Working with distressed properties and at-risk sellers is, well … distressing. Short sales take forever and REO sellers and asset managers generally believe that it is their way or the highway. Short sale sellers are in financial distress, and buyers are having the darnedest time finding a suitable loan. While these transactions are challenging, they can be successful for those who understand the process and persevere. Although diligence, patience and luck are important factors for those that make it to the finish line, those professionals achieving success also know how to avoid some of the potential pitfalls along the way.

Unfortunately there are plenty of liability traps for the unwary in this area of practice. Real estate professionals know that if the deal goes wrong, frequently the parties will be looking for someone to blame. Sometimes an agent has missed a deadline or made some other error. Or at the last minute, the buyers might discover a property condition they believe is a defect that should have been disclosed to them. Often the parties are simply frustrated, so they blame the agents when the deal did not come together despite the agents’ best efforts. While these situations sometimes cannot be avoided, REALTORS^® should not provide ammunition to stressed-out parties looking for targets for their frustration and anger. Adherence to the rules, repeated discussions with the parties regarding the quirks of REOs and short sales, and resisting the urge to fall into the known practice traps go a long way toward avoiding unnecessary conflict and potential liability. 

Typical areas of avoidable miscues in short sales and REO sales involve the absence of property condition disclosure and repairs, giving legal or tax advice, “as-is” misconceptions, and accidental property manager problems.

1. No disclosures, no repairs

Occasionally short sale sellers resist making any property condition disclosures because they see no benefit or point in doing so. Even when they do, conditions may change since many short sales take such a long time that the disclosures may no longer be entirely accurate by the time the transaction closes. Seller’s lenders in short sales, as well as REO lenders and sellers, frequently insist on “as-is” sales, leading to the absence of meaningful property condition disclosures. Many sellers ignore the federal law mandate for lead-based paint (LBP) disclosures, even though there is no special exception carved out in the federal LBP law for these distressed transactions. 

Not only do REO sellers fail to disclose property conditions, they often do nothing to prevent or repair serious damage or deterioration. Even though “as-is” clauses are typically used, buyers and agents may still expect them to cure major defects that are a threat to health and safety. The REO sellers refusing to repair serious defects and the buyer’s lenders refusing to allow the buyer to make repairs together put the buyer behind the eight ball because the buyer’s lender insists the problems be corrected before it can provide a mortgage loan to the buyer. 

In these scenarios, the responsibility to make disclosures falls squarely on the listing and cooperating brokers. Many licensees and consumers apparently believe that an “as-is” clause in a contract absolves the brokers of any duty to disclose known material adverse facts, but that simply is not the case. REALTOR^® disclosures are critical to the buyers in these transactions and are legally required.

• REALTOR^® Practice Tip: Wis. Admin. Code § RL 24.07 requires listing brokers to inspect property prior to entering into a listing and cooperating brokers are to inspect during the showing. They are both then required to promptly disclose material adverse facts and conditions suggesting the possibility of material adverse facts to the parties in writing – no exceptions! 
• REALTOR^® Practice Tip: There is no exemption from the Wis. Stat. Chapter 709 seller disclosure law for most short sale and REO sellers. The federal LBP law does not exempt short sales or REOs so the agent may have to act to ensure compliance. If the seller does not complete a Real Estate Condition Report (RECR), the listing and cooperating brokes are still required to make timely written disclosures of any material adverse facts. 
• REALTOR^® Practice Tip: One way to avoid some of these headaches is to follow the lead of one Massachusetts brokerage that now requires sellers to complete the RECR before the company will list a home on the market. The company acknowledges that listings are hard to come by but feels it is more important to avoid the red flags associated with a seller who won’t disclose.

2. Don’t give tax or legal advice

Short sale parties frequently have many questions, and REALTORS^® must resist the urge to advise sellers on matters outside of their expertise. This means: do not provide tax or legal advice! For instance, short sale sellers want to know whether they will owe any deficiency and what the tax consequences will be. Will they be better off to let the bank foreclose or to just walk away? The REALTOR^® undoubtly intends to be helpful, but if the REALTOR^® answers, he or she will invariably be in violation of license law. If he or she gets it wrong, that REALTOR^® will be the number one target in a costly lawsuit. 

One tool used in many states to help avoid such potential legal trouble is the short sale advisory form. In Wisconsin, we have the WRA Addendum SSL to the Listing Contract – Short Sales. This addendum gives the broker an opportunity to obtain the sellers’ signatures on a document whereby the sellers acknowledge that they have been cautioned about the potential outcome and consequences of a short sale. Key points that should be covered in a short sale advisory form include all of the personal financial information and additional paperwork involved, the maddening delays, the seemingly discretionary and arbitrary control that the lenders have, and the last-minute obligations that lenders seem to cook up. The form also urges sellers to consult attorneys and tax professionals with their questions. 

• REALTOR^® Practice Tip: In addition to using the Addendum SSL for short sale sellers, parties should be encouraged at every juncture to consult with their attorneys and tax advisors if they have any legal or financial questions or concerns.

Note: The WRA-SSC Short Sale Checklist, WRA-SSL Addendum SSL to the Listing Contract – Short Sales, and WRA-SSO Addendum SSO to the Offer to Purchase – Short Sales are discussed in the March 2009 Legal Update, “Working with Distressed Sales,” at www.wra.org/LU0903, and available from the WRA in hard copy as well as on ZipForm.

3. “As-is” misconceptions

“As-is” means that if the buyer closes and defects are later found, the buyer cannot go back to the seller for any compensation. Banks disclaim seller disclosure duties and require “as-is” deals. REO agents simply do not provide any information regarding the property condition, despite the fact that the broker will be blamed for undisclosed defects discovered after the transaction closes. Clearly many REALTORS^® and consumers mistakingly believe that an “as-is” clause absolves them of any duty to disclose known material defects.

• REALTOR^® Practice Tip: The fact that the seller will sell “as is” does not release REALTORS^® from compliance with Wisconsin license law and the obligation to inspect and to disclose material adverse facts.
• REALTOR^® Practice Tip: An “as-is” clause alerts the buyer that he or she is responsible for determining the condition of the property being purchased, that is, having the property thoroughly inspected and tested. The inspection contingency provides a way for the buyer to get out of the transaction if the condition is such that the buyer no longer wants the property.

See “Uncovering the Truth: As Is Transactions” in the June 2011 edition of Wisconsin Real Estate Magazine at www.wra.org/WREM/JUN11/AsIsTransactions for discussion of additional misconceptions.

4. Accidental property manager status

Often brokers and agents are not truly aware of the consequences of handling REO sales, for example, that in most cases they must assume the additional role of a property manager, and as a result, they may not be covered under their E&O insurance. Listing agents are asked, for example, to clean out personal property, arrange for weatherization, hire contractors to make repairs, change locks, frequently drive by the property to assure it remains vacant, turn off power and change utility bills into the agent’s name. Physical property management-type services, which do not require a real estate license, may be performed under the name of the brokerage as one of the company’s services, or this may be an activity performed by the agent as a business that is completely separate from the brokerage.

For additional information, see “Best of the Legal Hotline: The Accidental Property Manager, Take 2” in the January 2011 edition of Wisconsin Real Estate Magazine at www.wra.org/WREM/Jan11/AccidentialPropertyManagerTake2.

Debbi Conrad is Senior Attorney and Director of Legal Affairs for the WRA.