Helpful Information for REALTORS®:
Pitfalls of Handling Short Sales
-Shannon B. Jones, Partner, Shannon B. Jones Law Group, firstname.lastname@example.org
Short sales have become a “necessary evil” for real estate agents in today’s market. Because short sales are so prevalent in the West Coast market, in order for agents to earn a living, most have no alternative but to represent clients in them. Although short sales are becoming a majority part of the market in some locations, short sales can be fraught with legal pitfalls. The most common problems are identified in this article with recommendations for handling those issues to avoid claims.
1. Handling an Initial Call from the Seller.
It is common for a seller/borrower to contact an agent for advice, notifying the agent that their property is “under water.” Many agents, without considering the many alternatives a seller/borrower may consider, immediately suggest a short sale. However, in many circumstances, there are other alternatives, which may be more appropriate for the seller. For example, sellers can consider the following: foreclosure; deed in lieu of foreclosure; bankruptcy; loan modification; or renting out their property and moving to another less expensive property. There may also be tax consequences associated with short sales that agents do not consider. In order to properly advise a client on their many alternatives, a client should be referred to an accountant and an attorney to analyze the seller’s situation before the seller makes a decision. This makes legal and practical sense. Remember that if a client is better off with a foreclosure sale, the client may cancel the short sale at any given time and proceed with a foreclosure sale. If that occurs, the agent wastes their time, effort and money in marketing the property without the benefit of receiving a commission. Therefore, it is important that a client make a decision as to how to proceed with their property before an agent lists it.
2. Preparing the Buyer for the Short Sale Process.
Many buyers are interested in short sale purchases because they believe they are “getting a deal” or they simply like the property. However, it is important to manage buyer’s expectations before writing an offer on a short sale. The buyer should understand that the sale is more likely a “long sale” and not a “short sale.” In other words, it could take a long time to close or may not ever close. Agents should advise buyers that to close, all of the lenders must approve of the short sale. It is entirely voluntarily on the part of the lenders. If one lender does not approve of the sale, then it will not close. It can take a significant amount of time to obtain approvals from the lenders, particularly, if there are multiple lenders or lien holders. In addition, while the short sale is pending, the seller’s agent may be required to present additional purchase offers to the seller for consideration and that at the seller’s option the additional offer(s) can be forwarded to the lien-holder(s) usurping the original offer. The buyer also needs to be made aware of their own rights to rescind the purchase offer and walk away from the transaction as well as any financial consequences to this option if any earnest monies have been deposited.
3. Understanding a Short Sale.
It is important for agents to understand the parties’ roles in a short sale and how the transaction works. The purchase and sale agreement is by and between the buyer and the seller. They are the parties to the contract. The lenders are not parties to the contract. The contract should be prepared so that the seller’s acceptance is subject to approval by the lender and that any conditions of approval set by the lender are subject to approval by the seller. Therefore, these are two (2) additional contingencies in a short sale that are not in a traditional transaction. Once the offer is accepted by the seller, the seller submits the offer to the lender for the lender’s approval. If the lender does not approve the sale, the transaction will not close. If the lender approves the offer, the lender’s terms are subject to approval by the seller. Once the seller approves the lender’s terms, the escrow can close in accordance with the remaining terms of the contract.
4. Disclosure Obligations.
A California appellate court recently held a listing agent liable for failing to disclose that a seller was short and that escrow may not close. Holmes v. Summer. In order to protect the seller, as well as provide an adequate disclosure to the buyer, it is recommended that agents utilize an addendum to the purchase and sale agreement, which provides that the sale will be short and is contingent upon a lender’s approval. In California, agents are advised to use the California Association of Realtors’ Short Sale Addendum.
5. Lender’s Approval Letters.
When a lender approves of a short sale, the lender generally issues a letter setting forth the terms of that approval. The terms generally include without limitation the following: close of escrow date; minimum amount that the lender is willing to accept; confirmation that the sale is an arms length transaction; confirmation that the seller is not accepting any sales proceeds; if there is a junior lien holder, the senior lien holder will dictate how much money the junior is receiving; how much commission the agents receive; and whether the lender is willing to extend a release to the borrower for the amount owed or reserve their right to proceed against the borrower for any deficiencies. The release is an extremely important part of the approval letter. Agents are advised to refer their clients to attorneys and accountants when these approval letters are received to negotiate the release language. If agents advise their clients to accept the release terms, the agent could be subject to liability if the release terms are not beneficial to the client or if the client is unaware of the risks. In most approval letters, lenders reserve the right to proceed against the borrower for any deficiencies even if the lender does not otherwise have that right. Agents should be cautious about recommending that clients sign those approval letters without referring them to an attorney.
6. Payments Outside of Escrow.
In short sales, agents are sometimes asked to allow payments outside of escrow. For example, if the senior lender permits the junior lender to accept only $2,000 of the sales proceeds, the junior lender occasionally will ask for a larger payment outside of escrow. This is not only a breach of the senior lender’s terms, but constitutes lender fraud. Senior lien holders are now asserting claims against title companies who allow payments outside of escrow, which are not listed on the HUD-1 closing statement or are contrary to the lender’s approval letter. It is likely that in the future, lenders will consider pursuing claims against agents. All payments should be on the HUD-1. If any payments deviate from the senior lender’s approval letter, permission from the senior lender should be obtained.
7. Short Sale Negotiators.
There are a number of agents and individuals performing services as short sale negotiators or consultants. Unfortunately, some of these agents are not complying with the law, which can lead to significant liability for agents who utilize them. It is imperative that a short sale negotiator be a licensed real estate agent or attorney. Any fees paid to short sale negotiators must be disclosed to the lenders and approved. Short sale negotiators who are paid by buyers are also likely acting as an agent for a buyer, which must be disclosed and provide a consent for dual agency. Moreover, agents need to be cautious that they are not being paid unearned fees, which is a RESPA violation. Additionally, if an agent negotiates with banks other than the current lender(s), this may be considered mortgage brokering which creates additional issues which can include issues with licensing and coverage by any applicable E&O policy. For these reasons it is important to be sure the negotiations do not stray outside the expertise of the agent(s) involved and obtain the advice and assistance from professionals qualified to handle these exposures. Many agents are earning a tremendous income in this challenging market by undertaking short sales. However, it is important that agents address short sales with care to ensure that they do not subject themselves to unnecessary liability.
Some information in this article has been provided by Lisa Riggins, Regional Director, Pearl Insurance. Pearl Insurance is a nationally known broker, marketer, and administrator that specializes in the design and administration of quality insurance plans for associations, affinity groups, unions, and large firms. In addition to providing real estate professionals with quality products and services for 30 years, their partnership with the XL Insurance companies (through Indian Harbor Insurance Company and Greenwich Insurance Company) solidifies their strength, allowing them to offer association members an A rated (by A.M. Best) E&O program. For more information about Pearl’s sponsored E&O programs, call Lisa Riggins at 866.679.0893.
Information provided within this article is not to be taken as legal advice and is to be used for educational and illustrative purposes only.