Mcle Self-study Article: Real Estate Broker Exculpatory Clauses: Their Use and Misuse

• Publication year: 2014
• Author: By Edward W. Newman

MCLE Self-Study Article: Real Estate Broker Exculpatory Clauses: Their Use and Misuse

(Check the end of this article for information on how to access 1.0 self-study credits.)

By Edward W. Newman

©2014 All Rights Reserved.

I. INTRODUCTION

Real estate brokers¹ are understandably motivated to limit their exposure to lawsuits for negligence or other misconduct in transactions they handle. In furtherance of this objective, it is now common for brokers to incorporate, for their own benefit, a variety of exculpatory clauses and other provisions into agreements presented by brokers to their own clients and into transaction forms generated by brokers for execution by the principals. This article examines both the legal validity and the propriety of such provisions in light of the recognized duties of real estate brokers to their clients and to third parties.

The California legislature and California courts have not been reticent about the duties and responsibilities of real estate agents. As to his own clients, the real estate agent has "the same obligation of undivided service and loyalty that [the law] imposes on a trustee in favor of a beneficiary. Violation of this trust is subject to the same punitory consequences that are provided for a disloyal or recreant trustee."² This fiduciary relationship not only imposes upon the agent the duty of acting in the highest good faith toward his principal but precludes the agent from obtaining any advantage over the principal in any transaction had by virtue of his or her agency.³ California Civil Code section 2322, which dates back to 1872, prohibits an agent from violating any duty to which a trustee is subject under sections 16002, 16004, 16005, or 16009 of the Probate Code. Section 16002 requires a trustee to administer a trust solely in the interest of the beneficiaries (duty of loyalty), and section 16004 provides that any transaction by which the trustee obtains an advantage from the beneficiary is presumed to be a violation of the trustee's fiduciary duties (conflicts of interest).⁴

There is no fiduciary relationship to the other parties to a transaction who are not clients of the agent. As to those parties, the duties of a real estate agent are somewhat less demanding but also less clear. At a minimum, the agent has a duty to deal honestly and fairly with all parties to a transaction.⁵ Civil Code section 2079(b) imposes on a real estate broker or salesperson the broad duty to comply not only with the detailed disclosure requirements of section 2079, et seq., in residential transactions, but also to comply with any regulations implementing Business and Professions Code sections 10176 and 10177 in all transactions. Those sections in turn prohibit any conduct which constitutes fraud or dishonest dealing, as well as negligence or incompetence in performing any act which requires a real estate license.

A broker who breaches any of the foregoing duties faces both possible suspension or revocation of his or her real estate license,⁶ and potential civil liability. To minimize the risks of civil liability, brokers and their trade organizations have developed a variety of exculpatory provisions that are often found in agreements between brokers and their own clients, such as listing agreements, and also in agreements furnished by brokers for use by the parties, such as purchase agreements or leases. One common approach is to limit by contract the role of the broker. As an example, the commercial property purchase agreement published by the California Association of Realtors ("CAR") provides:

SCOPE OF BROKER DUTY: Buyer and Seller acknowledge and agree that: Brokers: (i) do not decide what price Buyer should pay or Seller should accept; (ii) do not guarantee the condition of the Property; (iii) do not guarantee the performance, adequacy or completeness of inspections, services, products or repairs provided or made by Seller or others; (iv) shall not be responsible for identifying defects that are not known to Brokers(s); (v) shall not be responsible for inspecting public records or permits concerning the title or use of the Property; (vi) shall not be responsible for identifying location of boundary lines or other items affecting title; (vii) shall not be responsible for verifying square footage, representations of others or information contained in inspection reports, MLS or PDS, advertisements, flyers or other promotional material, unless otherwise agreed in writing; (viii) shall not be responsible for providing legal or tax advice regarding any aspect of a transaction entered into by Buyer or Seller in the course of this representation; and (ix) shall not be responsible for providing other advice or information that exceeds the knowledge, education and experience required to perform real estate licensed activity. Buyer and Seller agree to seek legal, tax, insurance, title and other desired assistance from appropriate professionals.

Other clauses are aimed at limiting the substantive rights of clients or parties to real estate transactions against the broker, and some even go so far as to provide for indemnification of the broker. As an example, the following clause is contained in the purchase agreement form used by a major commercial brokerage company:

LIMITATION OF AGENT'S LIABILITY: Except for Agent's sole gross negligence for sole willful misconduct, Seller and Buyer agree to hold the agents harmless from any damages, claims, costs and expenses resulting from or related to any party furnishing to the Agents or Buyer any false, incorrect or inaccurate information with respect to the property or Seller's concealing any material information with respect to the condition of the property. To the extent permitted by applicable law, the Agents' liability for errors or omissions, negligence, or otherwise, is limited to the return of the fee, if any, paid to the responsible agent pursuant to this contract. In addition, Seller and Buyer agree to defend and hold the Agents participating in this transaction harmless from and against any and all liabilities, claims, debts, damages, costs, and expenses including, but not limited to, reasonable attorneys' fees and court costs, related to or arising out of or in any way connected to representations about the property or matters that should be analyzed with experts.

[Page 14]

Other clauses afford procedural advantages to the broker, such as the CAR residential purchase agreement, which obligates a client to mediate any dispute or claim with the broker solely at the broker's election. The validity of these various exculpatory provisions runs the gamut from being fully enforceable to themselves constituting a breach of fiduciary duty and arguably a violation of professional ethics.

II. VALIDITY OF EXCULPATORY CLAUSES IN GENERAL

A. The Governing Statute: Civil Code Section 1668

Section 1668 of the California Civil Code, also enacted as part of the original code in 1872, provides that "[a]ll contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud or willful injury to the person or property of another or violation of law, whether willful or negligent, are against the policy of the law." Civil Code section 1667 further provides that anything contrary to the policy of the law is unlawful.

The application of section 1668 to willful misconduct and to intentional fraud is obvious and has never been the subject of dispute. The extensions of the statutory bar to liability for negligent fraud and breach of fiduciary duty (constructive fraud) are also now settled.⁷ However, the validity of contracts exempting a party from responsibility for ordinary negligence or for "violation of law" has been far more troublesome, as discussed below.

B. Tunkl v. The Regents of the University of California

In 1963, in a case concerning a release required as a condition for admission to a charitable research hospital, the California Supreme Court issued its landmark decision holding that a release from liability for future negligence can stand only if the public interest is not involved.⁸ The Supreme Court found that existing interpretations of section 1668 in the context of ordinary negligence were inconsistent. One line of cases held categorically that contracts seeking to relieve individuals from liability for their own negligence are always valid.⁹ The only uniformity the court could discern in the remainder of the case law was that exculpatory clauses affecting the public interest are invalid.¹⁰ Acknowledging the difficulty in defining the concept of public interest, the court delineated the following six criteria to identify the kind of agreement in which an exculpatory clause is invalid as contrary to public policy:

1. It concerns a business of a type generally thought suitable for public regulation.
2. The party seeking exculpation is engaged in performing a service of great importance to the public, which is often a matter of practical necessity for some members of the public.
3. The party holds himself out as willing to perform this service for any member of the public who seeks it, or at least any member coming within certain established standards.
4. As a result of the essential nature of the service, in the economic setting of the transaction, the party invoking exculpation possesses a decisive advantage of bargaining strength against any member of the public who seeks his services.
5. In exercising a superior bargaining power the party confronts the public with a standardized adhesion contract of exculpation, and makes no provision whereby a purchaser may pay additional fees and obtain protection against negligence.
6. Finally, as a result of the transaction, the person or property of the purchaser is placed under the control of the seller, subject to the risk of carelessness by the seller or his agents.¹¹

The Tunkl criteria have been applied by the courts in numerous cases over the last fifty years.¹...