Disclose, Disclose, Disclose – Or Your Deal May Get Flushed Down The Drain

By Ronald R. Rossi

An appellate decision arising out of a case in San Mateo County and published in May of 2015 should be of great interest to California real estate brokers, agents, buyers, and sellers. The case, Wong v. Stoler, is the latest warning by the courts that participants in real property transactions who fail to make complete and accurate disclosures do so at their peril.

The facts of the underlying Superior Court case were a recipe for disaster. The Wongs bought a hillside home in San Carlos for $2.35 million. They bought this property in May of 2008 (that’s right – just before the real estate crash). After the Wongs moved into the house, they discovered that their house was not connected to the public sewer system but, instead, was on a private system owned by themselves and 12 of their neighbors. The Wongs believed they were defrauded, and they sued the sellers, the real estate agents, and the brokers involved in the transaction. They asked for rescission – in other words, they wanted to give the property back to the Stolers in return for the money they had paid for it. The agents paid $200,000 to settle the case right before trial.

At trial, the following points were brought up regarding the Stolers’ knowledge of the fact that the property was not connected to a public sewer system. First of all, in the Transfer Disclosure Statement and all other disclosure documents, the sellers did indicate that the property was connected to a public sewer system. However, there were documents recorded back in 1984 and 1987 with covenants, conditions, and restrictions regarding the private sewer system and the obligations of the downhill property owners with regard to cross-easements for installation of that private system. The Wongs relied on the sellers’ disclosure documents, which indicated that the house was on a public sewer system.

At trial, it also came out that the sellers had not only participated in forming an informal homeowners’ association to pay for sewer maintenance, they had also contributed money to that association. In fact, Mrs. Stoler was the initial signator on the private association’s bank account. It was also pointed out that the Stolers did not give the Wongs the cross-easement agreements that referred to the private association formed to address issues related to the private sewer system. Finally, the coup de grâce – the sellers did not give the buyers the letter they received from the city reminding them and the other owners about the obligation to form an association as “part of the privately owned and maintained sewage disposal system.”

The Stolers argued that rescission shouldn’t be granted because they had already bought another house, they had made improvements on that house and had substantial out-of-pocket costs as a result, and it wouldn’t be fair to force them to take their former house back. (It must be noted that after the Wongs moved in, they remodeled the house extensively and had even more out-of-pocket expenses than the sellers, to the tune of about $300,000.)

The court held that the sellers acted “with reckless disregard in negligently misrepresenting the material facts about the true nature of the sewer system and the existence of the informal association loosely established to maintain it.” The court held that the sellers’ misrepresentations affected the property’s value, and experts testified that the private sewer system was in such poor condition, it would cost between $470,000 and $592,000 to repair and replace various lines that were over 25 years old with a life expectancy of approximately 50 years. However, it did not grant the Wongs’ request for rescission.

On appeal, the appellate court ordered the trial court to essentially grant rescission to the buyers and make them whole in terms of their out-of-pocket expenses related to their purchase of the house. Even though the significant remediation and remodeling work they had started on the house was not yet finished, the Wongs were allowed to return the property to the Stolers in its current condition.

The appellate court explained that while it found no actual fraud on the sellers’ part, the court followed other case law and Civil Code sections holding that “Negligent misrepresentation is a form of ‘actual fraud,’ consisting of ‘ the positive assertion, in a manner not warranted by the information of the person making it, of that which is not true, though he believes it to be true.'” The court went on to say that even a single misstatement as to a material fact, knowingly made with the intent to induce another into entering a contract, will, if believed and relied on by the other party, provides grounds for rescission. Here, the sellers made representations that were not true with reckless disregard for the effect of those misrepresentations on the buyers and were therefore negligent – at least, that’s what the court found. It’s difficult to believe that the Stolers, when filling out all the detailed disclosure paperwork, somehow forgot that their house was connected to a private sewer system.

The real estate agents involved paid money to settle because, obviously, they received preliminary title reports indicating that there were recorded CC&Rs and easements associated with a private sewer system. The information in these reports conflicted with the sellers’ disclosures, and competent real estate agents would have spotted these red flags and followed up with recommendations to their clients to determine what was really going on with the property’s sewer system.

This decision is another stern warning by the California courts that if anyone involved in a purchase-and-sale transaction takes the issue of disclosure lightly, they can end up paying a very high price for that mistake.