Avoid Risk by Avoiding Promises: An E&O Best Practice

Our errors and omissions (E&O) insurance experts have gathered a host of real-world scenarios to illustrate how important risk management is in the protection of your small business. By following standard business policies, practices, and guidelines, you can complement your insurance coverage and decrease the risk of a claim.

Follow along with this real estate agent who progressed too far with promises and guarantees, and uncover the perilous consequences.

Professional liability insurance (or errors and omissions) protects you and your business in the event you make a mistake, or a client believes you did, and you’re taken to court.

If you’re a practicing real estate professional, you know it’s easy to fall into the trap of making a property sound better than it really is. An extra adjective or two can make an average property sound like the best thing since sliced bread. But when real estate agents cross over into blatant promises of profitability, performance, or future value, the risk of a claim and unwanted litigation becomes excessive.

Guarantees can lead to problems.

A real estate agent marketed a commercial property that included street-level retail and residential units on the upper two floors. The residential units were producing a steady stream of revenue, since they were occupied by longtime residents who were making timely rental payments. However, the owner of the property operated a failing business on the ground level and was eager to sell the entire building before the mortgage holder began foreclosure actions.

The real estate agent was overly optimistic about the location of the property and erroneously believed that the street level retail could be successful. In addition, the agent felt the residential rents could be increased, since the tenants were comfortable living there and were unlikely to move.

While working with a prospective buyer, the real estate agent guaranteed the buyer’s greeting card business would generate a positive cash flow with the street-level retail and promised the residential tenants would absorb an increase in their monthly rent.

Misrepresentation can lead to a lawsuit.

Given these assurances, the buyer decided to acquire the property and notified the tenants of their respective rent increases shortly after the close of escrow. Within the first few months, four of the six tenants told the new owner they were unable to pay the increased rent and were moving. The buyer experienced difficulty in finding new tenants willing to pay what was needed to make the residential component successful.

Compounding the problem, the buyer’s greeting card business was not seeing the desired foot traffic and corresponding revenue. Over the ensuing months, the status of the business remained unchanged, so the buyer sued the real estate agent, alleging that he intentionally misrepresented the property’s profit potential. Damages sought included lost business profits and lost rental income. The parties ultimately resolved the litigation for $50,000 in lieu of enduring a two-week trial.

Make no promises about future value.

Agents should never make promises or guarantees about the revenue potential or future value of any property marketed for sale. Acting outside their scope of expertise is a dangerous proposition, and such tasks should be left to a buyer as part of their due diligence obligation. Agents should always recommend in writing that buyers seek the counsel of qualified accounting and financial planning experts to help them make decisions on whether to acquire revenue-producing property. Following this practice will not only result in satisfied buyers but will help avoid unwanted litigation.

Most real estate errors and omissions policies do not provide coverage for claims arising out of promises, warranties, or guarantees of the future value of property, or the income potential or performance of a business. A lack of coverage can make this kind of mistake even costlier.

For more practical risk management tips for real estate professionals, visit our E&O Risk Management Video Library.

Lisa Scoble is Pearl’s Vice President of Programs managing our Real Estate Errors and Omissions Program. She holds her Certified Insurance Counselor (CIC) and Certified Risk Manager (CRM) designations from the National Alliance, is a member of the Professional Liability Underwriting Society (PLUS), and holds a real estate license in Michigan. For questions regarding this blog post or other professional liability insurance matters, she can be reached at 309.679.0508 or via email at lisa.scoble@pearlinsurance.com.