 U.S. Dist. LEXIS 69168 (S.D.N.Y. June 27, 2011), a New York federal district court denied a motion to dismiss filed by a mortgage originator who was alleged to have failed to adequately disclose environmental conditions at a shopping center.  In that case, a mortgage loan purchase agreement was entered into in connection with a shopping center that had been constructed on a former landfill.  The landlord at the shopping center was required to monitor methane gas and had been subject to a number of violations.  Just before the loan closed, the largest tenant of the shopping center issued a Notice of Default accusing the owner of failing to properly manage the methane gas and alleging that methane gas levels had reached dangerous levels.  Although the landlord’s Phase I discussed the methane issue, the court declined to grant the defendant’s motion to dismiss finding that the purpose of the report was to identify RECs, that the report had not identified any RECs.  The court held that an “item of environmental concern” was not necessarily congruent with an REC.  Accordingly, the court found there was a legitimate dispute as to whether the Phase I had adequately disclosed the existence of a material environmental threat, which resulted in the loss of the primary tenant.

In addition to providing a caution to due diligence counsel concerning the scope of the Phase I, Larry also raises a concern about the practice of some environmental consultants in providing recommendations for further investigation or remediation in the Phase I report.  If such recommendations are made, and the purchaser fails for any reason to promptly implement them, the purchaser’s bona fide prospective purchaser defense arguably may be jeopardized.  Accordingly, the article recommends that any recommendations for further investigation or remediation be provided by the consultant in a separate letter to counsel and not be transmitted to the client directly.