No Duty To Disclose To Prospective Homeowners

What is the duty of a real estate developer to disclose to prospective residential purchasers information about the neighborhood that may adversely impact property values? Apparently none if the developer is not in privity with the homeowners, according to the Eleventh Circuit.

On May 21, 2012, Law 360 reported on the Eleventh Circuit’s decision in Luis Virgilio v. Terrabrook Vista Lakes L.P., et al. , Case No. 11-11027 (5/18/12).  We have discussed in a past article the circumstances under which a commercial  real estate broker may be found have a duty to disclose environmental liabilities to a prospective purchaser.  Here, the court was clearly troubled by the question of how far the developer’s potential liablity to disclose “inside information” would extend and how an obligation to disclose this information could be satisfied..

By way of background, class action plaintiffs purchased their homes from a builder, The Ryland Group, Inc. (“Ryland”), in a subdivision in Vista Lakes, a residential development in Orlando, Florida. Unbeknownst to the Virgilios (and other members of the class), the homes they purchased from Ryland were located adjacent to Pinecastle,  a World War II bombing range that, to this day, remains laden with unexploded bombs, ammunition, ordinance and related chemicals. Once Pinecastle’s existence became public, the homes in the subdivision lost considerable market value and the Virgilios brought this lawsuit to compensate for their loss.

Plaintiffs entered into a $1,200,000 settlement with Ryland and then turned their attention to the four other defendants involved in the development and marketing of the subdivision. However, on the same day that the district court certified the plaintiff class and approved the Ryland settlement, it dismissed plaintiffs’ claims against the remaining defendants as legally insufficient. On appeal, the Eleventh Circuit affirmed the trial court ruling in all respects.

Plaintiffs pursued four legal theories against the developer defendants, all based on their failure to inform plaintiffs about Pinecastle before they purchased their homes. One developer/defendant, Terrabrook, sold Ryland the undeveloped land that became the subdivision. At the time of the sale, Terrabrook informed Ryland of this real estate law firm existence. Terrabrook actively marketed Vista Lakes to prospective buyers and received a commission for each home or lot sold.

Count 1 of the Complaint attributed the defendants’ duty to disclose to the Florida Supreme Court’s landmark decision in Johnson v. Davis, which holds that “when a seller of a home knows the facts materially affecting the value of the property which are not readily observable and are not known to the buyer, the seller is under a duty to disclose them to the buyer.”

In Johnson v. Davis, the court overturned the old rule that  “where the parties are dealing at arms length and facts lie equally open to both parties, with equal opportunity of examination, mere non-disclosure does not constitute fraudulent concealment.” The Florida Supreme Court concluded, however, that this rule was “not in tune with the times and did not conform with current notions of justice, equity and fair dealing.” Thus, Florida’s high court held that the law required “full disclosure of all material facts” whenever “elementary fair conduct demands it.”

In rejecting plaintiffs’ argument that Johnson v. Davis should be applied to uphold their claims, the Eleventh Circuit found no facts to support the plaintiffs’ conclusory allegation that the defendants were acting as Ryland’s agent in promoting homes in the development. As the Court noted, “Count 1 is missing an essential allegation – the critical element of an agency relationship – that the principal exercised, or had the ability to exercise, control over the agent.”

Count 2 is silent as to the source of the duty, but suggests that it lies in equity since it is a claim for unjust enrichment. Count 2 alleges that because defendants failed to inform plaintiffs about Pinecastle, it would be inequitable for defendants to retain the benefits. Count 3 locates the duty in the Florida Deceptive and Unfair Trade Practices Act (“FDUTPA”), FLA Stat. §§ 501.201 et seq., asserting that defendants’ failure to inform plaintiffs about Pinecastle constituted a “deceptive, misleading and unfair trade practice.” Count 4 locates the duty to disclose in common law negligence.

The heart of the Eleventh Circuit’s decision is its refusal to extend Johnson v. Davis.  The court found that the case did not apply because: (1) the defendants were not in privity with the buyer or acting as an agent in privity with the buyer (such as the seller’s real estate broker); and (2) there was no allegation in Count 1 that defendants’ “marketing efforts were at the behest or direction of Ryland, that Ryland exercised any control over [the] marketing efforts, or that [defendants] actually listed any of the homes… on behalf of Ryland.”

Applying the same logic to Count 2, the court held that even assuming the plaintiffs conferred a benefit on defendants, Johnson’s duty to disclose did not extend to defendants. Thus, since defendants did not breach a duty to plaintiffs, plaintiffs had not been wronged and defendants were not unjustly enriched. The trial court dismissed Count 3 because the alleged FDUTPA “deceptive or unfair trade practice” was the breach of an affirmative duty of disclosure. Since the Court determined in dismissing Count 1 that there was no such duty, the FDUTPA claim was dismissed as well.

In essence, the Eleventh Circuit found plaintiffs’ “argument – that because defendants developed and marketed Vista Lakes, they had a duty to warn prospective purchasers of Pinecastle’s existence – without merit.”  Rejecting plaintiffs’ logic, the Court observed:

What about those to whom Ryland’s home buyers sold their houses? Would Terrabrook have a duty to them as well? Since Terrabrook was not a party to Ryland’s contracts with the buyers, and thus did not know the buyers’ identities, under Plaintiffs’ approach the only way Defendants could discharge their duty of care would be through marketing: Defendants could not escape liability unless they saturated the market place with the negative information

Would  the case have turned out differently if the developer had prepared brochures that affirmatively misrepresented the environmental condition of the neighborhood?  In granting summary judgment, the district court said that while it was foreseeable that the defendants’ general marketing campaign could lead some members of the public to consider purchasing a home in Vista Lakes, the general marketing had nothing to do with any particular home in Vista Lakes and simply put plaintiffs in face-to-face discussions with Ryland.

For more on the lower court’s decision and a discussion of developments built on former bombing ranges, see Larry Schnapf’s informative discussion titled “Home on the Bombing Range” and his more recent discussion about the Eleventh Circuit’s decision.


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.