Forward To The Past

The impact of Jue v. Smiser, 23 Cal. App. 4th 312, 28 Cal. Rptr. 2d 242
(1st Dist. 1994), as modified on denial of reh'g, (Apr. 15, 1994)


Harry I. Price, Esq.

On March 16, 1994, the California Court of Appeals in San Francisco reopened a door that had been closed to real property purchasers in cases where they learned of material misrepresentations before the completion of the sale. As a result, instead of the purchaser being faced with unenviable choices, the seller and brokers will now be faced with the purchaser's new remedy: the threat of litigation if they do not capitulate before the close of escrow. By striving to be fair to the purchaser, the court has instead empowered the purchaser with a "big stick", affording him the best of all worlds.

The court distilled the controversy to a single issue, stating as follows:

The case at bench requires this court to resolve the following question: May a purchaser of real property who learns of potential material misrepresentations about the property after execution of a purchase agreement - but before consummation of the sale -close escrow and sue for damages? Our answer is, "yes."

In recent years, a purchaser was to be provided, as soon as practically possible prior to the close of escrow, disclosure in writing of all material information affecting the value, use or desirability of real property (Civil Code §§ 1102 et seq. and 2079 et seq, the statutory follow up to Easton v. Strassburger(1984) 152 CA3d 90, 199 CR 383, and Reed v. King (1983) 145 CA3d 261, 193 CR 130). Upon the receipt of negative information, the purchaser then had the choice of closing escrow and "waiving" the defect, or rescinding the transaction and receiving a refund of the deposit. In effect, the purchaser's choice was "close or cancel." The court determined that those two choices were too limiting. Now, the purchaser has an election of remedies among three choices: "close, cancel or close and sue (seek compensatory damages)."

The Case

On April 1, 1992, the Sellers, Mr. and Mrs. Smiser, listed their home in Oakland with a real estate brokerage office, Tabaloff & Company. An article about the house, in the San Francisco Chronicle, first brought the property to the attention of Mr. and Mrs. Jue, the purchasers. The article stated "that the home had been designed by Julia Morgan, a celebrated architect whose credits include Hearst Castle." Purchasers contacted the realtor, toured the home, and were given a brochure that indicated that it was an "Authenticated, Julia Morgan Design, built 1917." A real estate purchase and sales agreement was entered into, scheduling a close of escrow for June 11. On June 8, while at the title company to execute closing papers, purchasers were presented with a disclaimer to sign, which stated as follows:


Purchasers refused to sign the disclaimer. They did some independent investigation, speaking to an author of a book profiling the architect and to Morgan's goddaughter. The next day, the sellers signed off, and escrow closed. Five months later, the purchasers filed a complaint for damages because there were no official records to authenticate the property as a Julia Morgan design. In typical shotgun fashion, the complaint sought relief under various theories including "fraud, concealment, negligent misrepresentation, negligence, mutual mistake of fact, unilateral mistake of fact (on the part of appellants), intentional infliction of emotional distress, negligent infliction of emotional distress, and various common counts."

Sellers prevailed before the trial court on their motion for summary judgment. The ruling was made because the purchasers "knew" before the close of escrow the very information that they were now complaining about. The trial court explained: "They chose to proceed anyway; thus they did not purchase the property in justifiable reliance on the alleged fraud." The appellate court reversed, holding that such knowledge did not preclude a later lawsuit for damages.

The Decision

The holding centered upon the issue of "justifiable reliance." Sellers argued that since Purchasers acquired knowledge of the relevant information while the contract was executory in nature, their closing of escrow was based upon the correct information, not in reliance upon any misstatements. However, the court found it critical that the claimed misinformation came to Purchasers before they entered into the contract, rather than during the escrow term. Thus, this is an example of fraud at the inception of the transaction. The appellate court cited Storage Services v. Oosterbaan (1989), 214 Cal. App. 3d 498, as supporting authority, where it was:

"determined that reliance must be established at the time the initial contract is struck. It is not necessary that a claimant establish continuing reliance until the contract is fully executed in order to maintain an action for damages."

The appellate court further held that "a party's continued performance of the agreement does not constitute a waiver of his action for damages.

"The relevant issue was (is) whether or not appellants relied on respondents' (alleged) misrepresentations when the purchase agreement was struck."

Addressing the contemplated impact of the decision, the court determined that sound public policy considerations supported the decision. These include the statutory scheme designed to "encourage sellers and their representatives to investigate and learn the 'true facts' pertaining to real property before it is offered for sale." Otherwise, the court reasoned, the practical effect is to force upon purchasers who learn of adverse material information on the eve of the close of escrow an "extraordinarily difficult choice": (1) close escrow and waive the defect or (2) rescind the transaction. Consequently, the appellate court reversed the decision of the trial court, re-instituting the rule that purchasers have a third choice: close escrow and sue for compensatory damages.

The Impact

The result, while it may be applauded by purchasers, will dismay real estate brokers and sellers who seek certainty in their transactions. The decision, while trying to avoid harshness to purchasers, will create ambiguity that will be harsh on sellers. Where there is ambiguity, contrary to the stated motivations of the court, litigation will increase.

In a typical sale of a single-family residential home, the Transfer Disclosure Statement (TDS) is provided to the purchaser after the formation of the purchase contract. That factual setting alone dovetails with the objections of the court: critical information provided to a buyer after the executory contract is formed. One obvious TIP to brokers: provide the TDS to purchasers prior to contract formation. Typically, problems encountered during the close of escrow fall into one of three categories: historical or situs; structural or physical conditions; and title or financial encumbrances. The short-term impact of the "close and sue" rule can be seen in the following examples:

Historical or situs: In addition to architectural history of a property, such as the subject case, a buyer may learn during escrow of negative neighborhood conditions, boundary disputes or that the property will be impacted by creeping commercialism or development. For instance, the buyer learns during escrow that a church, located two blocks away, operates a soup kitchen for the homeless. The buyer contends that the information was material, purposefully withheld, and feels that this information diminishes the fair market value of the neighborhood and property, but wants to continue to purchase the property at a reduced price.

Structural or physical conditions: The buyer may learn of structural additions made without building permits, soil or drainage problems, or building code violations. The buyer insists that the seller remedy the situation as a condition of the close of escrow, so that there will be no "failure of consideration" when he receives title to the property.

Title or financial encumbrances: As a result of a lot line adjustment, the seller's property now includes a strip of land from adjoining property. However, when the boundary realignment was made, the seller neglected to obtain a deed of partial reconveyance from the neighbor's lien holders. The buyer wants the title issue cleared before close of escrow, and seeks damages for delay in performance because of the anticipated rise in interest rates during the projected time that the seller tries to sort out the mess.

In each of these cases, the seller, in the recent past, could have refused, telling the buyer to either close or cancel. Now, however, the purchaser wants to compel a sale, but with an appropriate offset of the purchase price. This is in spite of the fact that the seller has a back-up buyer who, now informed of the new information, is ready to pay the same price and close immediately, thus establishing that the fair market value of the property remains the same, and that the new information is immaterial as to the issues of value or use. The amorphous claim of impact upon "desirability" should only be a factor for a court reviewing a claim for rescission.

The seller may try to respond to the purchaser's ultimatum with his own demand that the purchaser either "take it or leave it." But now the purchaser's attorney can dust off an old weapon in his arsenal: the threat of a specific performance action coupled with a claim for both "failure of consideration" and "delay in performance" damages. I know it does not sound like specific performance when, in actuality, the purchaser is asking the court to rewrite the contract purchase price downward. But how different is that from the purchaser closing escrow now, and suing for damages later? After reviewing this decision, the purchaser's attorney should be asking: Why not resolve it all in one hearing, without being harsh on the purchaser? This adds new meaning to the phrase "buying a lawsuit."

Thus, as certainty gives way to ambiguity, relieving perceived harshness to the buyer causes the pendulum to swing to imposing harshness on the seller and brokers. The buyer gets the leverage of threatening a lawsuit in seeking a price reduction where there may be no impact upon fair market value, and the seller is saddled with the inability to sell to a subsequent purchaser to whom the claimed defect is a non-event.

And what of the purchaser who learned of a defect during close of escrow, and was compensated by a price reduction and even signed a waiver? Even that purchaser can sue, after the close of escrow, claiming that his "paid-for waiver" should be deemed to be based upon incomplete information, since he was rushed at the tail end of his escrow transaction. Thus the settlement on the "eve" of the close of escrow is a factual setting ripe for the claim that the settlement should not be upheld, because the waiver was extracted from the purchaser without adequate time or information, when the purchaser was under "economic duress": the financial pressure to close escrow due to the anticipated expiration of the loan commitment or the contract escrow term.

Thus, being fair to the purchaser, by restoring the third choice of "close and sue", has a potentially drastic impact upon the seller. Between the two, why is it more fair to be harsh on the purchaser before the close of escrow rather than on the seller? Because the purchaser can elect to cancel the transaction and find an alternate property more suitable to his needs. The seller, knowing that the new information was provided to the purchaser before the close of escrow, and having sold the property and spent the proceeds, has changed his position in reliance upon the escrow being over. Only now, it is not over. Seller beware..