In today’s hot real estate market, buyers will purchase real property without contingencies.  While not advisable, many buyers believe that a non-contingent offer is the only way they can be competitive against other prospective purchasers.  When this is done, the buyer passes on the opportunity to more fully vet the seller’s disclosures (e.g. Transfer Disclosure Statement [TDS], Seller Property Questionnaire [SPQ], and Supplemental Seller’s Checklist) and any third-party property inspection reports.  Having to rely completely on these disclosures and reports can leave the buyer more susceptible to misrepresentations.  Misrepresentations as to material facts, even those accidentally made, can be incredibly costly to the seller.

Following a home purchase and the discovery of misrepresentations made by the seller, the buyer will often consider seeking rescission.  Rescission “undoes” or “reverses” the contract and places the parties to the contract in the position they would have been in had the transaction never occurred.  The grounds for and the ways to rescind a contract are governed by statute (specifically, California Civil Code section 1688, et seq.).

The discovery of the misrepresentation or other ground for rescission can occur well after the purchase is completed.  If there is a time gap, the seller may have purchased a new home and performed renovations or improvements.  Similarly, the buyer may have made repairs or completed additions to the property.

The San Mateo Superior Court and California Court of Appeal were confronted with a situation where this hypothetical unfolded.  In reversing the trial court decision, the Court of Appeal made clear that should a party be entitled to rescission based on a misrepresentation of a material fact by another party, they will receive complete relief.  No consideration will be given to any claimed prejudice by the party committing the misrepresentation.  It also appears that the difficulty of untangling the deal will not be a significant factor in granting rescission.  In other words, should the requirements for rescission be met, the Court will unwind the transaction.

Factual Scenario and Trial Court Decision
In Wong v. Stoler, the buyers purchased a hillside home in San Carlos.  Unbeknownst to the buyers, they and 12 of their neighbors were connected to a private sewer system, rather than the City’s public system.  A “Declaration of Conditions, Covenants, and Restrictions for Sewer Easements” (CC&Rs) recorded against the property and a “Cross-Easement Agreement” do not clearly attach the easements to the titles of the 13 properties served by the private sewer.  Notably, the 13 property owners on the private system never agreed to establish an emergency repair fund or create a long-term reserve for the system’s eventual replacement.  The cost to replace the 25-year old system would be over $500,000 and it was anticipated it would need to be replaced within 20 to 30 years.

The sellers failed to disclose that they participated in forming an informal association to pay for sewer maintenance and contributed money to the association.  They also possessed, but failed to provide the buyers with a copy of a recorded document and a notice from the City of San Carlos concerning the private sewer system.

Shortly after moving in, the buyers commenced an extensive remodeling project, costing about $300,000.  About the time the home was down to the studs as a result of construction, the buyers learned of the private sewer system, the informal homeowners’ association, and previous sewage overflows.  Believing they had been deceived, they sued the sellers and both the listing and selling brokers.  The buyers’ lawsuit sought rescission of the purchase agreement.

Prior to the commencement of litigation, the sellers purchased a new home and made improvements costing approximately $100,000.  Despite the improvements, the sellers believed the value of their new home had decreased.

At trial the court determined that the sellers had negligently misrepresented material facts about the sewer system and the existence of the informal association.  However, the Court did not grant rescission because of the difficulty of unwinding the transaction and because of the burden on the sellers.  The decision was appealed and reversed.

The Appellate Court Reverses
The appellate court reversed the trial court’s decision because the buyers had satisfied the statutory requirements for rescission.  The appellate court recognized that any prejudice to the deceiving party is not something that should be considered.  The appellate court also reasoned that just because changes have been made to the property and years have passed, does not mean rescission is inappropriate.

The Wong v. Stoler is an important reminder of the need for full disclosure in a real estate transaction.  A seller and their agent should not simply presume that critical information will be appropriately gleaned from a preliminary title report or from a buyer performing due diligence.

The ramifications of rescission can be devastating.  Rescission involving a real estate purchase requires the seller to refund the payments received and requires the buyer to restore possession.  It also includes consequential damages such as real estate commissions, escrow payments, interest on specific sums paid to the other party, and even the cost of improvements.

If you have any question about this case, or any other real estate-related issue, please contact us at 408-290-8228.  We look forward to assisting you.

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