Real Estate Agents and Title Insurance Agents Could Be Liable In A Short Sale Transaction

If you have ever been involved in a short sale transaction, you likely were required to sign a Short Sale Affidavit a/k/a Arms-Length Transaction Affidavit. The purpose of the affidavit is to protect the lender that is accepting a lesser (short) payoff of the debt the property owner owes. All parties involved in the transaction, seller, buyer, realtors and title insurance agent must sign this form. Generally it states that none of the parties are related personally or by business enterprise and that there are no side agreements or money being paid which have not been disclosed to the lender. The lender wants to be sure there is no agreement or scheme to defraud the lender.

If you read the affidavit carefully you may have seen a clause stating something like this: “All of the parties agree to indemnify the lender from any and all loss from any negligent or intentional misrepresentation of the facts in the affidavit. Loss includes the difference in the actual and short payoff being paid to the lender plus all costs and expenses it incurs, including attorney fees trying to recover its loss.” This is called an indemnity clause. The word “negligent” may come back to haunt you.

Do you understand how dangerous that indemnity clause is? Consider this example: I will use the term “Real Estate Professional” to refer to both real estate agents and title insurance agents. You are one of the Real Estate Professionals in a sale transaction. You don’t know either the buyer or seller personally. You know nothing about their relatives, friends or business associates. The price being paid is less than then the seller’s mortgage payoff and settlement fees. After lots of hard work on everyone’s part the seller’s lender approves the short payoff. Now you are asked to sign the affidavit. The deal closes. Later the lender that accepted the short payoff finds out the buyer was related to a friend of or business associate of the seller, finds evidence that the price might have been lower than possible in an arms-length deal by $50,000. The lender suspects that there was a secret agreement to allow the property to be sold a low price and that the seller was paid a kickback.

Can you guess who the short sale lender is going to sue? Everyone who signed that affidavit. The filing of the lawsuit alone will force you to hire a lawyer to defend yourself. When you get notice of the claim you will likely call your errors and omissions insurance company only to find out you are not covered for “contractual liability.” That means that by signing the Short Sale Affidavit, you contracted with the lender to pay if you made a negligent or intentional representation. Many E&O insurance policies do not cover contractual liability. I know of no E&O carrier that will insure title agents for contractual liability. If your policy does not cover it then you have to pay your own lawyer to defend against a claim by a large mortgage company. That lender has plenty of money to come after you. You could easily be forced to pay $10,000 to $20,000 in legal fees to your lawyer even if you did nothing wrong.

Could the lender win a lawsuit against you? You did not know about the parties’ relationship or any secret deal. But, what investigation did you perform to find out? Did you have the buyer, seller and other Real Estate Professionals sign YOUR AFFIDAVIT stating that they did not know about this? Did you search the buyer and seller online to see what you could find out about them? If you didn’t do any investigation then you might be found to be negligent and have judgment entered against you. Remember the indemnity clause included “negligent” representation. You could be on the hook for all of the lender’s losses and costs including attorney’s fees , well over $50,000 in our hypothetical.

If you are lucky and your E&O policy covers contractual liability then it might only cost you your policy deductible, maybe $10,000. You better know whether your E&O policy covers you for this.

Title insurance agents should not anticipate that their underwriters would protect them from such a claim. This is not a title issue.

Here’s the takeaway : Real estate agents and title insurance agents should proceed very carefully and know the risks when becoming involved in short sale transactions. Signing a short sale affidavit that holds you liable for negligence could end up costing you plenty.