Suits Put Brokers on Guard : Realtors Try to Cut Risks With Extra Prudence
The forms that every real estate broker now must carefully attend to are the clearest indication that a major change has taken place in the marketplace.
Every step in a real estate transaction must be noted, signed, countersigned and reviewed. Brokers and agents may be helping clients buy a house today, but tomorrow the clients may be hauling the brokers off to court, seeking thousands of dollars in damages because they claim they weren’t warned about that fissure arching across the living room ceiling.
One can’t be too careful.
“The business is far more complicated than it was 10 years ago,” said Fred Sands of Fred Sands Realty. “The days of the part-time broker walking through a house saying, ‘Ooh, look at that shag carpet. Ooh, look at the microwave oven,’ those days are over. You have to be really professional and well-informed of what’s going on today.”
“There is an extra burden on us now to be careful,” agreed Monty Gardner, president of Monty Gardner Realty.
What has triggered the nervousness was a 1984 court ruling in the Easton case that held real estate brokers responsible for disclosing all the facts materially affecting the property being sold. The case set off numerous liability lawsuits, and, under pressure of the litigation and high damage judgments, many insurance companies were forced to leave the California real estate insurance market.
Be careful or be sued. Like the doctors, lawyers, architects and engineers before them, real estate brokers increasingly are becoming defendants in lawsuits brought by clients who claim they have been carelessly served. And, like the people in those professions, real estate brokers probably could have survived the fall from grace more or less intact if only their safety net hadn’t collapsed.
The safety net is insurance--malpractice, or professional liability insurance, called errors and omissions insurance in the real estate industry. As the name implies, errors and omissions insurance is supposed to protect brokers from any errors or omissions they may have made in their disclosures about a property to a prospective buyer.
Until about a year ago, there was no problem. Such insurance was available and affordable. Now it is neither. Until early 1985, there were about half a dozen companies offering errors and omissions insurance to real estate brokers in California.
Now, according to John Linton, vice president of legal affairs for the National Assn. of Realtors, Travelers Insurance Co., underwritten by Victor O. Schinnerer & Co., is the only national carrier the association recognizes. With the number of companies competing in the market distinctly reduced, the price of insurance has skyrocketed.
According to a Carriage Realty corporate official in Rolling Hills Estates, the premiums on his firm’s errors and omissions insurance have gone from about $30,000 a year to about $40,000 on $1 million coverage. The deductible, the amount after which the insurance company begins to pick up the tab, has jumped even higher. Carriage’s deductible has gone from $2,500 to $25,000 in the last year. Fred Sands has a deductible of $100,000.
Many Agents Rebelled
At the Sands firm, when management last February asked its sales staff to help pay for the errors and omissions policy, many of his agents rebelled. Although they did not object to contributing to the cost of the insurance policy, according to one sales agent, many expressed opposition to what they considered to be a one-sided agreement.
The agents claimed it protected the company more than themselves and that it gave all decision-making powers on handling possible lawsuits to Sands. After negotiations, heated at times, eventually 98% of the agents signed the agreement.
Many real estate companies have felt the financial strain of making the payments. Some have gone under. “Many brokers have gone out of business because of the downward spiral in business and the cost of the overhead, and the cost of errors and omissions insurance has contributed to that,” said Colin Daly, vice president of Mike Silverman & Associates in Beverly Hills.
The larger companies are able to make the payments comfortably, but they face a different problem--some are not able to get insurance. Large companies handle a greater volume of sales, hence they are more likely to make a mistake--and be sued for it. The insurance company may be unwilling to take that risk.
In-House Policy
Neither Merrill Lynch Realty nor Jon Douglas Realty, for example, has errors and omission insurance. Merrill Lynch has given up the search and is relying completely on an in-house policy.
“The premium structure is so high that it’s economically safer to go ‘naked,’ ” said Lou Piatt, senior vice president of the Douglas firm. “The premium for a policy with a deductible of $100,000 to $300,000 and $1-million to $2-million coverage could be as high as $200,000 a year.”
Marvin Silverman, executive vice president and general manager of Merrill Lynch, said, “Carriers either refused to insure us or charged such high premiums that they were, in effect, refusing to insure us. We would rather have a policy, but the market has forced us to adopt our present posture.”
As a recourse, some large companies have insured themselves. Even those large companies that do have insurance, like Carriage Realty and Fred Sands, for example, have started self-insurance funds as a buffer against the high deductible on their policies.
High Cost of Defense
In these days of million-dollar lawsuits, insurance is a necessity. No matter what the cost, “We pay it,” Sands said. “We don’t like it, but we have no choice. If you don’t have insurance, you are exposed to almost anything. A company could be wiped out by one major claim.”
Merely defending oneself against a lawsuit can cost between $50,000 and $60,000, according to Steven Groome, senior counsel for the California Assn. of Realtors. And in many cases those legal fees are not covered by the insurance, John Criss, broker-manager for Carriage Realty, said.
That is one reason real estate brokers are so careful these days. That is why real estate brokers have so many forms to deal with. And that is why disclosur e has become such an important word to real estate brokers.
The theory is that if a house’s every flaw is noted and related to the buyer, and if the buyer signs a form acknowledging that he has been warned about those problems, then there can be no surprises. The broker has covered himself.
“Disclose, disclose, disclose, and when in doubt, disclose some more,” Groome said. “The old days of not telling a buyer about a problem with a house--for fear that they would not buy the house if they knew--are over. We tell brokers to disclose everything that could remotely be related to some problem with the house.”
Unfit Can’t Survive
That is good, in the opinion of many in the industry. The real estate industry has been trying for years to police itself, and now this problem with lawsuits and the high cost of insurance has helped get the job done faster, according to Piatt of Jon Douglas Realty. The slipshod and the sneaky cannot survive in today’s world, Piatt said. Like it or not, the real estate industry is being purged.
Criss, of Carriage Realty, appreciates the beneficial byproducts of the insurance crisis, but he also sees a potential for danger in all this paper chase.
“This proliferation of forms has taken the ‘buyer beware’ warning out of the picture,” Criss said. “Everyone is trying to get to the point where the buyer can rely totally on the realtor.
“We’ve gone overboard. Some people pick up on the fact that because there is a form for disclosures, and because so many things are covered on these forms, that everything should be perfect with the house. The buyers are really nit-picking now, and they are more aware of the kinds of things that can initiate a suit.”
The disclosure forms are exhaustive, covering everything from the septic tank and the water heater to the sump pump, built-in barbecue and trash compactor. All those items and many more must be inspected either by the broker or a qualified inspector and checked off on the disclosure form.
Layers of Review
To prevent anything from falling through the cracks, some companies have set up several layers of review for each transaction. At Fred Sands, for example, the legal research department reviews every document the brokers fill out. If there is something unusual about the case, the broker, an attorney and the manager sit down and discuss the next step.
And to keep its brokers aware of the latest laws passed in the area of professional liability and to advise them of any other legal matters, Fred Sands has begun publication of an in-house newsletter.
“You have to try to nip things in the bud instead of trying to deal with them after the fact,” Sands said. “It’s hard to fix something three months after the close of escrow.”
All the forms, lawyers and legal reviews have created an atmosphere of paranoia that some realtors find stifling. Andy Nelson, president of Willis M. Allen Co. in San Diego, has been quoted as saying that the problems of the last year have “changed the complexion of our job. We almost lose all of our true sales ability.
“Rather than stress the positive about a home, we have to be cautious and accentuate the negative. It has almost created a fear.”
Earth Movement
The real estate brokers’ troubles began in 1984, when the California Court of Appeal found in favor of Leticia Easton in her suit against William F. Strassburger. Strassburger owned a house in Diablo, a city on the fringe of the San Francisco Bay area, that he sold to Easton for $170,000 in May, 1976.
Shortly after Easton occupied the house, the earth began to move, carrying away large sections of the driveway and causing the foundation of the house to settle in such a way that many of the walls cracked and the doorway warped. Estimates of the cost to repair the damage ran to about $213,000.
Apparently, the property had a history of soil problems, but no one bothered to tell Easton. The house had been inspected by the brokers before purchase, but they neglected to have the stability of the soil tested. Easton was awarded damages of $197,000.
What set that case apart was the way that the court interpreted the real estate broker’s liability. The court held that “a real estate broker is a licensed person or entity who holds himself out to the public as having particular skills and knowledge in the real estate field.
“He is under duty to disclose facts materially affecting the value or desirability of the property that are known to him or which through reasonable diligence should be known to him.”
Court Sets Standards
It’s that last clause that really sticks in the real estate broker’s craw: “. . . or which through reasonable diligence should be known to him.” The court argued that “if a broker were required to disclose any known defects, but not also those that are reasonably discoverable, he would be shielded by his ignorance of that which he holds himself out to know.”
To which Groome, the California Assn. of Realtors attorney, says, “What is that? That case gives such a broad outline of a real estate broker’s duties that it provides ammunition for all kinds of marginal claims.”
Many brokers complained that the wording of the decision implied that a broker would have to be a qualified geologist, architect and structural engineer to rightfully conduct his business. The real estate industry has since mobilized its forces and descended upon Sacramento to persuade the Legislature to pass two bills clarifying the intent of the Easton case and refining the definition of a broker’s responsibilities.
Before the bills were passed, however, the Easton case swung the courtroom doors wide open, allowing many angry property owners and their lawyers to rush in. No one knows how many cases were filed against real estate brokers in 1985, but Groome estimates that the number was up sharply from the year before.
Effect on Insurance
And, he added, the number of what he called nuisance suits, or cases filed primarily to squeeze money out of the insurance companies, outnumbered what he called legitimate claims by about 5 to 1.
The proliferation of cases filed against brokers was one of the factors that led to the failure of many insurance companies and the rise of premiums and deductibles.
And realtor Monty Gardner, for one, puts the blame squarely on the shoulders of the lawyers. “They take these cases on a contingency basis (meaning they only get paid in the event of an out-of-court settlement or a judgment in favor of their client).
“If there were legal fees up front, a lot of these cases would never get started. If it costs nothing to get a settlement, you’d be crazy not to try it.”
Richard Wiebe, regional director of the Alliance of American Insurers, carries Gardner’s reasoning one step further. He blames the courts.
He says that “the rules by which these cases are decided are unfair.” He is referring to the rule of joint and several liability, or “deep pockets,” which the California courts have adopted.
That rule places the greatest financial burden for settling the damages upon the defendant with the means to pay for it, regardless of what that defendant’s share of the blame might be. And, typically, Wiebe said, insurance companies have the deepest pockets.
Proposition 51, on the June 3 primary election ballot, if approved, will restrict the amount of damages that can be collected from so-called “deep pockets” defendants.
Cutthroat Price War
In portioning out the blame for the present crisis, one must remember that for six years during the late ‘70s and early ‘80s, the insurance industry was engaged in a cutthroat price war in professional liability insurance, according to Jim McCann, regional vice president for the Insurance Information Institute. Prices for liability insurance during that time plummeted as the insurance companies fought for a share of the market.
“The insurance companies were fighting for their lives,” McCann said. “If they didn’t cut their rates, they would begin immediately to lose business.”
At the same time, new standards for liability law were slowly evolving in the courts, McCann said. And when the hundreds of professionals who were being sued turned to their insurance companies to bail them out, the insurance companies panicked, McCann said.
“The insurance companies definitely overreacted,” said Douglas Dolan, vice president for Victor O. Schinnerer & Co. Inc., underwriters of Travelers Insurance. “They had cut their rates below what was actuarially sound in an attempt to gain market share. When they found that their rates were inadequate to cover the claims, instead of correcting their rates, they tossed in the towel.”
The losses for insurance companies in 1984 and 1985 were heavy. In liability insurance, according to McCann, insurance companies in 1985 paid out $1.59 in claims for every $1 in premiums they collected. Operational losses throughout the industry in 1985 totaled $5.5 billion, he added.
Rates Cover Losses
Travelers was able to survive, Dolan said, “because we have rates that we are sure will cover all losses and because we know how to evaluate risk. We are still in this business, and we are satisfied that we can be in it for a long time.”
In the meantime, they are the only game in town, and Dolan said that it could be quite a few years before the industry stabilizes. The best recourse for the real estate industry, in the opinion of many in the business, is the state Legislature.
The real estate industry has already won passage of two bills defining the impact of the Easton case. Wiebe of the Alliance of American Insurers recommends an entire package of tort reforms similar to the Medical Injury Compensation Act passed in 1975, which put a ceiling on the damages that could be awarded in medical malpractice cases.
Assemblyman Alister McAlister (D-San Jose), has introduced two bills affecting insurance. One would take the stipulations of the Medical Injury Compensation Act and apply them across the board to all areas of professional liability, and the other would, if passed, essentially establish California as a no-fault state. Both were passed, with amendments, in the Assembly, and now are in the Senate, where they face an uphill struggle, according to Bill George, an aide to McAlister.
“I think that the legislation that has been passed, and with the bills that are in the works, that the pendulum is beginning to swing the other way,” Sands said. “I think we’ve seen the worst of the excesses.”
