Although not all states treat commercial real estate disclosure as strictly as disclosure laws for residential real estate, sellers of commercial real estate should remain wary when preparing their disclosure documents. A mistake in disclosure could negatively affect or even void your professional liability insurance, in some circumstances.
When selling an investment property, most states require sellers to disclose certain hazards and risks that the property may hold. Eight states mandate specific commercial real estate disclosure forms similar to those used in residential real estate sales including California, Maine, Michigan, New Hampshire, Minnesota, Tennessee, Texas, and Washington. Some commercial disclosure issues can include flood risks, environmental concerns, title discrepancies, water rights, structural and systems matters, problems with electrical, ventilation, heating, or plumbing issues. In some states, the seller must disclose whether the property is compliant with fire, electrical, or other building codes.
California’s Disclosure Requirements
California may have some of the strictest disclosure laws, including disability access compliance, energy efficiency and more. In short, California disclosures in commercial real estate now mirror residential disclosures. For commercial real estate, it is no longer “Buyer beware” in the sunny state of California. In 2015, the California state legislature passed SB 1171, which re-categorized “real property” to include commercial property. This law now applies not only to the sale of commercial property, but also to any commercial lease that exceeds one year in length.
See below for a few of the key disclosure requirements in California:
- The location of any property in an earthquake fault zone or a seismic hazard zone
- Improvements in earthquake safety
- Wildland/urban interface location
- Location in an area designated as a Very High Fire Hazard Severity Zone
- Flood hazards and the need to maintain flood insurance
- Water heater bracing
- Mold presence
How to Protect Yourself by Maximizing Disclosure
While an insurance broker experienced in real estate law may be a sounding board in confirming the need to disclose, make sure your insurance agent or broker is an expert in disclosure requirements as well. Be sure to work closely with an expert who can guide you in disclosures. For example, if a crime occurred on the premises, must you disclose that? Alternatively, what about if a feud with a neighbor resulted in property damage or an assault, like in the case of Rand Paul? Is that a disclosable issue?
Experts in real estate agree on one key point – err on the side of over-disclosing rather than omitting information that a litigious party may discover and later allege in a claim. According to one law firm, commercial real estate sellers may mistakenly rely on “as is” provisions in a sales contract to limit their liability. This language is not foolproof, especially when the seller knows of the condition of the property prior to its sale.
What does all this have to do with insurance coverage? An intentional failure to disclose can cause insurers to deny coverage based on the “intentional acts” exclusion.
Be sure to disclose even latent defects, such as a faulty sewer hookup that is not currently problematic. In a 2011 case, a seller failed to disclose a future road widening that would include a loss of a portion of the property. In this case, the court decided “widespread public notice” precluded the duty of the seller and placed the onus for knowledge of this change on the buyer as a responsibility of the buyer’s due diligence. However, in a similar situation, the carrier might defend the seller under a “reservation of rights (ROR).” A ROR outlines the carrier’s position that it will defend the insured but reserves its right to later deny or disclaim coverage.
Clearly, disclosure of this matter, would prevent an insurance coverage issue along with a lengthy and costly legal battle.
Here are some of the legal theories used in cases involving a failure to disclose.
- Misrepresentation – Courts can affirm that a party “misrepresented” facts based on an affirmative statement made by the seller. For example, courts would probably consider this a misrepresentation: Stating, “This property has never suffered mold damage” when in fact a recent water loss involved professional mold remediation services.
- Nondisclosure – In contrast to misrepresentation, nondisclosure is just that – you fail to disclose when you should have disclosed. This is where insurance coverage can get sticky, because insurers may construe that failure to disclose is an intentional act or decision by the property owner. Given those circumstances, it is well within the insurer’s rights under the insurance contract to assert a coverage declination.
- Potential damages – Plaintiffs usually seek damages for the cost to remediate any defects. In the example of a faulty roof structure, the cost to repair the roof would be part of the damages sought in the lawsuit. What if the plaintiff loses rental income due to the roof repair? Certainly, the plaintiff will assert a claim for this type of loss or any decrease in the value of the property.
For the commercial real estate owner or manager, the cost of non-disclosure can be steep. The courts may also award attorneys’ fees and costs if the plaintiff prevails. The best way to stay out of litigation is to disclose. At ReShield we are always happy to chat regarding disclosure requirements or any insurance related questions. Check out our blog on Insurance for Commercial Real Estate Owners here or fill out our insurance application today to receive a quote!