So, here's what happens. You, the broker, receive notice that your company, your agent, Honest Abe, and the sellers are being sued for failure to disclose a condition in a property that your firm had listed and sold two years ago. Immediately you do two things. (1) You notify your attorney, who will than notify your E&O (Errors and Admissions) carrier. (2) You ask Honest Abe to come into your office and bring you up to speed as to what has been going on with respect to this transaction and its aftermath.
Abe comes in and tells you this: "During the transaction the sellers disclosed that they had once had a severe sewer line backup. They had it cleared out and never had another problem. The buyers were satisfied with that.
"A few months after escrow closed, I heard from the buyer. He had experienced another line backup and he wanted to contact the seller. I called the seller who was perfectly willing to talk with the buyer. A couple of weeks later, he (the seller) told me that they were still having some disagreements about responsibility and the cost of repairs. The buyer had even threatened to call a lawyer, but the seller was sure they could work things out. That's the last I heard of it."
"Whew," you think, "this may be a hassle, but it shouldn't be a big problem."
Not much later, your attorney calls. "I'm afraid I have some bad news. Your insurance carrier has reviewed your file, as well as the statement that Honest Abe prepared after you talked with him. They are declining to provide coverage, because you had not advised them of this potential problem when you applied for coverage renewal a few months ago. They will not pay for your legal representation in this matter. Not even for this phone call."
Do things like this ever happen? Yes, and apparently with increasing frequency. Recently, real estate attorney, Andrew McCarron -- one of the sharper tools in our local legal shed -- gave a presentation on E&O insurance to a group of brokers at the Orange County Association of REALTORS®. The theme to which he paid major attention was that he is seeing an increase in the number of coverage denials based on the failure of applicants to provide the insurance company with adequate notice of known potential problems.
When a real estate company applies for E&O coverage, quite understandably the insurance company wants to know what potential there is for claims to be made. Of course they want to know your track record and how much business you do. But they don't just want to make a probability estimate on your future transactions. They also want to know if there are potential problems simmering out there on recent past (within the statute of limitations) transactions.
This is because E&O insurance is a "claims made" coverage. It covers you for claims made during the policy period, even if the event may have taken place before the policy period.
So E&O companies will ask you to provide them with a brief description of any potentials of which you have knowledge. Here is where things can get a little tricky. While there may be some situations of which the broker may have direct knowledge, there are quite possibly situations -- such as the one that involved Honest Abe -- where the broker has not been involved and doesn't have active knowledge. Too bad. The broker is presumed to know what the agent knows.
Now, I don't have any hard evidence to support this, but I suspect that most agents would not be likely to just volunteer to their broker after-escrow information of the sort Honest Abe possessed.
Nor, in this age of paperless transactions and compliance-by-checklist, would these sorts of exchanges be likely to come to a broker's attention, even if they had happened before the close of escrow.
What is a broker to do? I think the main take-away is that, on a periodic basis, brokers need to make diligent inquiry of their agents as to their awareness of the existence of any potential "hot spots." It should be clear that there be no punitive consequences to the agents who identify such potentials. Moreover, it should be clear that no lawsuit against the firm need to have been threatened. (I presume that firms already have a protocol for dealing with threatened lawsuits.) It is enough if the agent perceives a strong dissatisfaction on the part of one of the principals, or if there is a palpable hostility between them.
Now, one might say, "Encouraging that kind of agent reporting is too much. You would overload your E&O applications with frivolous reports." But that misreads the situation. It is a management decision as to what is subsequently reported to the insurance carrier. One would expect some intelligent filters to be at work here. But you can't apply those filters unless you have some raw data to work with.