This is the property of the Daily Journal Corporation and fully protected by copyright. It is made available only to Daily Journal subscribers for personal or collaborative purposes and may not be distributed, reproduced, modified, stored or transferred without written permission. Please click "Reprint" to order presentation-ready copies to distribute to clients or use in commercial marketing materials or for permission to post on a website. and copyright (showing year of publication) at the bottom.

general / Real Estate

Advice to your broker clients to protect themselves from liability for cyber fraud

Shutterstock

There is likely no more enticing place for a thief to commit cybertheft than in California due to our real estate prices. And, all parties involved in the sale of property (whether purchaser, seller, agent, broker or escrow) are subject to potential hacking in an attempt to divert funds. This article provides advice to offer to brokers to avoid liability for cyber fraud.

In June 2016, the California Association of Realtors issued a new form titled "Wire Fraud Advisory" due to the drastic increase in wire transfer fraud targeting real estate transactions. Yet, as a fiduciary, a well-meaning broker may be inclined help their client close escrow by facilitating the transfer of the down payment. For example, the broker may confirm that wire instructions from escrow are correct. However, an inevitable problem arises when the instructions that the broker confirm are, in fact, the fake instructions.

A strikingly similar situation arose recently in a federal district court case in Kansas. In Bain v. Platinum Realty, LLC, 16-2326-JWL (D. Kansas Feb. 14, 2018), plaintiffs sought to purchase a house. Plaintiffs had their bank wire the purchase funds to a bank account that they thought was the sellers' account. Unfortunately, it was actually some unknown criminal's account who unlawfully entered the transaction by using fake email accounts that appeared to be similar to accounts used in the transaction. The plaintiff buyers wired the money based on wiring instructions that were attached to an email account purportedly from the seller's broker's account. Having lost their money, the buyers sued the seller's real estate agent and her employer claiming that an unknown criminal hacker intercepted an email from the title company to the real estate agent that contained the actual wiring instructions, altered the instructions to redirect the funds, created an email address similar to the title company, and sent the new fake wiring instructions to the agent, who then forwarded them to one of the buyers.

For some reason, the plaintiffs did not oppose the agent's motion for summary judgment as to plaintiffs' negligence and breach of fiduciary duty claims. Relying upon a California case, the agent argued at summary judgment that negligent misrepresentation requires a "positive assertion," not an implied assertion. As argued, the agent forwarding an email was not sufficient. The court denied the motion, holding that Kansas law differed from California law. The jury found against the broker and the employer at trial. But was the agent right that the case would have turned out differently under California law?

Is the broker liable for enabling the wire fraud?

Both the principal's broker and the other side's broker may be liable for even inadvertently enabling wire fraud. The principal's broker is a fiduciary and owes the principal a duty to exercise reasonable skill and care in the exercise of agency duties. As fiduciaries, their clients are entitled to rely upon the information given to them by their broker. Thus, the client's broker may be liable for confirming that the fraudulent email is valid. Salahutdin v. Valley of California, Inc., 24 Cal. App. 4th 555, 562 (Cal. App. 1st Dist. April 28, 1994). As a fiduciary, the broker has a duty to verify information before transmitting it to the principal or inform the principal that the information is not verified. Thus, the client's broker may also be liable on a constructive fraud theory if he serves as a conduit by simply forwarding the fraudulent email because it implies that the fraudulent email is valid.

If the other side's broker inadvertently misleads the client, then he would not be liable for constructive fraud because it is limited to confidential and fiduciary relationships. However, he may be liable for negligent misrepresentation if he represents that the fraudulent email is valid without reasonable grounds for doing so. But the broker likely would not be liable for negligent misrepresentation for merely serving as a conduit for the hackers (i.e., forwarding the email without confirming that it's valid) because negligent misrepresentation has to be based on an affirmative statement; it cannot be implied. See Byrum v. Brand, 219 Cal. App. 3d 926, 941 (Cal. App. 4th Dist. April 20, 1990); Yanase v. Automobile Club of Southern Calif., 212 Cal. App. 3d 468, 473 (Cal. App. 4th Dist. July 21, 1989).

In sum, whether Bain would turn out differently in California depends on the facts.

Can the broker exempt his responsibility to his principal for enabling wire fraud?

The next issue is whether the broker can exempt himself from liability through either the wire fraud advisory warning or a separate exemption clause. The broker cannot exempt his conduct if he is sued for negligent misrepresentation. Section 1668 of the Civil Code provides, "All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law." This section applies to both intentional and negligent misrepresentation claims. See Continental Airlines, Inc. v. McDonnell Douglas Corp., 216 Cal. App. 3d 388 (Cal. App. 2nd Dist. Dec. 7, 1989).

But Section 1668 does not necessarily prevent a broker from exempting liability for his ordinary negligence as opposed to fraud. While there may be conflicting cases on the issue, Witkin concludes that California now follows the modern view of the Restatement of Contracts which states that, "a contract exempting from liability for ordinary negligence is valid where no public interest is involved ... and no statute expressly prohibits it." Gardner v. Downtown Porsche Audi, 180 Cal. App. 3d 713, 716 (Cal. App. 2nd Dist. May 2, 1986).

In Tunkl v. Regents of University of California, 60 Cal. 2d 92 (1963), the California Supreme Court set forth six characteristics typical of contracts affecting the public interest: (1) it concerns a business of a type generally thought suitable for public regulation; (2) the party seeking exculpation is engaged in performing a service of great importance to the public, which is often a matter of practical necessity for some members of the public; (3) the party holds himself out as willing to perform this service for any member of the public who seeks it, or at least any member coming within certain established standards; (4) as a result of the essential nature of the service, in the economic setting of the transaction, the party invoking exculpation possesses a decisive advantage of bargaining strength against any member of the public who seeks his services; (5) in exercising a superior bargaining power the party confronts the public with a standardized adhesion contract of exculpation, and makes no provision whereby a purchaser may pay additional fees and obtain protection against negligence; and (6) finally, as a result of the transaction, the person or property of the purchaser is placed under the control of the seller, subject to the risk of carelessness by the seller or his agents. The Supreme Court emphasized a contract could involve the public interest even if it did not meet each and every one of these six criteria.

The Tunkl analysis has been applied to real estate transactions with differing results. In Akin v. Business Title Corp., 264 Cal. App. 2d 153 (Cal. App. 2nd Dist. July, 18, 1968), the Court of Appeal held that an exculpatory clause in an escrow holder's contract was invalid. Applying the Tunkl factors, the court reasoned that: (1) the business was publicly regulated; (2) the escrow company performed an important public service; (3) the company had a decisive advantage of bargaining strength, presented a standard adhesion contract of exculpation, and there was no provision for paying an additional reasonable fee for additional protection from negligence; and (4) as a result of the transaction, plaintiff was placed under the control of the escrow company and subject to the risk of its carelessness.

The Court of Appeal reached the opposite conclusion in Rooz v. Kimmel, 55 Cal. App. 4th 573 (Cal. App. 1st Dist. June 4, 1997). In that case, an escrow company failed to timely record a deed of trust. The escrow company had agreed to perform "an accommodation recording," which "means the title company is recording the document without liability since no title insurance will be issued to cover the transaction," on the condition "the principals sign accommodation instructions and an indemnity agreement absolving [the escrow company] of liability in connection with the recording." After analyzing the Tunkl factors, the Rooz court determined that the indemnity and hold harmless agreement was not void for violating public policy. In doing so, the court noted that "[t]he Akin court did not hold ... that all transactions conducted by title companies necessarily affect the public interest."

The issue of whether a broker could exempt himself from liability for negligence arose in a single unpublished decision: Kelly v. Arias, B189264 (Nov. 6, 2007). In that case, the plaintiff alleged that her commercial real estate broker negligently prepared an agreement in connection with the plaintiff's sale of real property. While plaintiff prevailed, she challenged the contractual limitation on damages. Plaintiff's argument presumed that a commercial contract provision limiting to a non-nominal amount the economic damages recoverable in an action for breach of duty may be challenged as an invalid exculpatory clause under Civil Code Section 1668 using Tunkl's public policy analysis. Assuming arguendo that the Tunkl analysis was relevant, the Kelly court held that there was no basis for invalidating the provision. The court reasoned that there is no "great importance to the public" in the typical private real estate transaction. Moreover, given that it was not a residential home, the services were not so essential that the broker had a decisive advantage in bargaining strength. And, although it was a pre-printed form contract, there was no evidence that it could not have been negotiated.

The author does not agree entirely with Kelly's analysis. Whether an exemption clause for brokers (residential or commercial) would withstand scrutiny is factually intensive. Applying the Tunkl factors: (1) commercial and residential brokers are regulated; (2) the author agrees that the typical private transaction (whether commercial or residential) is not of "great public importance"; (3) brokers hold themselves out to all persons for both residential and commercial purposes, which weighs in favor of finding a public interest; (4) the Kelly court implied that it may have ruled differently if it were a residential house due to the fundamental need for housing versus the need for a commercial property. This may be a false distinction. Absent a commercial property, the individual may not be able to afford the residential house; and the fifth and sixth factors will always be factually intensive. In sum, the first, third and fourth factors favor a finding that an exemption clause would violate the public interest. The second factor weighs against it. And, the final two factors depend on the circumstances.

Conclusion

In conclusion, the best advice to brokers is to have buyers and sellers work directly with escrow for the purchase of property without interference. When in doubt, direct them back to escrow. There is no reason that a broker, as opposed to escrow, should confirm or even forward wiring instructions. Any interference (even the simply well-intentioned confirmation of the validity of an email) could result in liability.

#440

Ilan Isaacs

Associate Legal Editor
ilan_isaacs@dailyjournal.com

Related Tests for Real estate

general/Real Estate

Residential Solar Rights

general/Real Estate

New EU-US data privacy regime raises the bar

By Everett Monroe

general/Real Estate

The ABCs of UDs

By William D. Dodson

general/Real Estate

Elements of unlawful detainers

By William D. Dodson

general/Real Estate

Eminent Domain Under Review