Sellers beware! – Sellers of residential properties are responsible for disclosing latent defects

If you are selling a home in Colorado and you know that the home or property has a latent defect (i.e., a defect which is unlikely to be discovered in an inspection), you must affirmatively disclose it to the buyer.  In Gattis v. McNutt, 2013COA 145 (November 7, 2013), the Colorado Court of Appeals ruled that sellers have an independent duty to disclose latent defects to buyers, and that the failure to disclose may give rise to a tort claim.

In Gattis, the Seller knew from an engineering report that the residence had structural problems resulting from expansive soils.  An entity controlled by the Seller oversaw repair work to remedy the structural problems.  Once the repairs were complete, Seller purchased the residence, then entered into a contract to sell the residence to Buyer.  The contract was a standard form real estate contract, approved by the Colorado Real Estate Commission, to which no changes were made.  Although Seller disclosed the structural repairs on a disclosure form which accompanied the contract, it did not disclose the underlying soil problems or that Seller controlled the company which performed the repairs. 

Years after purchasing the property, Buyer sued Seller asserting tort claims for economic losses caused by the negligent non-disclosure of the expansive soil problem.  The trial court denied Seller’s motion for summary judgment based on the “economic loss rule,”¹ and ruled in favor of Buyer on the nondisclosure claim. 

On appeal, the Colorado Court of Appeals held that the economic loss rule did not bar the nondisclosure claim because Seller had a duty to disclose the defects which was independent of the contract.  The Court reviewed other Colorado cases which have held that builders of residential construction have an independent duty to disclose latent defects to buyers and the policy reasons cited therein.  The Court concluded that these same policy reasons apply to home sellers and buyers as well, as follows:

Home sellers have a long recognized common law duty to disclose known but latent defects in the property.

A seller who has actual knowledge of a latent defect is in a superior position than a buyer, and has a duty to disclose facts that in equity and good conscience should be disclosed. 

Buyers have difficulty in learning of a latent defect.

A purchaser of a home (the biggest and most important investment in many people’s lives), can ill afford to suddenly find a latent defect that completely destroys the family’s budget, and have no remedy for recourse.

It is foreseeable that a latent defect will cause harm to the home and homeowner.

Enforcing a duty of disclosure avoids preventable harm to innocent parties and discourages misconduct.

The burden of disclosure is minor because it only applies to defects which are material (i.e. ones which may affect the buyer’s decision to buy).

Gattis, ¶16.  The Court did not rule out the potential for a home sale contract to bar tort recovery.  The Court noted that there are transaction-specific negotiated contracts which address common law duties and completely subsume them.  Gattis, ¶¶18-20.  For example, a contract may state that the buyer is relying solely upon its own investigation and not in any way upon any representations made by the seller, in which case, a nondisclosure claim would likely be barred.  Gattis, ¶21. 

You can read the Court’s opinion here: http://www.courts.state.co.us/Courts/Court_of_Appeals/Opinion/2013/12CA1269-PD.pdf

Fn.1 The economic loss rule is a judicial doctrine intended to maintain the boundary between contract law and tort law by preventing a party from recovering in tort when losses are caused by the negligent breach of a contractual duty.  The economic loss rule helps ensure that contracting parties can allocate their risks and costs by restricting the parties to the remedies they bargained for in their contract rather than allowing use of the more expansive remedies available under tort law.  For a discussion of the origins of the doctrine and its adoption and application in Colorado, see the Colorado Supreme Court’s decision in Town of Alma v. AZCO Construction, Inc., 10 P.3d 1256, 1259-1266 (Colo. 2000).  Broadly speaking, under Colorado law, the economic loss rule bars recovery under tort law unless the party is acting under a duty which is independent of the duties imposed by the parties’ contract.  Gattis, ¶13. 

Lee Katherine Goldstein is an appellate lawyer with the Denver law firm of Fairfield and Woods, PC.