Appraisal reports are an ordinary part of real estate transactions. Lenders follow certain criteria in connection with making loans secured by real property, particularly including the requirement of a "cushion" of equity to protect the Lender in the event of foreclosure. Thus, if the property does not "appraise" at a specified value, the Lender will not make any loan to the Borrower.
Generally speaking, Appraisers are hired by a broker or agent on behalf of the Lender, to whom the Appraiser prepares and submits the appraisal report. That report contains information and estimates concerning the subject property, which constitute representations on which the Lender relies in determining to make a loan.
Erroneous Appraiser Reports
What if the Appraiser's report is erroneous, and the Lender suffers loss on its loan? Can the Lender bring action against the Appraiser?
Traditionally, recovery on claims for fraud and breach of contract requires the Lender to establish that the Appraiser had performed the appraisal services directly for the Lender. This may not always be the case; for example, many transactions involve the use of a mortgage broker who may have hired the Appraiser directly as a part of brokering loans on behalf of investors.
In the matter of Christiansen v. Roddy, a 1986 California appellate court, supported the position that an Appraiser could not be held liable to the investors in the situation where the appraiser was hired by a mortgage broker (and not by the investors). The decision turned on the relationship of the Appraiser to the other parties in the transaction: since the Appraiser was hired by the mortgage broker, not the investors, the court determined that the Appraiser could not have intended that the investors rely on his representations of the value of the property.
Six years later, the California Supreme Court handed down its decision in Bily v. Arthur Young & Co., in which accountants were held liable to third parties who relied to their damage on audit reports which contained negligent misrepresentations. In that case, the Court determined that a provider of professional services (such as an accountant) could be liable to third persons who may receive and rely on the information in the professional's report.
Following the lead of the Supreme Court, a decision has been issued this year by a California appellate court, Soderberg v. McKinney, which holds appraisers liable to third party investors where the investor sustains damage due to an inaccurate appraisal.
The facts are not complex. National Home Loans, Inc., a mortgage broker, contacted a pension plan/investor to invest $75,000.00 in a second deed of trust on residential property located in Redondo Beach, California. The plan trustee was told that the appraised value of the property was $670,000.00 with a balance of $341,000.00 on the first deed of trust. An appraisal report prepared by Gary McKinney was provided to the plan trustee which confirmed the valuation of the property.
Relying on McKinney's appraisal, a $75,000.00 loan was made secured by a second deed of trust against the property. Unfortunately, the Borrower defaulted on both the first and second deeds of trust, and it was then that the plan trustee learned that the true value of the property was between $450,000.00 to $500,000.00. The plan trustee foreclosed the second deed of trust, but ultimately the first deed of trust was also foreclosed.
The plan trustee filed suit against the Appraiser and the mortgage broker, alleging fraud, negligent misrepresentation, concealment, and breach of contract. McKinney filed a motion for summary judgment (a request that the court grant judgment in his favor without the necessity of a full trial). The trial court granted the motion.
Appraiser Can Be Held Liable
The Court of Appeal reversed. Relying on the Supreme Court's decision in Bily, the appellate court held that an Appraiser who prepares an inaccurate appraisal report could be held liable for negligent misrepresentation to third party investors who make loans in reliance on the report. According to the appellate court, the Appraiser need not even know the name or specific identity of the potential investor or the details of the contemplated transaction; liability may be appropriate where the Appraiser "knows with substantial certainty that plaintiff, or the particular class of person to which plaintiff belongs, will rely on the representation in the course of the transaction."
Additionally, the Court of Appeal ruled that the third party investor might be able to state causes of action under breach of contract theory as "third party beneficiaries" of the contract between the mortgage broker (National Home Loans) and the Appraiser (McKinney), even though the investor's identity was not specifically named in the contract.
After Soderberg v. McKinney, the decision in Christiansen v. Roddy is of questionable value. The Soderberg case explained Christiansen as a case in which there was no evidence that the Appraiser knew his report would be used by third party investors and thus "may not have known what purpose his appraisal was intended to serve."
Nevertheless, the Soderberg decision now stands as authority permitting investors to recover damages from Appraisers who inaccurately value property.
Postscript: The Soderberg decision was handed down by the California Court of Appeal for the Second Appellate District (the greater Los Angeles area). On August 28, 1996, the Court of Appeal for the Fourth Appellate District (the greater San Diego area) handed down its decision titled Sorosky v. Hamill, a case involving facts similar to the Soderberg case. The Sorosky Court held that the private lender could recover against an Appraiser for damages sustained as a result of misrepresentations in the appraisal report, where the appraiser knew that the appraisal report would be delivered to a lender for the purposes of securing a refinance loan.
Clearly, exposure of appraisers to liability for damages arising from negligent misrepresentation is a trend which is being quickly endorsed by the California courts.