The California Court of Appeal recently decided a case, Barnes v. Morales[1], which has important consequences to anyone involved in buying or selling rental property in the City of Los Angeles. In this case the Seller of rental property overstated the amount of rent the tenants paid, failed to advise the Buyers that the property was subject to the City’s rent control provisions, and failed to disclose that portions of the premises lacked the necessary permits from the City. Affirming the wrongfulness of the Seller’s actions, the Court affirmed an award of nearly $350,000 to the Buyers, highlighting the importance of complete and honest disclosures in rental property transactions.
The Buyers in Barnes v. Morales purchased a mixed residential and commercial property from the Seller for $725,000 in 2006 that included two residential units and rental income from a catering truck using the property. The Seller represented that the rent for each residential unit was $800 per month; however, he did not provide estoppel certificates for either tenant or documentation regarding the rental income from the catering truck. In addition, the Seller failed to disclose that he did not obtain a building permit for a large metal shade canopy he installed.
After escrow closed, the Buyers attempted to collect rent from the residential tenants; however, they were informed that they did not pay $800 per month. Subsequently, the tenants filed a claim with the Los Angeles Housing Department who found that the allowable rent was $583.50. Prior to the sale, the rent for each residential unit was $700 per month. The Buyers – who were unaware that the property was subject to the Los Angeles Rent Stabilization Ordinance – also learned that the property was subject to the Ordinance.
Further, the Buyers received an order to comply from the City of Los Angeles requiring that they cease using the property as an outdoor restaurant (the catering truck), demolish the unapproved metal canopy or receive the proper building permits for it, and remove extension cords providing supply to the canopy and truck. Buyers removed the canopy at a cost of $1,000 and discovered it would cost $28,466 to replace it.
In response to all of these issues after the purchase, Buyers filed a lawsuit against Seller and the real estate agents for both Buyer and Seller, alleging claims for breach of contract, negligent and intentional misrepresentation, and damages for the removal and replacement of the metal canopy. The trial court awarded the Buyers $26,466.20 for their breach of contract claim, $295,000 for the fraud claim, and an additional $56,418.75 in punitive damages. In total, the trial court awarded the Buyers $347,884.95.
On appeal, Seller alleged that the real estate agents had a duty to discover and disclose that the property was subject to rent control and that the metal structure lacked building permits. However, the Seller failed to successfully argue any of his points.
First, the Court found that the Seller, who had engaged in real transactions before, knew that the Buyers would rely on his misrepresentation that the each residential tenant was paying $800 per month. The Court also did not believe that the Seller did not know the property was subject to rent control because as a landlord, he was assumed to know that it was subject to rent control.
The Court confirmed that the Seller’s misrepresentations about rent from the residential units constituted fraud because the Seller intentionally overstated the rent to deceive the Buyers, and the Buyers justifiably relied upon these misrepresentations.
In addition, the Seller confirmed that he failed to obtain building permits to install a metal canopy as a shade structure and convert a commercial structure from a restaurant to a stereo and alarm store. The Court confirmed that he had failed to make the appropriate disclosures that the work performed was done so without building permits.
The Seller attempted to argue that, as a seller, he did not have a duty to disclose the existence of rent control or the lack of building permits. However, the Court disagreed, holding that the Seller had a duty to disclose the true rental amounts and disclose any improvements to the property which had been performed without proper City permits. Whether or not the real estate agents for seller or buyer had a duty to discover and disclose rent control laws was immaterial because Seller had the duty to truthfully disclose rental income and unpermitted modifications.
This case is important because it highlights the potential damages if a seller misrepresents the rental income of a property or the lack of proper building permits. Not only did the Buyer receive damages because the property was worth less as a result of the lower rents and the lack of building permits, but they also received punitive damages because of the Seller’s fraud. Further, if the Purchase-Sale Agreement allowed, the Buyer would also be able to obtain attorneys’ fees for the lawsuit, meaning the Seller would have to pay for his own attorneys to defend the lawsuit plus the Buyer’s attorneys for bringing the lawsuit.
The case also highlights the potential issues involved in buying a property with a lack of disclosures. After purchasing the property, the Buyers were required to proceed in a Los Angeles Housing Department hearing regarding the residential units, received a Notice to Comply from the City of Los Angeles for illegal structures, and a lawsuit against the Seller. While the Buyers ultimately were awarded substantial damages for the Seller’s deceptive acts, their predicament could have been avoided from the outset through due diligence, including their investigation of City requirements, property permit history, and obtaining estoppel certificates from the tenants prior to purchase. While the damages recovered by the Buyers was significant, the actual harm this situation caused them might have been even greater.
In short, Barnes v. Morales underscores a critical point for those engaged in buying and selling rental properties: a full and truthful disclosure of all material facts in any transaction for the purchase or sale of rental properties is essential, and failing to fulfill this obligation can lead to substantial consequences for all parties involved. Please contact Anthony Marinaccio at amarinaccio@agclawfirm.com or at (562) 699-5500 for more information regarding these issues and other real estate or landlord-tenant matters.
[1] Barnes v. Morales 2010 WL 571968 (No. B214360) Cal. Ct. of Appeal, 2d Dist., Div. 3, February 19, 2010.
