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Volume IV – Risk Management
What is this topic about?
Risk management is about managing threats to your business. In the broadest sense, risk management includes threats created by everything from politics to the environment to a particular real estate transaction. Managing risk is, therefore, always about prioritization. What is needed is a plan to deal with the risks that create the potential loses most likely to occur in your business.
Your business is helping buyers and sellers involved in real estate transactions. To manage the risk generated by that activity you must look at the business activities that create the potential for economic loss. These will include the “generic” risks that attach to operating any business as well as the “transaction” risk that attach to individual real estate transactions. That means dealing with the risk involved in driving customers and clients around in your car as well as the risk that a client will experience a financial loss as the result of a transaction. Beginning with Risk Identification, this topic covers both the generic and transaction risks associated with providing professional real estate services.
Once the generic and transaction risks associated with providing professional real estate services have been identified, specific risks will be analyzed in the Risk Analysis section of this topic. Risk analysis involves identifying the events and activities most associated with specific legal claims like misrepresentation, lack of due diligence or law or rule violations. The final section of this topic is devoted to Risk Mitigation, or how to use human, organizational and technological resources to reduce risk.
- Risk Identification
- Risk Analysis
- Risk Mitigation
Risk identification takes place on two levels. One is identification of the risks associated with being involved in real estate transactions. The other is the risk associated with operating a business. Potential losses associated with owning buildings, equipment, hiring staff, interacting with clients and customers and the like are fundamentally the same regardless of the business enterprise. You can think of such risks as “generic risks.” Real estate transaction risks are, on the other hand, specific to being in the business of helping clients buy or sell specific real property. You can think of such risks as “transaction risks.”
Businesses, all businesses, have assets in the form of buildings, tools and staff. These assets must be protected and managed in a way that reduces risk of lost – both loss of the asset and losses caused by loss of the asset. A fire or a car crash, for instance, can cost a business asset and staff losses that cause further losses.
The real estate industry is mostly structured around independent contractor relationships. That structure creates businesses within businesses. Real estate companies, many of them franchised entities within still larger businesses, associated with individual agents running their own small businesses as independent contractors. General business risks exist at each level. Typically, generic business risks are handled independently at each level. Analysis of these generic risks is covered in the Risk Analysis section of this subject.
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Most of the risk involved in real estate and, therefore, the risk we most want to learn to manage, is risk associated with real estate transactions. Transaction risks flow from principal to real estate agent. That is the case because most losses suffered by real estate professionals are losses one of the principals would suffer personally if they could not shift the loss to the agent. If there is no loss to a principal, there is nothing to shift and, therefore, no risk to the agent.
This simple insight is the key to understanding risk identification in the real estate profession. What we want to identify initially is not the real estate professional’s risks, but their client’s and customer’s risks. We want to identify all the ways a buyer or seller might end up suffering financial loss as the result of being involved in a real estate transaction. This sounds daunting, but it is actually very simple, at least initially.
Identifying transactional risks is easier on the seller’s side of the transaction. Seller’s normally do not suffer loses as the result of real estate transactions – as long as the property is worth more than the seller owes on it. That is the case because a real estate transaction reduced to its essence is the exchange of real property for money. The seller gets a pocket full of money and the buyer gets the deed to some kind of real property. If you think about it at that level, it is easy to see that it is a lot more likely there is something wrong with the property than it is there is something wrong with the money.
For identification purposes, transactional risks can be broken down into “direct risks” and “reflected risks.” Direct risks are those that flow directly from the agent’s duties and responsibilities to the client, to the public or to the Real Estate Agency. Reflected risks are those created by the agent’s principal. When the principal breaches a legal duty, their agent, though not directly responsible, may well be put at risk. Because the duties owed, and services performed, vary depending on which side of a transaction the agent is on, direct and reflected transactional risks must be identified on both the listing side and the selling side.
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Identifying Listing Side Risks
Direct transactional risks on the listing side are risks associated with the services provided, not the property. Direct risks flow from the duties an agent owes their client. These duties create the potential for the client to sue the agent claiming the agent breached a duty owed to the principal. Such claims are lumped under the heading of “professional malpractice.”
In Oregon, as in many states, the duties a real estate agent owes to the seller are set out in statute. Click here for a detailed discussion of statutory duties in Oregon. Notwithstanding this statutory illumination, the duties remain basically the same as under common law “fiduciary” duties: Loyalty; Obedience; Confidentiality; Disclosure; Reasonable Care and Diligence; and Accounting. Each duty is a separate risk generator for risk identification purposes.
The duty of loyalty will be implicated anytime the agent deals with their principal directly or otherwise benefits from the agency relationship in the way not known or anticipated by the principal. For example, a listing agent buying the listed property or an agent taking a kickback on a home warranty or receiving an undisclosed “bonus” of some kind on the sale or taking an interest in a company that is purchasing the property or anything that might secretly put money (other than the agreed-to commission) in the agent’s pocket. Analysis of these loyalty risks is covered in the Risk Analysis section of this subject.
Obedience means obeying the lawful instructions of the principal. This duty is rarely violated directly as in an agent refusing to do what the principal asks. Obedience becomes a risk management issue when the seller asks the agent to do something, usually withhold information, which violates the agent’s duties of honesty and fair dealing. Obedience issues are, therefore, almost always based on a conflict of duties. Analysis of these obedience risks is covered in the Risk Analysis section of this subject.
The duty of confidentiality is implicated anytime an agent discusses the object of the agency relationship with a third party. On the listing side, that means anytime the seller’s agent discusses the property, the seller’s motivation or the terms of a transaction with anyone other than the seller. Confidentiality is a big duty. Fortunately, the definition of confidential information (anything learned as an agent that it is not in the principal’s interest to disclose or is not required by law to be disclosed) makes analyzing and controlling confidentiality risk fairly simple. Analysis of confidentiality risks is covered in the Risk Analysis section of this subject.
An agent’s statutory duty of disclosure runs to all parties to a real estate transaction. To one’s own client, an agent must disclose anything that might be important or useful to the client. Direct risk is created anytime an agent withholds information from a client. On the listing side, for instance, the agent might withhold the fact that another offer has been made or is coming in, or that the buyer has failed to meet some deadline or anything else the client is entitled to know about. In Oregon, real estate licensees have a disclosure duty to all parties, not just their clients, creating yet another direct disclosure risk. This duty, however, is limited to material information not known or readily available to another party. Analysis of disclosure risks is covered in the Risk Analysis section of this subject.
The duty of reasonable care and diligence generates little risk on the listing side. Care and diligence is strictly a direct risk issue. Failing to exercise care and diligence means failing to protect or advance the client interests. The duty runs directly only to the client. On the listing side, the seller’s interests are mostly financial. Care and diligence can become an issue on the listing side if property is listed unreasonably high and doesn’t sell as a result, or listed too low and immediately sells below its market value or there is insufficient or incompetent marketing. Sellers who become aware of these costs may try to shift them to the real estate agent. It is this simple economic fact that drives listing cancellations, listing side marketing strife, lack of diligence ethics complaints and occasionally a lawsuit. Analysis of reasonable care and diligence risks is covered in the Risk Analysis section of this subject.
Accounting is the final direct risk duty. Accounting is a duty that flows logically from the duties of loyalty, disclosure and diligence. The duty to account requires the agent to keep track of (account for) any money or property of the client’s coming into the agent’s hands as a result of the agency. The duty to account can be violated innocently from ignorance, but typically failure-to-account claims are the result of the agent deliberately hiding or otherwise misappropriating their client’s funds. Because Oregon law requires licensees to keep their client’s funds in trust accounts, accounting is mostly a matter of following trust account rules. Analysis of accounting risk is covered in the Risk Analysis section of this subject.
In addition to the direct risks created by agency relationships, there is also a direct risk that flows from simply being in the business of providing real estate services. This risk results from the Unlawful Trade Practices Act. The Unlawful Trade Practices Act is state consumer protection legislation that protects consumers as consumers from sharp business practices. The Act creates a separate duty to conduct business affairs in a lawful manner. As such, it creates a direct risk for all real estate licensees. Analysis of risks created by the Unlawful Trade Practice Act is covered in the Risk Analysis section of this subject.
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Identifying Selling Side Direct Risks
Selling side risks flow from the same duties as listing side risks. The duties of loyalty, obedience, confidentiality, disclosure, reasonable care and diligence, and accounting all apply. Just like on the listing side, each duty is a separate risk generator for risk identification purposes. What changes is the relative importance of each duty as a risk generator. Loyalty, obedience, confidentiality, and disclosure duties create the same type of risk on the selling side as on the listing side. The risks are similar but, with the exception of confidentiality, there is less opportunity to violate these duties on the selling side. The opportunity to violate the duty of reasonable care and diligence is, however, greatly increased on the selling side.
Loyalty to a buyer client means placing the buyer’s interests in front of the agent’s. The buyer’s primary interest is in finding suitable property at a price they are willing to pay. Loyalty can become a risk management issue on the selling side when the buyer’s agent tries to beat their client out of a property by buying it himself. Loyalty can also be implicated if the agent places the interests of other buyers (buyer/buyer conflicts) or third parties (lenders, consultants etc.) over those of the client. Analysis of this kind of selling side loyalty risks is covered in the Risk Analysis section of this subject.
Obedience, as was the case on the listing side, is rarely violated directly by an agent refusing to do what the principal asks. Obedience usually becomes a risk management issue on the selling side only if the buyer demands the selling agent withhold material information from the seller, lenders or other service providers. On the selling side, the information the buyer wants withheld typically involves the buyer’s financial position. That information may or may not be confidential depending on the circumstances and who the information is being withheld from. For instance, buyers may ask their agent to help them hide material financial information from a lender and thus create a conflict between the agent’s obedience duty and their duty of honesty and fair dealing. Analysis of these obedience risks is covered in the Risk Analysis section of this subject.
Confidentiality is implicated anytime an agent discusses the object of the agency relationship with a third party. On the selling side, that means potential risk anytime the buyer’s agent discusses the buyer’s motivation, financial situation or best price with anyone other than the buyer. Confidentiality is a big duty on the selling side of a real estate transaction. Agents sometimes forget that confidential information gained as the result of an agency relationship remains confidential even after the agency relationship ends. Analysis of these direct risks is covered in the Risk Analysis section of this subject.
Disclosure requirements create potential risk anytime the buyer’s agent withholds information from the buyer. For instance, an agent might withhold information about a newly listed property because their client has an offer in on another property. In Oregon, real estate licensees have a disclosure duty to all parties, not just their clients, creating yet another disclosure risk. This disclosure duty to all parties is implicated if the buyer wants material information (like inability to redeem an earnest money note) withheld from the seller. Analysis of disclosure risks is covered in the Risk Analysis section of this subject.
Reasonable care and diligence, without doubt, generates the most risk on the selling side. The buyer’s direct risks in a real estate transaction are huge. They may pay too much for the property or find the property contains material defects or discover that it is unfit for their intended purpose or that external factors (everything from bad neighbors to flood hazards) greatly reduce its desirability. When any of these things happen, the buyer will wonder why their real estate professional did not prevent the harm or at least warn them of the potential. Analysis of these reasonable care and diligence risks is covered in the Risk Analysis section of this subject.
Accounting is the final direct risk duty on the selling side. As on the listing side, the duty to account requires the agent to keep track of (account for) any money or property of the client’s coming into the agent’s hands as a result of the agency. Because Oregon law requires licensees to keep their client’s funds in trust accounts, accounting is mostly a matter of following trust account rules. Analysis of direct accounting risk is covered in the Risk Analysis section of this subject.
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Generic Risk Analysis
Generic business risk is mostly a matter of insurance. Although there is overlap, each level of the real estate business will typically carry insurance. For instance, individual agents carry auto insurance on their vehicles consistent with transporting clients, but include the brokerage as an additional insured. Real estate companies will have their own errors and omissions (E&O) insurance, but include agents in the policy.
Fire insurance, premises liability insurance, income insurance and the like should be part of any business’ generic risk management strategy. Since each level of the real estate business is more or less independent, each level should consider and manage generic business risk at their level. How that is done is covered in the Risk Mitigation section of this subject.
Other than insurance, generic business risks are mostly a matter of having good internal policies and agreements. A business can act only through its agents and employees. The internal relationship between agents and employees and the business is, therefore, the source of considerable business risk. The business can find itself liable for the actions of its agents and employees. It can also find itself liable to its agents and employees.
These kinds of internal relationship risks exist no matter the kind of business. Large businesses have separate “human resources” departments to deal with internal relationships. In smaller businesses, internal relationships are handled by the owner or manager. Owners and managers must, therefore, educate themselves about the generic business risks associated with engaging agents and having employees. Tools to help with such education are covered in the Risk Mitigation section of this subject.
The most widely used, and effective, tools for managing generic risk created by being an employer are employee handbooks, office policies and written employee or independent contractor agreements. These tools help companies manage internal relationships. Managing internal relationships allows the company to manage external generic risks created by being an employer. Managing risk created by internal relationships through the proper use of management tools is covered in the Risk Mitigation section of this subject.
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Transaction Risks Analysis
Listing Side Transaction Risks Analysis
Whether statutory or common law, a real estate agent’s legal duties to the client are designed to protection the client’s interests. Breach of duty is a legal concept of some complexity. For risk analysis purposes, however, the legal complexities of breach of duty claims are of little interest or concern. Every time a principal in a real estate transaction suffers a loss as a result of the transaction, the agents are exposed to the risk that the principal may attempt to shift the loss to the agents.
Looked at in this way, it is easy to see that risk analysis is more about understanding the principal’s interests than the agent’s duties. You can think of agency duties, whether set out in statute or labeled and defined by common law courts, as mechanisms used by society to assure that professionals who represent the important interests of others are honest and competent. It follows that real estate agents are most exposed to direct risks when the situation creates doubts as to honestly or competency.
If you look again at the legal duties of a real estate agent, you will quickly see that most of them are honesty-based duties. Although there is some overlap with competence, duties like loyalty, honesty, obedience, confidentiality, disclosure and accounting are honesty duties. Although expressed as affirmative duties, these duties are intended, and used, to curb dishonesty in situations where there is plenty of opportunity to be dishonest.
Loyalty is an issue when the agent deals with the principal from an undisclosed position of advantage. The duty of loyalty prevents the agent from taking unfair advantage of the client’s trust. Loyalty, therefore, matters only when there is a conflict of interest, real or potential, between agent and client. Analyzing the direct risks associated with the duty of loyalty is, therefore, mostly about identifying conflicts of interest.
Any transaction between agent and client creates a direct risk that must be managed. Agents are hired to deal on the behalf of the client, not their own behalf. When the agent deals with the client personally, they create an actual conflict between their interests and those of their client. It does not matter how fair or in the client’s interest the deal actually is. The conflict exists and resulting risk must be mitigated no matter the circumstance every time an agent contemplates any kind of transaction with a client. Mitigation of such risk is covered in the Risk Mitigation section of this subject.
There are, of course, any number of ways an agent can take advantage of their relationship with the client without becoming involved in a transaction with the client. Referring a client to a third-party service provider who pays the agent for the referral creates a conflict of interest every bit as much as dealing directly with a client. Indeed, any payment to an agent from any source other than the client creates risk. That is the case because, unless the principal knows of the payment, the client may assume the agent’s conduct and advice was motivated more by personal gain than professional responsibility.
Whatever the truth between personal gain and professional responsibility, the fact that a personal interest was not disclosed will tip the balance toward personal interest if something goes wrong. That makes disclosure of potential conflicts the key to loyalty. Mitigation of such undisclosed conflict of interest risk is covered in the Risk Mitigation section of this subject.
Unlike the duty of loyalty, the duty of obedience is rarely violated directly. It is rare for an agent to simply refuse to do what the principal asks. No matter how stupid or ill advised the client’s desires, the agent must obey (after advising the client appropriately) unless doing so violates some other duty to another person. Obedience only becomes a risk management issue when the seller wants the agent to do something, usually withhold information, in circumstances where the agent has a duty to disclose that information.
Understanding obedience risks is about understanding conflicting duties. Duties conflict if owed to more than one person. There is no such thing, in a legal sense, of a conflict of duties to the client. The client is always right and always has the last word unless and until that word would require the agent to violate the law. One must, therefore, look to the law to find duty conflicts. In Oregon, such a conflict is written right into the statutory duties of a real estate licensee because licensees owe the duty of honesty and fair dealing to ALL parties to a real estate transaction.
False statements made during the course of a real estate transaction raise the question of fraud. Fraud (technically, intentional misrepresentation) violates both the contract and tort duty of honesty. Fraud requires the intent to deceive another to their detriment. It is rare for sellers or agents to engage in outright fraud. It is not rare, however, for buyers (and their lawyers) to claim both the agent and the seller engaged in fraud by deliberately failing to disclose material information. From the buyer’s after-closing perspective, almost any failure to disclose an after-discovered defect can be seen as an attempt to trick the buyer into buying something they otherwise would not have purchased.
A famous judge once opined that “even a dog knows the difference between being tripped over and being kicked.” That is a nice expression of the difference between intent and mistake, but not really consistent with human nature. A buyer harmed by a seller’s misstatement (or lack of statement) will invariably assume intent to deceive. Once a buyer assumes intent to deceive, they will look for evidence of that intent in the seller’s and agent’s conduct during the transaction. Innocent actions viewed in retrospect after something has gone wrong, can look very intentional. How to avoid creating such evidence is what managing this kind of risk is about. This subject is covered in detail in the Risk Mitigation section of this subject.
The duty of confidentiality is much like the duty of obedience for risk analysis purposes. The duty is implicated anytime an agent discusses the object of the agency relationship with a third party. In real estate, that means anytime an agent discusses the property, a client’s motivation or the terms of a transaction with anyone other than the client. Fortunately, the definition of confidential information (anything learned as an agent that is not in the principal’s interest to disclose or is not required by law to be disclosed) makes analyzing and controlling confidentiality risk fairly simple.
It is not uncommon for sellers to disagree with agents about what should or must be disclosed to buyers. Confidentiality is often used as a make-weight in these disagreements. Withholding information from buyers based on confidentiality duties raises the issue of “materiality” because Oregon license law requires the listing agent “[t]o disclose material facts known by the seller’s agent and not apparent or readily ascertainable to a party.” Basically, if the facts in question are material and not apparent or readily ascertainable, they are not confidential and, therefore, must be disclosed. Disclosure is once again the key. How to deal with confidentiality problems is covered in the Risk Mitigation section of this subject.
Loyalty, obedience and confidentiality are all disclosure-managed duties. The duty of reasonable care and diligence is not. The duty of reasonable care and diligence is breached by failure to protect or advance the client interests. To understand the risk created requires first understanding the client’s interests. The seller’s interests in a real estate transaction are mostly financial. The seller wants the best price and terms. Care and diligence on the listing side is, therefore, first about getting the seller the best price and terms.
If property is listed unreasonably high and doesn’t sell as a result, the seller may claim the agent did not exercise reasonable care and diligence in recommending a listing price. If a property is listed correctly but doesn’t sell, the seller may claim insufficient or incompetent marketing. What the seller is claiming is a financial lost due to the costs of staying on the market without a sale. Sellers who become aware of these costs may try to shift them to the real estate agent. At that point, the agent must be able to show the listing price was established with care and the property diligently marketed. How to do that is covered in the Risk Analysis section of this subject.
The same kind of lack of care and diligence claim can be created on the listing side risk if the property is listed too low for the market. Instead of lost opportunity costs, the seller will suffer a direct loss equal to the difference between the fair market value of the property and its sale price. This sort of claim is not uncommon in rapidly increasing markets. Again, the key is being able to show the price was established with care and the property diligently marketed. Mitigating of this kind of risk is covered in the Risk Mitigation section of this subject.
Care and diligence applies to any action taken as a real estate licensee, not just listing and marketing. On the listing side, agents also undertake to help the seller negotiate the contract and to assist the seller in performing the resulting agreement. Care and diligence attach to each of these undertakings. That means protecting and advancing the seller’s interests during negotiations and performance.
Much, of course, will depend on the exact circumstances under which the contract is negotiated and performed. The key to managing risk in negotiation and performance of contracts, however, is going to be making certain important decisions are made by the client, not the agent, and that the client has sufficient information to make the decisions. How to prove transaction decisions were the client’s and not the agent’s and that the client had sufficient information to make the decisions is covered in the Risk Mitigation section of this subject.
Although not often appreciated by real estate licensees, diligence is also at the bottom of most misrepresentation claims. The seller, and the seller’s agent, must exercise care in determining what is said or is not said to the buyer. That means deciding what facts are material and have to be disclosed. Another part of diligence is discovery of material facts. Both discovery and disclosure of material facts involve care and diligence.
A “material” representation is: “A representation relating to the matter which is so substantial and important as to influence the party to whom it is made.” In real estate, that means anything that would influence a buyer’s willingness to purchase, or how much might be offered. Money is one way to measure materiality. Anything that might cost the buyer real money to repair or that might, once discovered, substantially devalue the property, is material. The size of the property and location of the boundaries, for instance, is always material. A detailed discussion of materiality can be found in the Risk Mitigation section of this subject.
Generally, there is no legal duty for real estate licensees to inspect or investigate property to discover defects. In Oregon, the statutory section that sets out agency duties specifically states that: “Nothing in this section implies a duty to investigate matters that are outside the scope of the real estate licensee’s expertise, including but not limited to investigation of the condition of property, the legal status of the title or the owner’s past conformance with law, unless the licensee or the licensee’s agent agrees in writing to investigate a matter.” Click here to review statutory agency duties. This statute protects Oregon agents as long as the agent stays within the scope of their license and does not miss defects that would be apparent to an agent operating within the scope of their license.
Staying within the scope of a real estate license means refusing to perform tasks other professionals are trained or licensed to perform. The list of other professionals includes appraisers, surveyors, financial advisors, tax consultants, lawyers, engineers, home inspectors, mortgage brokers and the like. Real estate transactions implicate each of these other professions. Clients will invite real estate agents to help them with problems or decisions in each of these areas. Such invitations create substantial risk for licensees. How that risk can be controlled is covered in the Risk Mitigation section of the subject.
Accounting is the final statutory duty on the listing side that creates risk for the listing agent. Accounting is a duty that flows logically from the duties of loyalty, disclosure and diligence. The duty to account requires the agent to keep track of (account for) any money or property of the client’s coming into the agent’s hands as a result of the agency. On the selling side, there is usually not much opportunity for the client’s money to end up in the agent’s hands and, therefore, accounting is not a big duty on the listing side.
Although not a big duty on the listing side, the duty of accounting must always be taken seriously. The duty to account can be violated innocently by simply not keeping close track of the client’s money. For instance, money given an agent to pay inspectors or contractors or other third party service providers during a transaction must be recorded and accounted for to the penny. Unfortunately, failure-to-account claims can also be the result of the agent deliberately hiding or otherwise misappropriating their client’s funds. Avoiding such claims and proper accounting are covered in the Risk Mitigation section of this subject.
In addition to the risks created by agency duties, there is also a direct risk that flows from just being in the business of providing real estate services. This risk is created by the Unlawful Trade Practices Act. The Unlawful Trade Practices Act is state consumer protection legislation that protects consumers from sharp business practices. It creates a separate duty that applies to all businesses in Oregon to not engage in unlawful business or trade practices.
According to ORS 646.607, “[a] person engages in an unlawful practice when in the course of the person’s business, vocation or occupation the person: (1) Employs any unconscionable tactic in connection with the sale, rental or other disposition of real estate, goods or services, or collection or enforcement of an obligation; (2) Fails to deliver all or any portion of real estate, goods or services as promised, and upon request of the customer, fails to refund any money that has been received from the customer that was for the purchase of the undelivered real estate, goods or services and that is not retained by the seller pursuant to any right, claim or defense asserted in good faith. This subsection does not create a warranty obligation and does not apply to a dispute over the quality of real estate, goods or services delivered to a customer; or (3) Violates ORS 401.107 (1) to (4).”
In addition to these general unlawful practices, ORS 646.608 sets out some sixty-one different actions that are unlawful when in the course of the person’s business, vocation or occupation. The unlawful acts covered by ORS 646.608 fall into two general categories: Misrepresentation of goods, services or price and violation of specific other statutes. All real estate licensees are familiar with misrepresentation claims. The provision of ORS 646.608 simply add another means of complaining about the same behavior: lack of care in making material representations. The specific acts covered by ORS 646.608 include everything from violating state anti-discrimination statutes to making phone calls in violation of state “no call” statutes. Often, the Unlawful Trade Practices Act is just an enforcement mechanism for other laws.
Violations of the Unlawful Trade Practices Act must be “willful.” Under the Act, a “willful violation,” occurs “when the person committing the violation knew or should have known that the conduct of the person was a violation.” Because of the “should have known” language, Oregon courts have interpreted this provision as establishing a simple negligence standard. That means that real estate licensees must use reasonable care in their business to avoid a violation of the Act.
The employment of an “unconscionable tactic” under the Act includes, but is not limited to, actions that: “(a) Knowingly takes advantage of a customer’s physical infirmity, ignorance, illiteracy or inability to understand the language of the agreement; (b) Knowingly permits a customer to enter into a transaction from which the customer will derive no material benefit; or (c) Permits a customer to enter into a transaction with knowledge that there is no reasonable probability of payment of the attendant financial obligation in full by the customer when due.” There is very little case law on this provision of the Unlawful Trade Practice Act, but “unconscionable” generally means anything that is shocking, unfair or unjust. Unconscionable unusually involves deceit. That is deliberately misleading a consumer to their detriment.
The second unlawful act covered by the Unlawful Trade Practices Act that impacts real estate licensees is the failure to deliver all or part of real estate or goods as promised, or failing to refund money due the consumer. Advertising something that doesn’t for some reason get delivered is the most common way a real estate licensee gets involved with the Unlawful Trade Practice Act. The specific misrepresentation provisions of ORS 646.608 cover specific misrepresentation in the same way subsection 607 covers more general misrepresentation. Because the Act requires only negligence, the two sections of the Act place a separate legal duty on real estate licensees to avoid misleading advertising or representations in real estate transactions. For instance, when the seller takes the refrigerator the listing agent advertised as “included” in the sale, the question becomes whether the listing agent knew or should have known the seller intended to take the refrigerator and failed to correct their representation of what was included in the sale. Any representation, oral or otherwise, that concerns what is being sold, or its value, attributes or quality, raises potential Unlawful Trade Practices claims if that representation was made without exercising adequate care.
Lawyers who represent consumers love the Unlawful Trade Practices Act. The “should have known” standard is often easy to meet with hindsight. The Act allows punitive damages in some cases. Best of all, as far as the lawyers are concerned, the Act provides for attorney fees. If the plaintiff recovers anything under the Act, even the minimum $200 for a violation that causes no real monetary damage, the defendant has to pay the plaintiff’s legal fees. This provision essentially places a bounty on the heads of real estate licensees because lawyers will take a case that may be worth very little knowing that any win will get them their full fees. Fortunately, the statute of limitation for an Unlawful Trade Practices claim is one year from the discovery of the unlawful method, act or practice. How to deal with the risk created by the Unlawful Trade Practices Act is covered in the Risk Mitigation section of this subject.
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Selling Side Transaction Risks Analysis
Selling side risks flow from the same agency duties as on the listing side. The duties of loyalty, obedience, confidentiality, disclosure, reasonable care and diligence, and accounting all apply. Just like on the listing side, each duty is a separate risk generator for risk identification purposes. What changes is not the duties, but the relative importance of each duty as a risk generator. Loyalty, obedience, confidentiality, and disclosure duties create the same type of risk on the selling side as on the listing side, but the opportunity to violate these duties is greatly reduced. The opportunity to violate the duty of reasonable care and diligence is, however, greatly increased.
Loyalty to a buyer client means placing the buyer’s interests in front of the agent’s. The buyer’s primary interest is in finding suitable property at a price they are willing to pay. Loyalty usually only becomes an issue on the selling side if the buyer’s agent tries to beat their client out of a property by buying it himself or helping another client buy it.
Two buyers competing for the same property using the same agent raises serious loyalty issues. Indeed, it creates the most dangerous dual agency situation in real estate. Buyer/buyer dual agency is allowed under Oregon law if a disclosed limited agency agreement is signed by both buyers. Click here for a detailed discussion of dual agency and disclosed limited agency agreements. Notwithstanding that the law allows such situations, they are so dangerous that most companies forbid a single agent to represent two buyers competing for the same property.
Loyalty is always an issue in dual agency situations. Permission (through a disclosed limited agency agreement) to represent more than one party in a transaction does not resolve all loyalty risks. For instance, a listing agent who also represents a relative or even a close friend who wants to purchase the listed property has a loyalty problem even if they have permission to represent both parties. The loyalty problem is that the relationship with the buyer may influence the agent’s actions. That potential, the potential for influence created by the relationship with the buyer, must be disclosed to the seller to satisfy the duties of loyalty and disclosure. Controlling this kind of selling side loyalty risks is covered in the Risk Mitigation section of this subject.
As was the case on the listing side, the duty of obedience is rarely violated directly as in an agent refusing to do what the principal asks. Obedience becomes a risk management issue on the selling side only if the buyer demands the selling agent to do something, usually withhold information, which misleads the seller to their detriment. Typically, that information involves the buyer’s ability to perform the contract – for instance, the buyer’s inability to redeem the earnest money or lack of financial wherewithal in seller carry transaction. Controlling this kind of selling side obedience risk is covered in the Risk Mitigation section of this subject.
Confidentiality, we have seen, is implicated anytime an agent discusses the object of the agency relationship with a third party. On the selling side, that means potential risk anytime the buyer’s agent discusses the buyer’s motivation, financial situation, transaction details or other information with anyone other than the buyer. That doesn’t mean these things can never be discussed with third parties. But it does mean that agents should carefully consider confidentiality before doing so.
For instance, appraisers will often call agents and ask about transaction details. These details are, of course, known to both parties. That means that, as between the parties, the details are not confidential and either party may disclose them as they see fit. That, however, does not mean an agent can unilaterally disclose transaction details to a third party without permission of their client. One of the reasons buyer/buyer dual agency is so dangerous is because each buyer will seek information about what the other buyer is offering. Such information is, of course, strictly confidential notwithstanding the dual agency. Controlling selling side confidentiality risk is covered in the Risk Mitigation section of this subject.
The duty of disclosure creates risk anytime the buyer’s agent withholds information from the buyer. On the selling side, this is almost always the result of the agent placing their interests above the clients interests. For instance, an agent might withhold information about a newly listed property because their client is considering an offer received on a company property. If the newly listed property might be of interest to the buyer, the agent must disclose the information. We are talking here about the agent’s duty of disclosure to their own client. That duty requires disclosure of any information that may be helpful to or of interest to the client, not just “material” information. There is no such thing as withholding information for the client’s own good.
Material information, as we saw on the listing side, has to do with the license law duty to all parties to disclose latent material defects not know or readily apparent. Disclosure to all parties duty is implicated if the buyer wants material information (like inability to redeem an earnest money note) withheld from the seller. To be material, the information must go to the very purpose of the transaction. That is, it must be so important that it would cause a reasonable person to reassess the transaction. Controlling selling side disclosure risk is covered in the Risk Mitigation section of this subject.
The duty of reasonable care and diligence without doubt generates the most risk on the selling side. The buyer’s direct diligence risks in a real estate transaction are huge. The buyer may pay too much for the property or find the property contains material defects or discover that it is unfit for the buyer’s intended purpose or that external factors (everything from bad neighbors to flood hazards) greatly reduce its desirability.
When something is discovered after the transaction has closed that reduces the value or desirability of the property, the buyer will wonder why their real estate professional did not prevent the harm or at least warn them of the potential. Thus, a buyer’s agent is at risk in every transaction where the buyer questions the wisdom of their purchase after the fact. One need only consider the phenomenon of “buyer’s remorse” to understand why the duty of reasonable care and diligence creates so much risk for a buyer’s agent.
Almost all lack of care and diligence suits are based on hindsight. That is, the buyer finds a problem after closing and using hindsight looks back over the transaction to see where they went wrong. Once that point is identified, there is a tendency to look for someone to blame. The agent who allowed whatever it was to happen is an obvious target. The only defenses available for the agent at that point are: There is no way I could have known; or, I did know and warned you. That makes control of the risk created by the duty of care and diligence a matter of anticipating what might go wrong before it does. This can be a very daunting undertaking. Controlling this kind of selling side risks is covered in great detail in the Risk Mitigation section of this subject.
Accounting is the final direct risk duty on the selling side. As on the listing side, the duty to account requires the agent to keep track of (account for) any money or property of the client’s coming into the agent’s hands as a result of the agency. Because Oregon law requires licensees to keep their client’s funds in trust accounts, accounting is mostly a matter of following trust account rules.
Following trust account rules is usually not difficult. The exception, of course, is handling earnest money on the selling side. Click here for a discussion of earnest money rules and practices. Real estate practices regarding handling and accounting for earnest money are antiquated and dysfunctional. As a result, agents are often caught up in earnest money disputes. Controlling this kind of selling side accounting risk is covered in the Risk Mitigation section of this subject.
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Generic Risk Mitigation
Generic risks, we have seen, are risks that attach to doing business regardless of the business being done. Insurance, it has been suggested, is the first line of defense against generic business risks. General information about managing generic business risk with appropriate insurance is available from the Small Business Association here.
Most brokerages are employers for the purposes of state law even though the individual agents are, for the most part, independent contractors. That is the case because most brokerages employ unlicensed office personnel. Being an employer creates generic risks because of the myriad of responsibilities placed on employers in this and every other state. Mitigating such risk is a matter of knowing and following the rules. Fortunately, much of the information needed is available on-line.
Every Oregon employer should have a copy of “The Employer’s Guide for Doing Business in Oregon.” This state government publication is available here. Specific up-to-date information for employers is available from the Department of Labor and Industries (BOLI) here. BOLI rules cover everything from wage and hour regulations to civil rights, family leave and hiring and firing requirements.
In addition to BOLI requirements, all workplaces are subject to safety and health regulations under Occupational Safety and Health Administration (OSHA) standards. These laws are arcane and often hard to apply to real estate activities. For instance, beginning January 1, 2009, employers with ten (10) or more employees will be required to have a safety committee or conduct safety meetings. All employers in Oregon, regardless of the number of employees, will be required to have a safety committee or conduct safety meetings by September 19, 2009. These requirements are set out in rule in OAR 437-001-0765 A copy of the rule is available here. Oregon OSHA’s “Quick Guide to Safety Committees and Safety Meetings” can be found here. General information about Oregon OSHA can be found at: www.orosha.org
State employment regulations and requirements aside, every real estate company should have an office policy manual that spells out how the company will conduct its business. In real estate, such a manual will cover everything from floor time to agency relationships to record keeping to malpractice insurance. A good office policy manual is the cornerstone of generic risk management. Office policy manuals are so important to risk management that the Oregon Association of REALTORS® has developed a comprehensive model manual to guide Oregon brokers through the process of developing good office policies. Click here to view or download a copy of the Model Office Policy Guide.
Office policies must take into account the fact that real estate agents are typically independent contractors. Independent contractors are not employees and cannot, without increasing risk, be treated as such. Because most of the relationships are with independent contractors, managing a real estate office is more about managing contractual relationships than employer/employee relationships. Such management starts with a written independent contractor agreement between the company and each agent. No real estate agent should ever practice real estate under another broker’s license as an independent contractor without a written independent contractor agreement.
Independent contractor agreements control the scope of the relationship between agent and brokerage. The allocation of risk through insurance, the duties imposed on both sides and the all important financial arrangements between agent and company are contained in a good independent contractor agreement. Such contracts spell out how relationships will be terminated, pending sales completed and commissions divided. It is through independent contractor agreements (and incorporated office policies) that the brokerage controls the activities of its agents and therefore controls its generic risk.
Independent contractor agreements and office policies are also how a brokerage controls the generic business risk created by federal, state and local discrimination laws. Office policies and contracts should expressly state the brokerage’s commitment to nondiscrimination. They should also contain relevant special policies that set out procedures for reporting and resolving discrimination issues. Here, for instance, is the nondiscrimination provision found in the Association’s Model Office Policy Guide.
It is the strict policy of Broker that all professional real estate services and activities conducted under Broker’s, or his authorized designee’s, supervision be provided equally and fairly to all members of the public without regard to sex, race, color, religion, disability, familial status, national origin, sexual orientation, marital status, sources of income, age or ancestry. As independent real estate professionals, all Associates are expected to know and abide by all state, federal and local laws and regulations prohibiting discrimination. No unlawful discrimination by Associates of any kind will be tolerated, nor shall any Associate be a party to any plan by others to unlawfully discriminate. To assist Associates in meeting their responsibility to avoid sexual discrimination in the work place, a copy of Broker’s sexual harassment policy is attached to this Manual.
Broker will not discriminate against Associates, or other office personnel, in any manner inconsistent with state, federal or local law. Broker shall provide reasonable accommodation to disabled individuals otherwise qualified for employment or association with Broker unless such accommodation would impose an undue hardship. All Associates and office personnel shall report immediately to Broker, or Associate’s principal broker, any violation of this nondiscrimination policy.
Notice the nondiscrimination policy covers both risk created by agents dealing with others and risk created by the brokerage dealing with agents. The brokerage is, to some extent, insulated from its agents’ actions if those actions are contrary to the express policy of the brokerage. At the same time, the policies help the brokerage with the risk created by the brokerage interacting with its own agents. For instance, the brokerage’s risk of a sexual discrimination claim by an agent or employee against the brokerage can be mitigated by having a separate sexual discrimination policy that outlines reporting and resolution procedures.
Discrimination by agents is also a Fair Housing issue. The risk to the brokerage created by the Fair Housing Act is mitigated at the outset by having a clear nondiscrimination policy communicated to all agents. That is why nondiscrimination provisions are found in office policies and independent contractor agreements. More information on Fair Housing laws and requirement can found in the Fair Housing section of this Toolkit. The National Association of REALTORS® maintains a library of Fair Housing information for its members here.
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Direct Risk Mitigation
In the Risk Identification section of this subject, we identified the agency duties of loyalty, obedience, confidentiality, disclosure, reasonable care and diligence, and accounting as the source of listing side direct risk. Each of these duties was analyzed in the Risk Analysis section. We also identified the Unlawful Trade Practices Act as a source of direct risks. Here, we are interested in mitigation techniques that can be used to reduce the risks generated by these sources.
Risk mitigation is mostly about keeping clients and customers informed regarding those issues that may be material to their decision to purchase or sell. That sounds like, and in some ways is, a daunting task. There is no end of things that can go wrong in a real estate transaction.
Much of risk mitigation is about anticipating, looking for if you will, those things in a transaction that create risk for your client or yourself and coming up with some way to lessen (mitigate) that risk. What follows is a discussion of common problems that arise in real estate transactions and some potential solutions. Before getting into that discussion, however, a few words are in order about giving general information to clients about the risks inherent in real property transactions.
First, it is important to understand that providing a client with general information about potential risks will not protect you from misrepresentation claims or claims based on failing to protect your client from an actual risk. For instance, a general disclosure that houses sometimes have mold in them and the mold can sometimes be a health hazard will not protect you from a claim of misrepresentation or lack of diligence if there is mold in the particular house being sold and a reasonable licensee would have known there was mold in the house.
The fact that a general disclosure will not protect a licensee from a specific claim of misrepresentation or lack of diligence in a specific case does not mean that providing clients with general information about the potential risks involved in a real estate transaction is not a good idea. It is! Providing important information to clients is part of due diligence. It takes away any claim that the client didn’t know what to look out for, or didn’t understand what was happening or the importance of their decisions – for instance, the importance of the buyer having the property inspected or the seller disclosing known latent material defects.
The easiest way to provide general information about the risks inherent in real estate transactions in Oregon is to use buyer and seller advisories. The Oregon Association of REALTORS® (OAR) has developed both documents for use by members. The Buyer’s Advisory is available through OAR and on the Oregon Real Estate Agency’s website. The document is available on the Agency’s website so that the limitations on licensee duties found in the Advisory are public information. Click here for a copy of the Buyer’s Advisory.
A Seller’s Advisory is available to REALTOR® members on OAR’s website at www.oregonrealtors.org. This document is not intended as a public document. Its use is limited to members of the Oregon Association of REALTORS®. The Advisory provides sellers with important information and is typically given at the time of listing. Click here for a copy of the Seller’s Advisory.
It is always a good idea to document information provided to clients. The Advisories are no exception. Accordingly, some agents have their clients acknowledge receipt of the Advisory. Others incorporate acknowledgement of receipt in the Client Engagement Letter. Click here for a complete discussion of engagement letters. Whatever the method of acknowledgement, it is good risk management to start any agency relationship with a client advisory.
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Agency Duty Risks
Mitigating risk created by the duty of loyalty means using proper disclaimers and disclosures anytime an agent is involved in a transaction with their principal or otherwise benefits personally from the agency relationship in a way the client doesn’t know about. Click here for a complete discussion of the duty of loyalty. A listing agent buying the listed property, an agent representing a buyer relative, an agent taking a kickback on a home warranty purchased by a client, an agent taking an interest in property that is purchased though the agent are all classic examples of loyalty problems. Each situation creates a potential conflict between the interests of the principal and the interests of the agent.
Conflicts of interest are mitigated in one of two ways. The first is to avoid the conflict – don’t buy your own listing, don’t represent the seller and a relative at the same time, don’t take kickbacks from third-party providers, don’t take undisclosed bonuses and don’t be an agent and an investor in the same deal. Avoiding conflicts is always the safest approach. Unfortunately, conflicts cannot always be avoided or avoiding them may not be possible or even in the best interests of the client.
The second way to mitigate conflicts of interest is to proceed only after giving full disclosure and obtaining the knowing consent of the principal. “Full disclosure” and “knowing consent” are legal terms of art taken from the common law. Full disclosure means all of the facts relevant to the client’s understanding are disclosed. “Knowing consent” means the client has sufficient understanding to make an informed decision. Every agent should be proficient in making full disclosure/knowing consent conflict of interest disclosures.
A conflict of interest disclosure is effective only if it provides evidence that the client knowingly consented to a specific conflict in a specific situation. Take, for instance, the time honored tradition of disclosing that the buyer’s agent is “related to” the buyer. Scribbling “agent is related to buyer” on a sale agreement is the historic manner of handling this kind of disclosure. It is also the perfect example of an ineffective conflict of interest disclosure.
The “related to buyer” disclosure was born in the long gone era of seller only representation when everyone represented the seller – even agents from offices other than the listing office. In those “sub-agency” days of old, an agent from another office writing a deal for a buyer the agent was related to had an obvious conflict of interest because the agent actually represented the seller. Of course, the agent didn’t really have any loyalty to the seller and the seller didn’t really expect any. Scribbling “buyer related to agent” on the offer was thought fair disclosure in that “sub-agency” context.
Today, the “related to buyer” situation is more complicated. A buyer agent who does not represent the seller has no conflict to disclose just because they are related to their buyer. A buyer-only agent must put the buyer’s interests first whether the buyer is related to the agent or not. There is no conflicting duty to the seller. Notwithstanding the lack of actual conflict, the REALTOR® Code of Ethics is thought to require the “related to buyer” disclosure whether the buyer’s agent also represents the seller or not. Thus, needless “related to buyer” disclosures are still seen all the time in real estate and will no doubt continue for the foreseeable future.
Needless “related to buyer” disclosures aren’t a big problem. That is, they aren’t a big problem as long as they didn’t lead to inadequate disclosure when an actual conflict really does exist. Unfortunately, this is often the case. Take, for instance, the situation where the listing agent’s spouse wants to buy the listed property. “Agent is related to buyer” is not sufficient disclosure in this situation. That is the case because it does not inform the seller, whom the agent represents, of the actual conflict.
When the listing agent’s spouse is the buyer, the buyer may have access to the commission the seller is paying their agent. The agent may also benefit financially from the spouse’s purchase. A seller armed with that understanding will negotiate for a reduced commission or a higher purchase price. Telling your seller client you are “related to” the buyer is not the same as telling them “the buyer is my spouse.” “Related to” labels the conflict but does not inform the seller of the actual conflict. A “related to” disclosure is inadequate when the conflict involves a spouse.
“Related to” is too narrow a disclosure when the relationship is a spouse – and probably even a parent or a child – because representing a spouse (parent or child) focuses on the relationship rather than the conflict. It is the actual conflict that must be disclosed, not just the relationship that creates the conflict. Take for instance a listing agent who also represents their life-long best friend in the purchase of property they have listed. They may not be “related,” but the potential conflict should be obvious and disclosed. “Related to” is just a subset of potential conflicts where the agent’s loyalty may be called into question. To mitigate the risk created, the agent must focus on the conflict itself and disclose the potential consequences.
Conflict disclosures are similarly complicated when the listing agent wants to purchase their own listing. Over the years, a sort of Bullwinkle “agent is purchasing with the intent to make a profit” disclosure has become standard disclosure fare. That phrase is nice, but misses the real point. A listing agent who wants to purchase their own listing has a very serious conflict of interest that has little to do with wanting to make a profit.
When an agent negotiates with their own client, the agent is on both sides of the deal. The agent is engaged in dual agency as well as a personal transaction. Such a dual conflict cannot be disclosed with something as tepid as warning the client the agent intends to make a profit. That, at best, handles the personal transaction part of the disclosure. Something also must be said about the dual agency conflict. What is needed is evidence the client knowingly consented to both conflicts.
When an agent purchases their own listing, the client will owe a commission to the agent. The agent can apply the commission to the purchase price. They can also, as a real estate professional with complete knowledge of the seller’s situation, negotiate from a position of superior knowledge. The agent, unlike other buyers, can use superior knowledge and, if the seller allows dual agency, the commission to get a real bargain. The seller, as the principal, is entitled to understand the true situation. Therefore, the agent must disclose much more than that they intend to make a profit.
An agent purchasing their own listing should disclose the commission issue inherent in continuing the representation. The agent should also disclose that they are privy to confidential information regarding the property and the seller’s financial condition. It would be a very good idea to warn the client to seek legal or financial advice. Finally, the little “intends to make a profit” disclosure is always nice. Here is an example of an adequate listing-agent-purchasing-their-own-listing disclosure:
“The buyer in this transaction is the listing agent. As the listing agent, the buyer has been privy to information regarding the property, the seller’s motivation to sell and current market condition not available to other buyers. Seller has consented to the agent representing both the seller and himself in this transaction understanding that agent may apply the real estate commission paid by the seller to agent’s transaction costs. Agent is purchasing the property with the intent to resell the property for a profit. Seller is advised to seek such separate legal and financial advice regarding this transaction as they deem appropriate.”
The agent could, of course, forego the commission disclosure by ending the agency relationship and taking no commission. Even then, a disclosure would still be a very good idea so there was no confusion about the relationship after the fact. Here is an example of a listing agent purchasing their own listing disclosure where the listing agent foregoes the commission:
“The buyer in this transaction was the listing agent. As the listing agent, the buyer has been privy to information regarding the property, the seller’s motivation to sell and current market condition not available to other buyers. Seller and agent have agreed to terminate their agency relationship, including all commissions, and proceed with each party representing their own interests. Buyer is purchasing the property with the intent to resell the property for a profit. Seller is advised to seek such separate legal and financial advice regarding this transaction as they deem appropriate.”
Conflict of interest disclosures always follow the same pattern. That pattern is for the agent to disclose the actual conflict, the potential consequences of the conflict and that the client consents to the conflict. A separate legal and financial advice clause is always a good idea. If you apply this conflict disclosure pattern to the spouse in listing agent’s buyer scenario discussed above, a full disclosure/knowing consent disclosure might look like this:
“The buyer in this transaction is the listing agent’s spouse. Although the agent has not and will not disclose confidential information to the buyer, and will represent both parties under a separate Disclosed Limited Agency Agreement, seller understands that the close relationship between agent and buyer may be perceived as a conflict of interest. It may also allow the buyer to benefit indirectly from the commission paid the listing agent by the seller. Seller also understands that the listing agent may personally benefit indirectly from the transaction. By signing the Disclosed Limited Agency agreement, Seller has consented to the listing agent representing their spouse. Seller is advised to seek such separate legal and financial advice regarding this transaction as they deem appropriate.”
Now that you know the pattern, it should be easy to construct conflict of interest disclosures for other situations. Take, for example, the close personal friend situation mentioned earlier. Our disclosure pattern is to disclose the conflict, the potential consequences of the conflict and that the client consents to the conflict. As usual, we will include a separate legal and financial advice clause because it is always a good idea. Following the pattern, a close personal friend disclosure might look like this:
“The buyer in this transaction is the listing agent’s close personal friend. Although the agent has not and will not disclose confidential information to the buyer, and will represent both parties under a separate Disclosed Limited Agency Agreement, seller understands that the close relationship between agent and buyer may be perceived as a conflict of interest. By signing the Disclosed Limited Agency agreement, Seller has consented to the listing agent representing their close personal friend. Seller is advised to seek such separate legal and financial advice regarding this transaction as they deem appropriate.”
The key to mitigating risk created by the duty of loyalty is to be aware of both actual and potential conflicts of interest. An actual conflict is one where the agent will personally benefit in the transaction. A potential conflict exists anytime the loyalty of the agent could be questioned. A spouse client in a dual agency situation creates both actual and potential conflicts. A close personal friend relationship creates only a potential conflict unless the agent intends to share part of their commission with their friend. Anything that viewed with hindsight might call the agent’s loyalty into question should be dealt with by a full disclosure/knowing consent disclosure. That means everything from the old “related to” disclosure, to the buyer is a personal friend to the inspector is my brother-in-law to buyer is agent’s spouse. The relationship may create the conflict, but what is disclosed is not the potential conflict, its potential consequences and the principal’s consent.
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Obedience, Confidentiality, and Disclosure
The duties of obedience, confidentiality and disclosure become a risk management issue when a client wants an agent to withhold information in a transaction, or the agent withholds information themselves. When information is withheld during a transaction, the agent’s statutory duties of honesty and disclosure of latent material defects are implicated. Because these honesty and disclosure duties are found in the law, they cannot be avoided by claiming obedience to the client or pleading ignorance. Nor can the agent hide behind the duty of confidentiality.
The duty of confidentiality is implicated anytime an agent discusses the object of the agency relationship with a thirdparty. In real estate, that means anytime the agent discusses the property, their client’s motivation or the terms of a transaction with anyone other than their client. Confidentiality is a big duty. Fortunately, the definition of confidential information (anything learned as an agent that it is not in the principal’s interest to disclose or is not required by law to be disclosed) makes analyzing and controlling confidentiality risk fairly simple. Click HERE for the statutory definition of “confidential information.”
Mitigating the direct risk created the duty of confidentiality – that is the risk that the duty will be breached – is very easy in the abstract: Never discuss your client or your client’s affairs with anyone other than your client. That is, of course, far too strict a rule to be practical when listing and selling real property. It is, nevertheless, useful as a default risk mitigation rule in the sense that unless some specific exception applies, an agent should never discuss their client or the client’s affairs with anyone other than the client.
The “specific exceptions” to the never discuss rule are those found in the statutory definition of “confidential information.” The first exception is when “[t]he buyer instructs the licensee or the licensee’s agent to disclose about the buyer to the seller or the seller instructs the licensee or the licensee’ agent to disclose about the seller to the buyer.” The second exception is when “[t]he licensee or the licensee’s agent knows or should know failure to disclose would constitute fraudulent representation.” Unless the information is clearly within one of these two exceptions, no information gained by an agent as a result of their agency relationship should ever be discussed with anyone other than the client.
The client-instruction exception covers information transmitted between parties for the purpose of furthering the transaction. Information formally exchanged between parties is, therefore, not a problem as far as confidentiality is concerned. What is a problem is information exchanged informally outside the transaction. “What is the seller’s real bottom line here” is a classic example of the kind of question that cannot be answered by the listing agent – at least not without the seller’s instructions. Before answering any question by someone other than your client, always ask yourself: will this information fall within the client-instruction exception. If there is any doubt whatever, ask the client for instructions.
One place the duty of confidentiality comes up all the time is when appraisers call agents to talk about the details of a closed transaction. Appraisers have, for many years, sought transaction details from agents. Agents have, for years, given these details freely. The practice does, however, create risk for the agent. Agents who wish to share transaction details with appraisers, or other third parties, can mitigate that risk by obtaining the client’s instruction regarding such disclosures. On the listing side, this could be easily accomplished by obtaining the necessary permission in the listing agreement. On the selling side, where the risk of the client disapproving of sharing transaction details is greater, the safest course would be to not discuss the client’s transaction with third parties unless the client has given permission to do so.
The other exception to confidentiality – the “fraudulent representation” exception – is there to handle the potential conflict between the agent’s duty of honesty and disclosure to all parties and the duty of confidentiality to clients. It is not uncommon for sellers to disagree with agents about what should or must be disclosed to buyers. This confidentiality conflict is essentially the same as the conflict created by the duty to obey. The risk is mitigated in the same way: by applying the duty of disclosure.
Mitigating risk is first a matter of knowing what information cannot be lawfully withheld. Honesty is implicated when an agent deliberately misleads a party, knowing the party will act on the false information to their detriment. This kind of deliberate misrepresentation is actually very rare, but buyers bring intentional misrepresentation claims all the time. They do so because they assume, after the fact, that the agent must have lied to them so they could get their commission. This argument has proved persuasive to juries. It is, therefore, critical to error on the side of disclosure whenever disclosure becomes an issue in a transaction: If you have to ask, the answer is: disclose.
The license law duty of disclosure applies to “material facts known by the seller’s agent and not apparent or readily ascertainable to a party” Click HERE to review statutory agency duties. A “material fact” is any fact that would substantially affect what a buyer is willing to pay or their willingness to purchase. That is, a fact which goes to the essence of the contract itself by changing the value or desirability of the property. Any misrepresentation of such facts, even innocent misrepresentations, undermines the legitimacy of the contract by undermining the mutuality of consent.
Mitigating the risk created by the duties of obedience, confidentiality and disclosure requires careful documentation of any interaction with the client where something that may turn out to be material is discussed. Clients, for the most part, do not put an unlawful instruction in writing. Most often they just refuse to disclose something claiming it is not material. Recent repairs and inspection reports from a prior deal-fail are classic examples of things sellers sometimes refuse to disclose.
Anytime a conversation about whether or not to disclose something takes place, it creates a dangerous “risk point.” The resulting risk must be mitigated as soon as that conversation takes place. That is done by creating a written record of the discussion. For risk management purposes, if there is any question whether what is being discussed involves material facts, the agent should consider the discussion a risk point and take affirmative steps to mitigate the risk involved.
Email is the most effective risk management tool available. A letter works, but is more time consuming – and more likely off-putting to the client. A note in a business diary or “to file” is good, but direct communication with the client is always preferred. What is communicated is a confirmation of the subject discussed, the client’s instruction and the agent’s anticipated course of conduct. For instance, a discussion between listing agent and seller regarding a prior repair of the roof might cause the agent to send the following email to the client:
“This is to follow-up on our conversation regarding prior repairs to your roof. As we discussed, disclosure is required when the matter is material to the buyer’s purchase decision. The more significant the repairs and the more recent and untested the repairs, the more material they may be to a buyer. Disclosure to potential buyers is always the safest course when dealing with repairs that could cause problems in the future. I, therefore, strongly suggest you disclose the repairs to potential buyers. Please let me know how you wish to proceed and if you become aware of any further information regarding the roof or its repairs as we go forward.”
An email documenting the discussion and the agent’s suggestion to disclose is only the first step. It creates a record of the conversation and the agent’s position. It does not resolve the disclosure problem. If the fact is “material,” both the agent and the seller are under a legal obligation to disclose it. Although sellers often believe otherwise, it is foolish not to err on the side of disclosure. A simple disclosure at the outset of a transaction that something has been repaired or caused a problem in the past is not likely to have any effect. On the other hand, if the information is withheld, and there is later a problem, the buyer will assume the information was deliberately withheld to hide the problem.
There is no way around the material fact disclosure dilemma. Any undisclosed fact that may turn out to be material creates risk. If the fact has been discussed, the conversation documented and the client warned, but the client still refuses to make the disclosure, the agent has only two choices. If the agent believes the facts are material and must be disclosed, they cannot simply ignore the duties of honesty and disclosure and proceed. Instead, the agent must warn the client that state law requires the disclosure and that the agent cannot continue to represent the client unless the disclosure is made. Email is again a great tool for such a warning. Here (using again the prior roof repair as an example) is an example of such an email:
“This is to follow-up on our conversation regarding prior repairs to your roof. As we discussed, disclosure is required when a matter is material to the buyer’s purchase decision. You will remember that I advised disclosure to potential buyers is the safest course when dealing with anything that could cause problems in the future and advised you to disclose the repairs to potential buyers. You have determined not to make the disclosure. Based on my experience as a real estate professional, I strongly advise against this course of action and cannot, consistent with my duties to all parties, continue as your agent unless the disclosure is made. Please let me know immediately how you wish to proceed.”
Such an email will bring the matter to a head. This should be done only when the agent has determined that a problem creates sufficient risk that it is not worth continuing the representation. This will be the case only when potential latent defects are extremely material, the cost to the buyer substantial and the risk of future problems likely. Making such judgments is rarely called for, but risk-averse agents must be ready to “warn and walk” when the risk becomes too great. Any suspicion that a client is deliberately withholding material information would, of course, warrant a “warn and walk” letter.
In most cases, the client will make the disclosure based on the agent’s advice that disclosure is the safest course. If the seller does not agree in cases where the materiality of the undisclosed fact is honestly questionable and the potential monetary consequences to the buyer (if the seller is mistaken) are not great, the agent may elect to continue, but only after clarifying the situation with a follow up email or letter. Here is a sample, again, using the prior roof repair example:
“This is to follow-up on our conversation regarding prior repairs to your roof. As we discussed, disclosure is required when a matter is material to the buyer’s purchase decision. You will remember that I advised disclosure to potential buyers is the safest course when dealing with anything that could cause problems in the future. You have determined not to make the disclosure because you believe the repairs fixed the problem and the leak is no longer material. Having no information myself to the contrary, and no training or experience in roof repair or inspection, I will proceed based on your judgment and decision that the problem no longer exists. That in no way negates my advice that disclosure is the safest course. Please let me know if you become aware of any further information regarding the roof or its repairs as we go forward.”
This kind of client follow-up communication will not prevent all misrepresentation claims, but it will greatly reduce the odds of anyone claiming non-disclosure was the agent’s idea. It will also prevent the seller from turning on the agent claiming lack of diligence. It will also demonstrate to the Real Estate Agency that the agent was trying to follow the law. When something goes wrong after closing, buyers (and their lawyers) will always look for non-disclosure. Mitigating that risk is about anticipating potential non-disclosure problems when they arise during the deal and using the right communication tools to protect yourself.
As was the case with conflict of interest disclosures, risk point mitigation communication with clients follows a specific pattern. First, the communication should make it clear the matter has been discussed with the client. Next, the significance of the subject discussed must be made clear to the client. Next, the client’s instructions and agent’s course of action, including any caveats, must be clearly set out. Finally, the client’s responsibility for keeping the agent informed should be clearly stated. Remember, we are using anticipation to mitigate risk by communicating with clients, not drafting legal disclaimers that require signatures.
Because we are dealing here with risk mitigation, any question of any kind involving disclosure to a buyer should be documented – even if no disclosure is required or given. For instance, ORS 93.275 declares that certain facts, like a death or suicide, are not material to a real estate transaction in Oregon. Even when the statute clearly applies, it is still good risk management to have a risk point mitigation communication in the file. That is the case because whether to disclose or not is still the client’s decision. Even if not required, disclosure (other than in the case of AIDS) may still be a good idea for moral or practical reasons.
A good example of a material fact that is exempt from disclosure but still a risk management issue is a sex offender in the neighborhood. The fact or suspicion of a sex offender residing in the neighborhood is not material according to ORS 93.275. If a seller client has been given notice that a sex offender is located in the neighborhood and asks about disclosure, the agent can make the client aware of ORS 93.275 and direct the seller to the Oregon Seller’s Advisory discussion of “Deaths, Crimes and External Conditions.” Click here to view or obtain and copy of the Seller’s Advisory. The discussion with the client, the agent’s direction of the seller to the Advisory and the client’s decision regarding disclosure should then be memorialized in an email or letter to the client. Here is an example of such an email:
“This is to follow-up on our conversation regarding the notice you received that there is a sex offender living in the neighborhood. As we discussed, disclosure is not required because the fact or suspicion that a convicted sex offender resides in the area is not material to a real estate transaction in Oregon. You will remember that I directed you to the “Deaths, Crimes and External Conditions” of the Oregon Property Sellers Advisory for more information about Oregon real estate laws and practices. Please let me know if you have not been able to access this information or have any questions regarding the information. I will proceed based on your judgment and decision not to disclose the notice you received. Please let me know if you become aware of any further information regarding this matter.”
Notice again the pattern of the email. What we are doing is creating evidence of diligence in a way that promotes client service. Making use of external tools like the Oregon Property Sellers Advisory demonstrates competence and diligence and makes someone other than the agent the legal “authority.” Always look for such external sources when discussing legal matters with clients. Keep in mind always that the fact that something is not material, whether in fact or law, does not mean that the issue can be ignored. Focus on the potential for something to become material or even that someone will think it material. If the potential exists, mitigate the risk.
Mitigation of risk by disclosure applies to your client as well as others in the transaction. When it comes to your own client, however, a lot more than material defect disclosure is needed. The disclosure risk issue is raised anytime an agent withholds any information the client is entitled to know. On the listing side, for instance, the agent might withhold the fact that another offer is coming in, or that the buyer has failed to meet some deadline or anything else the client seller is entitled to know about. It is the “entitled to know about” part upon which managing this kind of risk must focus.
A client is entitled to know anything the agent knows or finds out that could in anyway affect the client’s decisions. The key is “decisions.” There are thousands of decisions, little and large, in a real estate transaction. Mitigating the risk created by the duty of disclosure is about understanding which of these decisions the client should make for themselves. It is not a matter of deciding what the seller will or ought to do. It is a matter of deciding whether the seller is entitled to the information. For risk management purposes, the answer is always “yes” if there is any question whatever about whether the information is important. When in doubt, disclose, but do so in a way that demonstrates professionalism and efficiency.
Email is again the most practical tool available to create the disclosure record necessary for risk mitigation purposes. When it comes to disclosure of information to the client, the pattern is to set out the subject of the client disclosure, the business consequences faced by the client and client’s decision. It is critical to allow the client an opportunity to make a decision after they have the relevant information. Take, for instance, a buyer’s failure to redeem an earnest money note as required under the contract.
When an agent learns that the other party has not, or even may not, meet a contract deadline, the client is entitled to know that fact. They are also entitled to understand the transaction consequences of what has happened and have a chance to make a reasonable business decision. Here is an example of an email in an unredeemed note situation that covers these points.
“It has come to my attention that the buyer has not redeemed the earnest money note as required by the purchase agreement. The buyer’s failure to redeem the note is covered in the “Earnest Money Payment/Refund” section of the purchase agreement. You should review that section and talk to an attorney if you want to terminate this transaction based on the buyer’s failure to redeem the earnest money when due. If you do not wish to terminate the transaction at this time, I recommend we immediately notify the buyer that failure to redeem the note is a serious matter and that unless immediately redeemed, you will exercise your right to enforce the contract. We can give this warning by email to the buyer’s agent. Please let me know how you wish to proceed.”
Notice that no legal advice is given. This is accomplished by reference to an external source – in this case, the purchase agreement. Notice also that business options, not legal options, are presented, (i.e. see a lawyer or proceed with a warning are business options). Finally, notice that the decision is left to the client. Client disclosures should follow this simple subject-business consequences-business decision format. The trick is to look forward to anticipate what might go wrong.
Foresight means taking action (here, making a disclosure) before the consequences of not acting are known. Once the roof leaks it is easy to see that recent roof repairs should have been disclosed. When the buyer backs out two weeks after the deposit was due without ever depositing the earnest money, the seller is going to want to know why they didn’t know what was going on. Anticipate what might go wrong.
The trick, for risk mitigation purposes, is to disclose the repairs before the roof leaks or the buyer backs out without depositing the earnest money. And that, and this is the point of risk mitigation when it comes to disclosure, requires thinking diligently about what might go wrong. That doesn’t mean being a deal killer. It means being a business focused realist with the client’s interests always in mind. Ultimately, disclosure isn’t a separate duty – it is wrapped up with all the fiduciary duties including, most particularly, the duty of reasonable care and diligence.
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Reasonable Care and Diligence
There are two components to reasonable care and diligence when it comes to what might go wrong in a real estate transaction. One is to know the facts involved in the transaction. This component raises the nasty and much fought over question of a real estate licensee’s duty to “investigate.” The other diligence component is assessing the probability of harm based on the facts known. That is, how likely is it that a specific harm will result from the buyer not knowing something the agent knows or with reasonable care should have known?
“Knows or should have known” is the key to understanding what facts regarding a real estate transaction a real estate licensee must know. Although it doesn’t seem that way, there is no duty to “investigate” – at least, none in the abstract. Instead, any fact of importance told to a real estate licensee by anyone during a transaction, or that would be apparent to a reasonable agent in the circumstances, is “known.” For instance, any important information contained in any document in the agent’s possession, is “known.” A few real life cases will help flesh out what must be “known.”
In a recent discipline action by the Oregon Real Estate Agency, a licensee was held responsible for falsely advertising property as “adjacent to BLM” because a narrow “flag” divided the listed property from nearby federal land. The owner told the agent the land was “adjacent.” The true state of affairs, however, was depicted on a plat map found in the agent’s files. According to the Agency, the agent’s reliance on the seller’s statement when the true state of affairs was right in the agent’s file demonstrated a lack of diligence.
Similarly, the Agency disciplined an agent for failing to disclose that the property was in the 100-year flood plain because an assessor’s report found in the agent’s file suggested the property was in the flood plain. A Washington State agent was held responsible for failing to disclose a past flooding event the agent, according to the seller’s testimony, told the seller no disclosure was necessary because the problem was fixed. Everyone did, in fact, think the problem was fixed, but that didn’t mean the fact that it had to be fixed and the nature of the fix were not material.
In each of these cases, the agent was mistaken about the true state of affairs but nevertheless made material representations or failed to disclose material information. The resulting liability doesn’t create a duty to investigate. Such liability is simply a function of the duty to use reasonable care and diligence when making representations or advising clients. There is a big difference between investigation and reasonable care and diligence. Take for example, the famous Arizona case Aranke v. RKP Investments.
In Aranke, a listing agent in Arizona was exonerated in a misrepresentation case involving failure to disclose serious foundation damage. The agent was exonerated because she recommended the seller have exterior cracks inspected by a contractor and shared the contractor’s report with the buyer. The disclosure worked even though the report was wrong because the listing agent used reasonable care and diligence in dealing with the exterior cracks. The buyer’s agent, on the other hand, did not fare so well because they could not show they warned the buyer about relying on the seller’s inspector or the importance of having their own inspection.
Reasonable care and diligence is a huge duty for risk management purposes. It creates direct risks to one’s own clients and underpins misrepresentation claims brought by other parties. On the listing side, the direct risks created by the duty of reasonable care and diligence mostly involve marketing. If property is listed unreasonably high on the agent’s recommendation and doesn’t sell as a result, or there is insufficient or incompetent marketing, the seller may suffer a financial lost due to staying on the market without a sale.
The same kind of money-based listing risk is created if the property is listed too low for the market. Instead of lost opportunity costs, the seller will suffer a direct loss equal to the difference between the fair market value of the property and its sale price. This sort of claim is not uncommon in rapidly increasing markets. Most successful claims of this kind, however, involve the agent purchasing their own listing and thus implicates the duty of loyalty.
Other than in “loyalty” situations, mitigation of listing side reasonable care and diligence risks is mostly a matter of being able to prove good business practices. That is the case because liability for financial loss can be shifted to an agent only if the principal shows that the loss resulted from the agent’s negligence. Breach of a duty of care requires proof of conduct below the standard of care for the industry. Listing too high or too low for the market, inadequate marketing and the like are all negligence type claims.
To defeat a negligence claim, it is necessary to document why things were done the way they were. That means being able to explain through documents how and why the listing price was established and how and why the property was marketed the way it was. There are two major business tools used to create the documentation necessary. They are a CMA/BPO and a written marketing plan.
Competitive Market Analysis (CMA) and Broker Price Opinions (BPO) are covered in depth in the Holding Yourself Out to the Public chapter of the Toolkit. For risk management purposes, the CMA is the more important document. That is the case because the CMA contains the research and analysis that goes into the BPO. It is what justifies the recommended listing price stated in the BPO. The more complete and professional the CMA, the more difficult it will later be for someone to attack the listing price as too high or too low.
Once the CMA and BPO are in place, the agent should think about how to document the listing price decision in a way that shows the decision was the made by the client, not the agent, and was based on timely accurate information. Probably the easiest way to do that is to have a CMA/BPO presentation that is followed by a client email. The presentation of the CMA/BPO is the agent’s presentation of current market data and a recommended listing price, but the listing price decision remains with the client. Once the client makes that decision, the agent can follow up with an email memorializing the information presented, the recommendation made and the client’s decision.
Here is an example of a follow up listing price email:
“To follow up on our meeting, I want to let you know I have completed the listing package and filed the listing with the Multiple Listing Service at the listed price of $__________________. As you know, this price is [more, less, the same] as the price recommended in the Broker Price Opinion I presented on [date]. My listing price recommendation was based on the Competitive Market Analysis I presented with the Price Opinion. I look forward to working with you to market and complete a sale at the listing price you selected. I will keep you informed of market conditions and any feed-back we receive as we are marketing the property.”
Notice again the pattern of the email. The list price is not only stated, but expressly compared to the price recommended in the broker price opinion. The BPO is then linked to the CMA. In this way, it is clear that the price was chosen by the seller based on market research provided by the agent.
So far, we have been dealing with diligence on the listing side with the focus on marketing because on that side of a real estate transaction it is negligence in marketing that is most likely to cost the seller money. The flip side of that kind of marketing risk exists on the selling side in advising the buyer on an offering price. Selling agents have sensed this risk exposure and controlled it in much the same way a listing agent should control the same kind of risk on the listing side. That is, by creating evidence that the client was properly informed and made the decision themselves. This can be a sensitive matter on the selling side.
“What should I offer?” goes right to the value of buyer representation. What the client buyer is seeking with that question is a professional opinion within the scope of a real estate licensee’s expertise. Dodging the question is poor client service. Expressing an opinion in dollars and cents without anything to back it up is risky. To mitigate that risk, follow the client information/client decision model.
Although a full CMA/BPO may not be called for, that doesn’t mean the buyer client is not entitled to a frank business discussion of how offer price affects negotiations in the circumstances. Once that conversation takes place, look for an opportunity to confirm it and the buyer’s decision with client email. For instance, notice to the buyer client that the offer has been presented could be an opportunity to set out the high points of the offer price discussion and document that the decision was the buyer’s, not the agent’s. For example:
I just wanted to let you know that your offer on the property at [address] has been presented to the seller. As you remember, we discussed market conditions, the listed price, your motivation and what we know of the seller’s circumstance before you decided on the offer price. I will, of course, let you know as soon as I hear anything from the listing agent and we can go from there. Until then, let’s keep our fingers crossed.
The idea is to combine client service with risk mitigation. Clients love to be kept informed. Why not take advantage of that need to make sure what actually happened is part of the record. That way, if someone later wants to cast what happened in a different light, there is more than just memory of what happened to go on.
Reasonable care and diligence is an empty concept in the abstract. The phrase takes on meaning only in a particular context. Anticipating and avoiding harm to clients is the hallmark of reasonable care and diligence. The risk-averse agent will always consider what might go wrong based on their understanding of the situation. That can be a very daunting undertaking in something as complicated as a real estate transaction.
A good way to deal with diligence in complex situations is to use checklists. A checklist is first a memory tool. It is a way to avoid “forgetting” something important. Checklists also, however, can be used to impose order and sequence on what might otherwise be a confusing mish-mash of facts and events. Real estate transactions lend themselves well to the use of checklists.
If you think about the risk points discussed, you can begin to isolate the particular events that can create risk as the various stages of a real estate transaction. The sequence of risk points begins with listing property. It continues through the agent’s walkthrough, getting the seller’s disclosure, getting the preliminary title report, entering the listing into the MLS, advertising the property, writing or receiving an offer, assisting clients in performance of the resulting contract (including deadline management) and, finally, closing the deal. Each of these stages can be mapped into a checklist.
A good checklist will do more than simply remind the agent of what must be done at a particular stage of a real estate transaction. The checklist can anticipate risk points and force the agent to resolve the risk or mitigate it. For instance, a listing checklist can force the issue of a prior listing onto the table so that potential procuring cause issues can be assessed. A preliminary title checklist can identify any mismatch between the parties to the listing agreement and those who hold title. An advertising checklist can force an agent to verify any material facts contained in the ad.
Checklists work by forcing the agent using the checklist to identify risk points. They can be tailored to specific kinds of transactions like rural property or short sales. They are themselves evidence of reasonable care and diligence in the performance of professional real estate activity. Oregon REALTORS® has developed a number of sample checklists for use by members. Below are sample checklists:
- Advertising Review
- Listing Contract Review
- MLS Data Entry Checklist
- Review of Offer
- Post-Closing Review
- Review of Preliminary Information From Title Company
- Listing Agent’s Review of Seller’s Property Disclosure Statement
- Transaction Review
- Listing Agent’s Walkthrough Review of Property
- Independent Contractor Agreement
- Sexual Discrimination Policy
- Client Spouse Disclosure Language