by Nathan D. Vaughan, Esq.
The real estate market has changed drastically over the last three years. This change has created a new niche market for REALTORS, the “short sale market.” However, this new market is not for the weak at heart. Short sales typically require REALTORS to work longer and harder than traditional sales, while often resulting in less pay. Further, short sales often involve managing unique legal and tax problems for clients, with which most REALTORS have little experience. REALTORS can avoid many of the short sale pitfalls by providing their client disclosures at their initial meeting.
The First Meeting
The potential for liability can arise at the first meeting with the client. Once the REALTOR determines a short sale is likely, he/she should inform their client that a short sale involves a number of legal issues and tax issues which require the professional advice of an attorney and an accountant. In some circumstances, a client may be better off filing bankruptcy or allowing a foreclosure to proceed as opposed to attempting a short sale. The REALTOR cannot provide legal advice and therefore cannot advise the client on what is, or is not, in the client’s best legal interests. For example, never instruct a client to intentionally default on their mortgage loan. This could create significant problems for REALTORS if the short sale does not result in a successful sale or a complete forgiveness of the client’s loan.
It is also important that the client understand the REALTOR’s role in a short sale transaction is to list, market, and sell the property. It is important that the client understand the decision to attempt a short sale should be determined by the client and their legal and accounting advisors. Clearly defining the limits of the REALTOR’s role, the expectations of the client, and who is responsible for making the decisions can prevent a number of misunderstandings in the future.
Brokers would be well served to work with their attorney in drafting disclosures for their REALTORS to use with clients considering a “short sale.” The disclosures should make clear the REALTOR’s limited role in the short sale transaction, provide examples of the issues that must be navigated throughout the short sale process, and finally advise the client to seek the professional advice of an attorney and an accountant to determine if a short sale is the best solution for the client.
Don’t assume a client in financial dire straits will not have the ability to access an attorney or an accountant. Many clients have family attorneys or accountants that could provide advice. Additionally, some clients can obtain free legal consultations from a legal aid society or even a bankruptcy attorney. Also, REALTORS should consider adding attorneys and accountants to their network to assist their clientele with short sale advice.
There is nothing worse than a client knocking on your door claiming he was not appropriately advised in the short sale process. While the situation will inevitably be stressful, REALTORS who possess a record of their disclosures, will be able to sleep much better at night.
After the client has made the determination to attempt a short sale, the next step is determining a list price for their home. Remember Standard of Practice 1-3, prevents a REALTOR from misleading a client as to the market value of their home. On occasion, a pending foreclosure or sheriff’s sale may require the list price to be lower than the fair market value to generate immediate offers. Unfortunately, REALTORS are put in a difficult balancing act to honor their fiduciary obligation to obtain the highest price for their client, and at the same time, ensuring the transaction can be closed soon enough to avoid the pending foreclosure. It is important that the client understand that listing the price of the home too low can result in the receipt of offers which will ultimately be rejected by the bank. Of course a list price too high will generate no interest, thereby undermining the goals of the short sale.
REALTORS should provide their clients with written disclosures regarding the recommended listing prices for short sale and traditional sales transactions. Be sure the disclosure makes clear that the market analysis is not an appraisal, but rather an estimated listing price based upon the data reviewed by the REALTOR. Provide the client with as many comparable sales as possible and let the client make the decision on what listing price to use. By informing the client of the different list price options, REALTORS can avoid claims that they misinformed the client about the true value of the home or pressured their client into accepting a listing price.
Another way REALTORS can protect their clients and themselves, is to pre-qualify the client for a short sale. Contact the bank with a CMA and obtain an approved sales price prior to putting the property on the market. Of course, time constraints generally make this option unavailable.
At times, the client will contact the REALTOR and advise they just received foreclosure papers. REALTORS are all aware that they cannot provide legal advice to their client, and the REALTOR must ensure that the client is informed of the need to contact an attorney as soon as possible. Due to the number of foreclosures at this time, many courts have online forms for homeowners to defend, and ultimately slow, the foreclosure process. Additionally, clients can obtain legal advice from legal aid societies in their area.
It is very important that the client understand that the REALTOR cannot guarantee a short sale will be closed prior to judgment being taken against the client or the sheriff’s sale.
Negotiating with the Lender
Another pitfall REALTORS often confront is negotiating with the client’s lender. If possible, REALTORS should try to have the clients deal with their lender directly. This prevents REALTORS from having to manage confidential information and from making representations to the lender which may end up being inaccurate.
The short sale process will require the client to send in certain financial information to the lender. When lenders request financial information from the client, REALTORS should advise their client to forward the information directly to the lender. The information requested will contain social security numbers, bank account information and income, which increase a REALTOR’s obligations to protect this information. Having the client work directly with the lender can help reduce the REALTOR’s liability.
Unfortunately, most clients turn to their REALTOR for this service. As a result, when REALTORS are negotiating with lenders, they need to be sure they have an appropriate release signed by their client which allows the REALTOR to speak freely with the lender. The release should also give the REALTOR authority to disclose all information requested by the lender. This will prevent any misunderstanding as to whether or not the REALTOR was authorized to disclose certain information to the client’s lender.
REALTORS should also ensure they are not providing any legal advice to their client during this process. The negotiation process can have legal repercussions for the client, and REALTORS must make it clear to their client that the REALTOR is not an attorney, cannot provide legal advice and that the client should consult an attorney.
In the event the REALTOR conveys information to the lender, he or she must understand that transmitting false information to the lender, can get the REALTOR into hot water. A clear disclaimer should accompany any information the REALTOR forwards to the lender, which advises the lender that the REALTOR has neither reviewed nor verified the information and is simply transmitting information provided directly from the client. Again, make sure you are using your brokerage’s approved forms when conveying this information. Of course, REALTORS should never convey information to the lender which they know to be false.
Dealing with Confidential Information
Standard of Practice 1-9 requires REALTORS to keep all information of their clients confidential. This ethical obligation is reinforced by Ohio R.C. §4735.62(I) which requires REALTORS to protect confidential information. Additionally, brokerages are required to maintain written confidentiality policies under R.C. §4735.54.
Does your brokerage’s confidentiality policy provide enough protection to protect social security numbers, bank account information, etc.? Does your brokerage’s written confidentiality policy cover the protection of confidential information received in electronic form? Hopefully the answer is “yes.”
Keep in mind that R.C. §1349.19, requires businesses to provide notifications to clients anytime there is unauthorized access to electronic confidential information. Obligations to protect confidential information continues to increase and REALTORS and their brokers should work with their counsel to ensure they have appropriate policies in place to protect themselves.
Due to the length of the closing process, it is not uncommon for offers to trickle in after a seller has already accepted an offer. Standard of Practice 1-7 requires REALTORS to submit these offers to their clients and advise them of the need to seek legal advice before accepting the second offer. REALTORS and sellers can be put into difficult positions when they receive an offer higher than the offer already being considered by their client’s lender.
Accepted offers are binding contracts on the seller and accepting two offers can get the seller and potentially the REALTOR, into hot water. To help resolve this issue appropriate contingency language should be included in the purchase agreement to give sellers flexibility in dealing with this situation, such as: “This Agreement is conditioned upon Seller’s mortgagee(s) releasing all liens on the property, forgiving Seller of all debt associated therewith, and Seller’s mortgagee(s) approving this Agreement. Seller reserves the right to present subsequent offers to Seller’s mortgagee(s) for consideration and approval.”
Reducing Your Commission
Despite the fact that the REALTORS are doing the bulk of the work, most lenders are demanding REALTORS reduce their commission in short sales. The commission reduction puts REALTORS in the difficult position of choosing between allowing the sale to go forward, or refusing to give up their commission. There is no good solution for this problem. Although tempting, REALTORS should not accept commissions from the client outside of closing, as this could be a violation of the Real Estate Settlement Procedures Act. Further, before authorizing any commission reduction, be sure you have all REALTORS and brokerages on board with the reduction to prevent confusion in the future. Keep in mind that REALTORS cannot reduce their commission as an inducement for the Seller and/or Buyer to enter into the purchase agreement, as the Ohio Division of Real Estate considers such conduct to be an improper inducement. See R.C. 4735.18(A)(14).
REALTORS were provided some relief in 2009 when Fannie Mae and Freddie Mac issued a directive that mortgage servicers were not allowed to require a reduction in commission below 6 percent. However, this directive does not apply to second mortgage holders or private mortgage insurance companies. The Freddie Mac and Fannie Mae Commission Policy is available on line at http://www.realtor.org/realtors/basics_short_sales.
The Approval Letter
The approval letter is the area most likely to create liability for REALTORS. There are generally three different types of approval letters. The first is commonly referred to as a total forgiveness letter and releases the client for the difference between the loan balance and the ultimate proceeds received by the lender in the short sale. While the Mortgage Forgiveness Debt Relief Act will generally prohibit the IRS from imposing income taxes on the amount of the forgiven debt in a short sale there are some exceptions to this rule, so make sure your client understands the need to consult a tax professional for advice on this issue. Again, a clear opening letter to the client advising of the need for legal and accounting advice will help prevent this surprise.
The second type of approval letter, reserves the lender’s right to pursue the customer for any deficiency between the loan balance and proceeds received by the lender. In this situation, the lender simply releases their mortgage and allows the transaction to conclude, but the client remains obligated to pay the loan. Again, this can present a very unwelcome surprise for clients after the closing. The final type of approval letter will require the client to execute a new promissory note for the difference between the proceeds the lender receives and the loan balance. This may allow additional flexibility for the customer to pay down the difference.
Keep in mind that some clients may prefer to keep their home when the balance of their loan is not forgiven. Additionally, some approval letters can put the client in a worse position than had the foreclosure continued. For example, under Ohio law, if an individual’s primary residence is the subject of a foreclosure action, any deficiency judgment is only valid for two years. However, this rule does not apply when there is no foreclosure, potentially keeping clients on the hook for the deficiency in a short sale for more than two years. Also, in some counties foreclosures may take up to one year, which allows the client a significant amount of time to live rent free and get back on their feet. Again REALTORS should not provide any legal advice to their clients about the foreclosure process, other than to obtain an attorney.
If you still want to engage in short sale transactions after reading this article, what do you need to do? You need to make sure you work with your broker and your broker’s attorney to have a clear set of forms designed to disclose the risks associated with short sales and your limited role in the transaction. A full and complete disclosure will resolve the majority of any problems REALTORS will confront with their clients in a short sale. Additionally, REALTORS should work with their broker and the broker’s insurance agent to determine the limits of any E&O coverage. Once you know the extent of your coverage, make sure your short sale forms and services provided in your office are covered by insurance. Remember without insurance coverage, REALTORS are forced to defend themselves and be responsible for all of their own attorneys’ fees associated with defending the lawsuit.
NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.
Nathan D. Vaughan, Esq. is a member of the Real Estate Section at the law firm of Krugliak, Wilkins, Griffiths & Dougherty Co., L.P.A. (www.kwgd.com) in New Philadelphia, Ohio. Feel free to contact him with real estate questions at email@example.com.