Your Guide to Seattle Real Estate

The Ecomonic Loss Rule

On March 1, 2007, an extremely significant court case was decided that will greatly affect real estate transactions in the State of Washington for the foreseeable future. For the first time in Washington, the Washington State Supreme Court applied the Economic Loss Rule and decided that buyers will no longer have a claim for negligent misrepresentation in post-closing property condition disputes if the parties did not allocate risk for claims of misrepresentation during their negotiations.

In determining whether the Economic Loss Rule applies, the key question is the nature of the loss and the manner in which it occurs. In other words, does the loss deal with an economic injury, personal injury or injury to other property. If the loss is economic, and no exception applies, then the complaining party will be limited to whatever contract remedies exist.

Historically, if a buyer of real estate closes and then determines that the property was not in the same condition as disclosed or that the seller withheld material facts, the buyer had two ways to state a claim against the seller. The first was via the contract if there were any express warranties that could be enforced. However, most residential transactions have few, if any, warranties that benefit the buyer. So as a practical matter, the buyer was forced to go outside the contract and rely on a claim of negligent misrepresentation or intentional misrepresentation (fraud). Since intentional misrepresentation is very difficult to prove, lawyers have relied on the negligent misrepresentation claim for their buyer clients.

In Alejandre v. Bull, the Buyer claimed that the seller should pay for damages associated with a failed septic system. The facts are lengthy but like most post-closing property condition disputes, this one clearly involved economic loss and not personal injury. In a nutshell, since the buyer had no warranties regarding the septic system, they were out of luck unless they could prove that the seller intentionally misrepresented the condition of the septic system (i.e. committed fraud). In the court’s mind, the seller’s mere negligence in this case was not enough to override the agreement made between the parties under the contract which included no warranty for the septic system. Furthermore, the court ruled that the parties did not contractually allocated risk for fraudulent or negligent misrepresentation claims. In other words, had the buyer and seller had negotiated the buyer’s future right to sue for economic losses due to the sellers negligence, then the buyer would have prevailed.

With the decision in Alejandre v. Bull, the landscape for handling property disputes after closing has changed the way real estate transactions will be negotiated for the foreseeable future. Beginning on October 15, 2007, new contract forms will be implemented state-wide which include a significant change to deal with the court’s decision. In the basic terms and conditions, when preparing an offer to purchase, buyer’s are faced with the choice to negotiate the buyer’s ability to make future claims based on mere negligent representation on the part of the seller.

Understandably, this will make transactions more difficult to put together for real estate professionals because both buyers and sellers will be forced to understand the ramifications of allocating risk of claims up front in their negotiations. The reality is that when faced with the choice, buyers will be reluctant to give up their right to seek redress from the seller for misrepresentation. The positive consequence to this development is that buyers will necessarily become more educated about the purchasing process and sellers more cautious regarding disclosure.