During his years of practice, Yuriy has concentrated in litigation and real estate transactions as his areas of expertise.
Published, Oct. 7, 2017
Updated, Jul. 13, 2020
This article will be the second part (Part #1) in our brokerage litigation series discussing common lawsuits that real estate brokers and agents have filed against them on a regular basis. Brokers are pseudo-legal personalities who deal with contracts on a daily basis and often facilitate communications between their clients and attorneys. This unique position places them at risk for litigation from unhappy clients on a regular basis. Today’s topic is legal misrepresentation and fraud.
Real estate brokers representing home sellers (or who represent a buyer and seller jointly) have to be particularly careful about making any representations of fact about the property being offered for sale. In general, most brokers (most reputable brokers anyway) would never lie or make a serious misrepresentation about the property. No broker lasts very long while maintaining a good reputation in the community when he or she literally peddles fraud as the core of the brokerage business model. Most misrepresentations occur innocently, but can still create legal trouble for brokers.
The Distinction Between Fraud and Negligent Misrepresentation
Negligent misrepresentation is a type of business tort that is often considered to be fraud’s younger step-sister. Fraud is a type of intentional tort that occurs where a person makes a misrepresentation of material fact with knowledge of its falsity while knowing that the person who hears the misrepresentation is going to justifiably rely on that fact. For example, assume a broker is selling a house that she knows has a history of terrible termite rot and damage while also knowing the homeowner has covered up such termite damage with a dummy wall (note: actual knowledge of a material problem). A prospective homebuyer asks directly about any prior termite damage (note: knowledge that this buyer will rely on the broker’s representation). If the broker tells the prospective buyer that the homeowner has no history of termite damage, that statement is actual fraud.
Negligent misrepresentation works similarly to fraud in that it involves a misrepresentation of a material fact that the recipient of that information will rely on; however, negligent misrepresentation does not involve intent to lie. Instead, negligent misrepresentation occurs when the speaker makes a statement either recklessly without knowing whether it is true or false, or by making a statement that is true but can be taken in a misleading way. Returning to the termite inspections, assume the broker failed to do her proper due diligence and simply has no idea whether the home has a history of termite damage. If the broker claims that the home has no history of termite damage, then she has made a negligent misrepresentation. Similarly, if all the broker says in response to the question is “the house has been recently inspected and it’s a good home,” then the broker has also made a negligent misrepresentation because the reasonable homebuyer would probably assume that the inspection turned up no termite damage. The point of negligent misrepresentation is that it applies in circumstances that are fraud-like, but do not actually constitute fraud.
The Nature of Negligent Misrepresentation – Exploring the Concept Further
As implied above, negligent misrepresentation can be proven by the confluence of several different circumstances including:
a statement of fact,
lack of knowledge or “constructive fraud” (the statement is misleading),
knowledge of reliance,
the justifiableness of the reliance.
Each of these elements must be present for a homebuyer to bring a claim for negligent misrepresentation against a broker. Therefore, knowing a little about the legal beginnings and ends of these elements can help brokers avoid bad situations.
First, only certain statements can result in liability for negligent misrepresentation. Brokers should be aware that there is a legal difference between a statement of fact and an opinion. A statement of fact inherently provides a piece of information about a property (such as a lack of termite damage), whereas an opinion (such as “it’s a great value”) provides no real information. Opinions do not qualify as negligent misrepresentations because the buyer of a home should know and expect that the broker thinks a home is a great value; the broker is trying to sell the home and is puffing its appeal. Additionally, whatever statement made must be reasonably material. Materiality simply means importance (does the buyer really care about this?). Most people would consider termite damage to be material because of the havoc it causes to the structure of the home; however, the material that the doors are made of (real oak vs. fake plastic wood) is probably not material unless it would actually affect the home value.
The next element to be keenly aware of is knowing when you have made (or are about to make) a misrepresentation. A broker’s simple rule of thumb should be this: if you do not know the answer to a buyer’s question do not make an assumption, instead, tell them you will ask the homeowner and get back to them. The line for intentionally misleading statements is narrower, and in general, brokers should use their best judgment and never attempt to intentionally mislead a buyer or dodge a question. One of the leading cases on this question involves GE drywall installed in a hospital (spoiler: the drywall material used was highly flammable). When the contractor asked about the quality of the material, the GE representatives indicated that the drywall material had undergone GE’s most stringent fire-testing protocols. What the GE representatives failed to mention that not only were the GE tests not nationally certified, but even under GE’s testing, the drywall material rapidly combusted at a rate of thirty-feet per minute, far below the national standard for fire safety. GE was held liable for damages after making its negligent representation.
The final point to know about is the question of reliance. There are two parts to the reliance question: knowledge of reliance and justifiableness of the reliance. First, the broker needs to know that the homebuyer will rely on the statement. To return to the termites example, if the homebuyer also indicates that she intends to have the house inspected for termite damage, the buyer is probably not going to rely on the realtor’s representation. The question of justifiability is similar. If the realtor answers the termite question by saying: “I don’t know for sure, but I don’t think the home has ever had termite damage,” then the buyer would be likely less justified in relying on that information because of the uncertainty it carried.
Negligent misrepresentation is an issue that brokers should be constantly on the lookout to prevent. While most instances of negligent misrepresentation can be prevented by having some knowledge about its legal elements, brokers should always be cautious when giving out information on subjects that they do not have all of the answers on. If you have additional questions about negligent misrepresentation law in either New York or New Jersey, or if you have been sued by a home buyer in either of those states on a theory of negligent misrepresentation, Law Firm of Yuriy Moshes would be happy to evaluate your case. Our law firm regularly handles real estate matters for brokers and we offer free intake consultations to our broker clients.