The Demise of the Section One Clearance

By David Hamerslough

June 13th, 2017

It's been a long time since I reviewed a transaction that included a Section 1 pest control clearance as either part of a disclosure packet or as a negotiated contractual allocation of pest control repairs. The demise of the Section 1 clearance is a result of, among other things, as-is transactions that eliminate contractual allocation of pest control repairs between the buyer and seller and market conditions that have produced non-contingent offers. Non-contingent offers and a market that has favored sellers have effectively limited the options a buyer has regarding pest control issues, including following up on inaccessible areas or making a request for repairs that asks for something more than fumigation of the property. These conditions have also caused some sellers to feel they do not need to provide a Section 1 clearance as part of a disclosure packet, either because it is not necessary for the marketing of their property or because they do not want to spend the money or discover additional issues with their property that would then need to be disclosed or repaired.

The demise of the Section 1 clearance has not, however, resulted in a corresponding demise of lawsuits over hidden damage, pest infestations, or dry rot that the buyer discovers once they undertake repairs or start renovations at the property. If the additional adverse conditions are minimal, most buyers absorb the costs associated with that additional damage. However, where that additional damage is significant, lawsuits are filed alleging that the seller knew of these adverse conditions or was responsible for their existence by virtue of some repairs or renovation that the seller had done to the property. These lawsuits also include claims against the brokers and agents alleging that there was a lack of inquiry regarding these issues or that no advice was provided on how to evaluate these issues.

The following language from a recent pest control report illustrates this situation:

"Wood-destroying beetles and fungus damage noted to the stucco sheeting and cripple framing. Recommendation: remove sufficient amount of stucco siding to access damage - remove and replace damage with new materials - install paper, wire, and re-stucco exterior to a reasonable match of existing materials. Owner to paint. Note: we assume no responsibility for possible concealed damage, which may be disclosed during the course of this repair and which may necessitate more repairs at additional cost. This is a Section 1 item."

The pest control report from this particular transaction also included similar findings that were identified as Section 2 items or as "unknown - further inspection recommended." No further investigations or evaluations were made in response to these findings by either the seller or buyer. The buyer closed escrow and then had the pest control company start what they thought were going to be minor repairs based on the estimates provided by the pest control company. Unfortunately, when the stucco was opened up, not only was there fungus and other infestations, but there was also extensive dry rot, which allegedly necessitated the reconstruction of a significant portion of the residence.

The buyer has alleged that the seller knew of these concealed adverse conditions, cut corners with their re-stuccoing of the house by using substandard materials, failed to disclose water intrusion, and otherwise failed to reasonably maintain the property.

The seller has denied having any knowledge of these concealed conditions. The seller hired licensed contractors to stucco the house many years before the sale and did not experience any moisture intrusion in the interior of the home. The home showed pride of ownership and was well-maintained over the years of the seller's ownership.

This fact pattern is not an isolated one and occurs more frequently than one might expect. The purpose of this article is to provide some general observations regarding this type of dispute.

When confronted with findings of adverse conditions that may be concealed or hidden, Section 2 items that call for further investigation, or information items that warn of potential adverse conditions, a buyer might consider doing the following:

  1. Contacting the pest-control operator for further details about their findings. What is it that the inspector observed that led them to make these findings? Is their finding based on only a visual evaluation or did they probe the area and encounter actual dry rot? Do they have any photographs? Ask the inspector what it would take to investigate the issue further (e.g., removing insulation, opening sheetrock, etc.), what the cost and timeline for doing so would be, and how invasive the follow-up investigation would be.
  2. Don't assume that Section 2 or information items are insignificant. Water damage and/or leakage may not be classified under Section 1 unless there is visible evidence of an infestation of a wood-destroying insect or organism. Clarify with the inspector whether findings include the potential for water damage/dry rot.
  3. Is there other information or documentation that can be provided to the inspector, including information from the seller, that might assist them in refining their opinions?
  4. What information or documentation can the seller and/or listing agent provide to assist the buyer in evaluating these issues? Past tenants, neighbors, and contractors who worked on the house or performed repairs at the property may have useful information. Is there any paperwork regarding the work that was performed so that the scope or details of that work can be evaluated by a qualified professional (engineer, contractor)? If any insurance claims were made, is there any related documentation?
  5. Documenting any discussions and the responses you receive is a good practice to eliminate any potential for miscommunication or misunderstanding and may reduce the risk in this type of situation.
  6. Request destructive testing. While such testing is not authorized by contract or in an as-is transaction, and market conditions might not motivate a seller to agree to this request, it is surprising to me that requests of this nature are still not made and certainly not documented as having been made.

From a seller's perspective, while current market conditions may allow sellers to reject any of these requests, once they are confronted with a claim, they will be spending money and time defending themselves and dealing with the stress of that claim. Conducting pre-sale inspections and having repairs performed, including a Section 1 clearance, can empower a seller and neutralize a buyer's ability to negotiate the price for the property or renegotiate that price as part of a request for repairs.

One thing that sellers need to recognize is that a buyer who has a significant claim regarding extensive dry rot has the right to seek a rescission of the transaction - the buyer is not limited to suing for damages. Rescission is an equitable remedy that is left in the hands of a judge or arbitrator. Rescission can be based on mutual mistake or failure of consideration and not only on a finding of fraud.

Allocating the loss to either a buyer or a seller in this type of claim generally is an all-or-nothing proposition. The law in this area does not provide for an assessment of comparative fault between the parties. The outcome of this type of case is going to turn on a number of factors, including evidence of prior knowledge on the part of the seller, whether the seller's disclosures were full and complete, whether the seller disclosed historical water intrusion but affirmatively represented that the cause of the water intrusion had been repaired, the number of references to the potential for hidden adverse conditions of this nature that were contained in the inspection reports, what actions and/or requests, if any, the buyer took or made in response to the information/documentation they received, and whether the buyer reasonably and justifiably relied on the information/documentation that they received.

This list is by no means exhaustive. Buyers and sellers should also not underestimate the impact that their actions and choices during the transaction (including those related to the issues raised in this article) may have on a judge or arbitrator handling a subsequent dispute of this nature. The concept of equity gives a judge/arbitrator considerable latitude to reach an outcome that judge/arbitrator believes is fair.

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