ALEJANDRE REVISITED
CURRENT DEVELOPMENTS IN REAL ESTATE PURCHASE DISPUTES
Scott B. Osborne
Of Counsel
K & L GATES LLP
Prepared for the Senior Lawyer Division
Washington State Bar Association
Annual Meeting
April 16, 2010
Scott B. Osborne is of counsel to K & L Gates, LLP in its Seattle office. He received
his undergraduate degree from Yale University in 1971 and graduated from the
University of Washington School of Law in 1975. His practice concentrates on real
estate transactions. Mr. Osborne has been a lecturer at the University of
Washington Law School, where he taught real property security. He is a past Chair
of the Real Property, Probate & Trust Section of the Washington State Bar
Association and is a member of the American College of Real Estate Lawyers. He
can be reached at [email protected].
1
© 2010
I.
INTRODUCTION
The purchase of a personal residence represents the largest financial
transaction that most individuals undertake during their lifetimes. Primary
residences account for a substantial portion of the assets of individual
households.1 In Washington, purchases of residences are routine transactions2
that generally have minimal attorney involvement during negotiation,
documentation and closing of the sale.3
Given the financial impacts of residential transactions and the frequency
of their occurrence, it is not surprising that there have been numerous lawsuits
arising from residential transactions. Buyers’ expectations have often been at
odds with leaky roofs, inadequate foundations and inaccurately described
building lots. Over the years, Washington case law has tended to expand the
liability of seller s for defects by qualifying the rule of caveat emptor, creating an
implied warranty of habitability for newly constructed residences and allowing
claims for negligent misrepresentation to be asserted in the absence of
contractual representations and warranties addressing the condition of the
property.
The expansion of potential seller liability in residential transactions came to
a halt with decision in Alejandre v. Bull, 159 Wn.2d 674 (2007). The Supreme
Court applied the economic loss doctrine to reject a claim against the seller
alleging negligent misrepresentation of the condition of a residential septic tank.
The full impact of the Alejandre decision is still being determined by Washington
courts, as the decision is applied to the almost unlimited fact patterns that
emerge in residential purchase and sale litigation. Alejandre, however, requires
an adjustment in the evaluation of potential claims and exposure for buyers and
sellers. Alejandre may also lead to an increased scrutiny of the contents of so-
1
“Housing wealth represents a large component of total family wealth; in 2007, the primary residence accounted for
31.8 percent of total family assets.” “Change in U.S. Family Finances from 2004 to 2007: Evidence from Survey of
Consumer Finances,” Federal Reserve Bulletin, February, 2009, p. A33
(http://www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf). The relative importance of residential real estate
to total family net worth varies with income levels. For families within the 20th to 60th income percentile in 2007,
the value of the primary residence represented 48 to 45 percent of family assets. Id.
2
According to the Washington Center for Real Estate Research at Washington State University, in 2007 there were
120,760 home sales (http://www.wcrer.wsu.edu/WSHM/WSHM.html).
3
The “lawyer-lite” aspect of residential real estate transactions received the official stamp of approval by the
Washington State Supreme Court in Cultum v. Heritage House, 103 Wn.2d 623 (1985), which held that a “real
estate broker or salesperson is permitted to complete simple printed standardized real estate forms” as the authorized
practice of law, citing various public policy reasons ranging from the obvious (involving lawyers would increase
transaction costs because lawyers charge fees) to industry-obsequious (getting a lawyer involved may be more time
consuming and would slow down the consummation of the deal).
2
© 2010
called “simple printed standardized real estate forms” to insure that the forms
accurately capture the benefit of the bargain for the buyer and seller.
II.
PRIOR CASE LAW
Claims by buyers against sellers in residential real estate transactions
typically arise because the condition of the property fails to meet the
expectation of the buyer. It is the rare case in which there was an actual
warranty or contractual provision dealing with the alleged defect. In most
cases, the buyer seeks relief in the absence of any contractual provision dealing
with the risk of loss from the defect. The buyer is, in effect, asking the court to
imply a remedy where none exists in the contract.
The term “caveat emptor” has been used frequently to allude to a legal
doctrine that, in the absence of fraud, places responsibility on the buyer to
determine the quality and suitability of an item being purchased. The seller has
no responsibility to share knowledge with the buyer.4 In the context of
residential real estate sales, caveat emptor implies that the seller has no
obligation to disclose information about the condition of the property to the
buyer and the buyer has no claim against the seller for undisclosed defects. In
the absence of a contractual warranty, the buyer takes the property “as is.”
As noted by Judge Frank James in Sorrell v. Young, 6 Wn.App. 220 (1971),
the vitality of the doctrine of caveat emptor in Washington cases law may be
overemphasized:
Washington's early unqualified adherence to the doctrine of
caveat emptor in real estate transactions was relatively short-lived.
In Washington Cent. Imp. Co. v. Newlands, 11 Wash. 212, 214, 39 P.
366 (1895), a purchaser was denied rescission as a matter of law
because he did not assert that he "was in such a position that he
was unable to make an investigation concerning the truth or falsity
of [the] alleged [false] representations." The court reflected 19th
century respect for rugged individualism in stating: [I]t seems to us
that parties must exercise ordinary business sense, and the faculties
which are given to them for the purpose of transacting business;
and that they cannot call upon the law to stand in loco parentis to
them in the ordinary transactions of business and their ordinary
4
Commentators trace the origin of the doctrine of caveat emptor in American jurisprudence to Justice Marshall’s
opinion in Laidlaw v. Organ, 15 U.S. 178 (1817), which held that one party to a contract to sell tobacco had no duty
to disclose to the other that the British embargo of American ports had ended leading to a subsequent rise in the
value of the tobacco.
3
© 2010
dealings with their fellow men. Washington Cent. Imp. Co. v. New
lands, supra at 214.
But by the turn of the century, Washington had recognized that "the
tendency of the more recent cases has been to restrict rather than
extend the doctrine of caveat emptor." Wooddy v. Benton Water
Co., 54 Wash. 124, 127, 102 P. 1054 (1909). And, "[a]s would be
expected when change in the law is taking place, there is no
unanimity" in the decisions of other jurisdictions. [citations omitted]
However, there is an "amorphous tendency" on the part of most
courts to grant relief to a purchaser for nondisclosure of facts which
would probably affect the purchaser's decision to purchase.
[Citations omitted] Id, p.
In Sorrell, the court held that the vendee under a real estate contract for the
purchase of a residential lot had the right to rescind the transaction as a result of
the vendor’s non-disclosure that the property had been filled.
The opinion in Sorrell v. Young, supra, relied on Obde v. Schlemeyer, 56
Wn.2d 449 (1960). In that case, the court affirmed a trial court judgment
awarding damages to the purchaser of an apartment building that was infested
with termites. The infestation was known to the seller, but was not readily visually
apparent. In rejecting the seller’s argument that there was no duty to disclose
the existence of the infestation, Justice Finley observed:
It is of course apparent that the content of the maxim 'caveat
emptor,' used in its broader meaning of imposing risks on both
parties to a transaction, has been greatly limited since its origin.
When Lord Cairns stated in Peek v. Gurney that there was no duty
to disclose facts, however mortally censurable their non-disclosure
may be, he was stating the law as shaped by an individualistic
philosophy based upon freedom of contract. It was not concerned
with morals. In the present stage of the law, the decisions show a
drawing away from this idea, and there can be seen an attempt by
many courts to reach a just result in so far as possible, but yet
maintaining the degree of certainty which the law must have. The
statement may often be found that if either party to a contract of
sale conceals or suppresses a material fact which he is in good faith
bound to disclose then his silence is fraudulent.
The attitude of the courts toward non-disclosure is undergoing a
change and contrary to Lord Cairns' famous remark it would seem
that the object of the law in these cases should be to impose on
parties to the transaction a duty to speak whenever justice, equity,
4
© 2010
and fair dealing demand it. Obde v. Schlemeyer, supra at pp. 452453.
The reasoning and the result in Obde was not particularly unusual,
although the language used in the opinion was somewhat more sweeping than
previous opinions. In a landlord-tenant dispute, in Perkins v. Marsh, 179 Wash.
362 (1934), the court applied the theory of fraudulent concealment to allow a
tenant to avoid a lease because the landlord had failed to disclose to the
tenant that the premises experienced water leaks that rendered them
unsuitable for the conduct of tenant’s business. The court had previously
imposed liability on sellers who had pointed out wrong boundary markers, even
if the mistake was unintentional. In essence, the representations concerning the
location of the boundaries became implied contractual warranties. See Darnell
v. Noel, 34 Wn.2d 428 (1949) and Hartman v. Anderson, 49 Wn.2d 154 (1956). It
was not a huge intellectual jump from imposing liability on sellers that pointed
out erroneous boundary markers and landlords that failed to disclose water
leaks to imposing liability on sellers that failed to disclose hidden infestations.
Not every latent defect resulted in a right of recovery against the seller,
however. In another opinion authored by Justice Finley, the court refused to
impose any seller liability in connection with the sale of a 36-year old residence
that was infested with termites and suffered from dry rot. The buyer was unable
to establish that the seller knew of either condition. Hughes v. Stusser, 68 Wn.2d
707 (1966)5. Knowledge of the seller and lack of knowledge of the buyer were
two essential elements of imposing liability on the seller in the absence of
contractual warranties.
Subsequent decisions have fleshed out the Obde concept of disclosure
required by “justice, equity, and fair dealing” with more objective standards.
The latest formulation of the elements required to establish fraudulent
concealment require proof that (1) the residential dwelling has a concealed
defect; (2) the seller knows of the defect; (3) the defect presents a danger to
the health, safety or life of the purchaser; (4) the defect is not known by the
buyer; and (5) the defect would not be disclosed by a careful, reasonable
inspection by the buyer.6 Inherent in this formulation is the concept that the
5
At the outset of this opinion, Justice Finley observed: “Of the forms of animal life known to modern science, few,
if any, classifications other than Homo sapiens have been the subject of as much legal controversy as the members
of the order Isoptera. The species involved in this particular lawsuit does not appear in the record, but it is likely it
was from the genus Reticulitermes of the family of Rhinotermitidae, known to the nonbiologically oriented as
"termites." The wooden edifices of man represent nothing more to these despicable insects than an abundant source
of cellulose, which is their principal food.” Hughes v. Stusser, supra at p. 708.
6
Atherton Condo Ass’n v. Blume Dev. Co., 115 Wn.2d 506 (1990); Carlisle v. Harbour Homes, Inc., 147 Wn.App.
193 (2008).
5
© 2010
seller of the property enjoys an unfair bargaining position because of the seller’s
knowledge of a fact that cannot be reasonably discovered by the buyer.
Emphasizing the different bargaining positions of the buyer and seller,
Washington courts have moved further to impose liability on commercial
builders that sold new homes that had been shoddily constructed. Rather than
insist upon the establishment of fraudulent concealment to support a recovery
for latent defects in newly constructed residences, Washington has created an
implied warranty of habitability for the benefit of the buyer. This rule was first
articulated in House v. Thornton, 76 Wn.2d 428 (1969):
Fraud is so easy to claim that the law makes it hard to prove. When
the basement, walls, floors and foundation of a house plaintiffs had
bought from defendants slipped and cracked and the supporting
terrain slid away from the foundation, plaintiffs brought this suit to
rescind the sale. Plaintiffs Homer and Noreen House charged the
sellers with overt false misrepresentations and deceit but the court
granted the rescission although expressly finding that these
allegations were not clearly, cogently and convincingly proved.
Defendant sellers appeal, and we perceive the major issue to be
whether, in the sale of a brand new house to its first buyer and
occupant, the law impresses the transaction with a warranty that the
foundation is firm and secure.
...
Although the court found that the defendants were free of fraud
and misrepresentation, and there was no proof that the defendants
failed to properly design and erect the building, or that they used
defective materials or in any respect did an unworkmanlike job,
and that they were innocent of any intentional wrong, the fact
remains that they sold and turned over to plaintiffs a brand-new
$32,000 residence which turned out to be unfit for occupancy. As
between vendor and purchaser, the builder-vendors, even though
exercising reasonable care to construct a sound building, had by
far the better opportunity to examine the stability of the site and to
determine the kind of foundation to install. Although hindsight, it is
frequently said, is 20-20 and defendants used reasonable prudence
in selecting the site and designing and constructing the building,
their position throughout the process of selection, planning and
construction was markedly superior to that of their first purchaseroccupant. To borrow an idea from equity, of the innocent parties
who suffered, it was the builder-vendor who made the harm
6
© 2010
possible. If there is a comparative standard of innocence, as well as
of culpability, the defendants who built and sold the house were less
innocent and more culpable than the wholly innocent and
unsuspecting buyer. Thus, the old rule of caveat emptor has little
relevance to the sale of a brand-new house by a vendor-builder to
a first buyer for purposes of occupancy.
We apprehend it to be the rule that, when a vendor-builder sells a
new house to its first intended occupant, he impliedly warrants that
the foundations supporting it are firm and secure and that the
house is structurally safe for the buyer's intended purpose of living in
it. . . . [citations omitted]
Id., pp. 429, 435-436 [emphasis added].
The implied warranty of fitness or habitability has been further refined by the
courts over time. Builders also responded to this court-created warranty by
inserting disclaimers and providing alternative warranty schemes for their
purchasers.7 Washington has no statutory warranty protection for new home
buyers, other than condominium purchasers. The existence of the implied
warranty encouraged builders to address warranties concerning physical
condition in their negotiations with their buyers.
Purchasers of previously used homes, however, were more or less left to
claims of fraudulent concealment or misrepresentation in the absence of
contractual protections that were negotiated with their sellers. These theories
were summarized in RESTATEMENT (SECOND) OF TORTS, §§551 and 552 (1977).
Liability for negligently failure to disclose was stated in §551:
(1) One who fails to disclose to another a fact that he knows may
justifiably induce the other to act or refrain from acting in a business
transaction is subject to the same liability to the other as though he
had represented the nonexistence of the matter that he has failed
to disclose, if, but only if, he is under a duty to the other to exercise
reasonable care to disclose the matter in question.
(2) One party to a business transaction is under a duty to exercise
reasonable care to disclose to the other before the transaction is
consummated,
7
See for example Burbo v. Harvey Douglass, Inc., 125 Wn.App. 684 (2005).
7
© 2010
(a) matters known to him that the other is entitled to know
because of a fiduciary or other similar relation of trust and
confidence between them; and
(b) matters known to him that he knows to be necessary to prevent
his partial or ambiguous statement of the facts from being
misleading[.]
As stated, this rule was a variation of the prior case law in Washington dealing
with fraudulent concealment or fraudulent non-disclosure, without the emphasis
upon the severe nature of the defect and the inability of the buyer to discover
the defect.
Liability for negligent misrepresentation was set out in §552:
(1) One who, in the course of his business, profession or
employment, or in any other transaction in which he has a
pecuniary interest, supplies false information for the guidance of
others in their business transactions, is subject to liability for
pecuniary loss caused to them by their justifiable reliance upon the
information, if he fails to exercise reasonable care or competence
in obtaining or communicating the information.
Negligent misrepresentation provided an alternative theory to recover to
defects in homes purchased from non-builders.8 In Tenant v. Lawton, 26
Wn.App. 701 (1980), the court imposed liability on a broker for repeating
erroneous statements to a buyer concerning the septic system serving the
property. Although the court did not reference negligent misrepresentation,
liability was imposed for repeating a statement that proved to be untrue by the
broker without exercising any care to determine the accuracy of the
statement.9
The court was more explicit in its theory in Zoda v. Eckert, 36 Wn.App. 292
(1983), that affirmed a judgment against a realtor based on inaccurate listing
8
For earlier cases discussing the theory of negligent misrepresentation, see Burien Motors v. Balch, 9 Wn.App. 573
(1973) and Wilber v. Western Properties, 22 Wn.App. 458 (1979).
9
“Thus, Mrs. Cutter knew the crucial nature of the septic tank condition indeed, she stated she always included
such a condition in earnest money agreements to protect the seller; she received from the seller false information
about that condition; she should have been alerted to problems concerning the information by the mismatch of sizes
on the site evaluation documents versus the property being sold and by the expiration of one of them; her principal
advised that they were expired and instructed her to "check on them"; and yet she did nothing to verify the existence
of a valid permit which was crucial to the transaction. That she acted without malice or fraudulent intent, we do not
doubt. But she failed to take the simple steps within her area of expertise and responsibility which would have
disclosed the absence of any health district approved site on the subject property. This failure constituted negligence
as a matter of law which resulted in damages to the Tennants.” Tennant v. Lawton, supra, at pp. 707 – 708.
8
© 2010
information about the area of the house and the existence of a heat pump
system was affirmed. Other cases, some of which also relied on the listing
information provided by the real estate broker to the buyer, refined the
parameters of liability.10
The legal landscape changed somewhat as a result of the adoption of
Chpt. 60.06 RCW, effective January 1, 1995, which created the so-called “Form
17” seller disclosure statement. Prior to this time, written material concerning the
physical condition of the house was more or less restricted to listing information
provided by the real estate agent, unless something more was negotiated in the
purchase and sale agreement. In Svendsen v. Stock, 142 Wn.2d 546 (2001),
claims for negligent misrepresentation and fraudulent concealment were both
based on the failure to accurately complete the Form 17 disclosure provided to
the buyer.11
As with claims for fraudulent concealment, courts continued to define the
theory of negligent misrepresentation. For example, a seller did not negligently
misrepresent the condition of the property by failing to disclose a potential
assessment,12 a claim of negligent misrepresentation overcame the merger
doctrine that representations concerning the condition of title merged into the
deed delivered at closing.13
Litigation involving condominium residences has followed a somewhat
different pattern from single family residences. There has been a dearth of
cases involving disputes over sales of previously owned condominiums from nonbuilder/developers. For new condominiums (or newly converted projects),
defect litigation has been highly influenced by the statutory scheme of
warranties in the Washington Condominium Act, Chpt. 64.34 RCW. The WCA
has specific warranties applicable to new condominiums and the litigation
arising claiming defects has been more heavily influenced by statutory
requirements than by theories of fraud and misrepresentation.14 The existence
10
See Hoffman v. Connall, 108 Wn.2d 69 (1987) [no liability for innocent statement concerning boundary location];
Johnson v. Brado, 56 Wn.App. 163 (1989) [inaccurate sewer service information in listing]; Brock v. Tarrant, 57
Wn.App. 562 (1990) [inaccurate information concerning formaldehyde insulation in listing material]
11
Claims of damages from the seller’s negligence caused property damage or injury also created the possibility that
the seller could make a claim in a homeowner’s insurance policy for defense of the claim. See. Allstate v. Bowen,
121 Wn.App. 879 (2004)
12
Van Dinter v. Orr, 157 Wn.2d 359 (2006).
13
Ross v. Kirner, 162 Wn.2d 493 (2007).
14
For an interesting view of how current litigation over condominium defects is conducted, see Water’s Edge
Homeowners’ Ass’n v. Water’s Edge Associates, 216 P.3d 1110 (Wash.App. Div II, No. 37415-3-II, September 29,
2009).
9
© 2010
of homeowners’ associations and the fact that the critical elements of a
condominium structure are common areas has required that defect litigation for
this type of residential housing be conducted in a different manner.
III.
ALEJANDRE V. BULL, 159 WN.2D 674 (2007)
The availability of misrepresentation as a basis for a claim of damages by
disappointed sellers was severely restricted in Alejandre v. Bull, 159 Wn.2d 674
(2007). The court held that the “economic loss doctrine” barred any claim for
damages under a theory of negligent misrepresentation.
Alejandre was similar to other cases involving buyers that sought to
recover damages resulting from defects in their homes that came to light after
the closing. Like other cases, the defect was a failed septic system. Mary Bull,
who owned a house in Walla Walla, noticed that the ground above her septic
tank was soggy. In the spring of 2000, she had the tank inspected and some
repair work was done on the system. She also investigated the possibility of
hooking into the city sewer system, but decided against this alternative because
of the $5,000 hook up fee.
About a year later, Bull decided to sell the house. She listed the house in
June, 2001, and in September, 2001, Arturo and Norma Alejandre made an offer
to buy the house. The purchase agreement contained (1) a representation that
the property was served by a septic system; (2) a covenant that Bull would have
the septic tank pumped prior to closing; and (3) an inspection addendum that
made the closing conditioned upon a satisfactory inspection of the septic
system.
The Form 17 supplied by Bull to Alejandre stated that the septic system
had been pumped in 2000 and that a broken pipe had been replaced at that
time. Bull answered “no” to the question of whether she knew of any defects to
the system. The septic tank was pumped, and Alejandre received a copy of the
bill for this service that indicated that a complete inspection of the tank baffle
was not possible. Alejandre waived the inspection contingency and after that,
the bank granting a mortgage to finance the purchase had the septic tank
inspected again. The inspection report indicated that system was in working
order and draining properly. The purchase was closed on December 10, 2001,
and Alejandre moved into the house.
In January, 2002, Alejandre began hearing gurgling noises of water
backing up and smelled odors in the house. The same inspector used by Bull
was retained to look at the system. The inspector told Alejandre that the system
was not draining. The inspector also told Alejandre that Bull had been told that
the system would not work and she should hook up to the city sewer.
10
© 2010
Alejandre connected to the city sewer and then sued Bull for $30,000 of
damages claiming fraud and misrepresentation. After the plaintiff rested, the
trial court took the case from the jury, dismissing the tort claims on the basis of
the economic loss doctrine and finding a lack of evidence to support the fraud
claims.
The Court of Appeals reversed,15 holding that, viewing the evidence most
favorably to Alejandre, a jury could find that Bull knew the system was beyond
repair and failed to tell Alejandre and that knew, but negligently failed to
disclose the true condition of the septic system. The Court of Appeals believed
that the economic loss rule was inapplicable since the parties did not
specifically bargain over the allocation of the risk associated with a failed septic
system.16
The nine justices of the Washington Supreme Court (Justices Chambers
and Sanders by concurring opinion) held that the trial court was correct and
reversed the Court of Appeals.
In short, the purpose of the economic loss rule is to bar recovery for
alleged breach of tort duties where a contractual relationship exists
and the losses are economic losses. If the economic loss rule
applies, the party will be held to contract remedies, regardless of
how the plaintiff characterizes the claims. [citations omitted]
...
Here, the injury complained of is a failed septic system. Purely
economic damages are at issue. . . . There is no question that the
parties' relationship is governed by contract. Thus, unless there is
some recognized exception to the economic loss rule that applies,
the plaintiffs' claim of negligence cannot stand because they are
limited to their contract remedies. No exception to the economic
loss rule has been established.
Alejandre v. Bull, supra at pp. 683 - 685
The court rejected the argument that a claim of negligent
misrepresentation avoided the effect of the economic loss doctrine, relying on
its prior decision in Berschauer/Phillips Constr. Co. v. Seattle Sch. Dist. No. 1, 124
15
Alejandre v. Bull, 123 Wn.App. 611 (2004)
16
“The economic loss rule bars certain tort claims when a contract exists between the parties that allocates risk and
future liability. In this case, the contract does not contain such a provision. For that reason, the trial court
erroneously dismissed the Alejandres’ claim based upon the economic loss rule.” Id, p. 628.
11
© 2010
Wn.2d 816 (1994), and an earlier Division I Court of Appeal decision, Griffith v.
Centex Real Estate Corp., 93 Wn.App. 202 (1998). The court also relied on its
opinions in Stuart v. Coldwell Banker Commercial Group, Inc., 109 Wn.2d 406
(1987) and Atherton Condo. Apartment-Owners Ass'n Bd. of Dirs. v. Blume Dev.
Co., 115 Wn.2d 506 (1990), which had held that Washington did not recognize
the tort of “negligent construction;” a claim for defect construction must be
made based on the obligations of the contractor under the construction
contract.
Accordingly, the Alejandres’ reliance on section 552 [RESTATEMENT
[SECOND] OF TORTS (1977)] and what must be proven under it is
foreclosed by our precedent. Because the parties' relationship is
governed by contract and the loss claimed is an economic loss, the
trial court correctly concluded that plaintiffs' negligent
misrepresentation claim must be dismissed.
Id., at p. 686.
The Court of Appeals argument that the economic loss rule applied only
when the allocation of the specific risk had been negotiated was rejected.
Allocation of loss can occur in various manners. The court observed that an
agreement with no warranties, but with a reduced purchase price was an
effective way of allocating risk between the parties. “If a court permits a tort
claim on the ground that the parties have not expressly allocated a particular
risk, it interferes with the parties' freedom to contract.” Id., p. 688.
The claim of fraudulent concealment could be maintained by Alejandre,
but the proof presented did not support this theory. Relying on the criteria
announced in Obde, supra, the court concluded that Alejandre had failed to
prove that the defect could not have been discovered through reasonable
diligence. The court emphasized that Alejandre failed to conduct any due
diligence, which defeated the “right to rely” on any statements made by Bull.17
In a footnote, however, the court specifically declined to rule on whether claims
of fraud were barred under the economic loss doctrine.18
In this case involving the sale of a residence with a defective septic
system, we hold that the economic loss rule applies and forecloses
the buyers' claim that the seller negligently misrepresented the
condition of the septic system. The buyers' claim of fraudulent
17
“As explained, the Alejandres were on notice that the septic system had not been completely inspected but failed
to conduct any further investigation and, indeed, accepted the findings of an incomplete inspection report. Having
failed to exercise the diligence required, they were unable to present sufficient evidence of a right to rely on the
allegedly fraudulent representations.” Alejandre v. Bull, supra at p. 690.
18
Id, footnote 6 at page 690.
12
© 2010
conveyance [sic] is not subject to the economic loss rule. However,
the buyers failed to present sufficient evidence on this claim and on
their claims of fraudulent misrepresentation to take these issues to
the jury. The trial court properly dismissed all of the claims under CR
50 at the close of the plaintiffs-buyers' case. Id., p. 691
The prior decisions of the Washington Supreme Court did not entirely
foreshadow this result. The Berschauer/Phillips Constr. Co., case involved a
construction dispute between the contractor building a school, the Seattle
School District and the district’s architects, engineers and inspectors. The
contractor claimed that the plans were negligently prepared and various
inspections negligently performed, causing delays and damages. After settling
with the District, the contractor pursued negligence claims against the architect,
engineer and inspector. The court dismissed these claims after acknowledging
that prior decisions did in fact allow recoveries of lost profits based on
negligence claims against design professionals:
We follow the Stuart and Atherton line of cases and maintain the
fundamental boundaries of tort and contract law by limiting the
recovery of economic loss due to construction delays to the
remedies provided by contract. We so hold to ensure that the
allocation of risk and the determination of potential future liability is
based on what the parties bargained for in the contract. We hold
parties to their contracts. If tort and contract remedies were
allowed to overlap, certainty and predictability in allocating risk
would decrease and impede future business activity. The
construction industry in particular would suffer, for it is in this industry
that we see most clearly the importance of the precise allocation of
risk as secured by contract. The fees charged by architects,
engineers, contractors, developers, vendors, and so on are
founded on their expected liability exposure as bargained and
provided for in the contract.
Berschauer/Phillips Constr. Co. v. Seattle Sch. Dist. No. 1, supra, at
pp. 826-827
Although the ruling was grounded on contractual expectations, the case
did not involve a dispute between parties to the same contact. This factual
situation of claims asserted between contracting parties was addressed in the
Griffith v. Centex Real Estate Corp, supra case. Griffith was a purported class
action against a home builder seeking damages for defective siding installed on
homes. Each sale involved a detailed limited warranty and various disclosures
concerning the requirement for on-going care of siding and other materials
incorporated into the house. The plaintiffs asserted that Centex had made
13
© 2010
various negligent misrepresentations concerning the siding material and its
quality that supported a claim for damages, even though the claims under the
limited warranty were barred.
The Court of Appeals, relying on Berschauer/Phillips, Stuart, and Atherton
concluded that the economic loss rule barred misrepresentation claim:
We conclude that Berschauer/Phillips controls the disposition of this
case, and that when a contract allocates liability, the economic
loss rule bars claims of negligent misrepresentation by homebuyers
against builder-vendors.
Griffith v. Centex Real Estate Corp., supra, at p. 213.
The economic loss rule has been the subject of much litigation in other
jurisdictions prior to Alejandre. The frequency of cases discussing this theory has
increased in recent years. A dissenting opinion in Grams v. Milk Products, 299
N.W.2d 167 (Wis. 2005) claimed that the issue had been before with Supreme
Court of Wisconsin more than forty times in a recent five year period. Cases are
not limited to real estate disputes. The doctrine can arise in the context of any
contractual relationship.
The results in other jurisdictions has been, at best, mixed19 and do not
necessarily offer any guidance as to how the case law in Washington may
continue to develop. In Oregon, for example, in Jones v. Emerald Pacific
Homes, 71 P.3d 574 (Or.App. 2003), the court held that a disappointed
homeowner could not sue the contractor that built the house for negligence in
the absence of a “special relationship,” which was not present in that case. This
case was similar to Stuart, supra, with a like result:
To summarize, parties to a contract are in a "special relationship"
imposing a heightened duty of care and thereby creating potential
tort liability when one party delegates to the other the authority to
make important decisions with the understanding that the authority
is to be exercised on behalf of and for the benefit of the authorizer.
Jones v. Emerald Pacific Homes, supra at p. 579.
However, in Harris v. Suniga, 180 P.3d 12 (Or. 2008), the Oregon Supreme
Court held that the economic loss doctrine did not bar a claim by an apartment
owner against the builder of the complex for property damage arising from
negligent construction. The plaintiff had purchased the project from its original
19
A summary of existing case law is contained in Vincent R. Johnson, “The Boundary-Line Function of the
Economic Loss Rule,” 66 Wash. & Lee L. Rev. 523 (2009)
14
© 2010
owner and had no contractual relationship with the defendant-contractor. The
court determined that “property damage” (dry rot and water damage) was not
purely an “economic loss.” This case is not particularly helpful to an analysis in
Washington, since following Stuart and Atherton, the plaintiff’s underlying claim
of negligent construction has not been recognized.
IV.
POST ALEJANDRE CASE LAW
Alejandre prompted a significant amount of comment among real estate
lawyers (particularly litigators). The list-serves maintained by the King County Bar
Association Real Property, Probate Trust Section ([email protected])
and the Washington State Bar Association Real Property Probate and Trust
Section ([email protected]) have been filled with comments on the
decision. There have also been several cases in the Court of Appeals that have
cited the opinion in resolving claims between buyers and sellers. The volume of
decisions is some indication of how frequent claims of negligent
misrepresentation had become in litigation between buyers and sellers.
Alejandre was cited in Nguyen v. Doak, 140 Wn.App. 726 (2007), but was
not determinative of the outcome of the case. Nguyen bough a house for Le,
who had previously purchased it from Doak, a builder. When water leaks
developed, Nguyen sued Doak for fraudulent concealment and violations of
the consumer protection act. The trial court dismissed the claim against Doak.
The Court of Appeals affirmed. Since Nguyen did not purchase the house from
Doak, the elements of fraudulent concealment could not be satisfied. The CPA
claim also failed because Doak was under no duty to make any disclosure to
Nguyen concerning the quality or condition of the house.
Bloor v. Fritz, 143 Wn.App. 718 (2008) cited Alejandre, but rejected its
application. In Bloor, the plaintiff-buyer sought rescission of a house purchase.
The seller and the seller’s agent failed to disclose that the house had been used
as a meth lab by the seller’s tenant. The trial court granted rescission and
awarded $18,000 in other expenses to Bloor plus $125,000 in attorney fees. On
appeal, the seller claimed that Alejandre barred plaintiff’s claim for negligent
misrepresentation. Division II of the Court of Appeals rejected this claim, finding
that the defendant waived this defense by not asserting the economic loss
doctrine at the time of trial. The judgment was for the most part affirmed,
although a portion of the damage award was reversed. The plaintiff did receive
damages for emotional distress, loss of income and damages related to a
diminished credit score.
In Stieneke v. Russi, 143 Wn.App. 544 (2008), Stieneke, the plaintiff-buyer,
sought recovery of damage caused by a leaky roof from the seller. The
purchase agreement contained an inspection contingency and an integration
15
© 2010
clause. On the Form 17 delivered to the buyer, the seller indicated that the roof
had not leaked. The inspector retained by Stieneke did not perform roof
inspections, so the report did not include the condition of the roof. In fact, the
house had experience prior leaks and water damage. Following a heavy rain
and attendant water damage, Stieneke sued to rescind the purchase, alleging
various theories, including fraudulent concealment and negligent
misrepresentation.
The trial court found in favor of Stieneke against the seller and the real
estate agent. Stieneke elected to receive damages rather than rescission, and
was awarded over $70,000 in damages, plus $174,000 in attorney fees.
The Court of Appeals applied Alejandre to bar the negligent
misrepresentation claim. The court rejected the plaintiff’s attempt to segregate
economic loss between damage to the roof and property damage to the
remainder of the house. The trial court findings did, however, support a claim of
fraudulent concealment, although the trial court did not enter findings that the
elements of fraudulent concealment were proved by clear, cogent and
convincing evidence and remanded the case to the trial court for further
findings. The court also reversed that portion of the trial court finding that found
a breach of contact by finding the Form 17 statements were representations
that were integrated into the contract.
In contrast to the evidence presented in Alejandre concerning in the
discoverability of the defect by a reasonable inspection, the court noted that
the defendant’s own expert was not able to identify the exact source of the
leaking and testified that additional testing costing in excess of the $10,000
would be required to determine the exact source of the problem. The court
concluded that the defect would not have been discovered by a reasonable
inspection.
The ruling in Alejandre did not bar a claim in King v. Rice, 146 Wn.App. 662
(2008) arising from the alleged wrongful destruction of personal property left on
property after its sale. The personal property was not the subject matter of the
contract of sale, so the economic loss doctrine was inapplicable.
In Carlile v. Harbour Homes, 147 Wn.App. 193 (2008), thirty-seven
homeowners in a residential plat sued the builder/developer for various
construction defects under various theories, including breach of the implied
warranty of habitability, misrepresentation, breach of contract and violation of
the Consumer Protection Act. Twenty six of the plaintiffs purchased the homes
directly from Harbour Homes. These plaintiffs had warranties that required
arbitration of defect claims, and the trial court ordered arbitration. The
16
© 2010
remaining eleven plaintiffs were subsequent purchasers, and the trial court
dismissed their claims.
On appeal, the Court of Appeals affirmed the dismissal of the implied
warranty claims, reaffirming that the implied warranty of habitability was
available only to buyers who purchased from the builder/developer. These
claims were not assignable. Alejandre was cited to affirm the dismissal of the
negligent misrepresentation claims. All of the damages sought related to
deterioration of the homes. The court rejected the plaintiffs’ fraud claims as
barred by the economic loss rule. Noting the difference between the elements
of fraudulent concealment and intentional misrepresentation (fraud), the court
concluded that claims asserting intentional misrepresentation were not the
same as the fraudulent concealment, and the economic loss rule barred
intentional misrepresentation.
The dismissal of the CPA claims was reversed, however. The court found
no reason why these claims could not be assigned to the subsequent
purchasers, and remanded these claims for trial. It is somewhat difficult to
envision a fact pattern that would support a claim for negligent
misrepresentation asserted by a subsequent purchaser who had no contact
with the builder that allegedly made the negligent misrepresentation. The
Supreme Court granted a partial review of the Carlile opinion, but the case was
subsequently settled.
Cox v. O’Brien, 150 Wn.App. 24 (2009), involved the sale of a 23-year old
home by the DeMers to the Coxes. DeMers had lived in the home after it had
been built and then rented the home. In 2000, the house was listed for sale for
$169,500. The Coxes made an offer at $162,000, which was accepted. The
agreement called for a roof inspection, pest inspection and septic inspection.
Beyond the inspections, there were no warranties concerning the condition of
the house. The Coxes undertook no independent inspection of the house.
The pest inspection was completed by O’Brien Home Inspection. The
agreement with O’Brien limited its damages resulting from any negligence to
the amount of the inspection fee. The sale closed and after the closing the
Coxes discovered that there was substantial rot in the walls and support beams.
The Coxes sued O’Brien alleging a negligent inspection. After settling with
O’Brien, the Coxes sued the DeMers claiming a right to recover under an
indemnity agreement with O’Brien and damages from unjust enrichment and
negligent misrepresentation. The trial court dismissed these claims. The Court of
Appeals affirmed the dismissal of the negligent misrepresentation claims based
on Alejandre.
17
© 2010
In Water’s Edge Homeowners’ Association v. Water’s Edge Associates, 216
P.3d 1110 (Wash.App. Div. 2 2009), the Court of Appeals discussed the possible
applicability of Alejandre to claims asserted by a homeowners’ association
against the developer of a condominium complex. The possibility that the
economic loss rule might bar some or all of the HOA’s claims was properly
considered by the trial court during a reasonableness hearing in which the HOA
proposed to settle with the developer over the objections of the developer’s
insurer.
The four plaintiff-homebuyers in Townsend v. Quadrant, 218 P.3d 230
(Wash.App. Div. I, 2009), sued Quadrant alleging that improper construction
techniques resulted in mold growth, pests, poisonous gases and violated the
Consumer Protection Act. The plaintiffs sought damages sought under the
theories of fraud, outrage, violation of the CPA, negligence, negligent
misrepresentation, rescission and breach of warranty. The trial court referred the
claims to arbitration based on the agreement between each of the purchasers
and Quadrant. The Court of Appeals reversed the trial court’s refusal to compel
arbitration of the claims related to the purchase contract. The court noted that
Alejandre would not bar “pure tort claims” and claims relating to damage to
personal property that was not the subject matter of the purchase agreement.
To the extent there were any claims of this nature, the arbitration clause would
not apply.
Finally, a few months after Alejandre was decided, the Supreme Court in
Ross v. Kirner, surpa, the Supreme Court relied on the doctrine of negligent
misrepresentation to avoid the application of the merger doctrine. Ross agreed
to buy property from Kirner. Ross was provided a map of the property that
showed a single easement burdening the property. However, Kirner had
granted other easements to his son for the benefit of other property adjacent to
the Ross parcel. Kirner did not disclose these easements. The preliminary
commitment for title insurance disclosed the easements and the easements
were included in the legal description on the deed prepared by the escrow.
Two years following the closing, Ross learned of the easements and sued the title
company and Kirner for damages. Included in the claims against Kirner were
fraud, negligent misrepresentation and breach of contract. The trial court found
that the claims were barred under the doctrine of merger since the easements
were included in the legal description in the deed that was delivered at closing.
The Court of Appeals reversed, holding that the merger doctrine did not
bar a claim for negligent misrepresentation and, Kirner’s failure to disclose the
easements constituted negligent misrepresentation. The Supreme Court held
that the doctrine of merger did not bar subsequent negligent claims. The
matter was remanded for trial to establish whether the elements of negligent
misrepresentation could be established, noting that the Court of Appeals
18
© 2010
determination that Kirner’s conduct constituted negligent misrepresentation as
a matter of law was not correct. No mention of Alejandre was made in the
opinion.
These subsequent decisions have not eroded the basic holding in
Alejandre concerning the effect of the economic loss rule. Claims arising from
alleged defects in the property will be barred unless the buyer can establish
facts that support a claim for fraudulent concealment or the contract provides
a remedy. However, negligent misrepresentation may provide a basis for
rescission (Bloor) and may be available to avoid the effect of the doctrine of
merger (Ross). Evidence establishing the knowledge of the seller and the
inability to discover the alleged defect by a reasonable inspection was critical in
cases in which the plaintiff prevailed.
V.
PENDING CASES
The Supreme Court may further revise the economic loss rule as
announced in Alejandre. The court accepted review of Jackowski v. Borchelt,
209 P.3d 514 (Wash.App. Div. II, 2009). The fact pattern in Jackowski is similar to
other cases involving negligent misrepresentation. The seller, Borchelt, had
owned the house, which was a waterfront home in Mason County, for some
time. Additions and improvements were made to the house, but there were
issues relating to the stability of the soil and slope leading to the water.
Jackowski agreed to buy the house in 2004. The Form 17 supplied by the
seller did not reveal any settling or the presence of any fill material. The seller
did provide the buyer with a copy of a letter from Mason County that disclosed
critical areas present on the property and the landslide hazard areas. The letter
also referred to a geotechnical report. The purchase agreement contained an
inspection addendum that conditioned Jackowski’s purchase obligation upon
obtaining satisfactory inspection reports. No inspections were made of soil
conditions or slope stability.
The sale closed in June 2004. In February 2006, the house slid causing
damage. Jackowski sued the seller and the real estate agents involved in the
transaction.
The claims against all of the parties related to fraud or
misrepresentation of the risk of landslides and the presence of fill on the
property. The trial court dismissed most of the claims, relying principally upon
Alejandre and the failure to establish the elements necessary to prove
fraudulent concealment. A claim associated with cracks in the basement slab
that the sellers allegedly concealed from view was not dismissed. All of the
claims against the brokers were dismissed, except those associated with the
basement slab cracks.
19
© 2010
The Court of Appeals affirmed the dismissal of the negligent
misrepresentation claims against the seller, citing Alejandre. Jackowski claimed
that the alleged defects were life threatening and therefore within the realm of
tort law. This argument was rejected and the court noted that all of the
damages related to the house. The court did reverse the dismissal of the breach
of contract claims because they were no properly before the trial court for a
decision. The fraud and fraudulent concealment claims against Borchelt were
also properly dismissed. The seller had knowledge of that the house was in a
landslide area and could not reasonably rely on erroneous statements to the
contrary in the Form 17. An inspection, which Jackowski did not pursue, would
have revealed the possibility of shift earth. The court preserved the fraudulent
concealment claim relating to the presence of fill. It was not clear from the
evidence that the presence of fill would have been obvious to an inspector at
the time the home was purchased.
The court had a different view concerning the claims against the real
estate agents. Jackowski claimed that the buyer’s brokers breached statutory
duties imposed by RCW 18.86.030 and common law duties. The court agreed
that those claims should not be dismissed and noted that common law claims
based on the broker’s fiduciary duty to the broker’s principal were not
abrogated by Chpt. 18.86 RCW. The court also disagreed that the economic
loss rule was a bar to claims against the brokers:
We are not willing at this time to expand our Supreme Court's
holding in Alejandre to preclude all recovery for economic loss
against professional agents, as to do so would be to abrogate
professional malpractice claims for all cases not involving physical
harm. We do not believe this to be the Alejandre court's intention.
Jackowski v. Borchelt, supra, at p. 520 [emphasis added].
The court reinstated the claims against Jackowski’s real estate agents relating to
claimed failures to promptly transmit information and refer Jackowski to other
experts in areas which were beyond the broker’s expertise.
The court also reversed the trial courts dismissal of the rescission claims.
Rescission was not barred by application of the economic loss rule:
Nevertheless, they [Jackowski] argue that rescission is an avoidance
of contract rather than a recovery. They contend that they should
be entitled to relief because they entered into a contract based on
misrepresentations. We agree. Id., at p. 521
20
© 2010
Assuming the case does not settle prior to an opinion, the Supreme Court
will have the opportunity to clarify whether application of the economic loss rule
precludes the right to rescind. The court will also have the opportunity to
determine whether the economic loss rule prohibits negligent misrepresentation
claims against brokers who are not parties to the purchase and sale agreement.
In Berschauer/Phillips, supra, which was one of the earliest cases applying the
economic loss rule, architects and engineers who were not parties to the
underlying construction contract were able to assert the rule as a defense to
malpractice claims asserted by a contactor.
The court has, however, in other cases, been reluctant to insulate brokers
from what might be termed “malpractice,” or at least activity that falls short of
the court’s view of responsible professional conduct. It is also unclear how
much effect a ruling applying the economic loss rule to claims of
misrepresentation asserted against real estate agents will have if the court
follows the Court of Appeal reasoning concerning the statutory and common
law duty of the agent to its principal.
VI.
CONCLUSION
Washington courts have a long history of dealing with claims by buyers
against sellers in residential transactions based on fraud and misrepresentation
theories. To some extent, the frequency of these claims is a direct result of the
manner in which residential real estate transactions are completed in
Washington. Broker prepared forms serve as the contract documentation for
the vast majority of transactions.
These forms do not have extensive
representations and warranties, so there is often a lack of contractual provisions
dealing with the condition of the property as represented to, or desired by, the
buyer.
The theories of fraudulent concealment and negligent misrepresentation
in effect create an implied covenant giving the buyer greater rights than
otherwise available under the contract. In the case of fraudulent concealment,
the covenant can be stated as follows:
Seller represents and warrants to Buyer that the property is free from
all concealed defects known to seller that
a.
present a danger to the health, safety or life of the purchaser
and
b.
are not known to, or reasonably discoverable by, Buyer.
In the case of negligent misrepresentation, the covenant can be stated as:
21
© 2010
Seller represents and warrants to Buyer that (1) the property is free
from all defects known to Seller and not disclosed to Buyer that (a)
are material inducements to Buyer to purchase the property and
(b) are not known and not reasonably discoverable by Buyer and
(2) all information provided by Seller concerning those aspect of the
property that are material to Buyer has been made after due
investigation by Seller.
While an attorney representing a seller might not object to the formulation of the
warranty addressing fraudulent concealment, there are many issues raised by
the implied warranty that flows from a claim of negligent misrepresentation.
In this regard, Alejandre does reflect a legitimate attempt to preserve the
distinction between contract and tort and allow parties to fashion their own
approach to the allocation of risk. This aspect of the economic loss rule has
been favorably viewed by some commentators.20
Alejandre does focus attention on the importance of the contents of the
agreement between the parties. Alejandre would have been better served if, in
addition to having the right to inspect the septic system, there had been an
insistence that the seller warrant that the system was in good working order.
Perhaps Mary Bull would have agreed to that warranty; perhaps not, but at least
the parties would have had a meaningful discussion of the risk of loss rather than
allow the risk be allocated between the parties by default in silence.
In Washington, for better or worse, those contract discussions generally do
not involve an attorney, but rather real estate agents motivated to complete
the sale and paid only if the sale is completed. Perhaps the Supreme Court in its
review of Jackowski will be influenced by this dynamic in evaluating the degree
to which real estate agents should be shielded from claims of arising from
conduct that falls below that expected of a professional.
20
See Johnson, The Boundary-Line Function of the Economic Loss Rule, supra at p. 546: “If there is a convincing
rationale for the economic loss rule, it is that the rule performs a critical boundary-line function, separating the law
of torts from the law of contracts.”
22
© 2010