You are looking forward to the close of another busy day. It is almost 5:00, and it's been one thing after another. It seems like every agent in the office needed to talk to the broker today.

Your secretary buzzes you, and says there is a gentleman to see you. In walks a well-dressed young man, who announces, "I am an officer of the Court. I am serving you with this lawsuit." He hands you a thick stack of papers, and turns to leave.

As you look through these papers, you see a Summons attached to a Complaint, which you begin reading. In the caption, you see that your company is named as a defendant; you, as the designated broker of the company are also named personally along with your spouse; so is the salesperson who sold this listing, and her spouse! A knot begins to form in the pit of your stomach. You stare intently at the Plaintiff's name, and then it seems to ring a bell: about two years or so ago, your salesperson sold this person a house.

As you read through the allegations of the Complaint, you find that all of you are accused of: intentional misrepresentation; negligent misrepresentation; constructive fraud; breach of fiduciary duty; fraudulent concealment; consumer fraud; negligence and ... Racketeering! The Plaintiff is demanding an award of damages, including punitive damages, in the hundreds of thousands of dollars! What is a broker to do?!

Being served with a lawsuit is without doubt, one of the most traumatic and jarring experiences that can occur in a real estate agent's life. It isn't just the thought of having to pay money to the Plaintiff: litigation is a lot more complicated than that. It is the very idea that someone is saying a lot of terrible (and probably untrue) things about you, that are now public record. You worry about what effect it will have on your reputation, and what the other people in your office will think. Fighting a lawsuit can consume enormous amounts of your time and money, over a period of years. Moreover, it can cause a great deal of additional stress on your family and other interpersonal relationships.

When served with a lawsuit such as this, you must promptly consult with, and retain an attorney to represent you. You generally must file a formal Answer to the Complaint rather quickly; the time limits are usually in the 20-30 day range. If you fail to file a timely Answer, the Plaintiff can move for a Default Judgment, without your having had your "day in court."

It is at this moment in time that the issue of malpractice insurance rises to the fore. The single most important question in your life will become, "Do you have Errors and Omissions coverage for this claim?"

No Insurance? Better Find a Lawyer, and Quick!

If you do not have E & O insurance, you will find a new and quite alien set of challenges to confront. You must quickly take the initiative to find an attorney to represent you. But beware: the field of real estate malpractice defense is becoming ever more specialized, and you will find that few lawyers in any particular city or town are truly specialists in this relatively new, but rapidly growing specialty of the law. If possible, try to find a lawyer who has a great deal of experience in the areas of real estate transactions, contracts and agency.

As important as these skills are, it can be every bit as important to find an attorney who also understands the way that real estate agents do business. However, be advised that any attorney who has taken the time to develop this rare combination of knowledge, experience and understanding of the industry, is likely going to charge somewhere around $175-250 per hour, and will usually require a retainer of several thousand dollars, just to take on your case.

This initial retainer is only the first check you will have to write during the course of this lawsuit. The attorney will need time to develop an understanding of the case, and a plan of action for the defense. The Answer will have to be drafted, along with any Affirmative Defenses; Counter-Claims; Cross-Claims and/or Third Party Complaints. In short, it won't take very long to burn through that initial retainer check. Once it is used up, you will have to replenish it, and/or you will be billed monthly for ongoing work, as the case progresses. Every time your attorney performs any work on your case, the time spent will be tracked and billed to you. If your case is at all complex, and/or if it is actively pursued by the Plaintiff, you may find yourself receiving statements from your attorney in the hundreds, or even thousands of dollars per month.

The case will then proceed through "discovery," during which documents will be exchanged; depositions will be taken of the parties and witnesses; written questions (Interrogatories) will need to be answered; all to the end that each side finds out what the other side's case is all about. At some point, your attorney may recommend that a settlement offer be made to the Plaintiff. If a settlement is reached, you will, of course, have to pay it, but at least this particular nightmare will be over. It is safe to say that the vast majority of all lawsuits are resolved through a negotiated settlement. However, if it is not possible to settle the case, and it becomes necessary to prepare for trial, you can expect that your costs will begin to soar.

Any competent attorney must expend a great deal of time to prepare for and conduct a trial. Bear in mind that you might lose this trial, and this is the worst of all possible worlds: you will find yourself being ordered to pay whatever judgment the Court may award to the Plaintiff, plus interest and costs. This is, of course, on top of the fees and costs that you have paid, and will pay to your attorney. Finally, to add insult to injury, the Judge might even hold you responsible for paying all of the Plaintiff's attorney's fees, as well! It is difficult to imagine a worse nightmare for a real estate agent.

Now that this catastrophe has befallen you, if you have not yet considered the "BK" word (Bankruptcy), this may be a good time to begin contemplating it. Unless, of course, you have been found guilty of intentional fraud or breach of fiduciary duty: these debts may not be discharged in Bankruptcy Court. The possibility that you may be found to have committed intentional wrongdoing is arguably the greatest risk of going to trial. There is simply no way out from under this kind of liability.

Errors & Omissions Insurance Makes the Difference

How would the preceding scenario have been different, had the broker been covered by an E & O policy?

Upon being served with the lawsuit, the broker would contact the Errors and Omissions insurance carrier, and send the carrier the Summons and Complaint. Thereafter, the broker will speak with a claims representative, who takes down details about the claim, and verifies that there is coverage for this claim. The broker is advised to contact one or more local attorneys, and make an appointment. In the larger cities, the carrier may have already established working relationships with attorneys who specialize in this kind of work.

If the policy provides for "first-dollar defense" (and most do), the attorney will be paid by the carrier from the outset. The broker and/or agent will usually be responsible for the payment of a deductible, but once the deductible is paid, that will be the end of the broker's (and salesperson's) financial liability. All further ongoing attorney's fees, and any settlement or judgment will be paid for by the carrier, up to the limits set forth in the policy.

Clearly, the broker who is covered by an E & O policy will find the trauma of litigation much more bearable, both psychologically and financially, than brokers and salespersons who must personally pay the freight through an entire lawsuit. Simply knowing that there is an experienced attorney, working in concert with an experienced claims adjuster to defend your case, can be very comforting.

Mandatory E & O

As of the date of this article, some seven states have implemented some form of state-mandated E & O coverage. Despite the author's general disinclination toward most new attempts by government to expand the regulatory quagmire, nevertheless, the concept of mandatory E & O is worthy of consideration. The specific programs these states have implemented differ, and a detailed discussion of each approach is not possible in this space. However, many regulators are watching closely as these programs evolve. It is hoped that, out of all these experiments, there will emerge a program of mandatory E & O which will offer above-average coverage, at a reasonable cost. Such a program should certainly emphasize educational (risk reduction) programs for licensees, but it also should educate the buying and selling public, as well.

Shopping for Your Malpractice Insurance

When one is shopping for an E & O policy, there are a number of features which should be compared among the various carriers. Ask for a "specimin" policy, and take the time to read and understand it. At a minimum, one should consider the following factors:

• The amount of the deductible, and when it is to be paid;
• Whether the deductible applies to "first-dollar" defense costs;
• What are the Exclusions (acts not covered by the policy)?
• Can any of these Exclusions be covered by an Endorsement?
• Does the policy allow the insured to approve any settlement?
• Are "claims costs" (attorney's fees, etc.) included in the overall policy limits?
• Does the policy have "tail" coverage (extended reporting period)? That is, will it cover you for some period after you leave the company?
• Is there "prior acts" coverage, to cover transactions and acts which occurred before the policy went into effect?

Like it or not, we live in a litigious society, and the typical broker is far more likely to be sued than the broker of fifteen years ago. A recent national survey of brokers found that considerations of legal liability was one of the foremost factors in their business. The prudent broker stays abreast of legal developments, and implements risk reduction techniques in each transaction. Agents are encouraged to attend continuing education classes on the law, Rules, and similar subjects. Over time, it will then become second nature to scrutinize contracts and other documents more closely, and to draft contract language in a clear and concise manner. Proper use of disclosures, disclaimers and waivers will become automatic. In short, the licensee who fu lly grasps the concept of risk reduction will naturally evolve into a true professional, all to the benefit of not only the licensee, but to their clients and customers as well.

Experience has shown that, through the exercise of reasonable care, and the use of risk reduction techniques, licensees can greatly minimize the chances of being sued, and/or having a license complaint filed against them, in any given transaction. This is a goal to which all real estate professionals aspire. But when that one deal "falls through the cracks," it is comforting to know that you and your agents have Errors and Omissions Insurance: Your Safety Net.

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Published: June 23, 1999

Use of this article without permission is a violation of federal copyright laws.

Editor's Note: This article reflects the opinions of Robert Bass Esq. only and not necessarily the views of this or any other publication, organization or Website owner.

Robert Bass has practiced law in Phoenix, Arizona since 1978. A former Administrative Law Judge for the Arizona Department of Real Estate, he presided over hundreds of disciplinary cases against real estate brokers and salespeople. A nationally-known writer and real estate educator, his law practice concentrates in defending real estate licensees in Errors & Omissions claims, and in license complaint cases before the Arizona Real Estate Department. He is an Affiliate Member of the Arizona Association of REALTORS®, and has served on its Contract Forms Committee, Information Management Committee and Agency Law Task Force.