In the wake of the housing market crash, the public has been inundated with stories of homeowners facing foreclosure, banks closing and once-successful real estate agents and appraisers struggling to make ends meet. As the government and media strive to determine who and what is to blame for this country’s financial crisis, the professionals who continue to work in the real estate industry find themselves operating in an ever-increasing litigious environment. Real estate appraisers, specifically, are routinely expected to sign engagement agreements with lending institutions containing indemnity provisions. A common indemnity provision looks like this:
Appraiser shall indemnify Bank and defend and hold Bank and its affiliates
harmless from and against any and all liabilities, damages, costs and expenses
(including all reasonable legal fees) asserted by a third party arising directly out
of or directly relating to any claim, action or other proceeding based upon the acts
or omissions of Appraiser.
Typically, an indemnity provision requires the appraiser to indemnify the lender in the event the lender is sued by a disgruntled homeowner based on allegations of an inaccurate appraisal. For better or for worse, the inclusion of indemnity provisions is now fairly common. As such, this article seeks to educate real estate appraisers about the potential legal liability they assume each time they perform an appraisal.
Tips to minimize the downside of indemnity provisions
First, it is crucial to recognize that a standard indemnity provision will generally be legally enforceable. Under basic contract law, a court must interpret and enforce contract provisions based on the plain meaning of the language used, and on the intent conveyed by the contracting parties. Indemnity provisions are no exception to this rule. Accordingly, when an appraiser enters into an engagement agreement with a lending institution that contains a clear and unambiguous indemnity provision, wherein the appraiser agrees to indemnify the lender for expenses and costs incurred as the result of a homeowner’s claim alleging inaccurate appraisal work, the appraiser legally obligates him/herself to indemnify the lender. Based on the express language of the indemnity provision, the court will most likely uphold the validity of and enforce the terms of the engagement agreement.
Given the enforceability of indemnity provisions, and given the fact that many lending institutions require an indemnity provision in their engagement agreements, appraisers should make every effort to negotiate the terms of the indemnity provision to limit their liability. For example, an appraiser should insist that the indemnity provision contain a “notice requirement.”
By requiring the lender to notify the appraiser within a specified time period following the occurrence of an “indemnifiable event,” the appraiser conditions his obligation to indemnify the lender upon the lender fulfilling its obligation to provide timely notice. Additionally, an appraiser should insist that the “indemnifiable event” triggering the indemnity provision be expressly defined as “any and all action” taken by a third-party with respect to the validity of the appraisal. “Any and all action” should be further defined to include something as simple as a homeowner emailing the bank questioning the appraisal, to something as complex as the homeowner filing a lawsuit. If the bank fails to provide timely notice, the appraiser will have a defense to assert against the ensuing indemnity claim.
An appraiser should also insist that the enforcement of the indemnity provision be restricted to claims brought by third parties. In doing so, the appraiser prevents the lender from seeking indemnification of attorney fees and legal costs it may incur while trying to enforce the indemnity provision against the appraiser. Because the courts in each state differ in their willingness to infer that a vague indemnity provision applies to the contracting parties as well as to third-parties, it is imperative that the indemnity provision be unmistakably clear in its application to only third-party claims.
An E&O insurance policy will minimize the risk
The most common way appraisers can limit their personal liability is through the purchase of “errors and omissions” (“E&O”) insurance. Generally speaking, an E&O policy will cover a claim asserted by a lender where the appraiser fails to comply with the standard of care in rendering the opinion of value.
Additionally, in states that allow claims directly by a property owner, an E&O policy typically insures those claims as well. The indemnity provision however, may create a hurdle where a property owner sues the bank and the bank, in turn, sues the appraiser. A common provision in E&O policies excludes claims arising out of a contract. A relatively common exclusion provides that the policy will not cover claims:
[b]ased on or arising out of liability assumed
by the named insured under any contract
or agreement, unless such liability would
have attached to the named insured even in
the absence of such contract or agreement.
Based on this language, some carriers will deny coverage altogether, especially if the only claim asserted against the appraiser is the indemnity claim without a separate claim for negligence. Alternatively, and more common, a carrier will defend under a reservation of rights in this scenario. In other words, the insurer will pay for the defense of the appraiser. However, if ultimately there is a judgment or verdict against the appraiser for the excluded acts, that judgment would not be covered.
Appraisers should also take note that insurers are increasingly writing policies to exclude coverage for actions brought by the FDIC, including outright exclusions for FDIC actions or by imposing sublimits within the policy. Following the high rate of bank closures in 2008-2009, came a rising rate of FDIC actions against appraisers. While fear of FDIC actions has plagued the appraisal industry over the past few years, there may be relief in sight. First, as the economy continues to recover, fewer banks will close, thereby reducing the number of potential actions for the FDIC to pursue. Second, the FDIC generally has three years to pursue legal action against an appraiser it alleges contributed to the failure of a bank, starting from the date of the bank’s closure. As time passes, the FDIC’s statute of limitations will run, and the frequency of FDIC actions should diminish accordingly, thereby reducing the impact of the FDIC exclusion.
Do your job well to avoid potential claims
Real estate appraisers must proceed with the utmost caution in today’s market. While an appraiser can reduce his/her risk of liability through the purchase of E&O insurance or a carefully drafted indemnity provision, the best way to reduce one’s liability is to disregard pressure from the lending institution to report a specific appraisal amount and perform thorough, well-researched appraisals, which homeowners and banks will ultimately find difficult to challenge.
Richard V. Mack is a member of Mack, Watson & Stratman, P.L.C. He is a State Bar Certified Real Estate Specialist and AV rated by Martindale Hubbell. He has also been designated as a Southwest Super Lawyer and is a member of Arizona’s Finest Lawyers. Mr. Mack also serves on the Arizona State Bar Real Estate Advisory Commission, which oversees the Real Estate Specialization Program. He can be reached at [email protected]
Dax R. Watson is a member of Mack, Watson & Stratman, P.L.C. He focuses his practice in the area of professional liability defense. Mr. Watson is a seasoned litigator and trial attorney, having successfully defended professionals in numerous trials. He can be reached at [email protected]