HOME WARRANTY AGREEMENTS AND ERRORS AND OMISSIONS INSURANCE

CHAPTER 2 HOME WARRANTY AGREEMENTS AND ERRORS AND OMISSIONS INSURANCE Now, you have the contact issues under control. So, let s minimize any other risks involved. In Chapter 2, home warranties, errors and omissions as well as general risk management will be examined. We will also cover a wide range of issues to be aware of when dealing with offers. CHAPTER LEARNING OBJECTIVES Upon completion of this chapter, the learner will be able to: Explain the needs for home warranty and errors & omissions insurance Implement some very basic risk management strategies Identify areas of concern when turning offers into contracts 17

CHAPTER 2 - SECTION 1 HOME WARRANTY AGREEMENTS AND ER- RORS AND OMISSIONS INSURANCE Home Warranty Insurance According to the statistics kept by the Errors & Omissions Insurance providers, 60% - 70% of the real estate lawsuits involve disclosure issues or the lack thereof. Many of these issues can be resolved if there is a home warranty insurance policy in place. These policies cover many minor repairs which could become disclosure Issues. Home warranty insurance, depending on the coverage, could insure such items as: Appliances (stoves, refrigerators, dish washers, water heaters, trash compactors) Systems in the home (heating systems, electrical systems, plumbing systems) Various structural issues (framing members, fences and outbuildings) The warranty could also cover the entire house in the case of new construction. The following are some benefits for the home purchaser: Coverage for unexpected home repairs or replacement costs Budget/cash flow protection on unexpected repairs Coverage regardless of the age, make or model of the appliances. If it can t be fixed, it could be replaced (depending on the terms and conditions of the policy) and most insurers provide 24 hour service. Some of the benefits to the seller are: A competitive edge over other homes in the marketplace not offering a warranty Value added incentive to attract purchasers Purchasers may tend to have more confidence in the home if there is a home warranty provided If something malfunctions after the sale, there is less liability for the seller (and the licensee as well) 18

Statistically, in most geographic areas, homes listed with a home warranty sell faster and closer to the asking price. Example #1 Marty buys a home and purchases a home warranty. Three months after moving in, the hot water heater breaks; this was included in the list of covered appliances. Marty received reimbursement for a new hot water heater from the insurer after paying the deductible. Example #2 Mary buys a home and purchases a home warranty. The bathroom faucet breaks. The cost of the faucet and installation is $80. The deductible on Mary s home warranty policy is $130. She must pay for the faucet since the deductible was greater than the cost. The importance of this coverage cannot be overstated, especially in relationship to the number of lawsuits that are created by disclosure issues. Most policies are for one year in duration and are relatively inexpensive (most costing $250-$400 per year). When you consider that cost in comparison to litigation, it is a wise investment. Usually these policies can be purchased by the seller, buyer, their representative or almost anyone. TIP: Consider purchasing the first year of a home warranty policy for your buyer as a house warming gift. This might be a great risk management tool for you and a practical gift for your buyer. Errors and Omissions Insurance Errors and omissions insurance is often referred in the real estate industry as E & O insurance and protects the licensee and the brokerage from just that errors and omissions. Most states do not require real estate brokerages to carry this insurance; however, many brokerages choose to purchase this coverage. This is a sound brokerage policy and is especially important should a large claim arise. Some states have a self-insured system for E & O Insurance that is derived from the original and renewal fee charges to licensees. 19

It is important to understand that this insurance does not cover intentional misrepresentation or illegal acts whereby the licensee had knowledge of the wrong doing. Like most insurance policies, there are usually exceptions to the coverage. These details and terms of the coverage may include the following: Limits of liability for each claim Limits of liability for each annual period (referred to as an aggregate limit) Extended reporting period Deductibles Exclusions to the coverage Types of property to be insured (residential, commercial, property management, business opportunities or vacant land) Personal injury Subrogation Lock box property damage Fair Housing coverage Pollution coverage (which may include mold, fungus, asbestos, radon, lead etc.) Bankruptcy or insolvency of the insured Assignment of the policy Arbitration Terms of cancellation of the policy Conformance to state statutes Two types of coverage are inside the limit of liability and outside the limit of liability. Inside the limit of liability coverage includes attorney fees and court costs within the limit of liability. Example limit of liability The limit of liability for the errors and omissions insurance for XYZ Realty is $1,000,000. It is an inside the limit of liability policy. 20

XYZ Realty had a claim for $800,000. The attorney fees and court costs associated with this claim were $300,000. The claim and the legal fees totaled $1,100,000. XYZ s limit was $1,000,000. In this scenario, XYZ would have to pay the additional $100,000 out of pocket. Outside the limit of liability coverage does not include attorney fees and court cost within the limit of liability. Example---outside the limit of liability ABC Realty has a limit of liability policy for errors and omissions insurance of $1,000,000. It is an outside of the limit of liability policy. ABC had a claim for $800,000. The attorney fees and court costs associated with this claim were $300,000. The claim and the legal fees totaled $1,100,000. The $800,000 was within the limit of liability and was covered by the policy. The $300,000 in legal fees were also completely covered because this policy was an outside of the limit of liability policy. It goes without saying, that errors and omissions insurance providers will charge a higher premium for an outside of the limit of liability policy.! In addition, there may be further restrictions and specific procedures should a licensee also be the principal (owner or part owner) of the property. Some insurers charge extra for this coverage and some will not cover the licensee as an owner. Each licensee should know exactly what type of E & O coverage that their brokerage carries. If they self-insured they should know the details for this policy as well. Here s what to ask: Does the brokerage have E & O coverage? Do the licensees pay the brokerage for this coverage (per transaction or per year)? What is the deductible? What is the limit of coverage per transaction? What is the aggregate limit for coverage for the year or policy period? If I sell my own property, am I insured by E & O Insurance? If so, are there any special procedures that I must follow to be insured? 21

TIP: Most real estate professionals don t know the details about their E & O Insurance or if they even are covered by it. Ask your managing broker to see the errors and omissions insurance policy that is in place at your brokerage, if you have one. Study it..ask questions. Risk Management With the increase in lawsuits over the last few decades, it s safe to state that we, in the United States, have become a litigious nation. Lawsuits, or the threat thereof, within the real estate industry, are certainly not an exception. One of the causes, perhaps, is that a party does not have to prove that they were wronged before filing a lawsuit. To complicate this even further, in most jurisdictions, the filing fee is very nominal. So, it becomes quite easy and inexpensive to threaten litigation. The purpose of sound risk management procedures is to minimize your exposure and reduce your risk of being threatened with a suit. You should emphasize shifting the risk to those professionals who specialize in a particular field within the real estate industry. In doing so, you ll also reduce the risk to your brokerage and to your client as well. Today s consumers, have increased expectations about the services that we provide as real estate professionals. Mastering some basic risk reduction procedures will assist you in meeting, or perhaps exceeding, these expectations and reduce your threat of litigation. So, what should you do when a client asks you a question that is outside of the area of your training and expertise? You should suggest that they seek counsel or advice from a professional. The list of professionals which support the real estate industry below is not an exhaustive list, but rather some common professionals that you may encounter in the industry: Real Estate Attorney Title Officer Tax Specialist or CPA Structural Inspector Building Contractor Environmental Specialist Soils Expert Pest Inspector 22

Septic System Inspector URHOTS (Underground Residential Heating Oil Tank) Specialist Surveyor Drinking Water Well Specialist Toxicologist Any specialist in the real estate field TIP: Whenever possible, try to document, in writing, that you have suggested that your client seek the advice of a professional. Such documentation could be to your advantage should a dispute arise. The importance having clear documentation regarding any transaction in real estate cannot be overly stated. All licensees should consider the possible threat of litigation in every aspect of a transaction. One of the best ways to protect yourself and your brokerage is to keep clear, accurate documentation throughout any transaction. This documentation could be extremely valuable should a lawsuit arise or in the event of a real estate audit at the state or federal level. Below are some suggestions for clear documentation: Take notes on correspondence with anyone involved in the transaction (buyers, sellers, coop licensees, lenders, structural inspectors, escrow, title companies etc.). These conversations may be in person, instant messaging, text messaging, e-mail or telephone calls. Initial and date all entries Present all disclosures and agreements in writing. All e-mails pertaining to the transaction should be printed and placed in the file. Keep all journals of fax transmittals (to show proof that you sent a fax). TIP: Most fax machines can be programmed so that an individual journal is produced after each fax transmittal. The journal should be attached to the sent document and placed in the file. If the fax machine in your office is not set up with this feature, check with your broker or office manager to see if an individual journal can be setup. This reduces the brokerage liability as well as yours. Save hardcopies of all documents pertaining to the transaction. Double check to see that each document has the required signatures or initials. 23

Photos can be solid documentation, especially when the issue involves construction and structural components. Include every component of documentation in the transaction or listing file. Hardcopy documentation is always stronger in a court case than recalling events from memory. Oral testimony in court is referred to as parol evidence. In the United States we pride ourselves on diversity. In doing so, we have many different cultures and languages. For many residents, English is not their primary language. Written documentation can certainly be of benefit in clearing up any misunderstanding which might arise in oral communication within a real estate transaction. Case Study The buyer s representative was meeting with his buyers and writing a contract to purchase a residential home. He called the listing representative to check on availability. The listing representative said that yes, the home was available, and that there had been an offer on the property the month prior, but that the sale fell through only due to financing. The buyer s representative asked if there had been a structural inspection performed by the first prospective buyer. The listing representative said yes. The buyer s representative then asked if their seller s disclosure statement had been updated to include information reflected in this inspection and the listing representative affirmed that it had. The buyer s representative made notes on the conversation with the listing representative. The buyers bought the home and upon occupying the property became very ill. They hired a toxicologist and found very high levels of toxic mold which the neighbors claimed the sellers had known about. The buyer s representative s notes became Exhibit A in a $2,000,000 lawsuit where the purchasers became the plaintiff and the sellers were the defendant. The licensee s handwritten documentation was crucial to this lawsuit. Offer Basics An offer to purchase a property is just that, an offer. This offer usually contains specific terms and conditions tailored to the property being offered for sale. The buyer making the original offer is called the offeree and the seller accepting the offer is called the offeror. When a counter offer is made by the seller, they become the offeror and the buyer becomes the offeree. The seller may accept, reject or counter the offer. The definition of a counter offer is when one of the parties makes a change to the original offer. Legally, it is considered a revocation of the original offer. When an offer is fully acknowledged (all parties have agreed and signed and no 24

other changes have been made) and all have initialed and agreed to any prior changes; an offer becomes a contract. When this happens, the contract is said to have mutual acceptance. Case Study The buyers made an offer through their buyer s broker using a preprinted purchase and sale agreement and delivered it via fax to the seller s representative. The sellers agreed to all of the many terms, except one, and changed the closing date. The sellers initialed the change and the seller s representative delivered it via fax back to the buyer s representative. The sellers submitted a counter offer. The buyer s representative was not able to receive the fax that evening as he was at a football game. During that evening, the sellers received another offer which was $10,000 higher than the first offer. The seller s withdrew their counteroffer before it was accepted by the purchaser. It is legal to withdraw an offer or counter offer only before the other party accepts it. In this case, the first purchaser was no longer in the contract and the sellers were able to accept the higher offer. Tip: When withdrawing an offer or counter-offer before it is accepted, a real estate licensee should keep extremely accurate documentation of the timeline, so that there is no dispute as to the timing of the withdrawal. Multiple forms of documentation may be used for this withdrawal, such as phoning, faxing and e-mailing (using all three) and a witness as proof of the timing of the withdrawal. There are a number of ways in which an offer can be effectively presented: In person Via facsimile Via e-mail While facsimile and e-mail can be convenient and can offer expedience, presenting offers in person can give a buyer s representative many added advantages such as: Being able to explain the offer and its terms and conditions Fully communicate the needs and intentions of the buyers Answer any questions that the sellers may have Make a case and negotiate for the buyer Observe any body language from the sellers or their representative 25

NOTE: The buyer s representative has a fiduciary responsibility to their buyer of trust and must act in their best interest. A fiduciary relationship is basically defined as the duty to deal with the client in trust and confidentiality and must act in the client s best interest. Before presenting an offer, you, as a buyer s representative, should take some time to learn as much information as possible about the needs and situations of both the buyers and the sellers. If the buyer s representative has this information, the offer will be more effective and the chance of an unacceptable counter-offer diminishes. You may also have the opportunity to tailor your offer to fits the needs of the parties. Offers, Counter-Offer and Multiple Offers First, let s discuss the details of offers and counter-offers and then explain the issues associated with multiple offers. In most circumstances, an offer to purchase real estate is written by the licensee who is working with the buyer. This contract to purchase, called a purchase and sale agreement (PSA), MUST be in writing. Verbal offers are not enforceable. The requirement that all offers be in writing is known as the Statute of Frauds. The licensee may be representing the buyer or the seller or both. The licensee must disclose which party they are representing before the offer is made. This is referred to as agency. The licensee could also be representing neither party, in which case this is referred to as no agency. The offer is then signed by the buyer (another name for signed is acknowledged). The buyer, in this circumstance, is known as the offeror. And the seller, who receives this offer, is known as the offeree. The licensee working with the buyer will then deliver the purchase and sale agreement to the seller s representative or in some circumstances meet with both the sellers and their representative. The buyer is almost never present if the offer is made in person. Please see the following two sections on methods of transmittal for an offer. The seller has basically three choices: 26

They can accept the offer Reject the offer Counter the offer Accepting an offer If a seller accepts the buyer's offer, they are accepting the offer and all of the terms and conditions in its entirety. The seller would then sign the offer. At this point, mutual acceptance has occurred and each party is bound by the terms and conditions of the contract. Rejecting the offer If a seller rejects an offer, they are rejecting the offer and its terms and conditions in its entirety. Usually, the listing representative will draw a line diagonally across all pages of the contract and write in bold writing REJECT. At this point, all negotiations are terminated. This seldom happens since the seller can always counter the offer at their original position. Countering the offer If the seller wishes to make any changes to the buyer s offer (even just one minor change) then the seller will line though the item, make the change and initial the change. This is known as a counter-offer. Technically, a counter-offer is a revocation of the original offer. We will discuss this in further detail later. The counter-offer is then sent back to the buyer. At this point, the seller is now the offeror and the buyer is the offeree. The buyer then has the following choices: Accept the counter-offer Reject the counter-offer Counter the counter-offer If the buyer accepts the counter-offer Then they will initial where the changes have been made and the sellers have initialed. At this point, mutual acceptance has occurred and each of the parties is bound by the terms of the contract. 27

If the buyer rejects the counter-offer Then the entire contract is rejected and negotiations are terminated. If the buyer counters the counter-offer This means that they have made additional changes. The same process takes place as when the seller made a change. The item to be changed is lined out, the change is made, initialed by the buyer and the contract is sent back to the seller. At this point, the buyer is now the offeror and the seller is the offeree. This process can go on repeatedly, until all of the terms and conditions of the contract are mutually agreed upon. When there is mutual agreement on all changes, then there is mutual acceptance. In situations where there are many counter-offers, real estate licensees must perform more work as the offer is transferred back and forth between buyer and seller. Multiple Offers: Multiple offers occur when there is more than one party desiring to purchase a particular property. The reasons for this occurrence may vary, but the following are some of the most common scenarios: Low inventory of homes for sale and many people wanting to buy (supply and demand) A property is priced under market value Interest rates are low and favorable for buyers The seller is offering seller financing to the buyer (this is known as a purchase money mortgage and may allow a greater number of purchasers to qualify for the purchase) The property has some very unique quality or reputation (such as a historical landmark or the home of a famous rock star) Zoning is favorable and attractive to investors A real estate licensee representing the seller has the duty to present all offers to the seller, even if mutual acceptance has occurred with a prior buyer and a contract has been signed. If a seller has multiple offers to view all at once, they will want to compare the desirability of each. 28

It s important to remember that you should treat each offer as a whole package when comparing offers. Price may not be the only key factor. The strength of the buyer, in terms of purchasing power, may be an additional factor. Other important factors would include the amount of the earnest money deposit, desired closing date (especially if the seller is attempting to close concurrently with another property), methods of financing, and contingencies in the contract. Often buyers will include escalation clauses with their offer if they think there may be multiple offers. Escalation Addendum to Purchase and Sale Agreement An escalation clause basically states that a buyer will pay a specified amount of dollars over the highest purchase price up to a specified dollar amount (usually referred to as a cap). The buyer with the best escalation clause will ask for a copy of the next highest offer as proof that their escalation clause was required. TIP: One or more escalation clauses being present when comparing offers can be a bit complicated. The best rule is to take the second to the highest best offer and have the BEST escalation clause escalate upon it. If you have any confusion, consult with your manager on the best way to approach this scenario. Licensees are encouraged to seek assistance from their designated broker or managing broker when dealing with their first transaction where multiple offers or escalation clauses are included. So, now you know what you need to include and how to deal with offers. Mistakes? What mistakes you re a pro. Check your understanding Use this link to open a short quiz: https://www.bookwidgets.com/play/bqk4p Copyright 2015 Simplify CE, LLC 29