Foreclosure: Material fact or confidential information?

By: Thomas R. Miller, Special Deputy Attorney General

You're a broker and you've just listed a 3-year-old, 4-bedroom, 2 1/2 bath house. The house is attractive, the price is reasonable, and you expect it to sell before the end of your 90-day listing agreement.

There's only one hitch: At the time you put the "for sale" sign in the yard, your seller told you that he was behind - way behind - on his mortgage payments! In fact, he showed you a couple of letters from the bank indicating that the bank was getting pretty impatient. You've talked to the people at the bank yourself and they weren't very sympathetic. Maybe Saturday's open house will net a quick buyer - you hope! If the seller can get a fair offer and soon, all should be well.

But wait a minute. What should you tell prospective purchasers? Is the seller's financial distress a material fact which, under the Real Estate License Law, you have to disclose? Surely a buyer would like to have that information before making an offer. However, if you have to tell everyone about your client's payment problems, you can't expect a competitive price for his property.

Fortunately, at this stage in the transaction you don't have to tell prospective purchasers anything about your client's financial distress. In fact, you should keep it confidential because of your duty to him as his agent. Under the License Law, a listing agent is required to disclose material facts to prospective purchasers. And a fact is considered "material" if it relates to a defect in the property or the seller's ability to fulfill his promises under the contract. Since you know that your client has enough equity to cover his back payments if he can sell his property for market value, his financial problems if they don't get any worse - would not be considered material.

Well, Saturday came and went. A nice couple stopped by the open house, said some nice things about the property and ate a couple of cookies. But by the end of the day, the balloons on the mailbox had wilted and there were no offers on the property.

Then it happened. On Tuesday your client got a formal notice from the trustee on the deed of trust. It said that his loan was in default and foreclosure proceedings had been filed in the clerk of court's office. The bank wants all its money - not just the back payments, but the whole unpaid balance of the loan - and they want it now - or they plan to sell the house from the courthouse steps!

The days now seem to fly by. Your seller can't pay, your pleas to the bank fall on deaf ears, and still there are no offers on the property.

Wait! Who's this? It's that nice couple from the open house with their buyer-agent. They tell you they're ready to make an offer - a full price offer! "Saved," you think to yourself.

But what should you say to the buyers and their agent? Shouldn't the buyers be told about the impending foreclosure? The hearing is tomorrow, so it's possible that the property could be sold in foreclosure before you can get the buyers' loan approved. This is serious. They're going to be awfully upset if they get halfway to closing and the seller loses the house. On the other hand, what about your duty to keep your seller's finances confidential?

A foreclosure proceeding is a "fast track" lawsuit to enforce a lender's rights under a deed of trust. Its purpose is to extinguish the seller's interest in a property and to sell the property to produce cash to pay off the loan.

Under these circumstances, a broker or salesman must disclose the foreclosure to prospective purchasers. This is because a foreclosure proceeding, once filed with the court, is a material fact about the property itself and it casts significant doubt upon the seller's ability to fulfill his contractual promise to convey the property to the buyer. A foreclosure proceeding is a "fast track" lawsuit to enforce a lender's rights under a deed of trust. Its purpose is to extinguish the seller's interest in a property and to sell the property to produce cash to pay off the loan. While there is always a chance that the seller will be able to pay off the loan before the foreclosure sale or that the bank will give the seller a break, the risk that the property will be sold out from under a buyer is just too great to leave him or her in the dark about the foreclosure

Commission Caveat

Although an agent who represents the seller has a duty to keep his client's financial problems confidential, a foreclosure action, once filed with the court, is a material fact which must be disclosed to prospective purchasers.