Arizona Real Estate Disclosure Disputes

While it certainly stands to reason that sellers of real property in Arizona have a legal duty and, generally, a contractual duty to disclose material and latent defects in a property to a buyer, there are many other potential disclosure pitfalls on both sides of a real estate transaction. The purpose of this article is to examine some of those pitfalls, including the disclosure duties and other obligations shared by buyers, sellers, and their agents related to a real estate transaction.

Background

The most commonly used contract for residential real estate transactions in Arizona is the Residential Real Estate Purchase Contract of the Arizona Association of Realtors®. In addition to this contract, the Arizona Association of Realtors® has many other useful forms available to Realtors® and the public, including the Residential Rental Agreement, Vacant Land Purchase Contract, the Commercial Real Estate Purchase Contract, and a number of disclosure based forms such as the Residential Seller Property Disclosure Statement (commonly referred to as the “SPDS”) and the Buyer’s Inspection Notice and Seller’s Response or “BINSR”. Although these documents are used quite often in real estate transactions, buyers and sellers or lessors and lessees of real property have the option to utilize other contracts or to draft their own contracts or agreements. Regardless of the specific documents used, buyers and sellers, as well as their agents, share common duties and obligations as “parties” to a real estate transaction.

The Duty of Good Faith

As previously mentioned, sellers of real property have a duty to disclose material information, such as “latent defects” to a buyer of a property. This duty stems from the general duty of good faith and fair dealing that Arizona courts have long applied to every contract. That duty applies to both parties to a transaction. While the seller may have a duty to deal fairly and in good faith with a buyer, the buyer also has a duty to deal fairly and in good faith with the seller. A buyer’s duty of good faith and fair dealing includes a duty to disclose whether the buyer is capable of carrying out the transaction and, if the purchase contract provides the buyer with an opportunity to “opt-out” of the contract after an inspection period, that the right to “opt-out” is exercised in good faith.

The Residential Real Estate Purchase Contract

Because so many residential real estate purchases in Arizona utilize the Residential Real Estate Purchase Contract of the Arizona Association of Realtors®, we will next address some of the specific duties and obligations set forth in that contract.

Section 4(b) of the Residential Real Estate Purchase Contract requires the seller to provide the buyer with a Seller Property Disclosure Statement or “SPDS” within five days of the acceptance of the contract. The SPDS is filled out by the seller and contains a wide variety of information about the property based on the seller’s actual knowledge. For example, the seller must disclose information about past or present water leaks, whether the property was a rental property, etc. The SPDS is a critical source of information to the buyer and is understandably relied on heavily. With the growing number of bank or lender-owned properties being sold in Arizona, oftentimes no SPDS or, at best, a limited SPDS will be provided to the buyer of these properties.

The seller also warrants to the buyer that he or she has disclosed all of the material latent defects about the property and any other information that the seller knows that impacts the consideration or value paid by the buyer for the property. The seller must also maintain the property in substantially the same condition through the close of escrow or “COE”.

The buyer has the opportunity to and should investigate the property. During the inspection period, which is, by default, 10 days under the Residential Real Estate Purchase Contract, the buyer can generally conduct whatever non-invasive inspections and investigations he or she wishes. Although information about the property was disclosed in the SPDS and also in the multiple listing service (“MLS”) information available to the buyer’s real estate agent, these inspections and investigations are critical to verifying the condition and value of the property. Oftentimes inspections, such as home inspections, wood-destroying insect inspections (i.e. termite inspections), and appraisals are required by the buyer’s lender. The buyer must also investigate issues that are important to him or her, including wastewater treatment, water availability, homeowners insurance, and any other item that is material to the buyer.

After the inspection period, the buyer can submit a Buyer’s Inspection Notice and Seller’s Response or “BINSR”. The purpose of the BINSR is to provide the seller with a list of items of which the buyer does not approve. The buyer can either elect to cancel the contract, provide the seller with an opportunity to correct the items, or accept the property in its current state. Again, it is important that the buyer exercise his or her rights under the contract and BINSR in good faith and not abuse this option as a free “out”. The seller then responds to the BINSR and either agrees to correct any items listed (or portion of items listed) or refuses to correct those items. If the seller refuses to correct all items, the buyer can cancel the contract or agree to accept the property in its current state or as agreed upon by the parties.

In short, the buyer and seller under the Residential Real Estate Purchase Contract of the Arizona Association of Realtors® have disclosure duties and obligations. For the buyer, these obligations include the disclosure of material information, such as latent or hidden defects, concerning the property. The seller similarly has a general legal duty to disclose information that might be relevant about the sale and, specifically, regarding his or her ability to perform. Furthermore, both parties have a duty to carry out their duties, obligations, and rights in good faith.

The Duties of Real Estate Agents to Parties

While it is clear that buyers and sellers have duties to each other in connection with a real estate transaction, real estate agents also owe duties to all of the parties involved. This duty extends not only to the person that the agent is representing, but the other party and his or her agent as well.

By representing a party to a transaction, a real estate agent owes a fiduciary duty to his or her client and must protect that client’s interests in the transaction. The real estate agent must also deal fairly with all other parties to a transaction and must disclose any information that the real estate agent has that may materially or adversely affect the consideration paid by either party. This duty requires a real estate agent to disclose whether his or her client is unable or unwilling to perform, any material latent defects with the property known to the agent, and whether there is any lien or encumbrance on the property. The real estate agent will also likely be bound by the National Association of Realtors® Code of Ethics.

What Is a “Disclosure Dispute”?

Disclosure disputes typically occur when one party to a real estate transaction believes that the other party and/or his or her agent failed to disclose material information related to a transaction. Most commonly, this occurs when a buyer contends, after the close of escrow or “COE”, that a seller failed to disclose a latent defect in the property being sold. For example, after moving into a property, a buyer finds out that the property has a roof leak or that there are mold issues with the property.

In order to prove a claim of non-disclosure, the party making the claim must show that the non-disclosing party had actual knowledge of the defect or material information that was not disclosed. If, for example, a seller had no knowledge that a roof was actually leaking, a buyer cannot prove that the seller did not disclose the leaky roof because the seller could not disclose information that was unknown to the seller. That is not to say that the buyer may not have a claim for relief if the seller failed to properly maintain the roof through the close of escrow, causing it to begin leaking.

Disclosure disputes also often involve the non-disclosing party’s agent and his or her broker or brokerage. When a claim for non-disclosure is made, a party may contended that the agent knew of and should have disclosed the defect, but failed to do so. Brokers and brokerages are often involved as well to the extent that they were responsible for supervising the agent or through the legal principle of respondeat superior.

Resolution of Disputes

Most commonly, parties seek an informal resolution of a disclosure dispute, prior to its escalation. This may include a party seeking representation by an attorney who sends a demand letter on his or her client’s behalf, requesting that the parties provide compensation for the damages. In the event that informal efforts to resolve a dispute are unsuccessful, a party may seek resolution through mediation, which is required pursuant to the Residential Real Estate Purchase Contract of the Arizona Association of Realtors®. Other contracts between a buyer or seller may not require this form of alternative dispute resolution or “ADR”.

Mediation is an informal process in which a neutral third-party attempts to negotiate a resolution between the parties, usually by pointing out the strengths and weakness of each party’s case and the risks associated with going forward with arbitration or litigation. If mediation is unsuccessful, the parties, pursuant to the Residential Real Estate Purchase Contract, agree to participate in binding arbitration, in which a neutral third-party makes a final and binding decision on the case. However, this contract also provides that either party may opt out of binding arbitration within 30 days of the conclusion of the mediation by providing the other party with notice, in which case either party may pursue litigation of the dispute.

Attorneys’ Fees

In Arizona, if an action arises out of a contract, reasonable attorneys’ fees may be recovered by the prevailing party in litigation. Judges have a wide range of discretion in awarding attorneys’ fees under Arizona statute and it is not uncommon for a judge to award less than all of a prevailing party’s attorneys’ fees. The Residential Real Estate Purchase Contract of the Arizona Association of Realtors® also provides that the prevailing party of any dispute between a seller and a buyer is entitled to an award of its reasonable attorneys’ fees.

This article is not intended to be specific legal advice. It only provides general legal information. You should consult an Arizona licensed attorney if you have a legal issue. The Bainbridge Law Firm, L.L.C., is experienced in this area of law and are available for consultation. You may contact our Phoenix office at 602-902-1930.