WP: Disclosure: Materiality (includes Stigmatized Property)

VIII. Materiality

A condition is material if it is something that would influence a buyer’s decision whether or not to purchase the property, or if it affects the value or desirability of the property. Often what is “material” is decided after the purchase, by a judge, during a suit brought by a dissatisfied buyer who claims that if the buyer had known about the condition, he or she would not have bought the property.

A “latent” material defect is a material condition which is not observable or readily discoverable upon a reasonable inspection.

As the case law demonstrates, the seller has a general duty to disclose to the purchaser any information the seller has regarding latent material conditions of the property. The sorts of things people think of most often are the existence of termites, a leaky roof, or a wet basement–things the purchaser may not be able to uncover during a reasonable inspection of the property. These are latent defects, those not necessarily visible, as opposed to patent defects, which are open to observation. Other types of latent defects a broker would likely be expected to be aware of and disclose would be the presence of appliances to be sold with the house that are not in working order, asbestos, or high levels of radon. Because a broker is generally held to a higher standard of knowledge than a purchaser, the broker will need to conduct a thorough inspection of the home and inquire about these types of defects.

The above mentioned conditions are obviously material to the average buyer–they would certainly influence him to act or refrain from acting in a particular manner. In addition to these, there are other types of conditions which could affect a buyer’s behavior. They are not as obvious as those described by the latent/patent distinction, but they could very well be considered material, and moreover, lead to liability for nondisclosure.

A. Neighborhood Conditions

“Neighborhood conditions” refers to such things as quality of the schools; proximity to a landfill or toxic or hazardous waste sites; zoning; building codes; availability of bus service; or proximity to a group home. While it is still unclear whether these are conditions which must be disclosed, if the seller or broker is specifically asked about any of these, and knows the answer, the seller or broker should honestly respond to the questions.

One such category of material conditions could be termed “neighborhood conditions.” For example, would it be material to the buyer that the land upon which the houses in the neighborhood are built was formerly used as a landfill? Would that affect his or her decision-making process regarding whether or not to purchase the home? Should the broker disclose this information? The answers are hardly easy or clear. As a fiduciary to the seller, the broker does not want to do anything that reduces the likelihood of obtaining the best offer for the seller’s property. The seller may not want the broker to tell prospective buyers about the former use of the land.

On the other hand, is this the sort of condition the average buyer would discover through a reasonable inspection? Is it the sort of thing a buyer would normally think to ask about? While perhaps not, might it nonetheless affect the property’s desirability or value to the buyer? Whether or not the seller or broker should disclose this information will turn on the specific facts of each transaction. If the buyer specifically asks whether there is a landfill nearby or if the land upon which the house is built used to be a landfill, neither the broker nor seller should make a misrepresentation to the purchaser. If the broker or seller knows the answer, the broker or seller should go ahead and disclose the information. The risk of having to prove to a court that the information was not material or was not misrepresented far outweighs the possibility that the information will have a negative impact on the buyer.

For example, in Market Street Group v. McComb, the buyer was entitled to rescind the contract when the seller misrepresented the number of student tenants in the apartments. The court found that this misrepresentation concerned a material issue on which the buyer relied when deciding to enter the contract. 1998 Ohio App. LEXIS 1151, at *8 (Greene Cty. Mar. 27, 1998). The seller knew that the student occupancy issue was important to the buyer and that any information on the issue would affect his purchasing decision. Id. at *9. The buyer was not required to inform the seller that the sale was contingent upon a precise number of student tenants. Id. at *10. It was enough that the buyer conveyed to the seller or his agent that the student-occupancy issue was important to the buyer. Id. For rescission, the buyer needed to prove that the representation was material and substantial; that it affected the identity, value, or character of the subject of the contract; that it was false; that he had a right to rely on it; and he was induced by it to make the contract. Id. at **5-6.

In Chapman v. Hosek, 475 N.E. 2d 593 (I11. Ct. App. 1985), the purchaser sought to rescind the purchase agreement on the grounds that the seller and brokers had fraudulently concealed and fraudulently misrepresented the fact that the home she purchased was in a flood hazard area, and subject to damage and inaccessibility after heavy rains. The purchaser claimed this was accomplished in part by the broker’s affirmative indication in his listing that no flood insurance was necessary. Chapman argued she relied on the listing and made no further inquiries on the matter. Id. at 595-97.

The court held that a material fact was one that, “had the other party been aware of it, he would have acted differently.” Id. at 598. Furthermore, “concealment of an existing material fact is actionable where employed as a device to mislead.” Id. In this case, the particular facts suggested the condition of the neighborhood, in as much as it was in a flood hazard area, was a material fact.

The brokers claimed Chapman had no right to rely on their listing regarding flood insurance because information was available to the public that would have told Chapman her house was in a flood hazard area. They characterized her reliance as relying on their representation of the law, and argued she could not justifiably rely on representation of law since the truth was readily discoverable through public records. Id. at 598. The court disagreed. The public records referred to were of commission maps and reports, “not tantamount to a public law, nor … the type of information an average prospective buyer would research if given no indication whatsoever that flooding was a problem.” Id. at 599. Thus, since flooding was not something one would expect the average purchaser to investigate, especially when told flood insurance was unnecessary, Chapman was justified in relying upon the broker’s representation.

It appears that the broker in Chapman was also negligent. The facts that the area was located in a flood hazard area and that a mortgagee would require flood hazard insurance are things one would expect a broker, held to a higher standard of knowledge, to know.

Zoning issues also present a question of materiality to brokers. What if a broker knew that the buyer wanted to use the property in a way which the broker knew would not conform to the zoning ordinance in effect for that area? Does the broker have a duty to disclose to the buyer that the buyer’s intended use of the property would not be allowed?

Generally, the answer would be that the broker has no duty to disclose this information. Whether a use is permitted by zoning ordinances is a matter of law, and “as a general rule, one is not entitled to rely upon a representation of law since both parties are presumed to be equally capable of knowing and interpreting the law.” City of Aurora v. Green, 467 N.E. 2d 610, 613 (Ill. Ct. App. 1984). So even if the broker made a representation as to how the property was zoned, the purchaser would have no right to rely on the statement. In City of Aurora, the purchasers relied on the misrepresentations of the sellers and their agent that the parcel of land was in a zone where it could be used for a five-unit apartment building. The court held that since the zoning maps and records were open to public examination, and that the zoning administrator would give the purchasers the information they needed upon request, the purchasers had no right to rely on the representation of the sellers. Had they done a reasonable investigation they would have been put on notice that their intended use was not permitted in that zone. Therefore, the purchasers’ claim was denied. See also Stichauf v. Cermak Rd. Realty, 236 Ill. App. 3d 557 (Ill. App. Ct. 1992) (denying a similar claim by buyer against sellers and real estate agents because the zoning ordinance involved was a matter of public record, not information in the exclusive knowledge of the sellers and agents, and thus a cursory review of the zoning ordinance would have put buyer on notice that his property was in violation and could not be resold). Id. at 568.

Likewise, in Van Horn v. Peoples Banking Co., 64 Ohio App. 3d 745 (1990), where the purchaser could have determined the actual acreage of the parcel he bought by means of a simple title check, he was not permitted to rely upon the seller’s representations of the parcel’s size. This was especially true since the seller had conveyed a quitclaim deed to the purchaser which should have warned the buyer to investigate any representation made by the seller. Id. at 748. See also Starrett v. Bryan, 1994 Ohio App. LEXIS 2351, at *4 (Cuyahoga Cty. June 2, 1994) (rejecting buyers’ action for fraudulent inducement based on failure of the seller or his agent to disclose either the correct boundaries of the property, or a tax lien on the title, was not appropriate because a buyer had no right to rely on the oral representations of the agent given that the boundaries and restrictions were public record and equally available to all parties). Id.

While zoning issues may generally be said to be issues of law, compliance with a building code has been considered a question of fact. In Kinsey v. Scott, 463 N.E. 2d 1359 (Ill. Ct. App. 1984), a building was not built in conformity with the building code, but the builder-seller represented to the buyer that it was in compliance. Since the lack of conformity was not something the average purchaser could discover upon reasonable inspection and was a matter of fact and not law, the purchaser was justified in relying upon the seller’s representation. The seller made a false representation; there was nothing to warn the purchaser as to the falsity of the statement; the purchaser relied on the statement and suffered injury because of it. Thus, the seller was found liable to the purchaser for fraudulent misrepresentation. Id. at 1365-66.

Similarly, in Curran v. Heslop, 252 P.2d 378 (Cal. Ct. App. 1953), the defendant did not reveal violations of the building code which were not apparent to the purchaser. Since they were not apparent, the court found a duty on the part of the sellers to disclose the violations to the buyer. The non-disclosure was concealment of material fact. Id. at 381. The court also stated that “an independent investigation or examination of property does not preclude reliance on representations where the falsity of the statement is not apparent from an inspection, or the person making the representation has a superior knowledge ….” Id. The facts were sufficient to uphold the lower court’s rescission of the contract.

Failure to disclose the fact that property is subject to an order to comply with the local building code also is concealment of material fact. For example, in Katz v. Dept. of Real Estate, a purchase agreement was rescinded because the seller, a real estate broker, failed to disclose that the residence was subject to an order to comply with the municipal building code. 96 Cal. App. 3d 895, 898 (Cal. Ct. App. 1979). The court found that the broker had a duty to disclose the order because this was a fact materially affecting the value and desirability of the property. Id. at 900. The broker, however, had purchased the residence subject to the order and then sold the property to the buyer “as is” without notifying buyer of the order. Id. at 898. Administrative action was taken against the broker, which resulted in the revocation of his license. Id. at 899. In addition, the court imposed this disclosure duty on the broker even though he had no actual knowledge that the buyer was unaware of the order. The broker’s silence was unacceptable given that knowledge of the order was not necessarily within buyer’s diligent reach as its existence was not visibly apparent. Id. at 900.

B. Stigmatized Property: Murder, Suicide, Ghosts and Goblins

“Stigmatized” or “psychologically impacted” property is property which has been the site of a murder or suicide, or is reputed to be inhabited by ghosts or poltergeists. In the few cases decided on the subject, courts have not ruled out the possibility that these things are material conditions requiring disclosure. Therefore, if a broker is ever confronted with such a problem, the broker should inform prospective buyers of the conditions at some point during the negotiations–not necessarily at the first viewing, but certainly once it is established that the purchasers are serious about the property.

Another category of conditions which may be material fact to a prospective purchaser comes under the heading of stigmatized or psychologically impacted property. Would you want to know if the home you were considering buying had recently been the scene of a gruesome murder? What if the murder occurred five years ago? Ten years? Thirty years? Is this a material fact which affects the desirability or value of the property? The answer is “Maybe.”

One court that considered the question decided that if the purchaser could prove the value of the house was less than she paid for it because the home was the site of a gruesome murder, she would be entitled to damages. In Reed v. King, 193 Cal. Rptr. 130 (Cal. Ct. App. 1983), Reed purchased a house from King which had ten years earlier been the site of a multiple murder.

Neither King nor his agents informed Reed of this fact. After the sale, Reed was told about the incident by her neighbor. Id. at 130. Reed filed suit against King and his agents for fraudulent concealment, claiming the house was only worth $65,000 because of its history, and thus, because King concealed its history, Reed paid $11,000 more than the house was worth. She sought rescission and damages.

The critical question in the case was whether the stigma of the house was material such that the seller was placed under a duty to disclose the fact to the purchaser. Id. at 131. “Whether information is of sufficient materiality to affect the value or desirability of the property . . . depends on the facts of the particular case.” Id. at 132.

The court was forced to weigh the consequences of allowing such an “irrational” basis for rescission of contracts and the potential for instability in contractual relations against the fact that murder is unsettling and not something which the average buyer would necessarily uncover or inquire about during a reasonable inspection. The court concluded that since this case came as a review of summary judgment against the purchaser, simply allowing the case to proceed would not be an endorsement of the fact’s materiality. Instead, the claim was allowed to proceed in order to permit Reed to try to prove her claim that the murder did have a significant effect on market value. If she could do so, she would be entitled to a judgment in her favor regarding materiality and the duty to disclose. The court said that [if] information known or accessible only to the seller has a signigicant and measurable effect on market value and, . . . the seller is aware of this effect, we see no principled basis for making the duty to disclose turn upon the character of the information.” Id. at 133. Thus, Reed has paved the way for future cases of this nature to result in liability on the seller for nondisclosure where the purchaser can competently show the stigma’s effect on the value of the property.

Even in states where the doctrine of caveat emptor is rigorously applied, a seller has a duty to disclose the existence of poltergeists to avoid rescission of the purchase agreement. Stambovsky v. Ackley, 169 A.D. 2d 254, 256 (N.Y. App. Div. 1991). In Stambovsky, after the sale was complete, the buyer learned the house had a reputation for being possessed by poltergeists. The court determined that “haunting” was not a condition that was expected to be ascertained by a buyer upon reasonable inspection of the premises. Id. at 257. The seller had deliberately reported the presence of poltergeists in both the national and local press, but because the plaintiff was not a resident of the local village, he could neither be familiar with the folklore of that area nor readily learn that the home was haunted. Id. at 256. The impact of the reputation the seller had created for the house went directly to the “very essence of the bargain” between the parties, greatly impairing the value of the property and its resale potential. Id. at 256. While caveat emptor precluded an award of damages, it did not prevent the equitable remedy of rescission. Id. at 258. Therefore, nondisclosure provided the basis for rescission where a condition that had been created by the seller materially impaired the value of the contract and was peculiarly within the knowledge of the seller, or unlikely to be discovered by a prudent purchaser exercising due care with respect to the transaction. Id. at 259.

Ohio recently acknowledged a cause of action for residential property tainted by stigmatizing events that have occurred on or near the premises. A seller now has a duty to disclose the psychological defect that the property is unsafe for habitation due to the serious crimes that have occurred in or near the residence. Van Camp v. Bradford, 63 Ohio Misc. 2d 245 (Butler Cty. July 29, 1993). In Van Camp, the buyer had inquired before closing about the bars on the basement windows. The seller stated that they were a result of a break-in sixteen years prior but failed to mention the numerous rapes that had occurred recently in the house and surrounding neighborhood. Id. at 250. After purchasing the home, the buyer discovered the criminal history of the home and the area and filed suit against the sellers and agents.

The court determined that caveat emptor would not apply and treated the stigma associated with the residence the same as a latent property defect. Id. at 252-53. Even the most prudent purchaser could not be expected to check police records to ascertain the relative safety of a neighborhood or a particular residence. Id. at 253. To succeed on a psychological defect claim, the buyer must prove fraudulent inducement. Id. at 254. The court will also review subjective considerations, such as whether the seller is aware that the buyer is likely to attach importance to a subject. Id. at 255. The misrepresentation will be found to be material, regardless of its significance to a reasonable person, if it would be subjectively material to the buyer. Id. In Van Camp, the seller knew that the buyer was a single mother with a teenage daughter. Id. at 259.

In addition, the court determined that Ohio law requires a seller or agent to provide a good faith response to an inquiry, even one regarding a potential psychological impairment. Id. at 257. The agents were released from liability, however, because the inquiry was directed solely to the seller. Id. at 259. The agents had no affirmative duty to speak up and disclose their knowledge of the crimes simply because they were in the room at the time the inquiry was made. The agents would have been liable had they similarly misrepresented or failed to disclose a material fact upon an inquiry directed to them. Id. at 260.

If a broker must confront such a problem with stigmatized property, the broker should inform prospective buyers of the conditions at some point, though not necessarily on the first showing. For instance, one Columbus area agent handled a listing of a stigmatized property by not informing potential buyers of the stigma until they came back for a second showing. In this way he did not scare everyone off, but gave the information only to those who showed a serious interest in the home. In his view, it was a negative characteristic of the home which, if disclosed up front, would not come back to “haunt” him after a transaction took place. See Columbus Monthly, April 1992, p.70. While disclosure may affect the sale price of the property, this is much more acceptable than being sued for nondisclosure once the transaction has been completed.

The whole idea of stigmatized property is a rather novel concept. As the Reed case shows, materiality may be molded to fit the circumstances. The general impression it creates is that materiality is a buyer’s concept – if it affects or would have affected the buyer’s conduct in the transaction, then in hindsight it is material. Equity and fair dealing are of paramount importance in this area. If your behavior offends the court’s sense of equity, you can plan on a finding of materiality, and losing your case.