In this unique period of declining property values, a flurry of litigation has arisen in the area of real estate appraisal. It used to be that once a borrower defaulted on a loan, a lending institution would foreclose and resell the property at the foreclosure sale for an amount sufficient to cover their interest in the property. Now, however, a lender that once had adequate security in the equity of a property securing a loan finds that at the time of foreclosure, the unpaid balance of the mortgage exceeds the value of the property. Coupled with the fact that foreclosures rise dramatically with increased unemployment, declining property values and generally bad economic times, lenders have looked to all sources to recoup their losses. That usually means that they will attempt to shift any losses to all others involved in the loan transaction. Since the borrower is protected by the anti-deficiency statute set forth in California Code of Civil Procedure, Section 580b and mortgage brokers are typically uninsured, appraisers have been the main target of this increasing area of litigation. So what exactly is the liability of an appraiser who is typically paid a nominal fee to perform a cursory appraisal in connection with the purchase or refinancing of real property?

Most often, claims against an appraiser are framed in terms of fraud, negligent misrepresentation and professional negligence based on allegations that an appraiser misrepresented the value of the property. However, all of these claims are not always readily available. With respect to negligence and negligent misrepresentation, the issue of duty must be analyzed first to see if there is any potential liability on the part of the appraiser assuming that the appraisal was inaccurate. This is done on a case by case basis but the critical factors in this assessment have been set forth in a series of judicial decisions on point.

In the landmark case which addresses appraiser liability, the Court of Appeal in Christianson v. Roddy (1986) 186 Cal.App.3d 780, held that an appraiser owes a duty only to those to whom or for whom the representation of value was made. The court refused to extend the duty to anyone else even when it is anticipated that the misinformation might reach others as long as their identity remains undisclosed.

This holding was confirmed in Nymark v. Hart Federal Savings & Loan Association (1991) 231 Cal.App.3d 1089. In that case, the court found that no duty was owed to a homeowner by an appraiser, because the appraisal was conducted for the lender to determine whether there was adequate security for the loan. The fact that the plaintiff paid for the appraisal report did not impact the court's decision.

Novel litigators first attempted to overcome the duty problem by arguing that the person or entity attempting to bring an action against an appraiser should be considered a third party beneficiary under the contract to perform the appraisal. However, in Gay v. Broder (1980) 109 Cal.App.3d 66, the court found that an appraiser owed no duty to a borrower who was denied a loan based on the inadequate appraised value of the property. As part of their analysis the Court found that the borrower did not qualify as a third party beneficiary to the appraisal. Although acknowledging that under certain circumstances a third party beneficiary status might exist, the court listed a number of factors which must be considered in determining that question.

Those factors include the extent to which the transaction was intended to affect the plaintiff, the foreseeability of harm to the plaintiff, the degree of certainty that the plaintiff suffered injury, the closeness of the connection between the defendant's conduct and the injuries suffered, the moral blame attached to the defendant's conduct, and the policy of preventing future harm. Clearly, a judicial weighing of these policy considerations would severely limit the applicability of a third party beneficiary argument in cases against real estate appraisers.

The liability of appraisers appears to have been extended somewhat in the case of Bily v. Arthur Young & Company (1992) 3 Cal.4th 370. There the Court found a duty to persons other than the client despite the fact that they found "as a matter of economic and social policy, third parties should be encouraged to rely on their own prudence, diligence and contracting power, as well as other informational tools. . . If, instead, third parties are simply permitted to recover from the auditor's mistakes in the client's financial statements, the auditor becomes, in effect, an insurer of not only the financial statements, but of bad loans and investments in general."

The court in Bily enumerated a lengthy list of professions in creating a narrow class of persons who, "although not clients, may reasonably come to receive and rely on an audit report and whose existence constitutes a risk of audit reporting that may fairly be imposed on the auditor. Such persons are specifically intended beneficiaries of the audit report who are known to the auditor and for whose benefit it renders the audit report. While such persons may not recover on a general negligence theory, they may...recover on a theory of negligent misrepresentation."

The Bily court went on to limit recovery even on a theory of negligent misrepresentation by requiring more than mere knowledge of the "ever present possibility of repetition [of the representation] to anyone, and the possibility of action and reliance upon [the information] on the part of anyone to whom it may be repeated."

This holding did expand the duty of certain professionals to those situations where it was foreseeable that the client or someone other than the client would rely on the information provided by the professional or in cases of fraud. While this appeared to extend liability beyond the holding in Christianson, the court clouded the applicability of their holding to appraisers by not including them in the list of professionals specifically enumerated in Bily. This despite the fact that the court cited Christianson with approval and the fact that appraisers were clearly considered based on the reference to Christianson.

In Industrial Indemnity Company v. Touche Ross & Company (1993) 13 Cal.App.4th 1086, the court reiterated the restrictive circumstances under which a third party could sue for negligent misrepresentations. There, the court was careful not to extend liability to that large class of persons who might reasonably be expected, sooner or later, to have access to the information and foreseeably take some action in reliance upon it without the knowledge or consent of the defendant.

Likewise, in the case of appraisers, it is reasonably foreseeable that the appraisal report may be circulated to any number of lenders without the express consent or knowledge of the appraiser. In fact, as one of its provisions, the standard appraisal form printed by the Department of Real Estate permits such dissemination of the report to large groups of persons. Although circulating an appraisal report is foreseeable, it does not create an unlimited duty to all such third parties as the courts in Bily, supra, and Industrial Indemnity, supra recognized.

Mortgage brokers frequently utilized by lenders, undertake a non-delegable fiduciary duty to the lender in the full disclosure of all material facts concerning the transaction that might affect the principal's decision. Mortgage brokers in turn hire appraisers to appraise the value of the property which is the subject of the loan transaction. Consequently, it is clear at this time that lenders relying on mortgage brokers risk giving up their rights against appraisers who misrepresent the value of the property used to secure a loan since they are not directly retained by the lender.

After overcoming the duty issue at the outset of a loan transaction, the next dangerous pitfall for the unwary lender is the manner in which the lender resorts to the security interest should a default occur.

Typically, a lender forecloses on the property securing the loan by entering a bid in an amount equal to the unpaid principal and interest of the mortgage debt, together with the costs, fees, and other expenses of the foreclosure. This is known as a "full credit bid". In the cases of Western Federal Savings & Loan Association v. Sawyer (1992) 10 Cal.App.4th 1615 and GN Mortgage Corp. v. Fidelity National Title Insurance Company of California (1994) 21 Cal.App.4th 1802, it was established that a full credit bid at the foreclosure sale will preclude further action by the lender, even as to third parties.

This was based on the fact that a full credit bid extinguishes the lien on the real property securing the loan. Since the lien is extinguished, the lender cannot maintain that its security interest was impaired. Consequently, no damages were suffered as a result of the improper appraisal or the foreclosure. (See also Commonwealth Mortgage Assurance Company v. Superior Court (1989) 211 Cal.App.3d 508.)

As with the issue of duty the courts have recently whittled away the applicability of the "full credit bid" rule. In the recent case of Romo v. Stewart Title of California (1995) 35 Cal. App. 4th 1609 [___ Cal. Rptr. ___] the Court of Appeal decided that although the full credit bid rule applies to third parties, the damages recoverable on both fraud and negligence theories are potentially greater than damages related to the impairment of the lender's security interest. Consequently, the theory of recovery and the damages sought dictate whether or not a full credit bid will eliminate a lender's claim against third parties.

Additionally, the Court of Appeal in Alliance Mortgage Company v. Rothwell (1994) 27 Cal.App.4th 218 created a split of authority at the appellate court level on issues relating to full credit bids. Division 2 of the First Appellate District chose not to follow the holding in Western Federal Savings (Division 7 of the Second Appellate District) or in GN Mortgage (Third Appellate District). Rather that court held that a full credit bid does not establish the value of the property as against third parties but only for the purpose of foreclosure proceedings against the borrower.

The court based part of their ruling on the fact that there is no policy upon which to permit a rule designed to protect debtors from the untoward effects of an economic downturn to be extended to insulate non-debtor tortfeasors from liability. The Court of Appeal in Alliance also found that the damages recoverable by the lender against a third party are different from those limited to the impairment of the security interest.

The Supreme Court of California has now reconciled this split in authority. In their recent review of the Alliance decision, the Supreme Court in addressing the issue of fraud only, agreed that fraud could be plead against a third party despite a full credit bid by the lender if: (1) the lender justifiably relied on the representations of the third party and the full credit bid was the proximate result of defendant's fraud; and (2) the lender suffered damages as a result of the fraud.

Additionally, the Supreme Court agreed with the underlying Court of Appeal in that a full credit bid does not constitute an admission of the property's value for use in immunizing wrongdoers from liability. Although they refused to comment on the proper measure of damages under such circumstances, the Supreme Court agreed that the measure of damages for fraud were different than simplify the impairment of the security interest in the property.

The issue of justifiable reliance will now be the pivotal issue in these cases. Since the Supreme Court has ruled that the full credit bid must have been proximately caused by the misrepresentation, entering a full credit bid where there is reason to doubt that the property's value is equal to or greater than the full credit bid may in fact preclude a subsequent suit against a third party. In those cases, the secured lender will only be able to recover by entering a bid for the fair market value of the property rather than a full credit bid.

Should a lender refrain from foreclosing on property in those cases where an inaccurate appraisal is suspected as the cause for the poor lending decision? Absolutely not! Under the holding in Slavin v. Trout (1994) 18 Cal.App.4th 1536, the statute of limitations on an action against an appraiser for a misrepresenta-tion of the value of real property does not begin to run until the lender resorts to its security interest in the property (through means of foreclosure or otherwise) and suffers actual damages. Failure to foreclose would result in a premature claim that is speculative at best and clearly not actionable.

In summary, a lender can bring an action against an appraiser if it directly retained the appraiser to conduct the appraisal report or if they are somehow identified as the entity for whom the appraisal report was prepared. This action can be maintained despite a full credit bid if the full credit bid is proximately caused by the fraudulent misrepresentations of the appraiser and the amount of recovery sought is in excess of the impairment of the lender's security interest.

Under those circumstances an appraiser could be subject to liability for all damages resulting from a lending decision based on an inaccurate appraisal. Considering the nominal fee charged by appraisers for conducting an appraisal, this result seems unfair. If the courts continue to increase exposure of appraisers and others in connection with loan transactions all consumers will lose because appraisal fees will have to rise dramatically to cover the additional costs and exposure to appraisers in the performance of their services. Hopefully, rising property values will resolve the predicament in which lenders and appraisers find themselves today, but until that occurs, lenders and appraisers should forge cautiously through the minefield of legal decisions governing their actions.