Is it Fraud for Owners and Real-Estate Agents to Fail to Disclose a Planned Taking in California?

freewayAuthor: Staff

In a recent California appellate case, DNI Food Service, Inc. dba Zaya’s Bistro v. Kim, the owner of a multi-tenant retail building in Los Angeles County was notified that two parcels of its land would be affected by a freeway expansion project. The building wasn’t located on either of the parcels, and there were five tenant vacancies.

Caltrans planned to take some land located between the street and building and create an easement over the sidewalk. Real estate agents working for the builder were communicating with Caltrans. At about the same time, these real estate agents advertised tenant space in the building, marketing the property on the basis of its location and its reduced rents. A food services company and its owner saw the ad and contacted the agents. They were hoping for a two-year lease but signed a five-year lease with a personal guarantee. The food services company spent money and time and opened a restaurant in the spot that they rented.

Just a couple of months later, Caltrans served an eminent domain complaint on the building owner and the food services company, among others. This was the first notice given to the food services company about the Caltrans Taking. A few months after getting the eminent domain notice, the owner of the food services company closed down the restaurant.

Update: You can read here about Koontz v. St. Johns River Management District, a significant 2013 US Supreme Court takings decision, and the subject of a law review article co-authored by Jarod Bona in the Georgetown International Environmental Law Review.

The food services company and its owner sued the real estate agents and the building owner, as well as others, on the theory that the agents should have disclosed the planned freeway expansion, since it affected the lease. They also claimed misrepresentation of historical rents by the agents.

The building owner and the agents filed a demurrer, which was sustained. A demurrer is a procedure to test whether a complaint pleads enough facts to state a cause of action. The food services company and its owner amended their pleading. Still, the agents’ next demurrer was sustained as to the claims for fraudulent deceit, intentional infliction of emotional distress, and fraud in the execution. In its ruling, the lower court reasoned that the failure to disclose the eminent domain proceeding wasn’t a material fact. Later, the court granted summary judgment, dismissing the last claim for a violation of the False Advertising Act.

The food services company and its owner appealed the ruling on the demurrer. On appeal, they argued that they’d adequately set forth facts that constituted fraud because the allegations established that the real estate agents owed them a duty to disclose the Caltrans Taking. The real estate agents argued that the taking wasn’t a material fact they were required to disclose, and the food services company hadn’t adequately pled reliance or causation.

The appellate court explained that to establish fraud, the claimants would need to establish:  (1) a misrepresentation or nondisclosure, (2) scienter or knowledge of falsity, (3) intent to defraud, (4) justifiable reliance, and (5) damages arising from that reliance. In California, a property owner owes a duty to disclose material facts that affect property value when these facts wouldn’t be known by the buyer; the seller’s real estate agent also owes this duty.

The appellate court explained that a fact is considered material if it affects a property’s desirability. In this case, the pleading alleged that the real estate agents knew about the planned taking but didn’t disclose it while also talking about the excellent location of the property. The trial court had found that the taking had a minimal impact on the lease’s value, so it couldn’t be considered a material fact. The exhibits of the claimant’s complaint showed the taking was minimal. Accordingly, the appellate court affirmed the lower court’s ruling that the taking didn’t create a duty to disclose.

The appellate court also found that the food services company didn’t owe rent until it opened, and the amount of money it owed was seriously reduced during the six months from the time it opened to the time it closed. Therefore, the court found that it was difficult to determine which allegations would be enough to show that the failure to disclose the taking caused the food services company’s damages, as opposed to the owner’s decision to close the business even before full rental payments needed to be made. For these and other reasons, the lower court’s ruling was affirmed.

Real-estate agents and property owners selling their property, however, should not take solace in this decision. If the taking had been material, they could have been found liable for fraud. So be careful about excluding facts from a listing that a buyer wouldn’t know, but would find to be important.

If you want to know the difference between eminent domain and inverse condemnation, you can read our Bona Law article.

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