Appraising Defenses

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                           The success of third-party claims against appraisers often
                           depends on determining who the appraiser’s clients are

                                       Most real estate appraisals are performed as              Under California law, USPAP is the generally accepted
                                       credit support for secured residential loans.         and recognized standard of appraisal practice and serves
                                       Since the crisis in the housing market, apprais-      as the foundation for arguments on the standard of care.1
                                       ers have found themselves under heightened            California requires licensed appraisers to be regulated
                                       scrutiny for their role in mortgage loan genera-      under USPAP.2 For federally regulated transactions—
                           tion, with particular focus on their precrisis valuations. This   which most lender-issued mortgage loans are—appraisers
                           has led to an increase in claims made against appraisers.         have to perform their appraisals in accordance with
                           Their risk of liability turns on a number of factors, includ-     USPAP,3 which provides guidelines on developing and
                           ing the type of appraisal, the contractual relationship (or       reporting the appraisal.4 USPAP also addresses other types
                           lack thereof) between the claimant and the appraiser, and         of written appraisals.5
                           the real estate appraisal standards applicable on the date
                           of the appraisal.                                                 Solving for Market Value
                               In the aftermath of the savings and loan crisis of the        USPAP defines an appraisal as “the act or process of devel-
                           1980s, appraisers formed the Appraisal Standards Board            oping an opinion of value.…”6 The appraiser is “one
                           to articulate and publish the generally accepted standards        who is expected to perform valuation services compe-
                           and rules for developing an appraisal and reporting the           tently and in a manner that is independent, impartial,
                                                                                                                                                               AMANE KANEKO

                           results of an appraisal. These standards, as interpreted and
                           amended in the years since their original publication, are        Lindsay McMenamin is a licensed real estate appraiser and asso-
                           known as the Uniform Standards of Professional Appraisal          ciate attorney at Gaglione, Dolan & Kaplan, a civil defense firm
                           Practice (USPAP).                                                 with offices in Los Angeles and Woodland Hills.

22 Los Angeles Lawyer January 2012
Los Angeles Lawyer January 2012 23
and objective.”7 The opinion of value in most       to-value ratio required by the lender. Similarly,   ware issue that an appraiser is not able to
residential appraisals is based on market           some recent claims against appraisers are           change and that should not be binding on the
value. Market value is defined as “a type of         brought by sellers of properties asserting that     appraiser.
value, stated as an opinion, that presumes the      they lost the sale of a property because the            Although a third party, usually the bor-
transfer of a property…as of a certain date,        appraiser’s opinion of value was not equal to       rower, may bring a negligence cause of action
under specific conditions set forth in the def-      or more than the purchase price.11 Attorneys        against the appraiser, only the client who
inition of the term identified by the appraiser      defending appraisers against these claims           retained the appraiser, or an intended user of
as applicable in an appraisal.”8                    therefore should emphasize the market data          the appraisal report, can succeed.17 Borrowers
    Appraisers preparing appraisals for resi-       available prior to the date of the appraisal as     may claim that the appraiser owes a duty to
dential mortgage loans typically are required       well as the definition of “market value.”            them because they paid for the appraisal,
to use standard forms that have been cre-               Complaints against appraisers frequently        but under USPAP, payment does not change
ated by secondary lender Fannie Mae/Freddie         contain causes of action for negligence, neg-       the client relationship.18
Mac. Different forms apply depending on             ligent and intentional misrepresentation,               Another area of focus for defendant
whether the property is, for example, a sin-        fraud, breach of contract (brought by either        appraisers should be the appraisal report’s lim-
gle-family residence, a multifamily property,       a contracting party or an alleged intended          iting conditions and certifications, which pro-
a condominium, a mobile home, or vacant             third-party beneficiary), civil conspiracy, and      tect the appraiser from liability and serve to
land. In appraising a single-family residence,      violation of various consumer protection            warn the client what information is and is not
the applicable form is the Freddie Mac Form         acts. Negligence and negligent misrepresen-         included in the appraisal report. Some of
70 March 2005/Fannie Mae Form 1004                  tation appear to be the most hotly contested.       these conditions include:
March 2005. (Fannie Mae/Freddie Mac are                                                                 • The appraiser is not responsible for legal
collectively referred to as a government-spon-      Negligence                                          matters that affect the property.
sored enterprise or GSE, and the form is typ-       To prevail on a negligence claim, the claimant      • The sketch is approximate.
ically called a GSE form.)                          must show duty, a breach of that duty, a            • The appraiser is not a surveyor or a home
    During the real estate boom of 2002             proximate causal connection between the             inspector.
through 2007, lenders increasingly relied on        negligent conduct and the resulting injury, and     • The appraisal was made under USPAP.19
the opinion of value in the GSE form to issue       loss or damage resulting from the negli-            Many of these conditions can be a defense
mortgage loans. These lenders also made             gence.12 Duty is often a critical element liti-     against complaints regarding such issues as
loans that required no verification of the bor-      gated in cases against appraisers. Appraisers       surveying, home inspection, construction
rower’s income or assets.9 Instead, the lender’s    provide opinions of value and as such are con-      defects, measurement errors, and encroach-
credit decision relied on an appraised value        sidered to be “professional information sup-        ments. In preprinted addenda, the GSE forms
that was for a specific date, typically the date     pliers.”13 Under California law, a profes-          include many of these conditions limiting the
the appraiser saw the property. In a time of        sional information supplier owes a duty only        extent of the appraiser’s duty.
steadily rising real estate values, lenders did     to the client, not third parties.14 The client is       After duty, another typical issue is rea-
not always consider what would happen if a          the particular person, or class of persons,         sonable standard of care. With this issue,
buyer defaulted and the value of the property       that the appraiser “knows with substantial          the best defense is a good offense. When the
declined.                                           certainty…will rely on the representation in        appraisal is difficult to defend, contributory
    In the years after 2007, however, real          the course of the transaction.”15                   negligence can help. Defense attorneys may
estate values have declined, borrower defaults          To determine whether the appraiser owes         argue that lenders failed to protect them-
have increased, and lenders have faced losses.      a duty to the claimant, the attorney defend-        selves. For example, did the lender comply
To try to recoup those losses, lenders made         ing the appraiser should first examine the           with its own underwriting criteria? The cri-
claims against appraisers mainly for the            engagement letter or appraisal order. The           teria may have required that the lender obtain
“inflated” values provided in appraisal             client and any intended users of the appraisal      an appraisal review (a summary review of the
reports. Borrowers have also brought similar        report should be clearly noted. If, for exam-       appraisal report by another appraiser) prior
claims against appraisers, contending that          ple, the plaintiff is the borrower, but the         to making the loan. Another question is
because the property value was inflated when         lender is the listed client, the defense attorney   whether the lender adequately verified that
the loan was issued, they were issued an            may argue that the appraiser owed no duty           the borrower could repay the loan. Loan
inflated loan that they could never repay.           to the borrower. USPAP defines an intended           underwriting experts can be retained to point
    In defending against these claims, it is        user as “the client and any other party as iden-    out red flags in the loan file that were ignored.
important to emphasize the definition of            tified, by name or type, as users of the            For example, did the lender question the
“market value,” particularly on a specific          appraisal…by the appraiser on the basis of          manicurist showing a monthly income of
date.10 Although the claimants typically con-       communication with the client at the time of        $15,000 on the loan application? Does evi-
tend that the appraised value was inflated at        the assignment.”16                                  dence appear in the loan file that the lender
the time the appraisal was made, in many                Attorneys defending appraisers should           sought any verification from IRS statements
instances the evidence for that claim is the fact   also be aware of a software issue that has          that $15,000 per month was normal for the
that years after the loan was made, the prop-       arisen on the GSE forms. Some of the soft-          applicant? Negligent underwriting that is
erty value is significantly lower. However, an       ware companies used by appraisers to input          not the fault of the appraiser can obtain a
appraisal is an opinion of value on a certain       data onto the required GSE forms continue           favorable outcome for the defense at trial or
date, not a representation that the value will      to include “client/borrower” on the cap-            mediation.
be stable.                                          tions on the top of the ancillary pages (the            Another defense may involve a battle of
    In a more recent twist, borrowers claim         photo page, addenda page, map page, etc.).          appraisal experts on the issue of whether the
that they cannot refinance their loan because        Borrowers have argued that this form lan-           appraiser followed the standard of care under
the appraised value of their home is too low.       guage shows that the appraiser’s client is the      USPAP. Was the valuation reasonable, based
Either the loan being refinanced is more than        borrower. Attorneys defending appraisers            on the comparable sales selected, the adjust-
the property value or it cannot meet the loan-      should be ready to explain that this is a soft-     ments made, and the limiting conditions cited?

24 Los Angeles Lawyer January 2012
If so, the appraiser fulfilled his or her duty.     weight than the specifically named users in the    judicial foreclosure sale and makes a full
    Finally, appraiser defense attorneys may       appraisal report is sometimes not enough to       credit bid at the sale, the lender has no loss
argue that there is no proximate causation. An     persuade the trier of fact. This warning also     to recover. Under California law, if the lender
attorney can argue that it was not the ap-         applies to the issue of the words “client/bor-    chooses to bid at the sale, “it does so in the
praisal report that caused the loan to default.    rower” appearing in the captions of the ancil-    capacity of a purchaser.”24 If the full credit bid
Rather, it was the failure of the borrower to      lary pages of the GSE appraisal forms.            is successful and results in the acquisition of
make payments as promised. Because the                Assuming that the plaintiff is able to suc-    the property, “the lender pays the full out-
appraiser is not the proximate cause of the        cessfully establish that he or she belongs to a   standing balance of the debt and costs of
lender’s loss, the negligence claim fails.         class that can rely on the appraisal, the next    foreclosure to itself and takes title to the
                                                   potential defense for an appraiser centers on     security property, releasing the borrower
Negligent Misrepresentation
A species of the tort of deceit, negligent mis-
representation is distinct from negligence.20
The elements of negligent misrepresentation
are 1) the defendant made a representation of
an important fact, 2) the representation was
not true, 3) the defendant made the repre-
sentation without any reasonable ground for
believing it to be true, 4) the representation
was made with the intent to induce reliance,
5) the plaintiff acted in justifiable reliance
upon the representation, and 6) there was a
    For an appraiser, negligent misrepresen-
tation is typically more difficult to defend
against than negligence, because of the ambi-
guity of which third-party plaintiffs may be
legally entitled to bring a claim. Unlike neg-
ligence claims, a third party who is neither the
client nor a specifically identified intended
user can still sue for negligent misrepresen-
tation if the third party can show that it
belongs to a particular class of persons to
whom or for whom the representations were
made.22 When the appraiser’s client was a
lender, this third party is often another lender
that purchased the loan.
    The appraisal agreement (or the order
and limiting conditions in the appraisal
report) can help the defense by specifically
naming the client and all intended users. If the   the requirement that the misrepresentation be     from further obligations under the defaulted
plaintiff’s name does not appear on the agree-     one of fact. An appraiser can argue that his      note.”25 As such, after a full credit bid, the
ment, the argument can be made that there          or her opinion of value is an opinion, not a      lender cannot pursue any other remedy
was no reasonable belief that the plaintiff        fact, and that the appraiser believed that        regardless of the actual value of the property
would rely on the report.                          opinion to be true at the time. After this        on the date of sale.26 Thus the lender is pre-
    The GSE forms, however, contain a              defense is presented, another battle of the       cluded from collecting its debt from an
preprinted certification that damages this         appraiser experts is likely to ensue about the    appraiser by claiming that the property was
defense. Certification 23, which was added on       value of the property, the comparable sales       actually worth less than the bid.27 Few full
the GSE form in March 2005, arguably               selected, and the adjustments made.               credit bids are made, but when they are, this
undermines an appraiser’s argument that                Defense attorneys should be aware, how-       defense is typically successful.
reliance is limited to only the named intended     ever, that in California, contributory negli-        Another defense issue is insurance policy
users. The certification reads:                     gence is usually not a defense against negli-     limits, which come into play in settlement
    The borrower, another lender at the            gent misrepresentation.23 However, the same       negotiation and trial. As housing values rose,
    request of the borrower, the mortgagee         facts that may establish contributory negli-      many appraisers did not raise their insur-
    or its successors and assigns, mort-           gence may be used to prove that the reliance      ance policy limits. Appraisers may still have
    gage insurers, government sponsored            was unreasonable. An appraiser’s defense          a policy limit as low as $300,000, which was
    enterprises, and other secondary mar-          attorney can argue that reasonable and pru-       adequate when housing values in many local
    ket participants may rely on this              dent underwriting was ignored by the lender.      markets ranged no higher. During the bubble,
    appraisal report as part of any mort-          Similarly, the defense can argue that there is    that range was more often exceeded, expos-
    gage finance transaction that involves          no proximate cause, since the lender’s loss is    ing appraisers to liability in excess of policy
    any one or more of these parties.              from a borrower default, not from the             limits. Settlement talks therefore take policy
    This certification is often part of the con-    appraisal opinion.                                limits into consideration. Most errors and
tentions in complaints. A defense argument             Finally, a defense attorney may attack the    omissions insurance policies have diminish-
that boilerplate should not be given more          loss. If the lender forecloses through a non-     ing limits in which the defense fees and costs

                                                                                                                       Los Angeles Lawyer January 2012 25
                                               are counted against the policy limit. The          Dodd-Frank Act will affect appraiser liabil-
                                               insurance carrier therefore has to weigh the       ity, it appears that appraisers are likely to
                                               cost of defense against exposing the appraiser     face more claims in the future. Appraisers
                                               to a judgment at trial.                            need to remain current with the legislation,
                                                                                                  statutory codes, and appraisal forms and
                                               The Dodd-Frank Act                                 software in order to be able to better defend
                                               The defense tactics described above apply to       their appraisals and opinions of value. This
                                               appraisals written between 2003 and 2008           will take detailed work files and adding more
                                               under the guidelines in place at that time.        limiting conditions and certifications that
                ER OF           THE ★★★
        ★★★ WINN
                                               The recent mortgage meltdown, however,             specifically address all issues and conditions
                         SERVICE AWA           has resulted in new rules for appraisers, and      affecting each appraisal report. With that,
      COMMUNIT Y                    e
                     ice Panel of th           these rules are for the most part untested in      attorneys can better defend their appraiser
        Criminal Just          ’s O ffice      court. In March 2008, for example, Freddie         clients.                                    ■
                  City Attorney
      Los Angeles                              Mac, the Federal Housing Finance Agency,
                                               and the New York State Attorney General            1 THE APPRAISAL FOUNDATION, UNIFORM STANDARDS
                                               issued the Home Valuation Code of Conduct          OF  PROFESSIONAL APPRAISAL PRACTICE U-1 (2010-11)
                                               (HVCC) to enhance the independence and             [hereinafter USPAP].
                                                                                                  2 BUS. & PROF. CODE §§11300 et seq., 11319.
                                               accuracy of appraisals.28 The purpose of this      3 The Financial Institutions Reform, Recovery, and

   Be an attorney                              new standard is to maintain a separation
                                               between risk management and loan produc-
                                                                                                  Enforcement Act of 1989, Pub. L. No. 101-73, 103 Stat.
                                                                                                  183 (1989) (incorporating USPAP). See also 12 U.S.C.

   who makes a                                 tion. This has resulted in the rise of Appraisal
                                               Management Companies (AMCs), which act
                                                                                                  §3339; 12 C.F.R. §225.64.
                                                                                                  4 USPAP, supra note 1.

     difference                                as intermediaries between the lender and the
                                               appraiser. To protect themselves, AMCs often
                                                                                                  5 Id.
                                                                                                  6 Id., Definitions, Appraisal.
                                                                                                  7 Id., Definitions, Appraiser.

                                               have contracts that include the appraiser’s        8 Id., Definitions, Market Value.
          Volunteer with the                   agreement to indemnify the AMC should a            9 U.S. Regulator to Sue Major Banks over Mortgages,

               LACBA                           claim be filed. Appraisers are advised not to       L.A. TIMES, Sept. 2, 2011.
                                                                                                  10 Freddie Mac Form 70 (Mar. 2005)/Fannie Mae
          Domestic Violence                    sign these contracts, which increase their
                                                                                                  Form 1004 (Mar. 2005), Definition of Market Value
                                               exposure to liability. Most errors and omis-
               Project                                                                            [hereinafter GSE form].
                                               sions insurance carriers for appraisers do not     11 Mitra Kalita & Carrick Mollenkamp, Judgment

                                               cover such claims. The era of the HVCC             Call: Appraisals Weigh Down Housing Sales, WALL ST.
     We provide one-on-one legal               appears to have ended, however, with the           J., Aug. 12, 2011.
                                                                                                  12 Carleton v. Tortosa, 14 Cal. App. 4th 745, 754
     assistance to our clients to enable       Dodd-Frank Act,29 which went into effect
     them to obtain temporary (and                                                                (1993).
                                               in November 2010.                                  13 Bily v. Arthur Young & Co., 3 Cal. 4th 370, 406
     ultimately permanent) Restraining             That act includes many of the provisions       (1992).
     Orders against their assailants.          that appear in the HVCC and is still under-        14 Id.
                                                                                                  15 Soderberg v. McKinney, 44 Cal. App. 4th 1760,
                                               going scrutiny. The act requires anyone
                                               reviewing appraisals to file a state board         1768 (1996).
     This is a rewarding opportunity (with                                                        16 USPAP, supra note 1, at U-3.
     a minimal time commitment) to give        complaint against any appraiser who has            17 Soderberg, 44 Cal. App. 4th at 1766.

     valuable assistance to an under-          prepared an appraisal report that appears to       18 USPAP, supra note 1, Frequently Asked Questions,

                                               be below the standard of care. 30 Many             at F-44, Item 93, Payment by a Party Other Than the
     represented population of our
                                               appraisers are critical of this measure for        Client.
     community who is in dire need of                                                             19 GSE form, supra note 10, Statement of Assumptions
                                               being overbroad and lacking due process.
     help.The Project is located in both the   Should someone who knows little about              and Limiting Conditions: Appraiser’s Certification.
                                                                                                  20 Bily v. Arthur Young & Co., 3 Cal. 4th 370, 407
     Downtown Los Angeles and                  appraisals, such as a borrower, be obliged to      (1992).
     Pasadena Branches of the Superior         file a state board complaint? Other potential       21 CACI 1903; Fox v. Pollack, 181 Cal. App. 3d 954,

     Court.                                    claimants are reviewers of appraisals, who         962 (1986).
                                                                                                  22 Soderberg, 44 Cal. App. 4th at 1771.
                                               often are competitors of the appraiser they
                                                                                                  23 3 LEVY, GOLDEN, SACKS, CALIFORNIA TORTS §§40.11,
     No prior experience is required. No       are reviewing. Some appraiser reviewers are
                                                                                                  40.48.11-40.48.12 (2007). See also 5 WITKIN, SUMMARY
     ongoing representation is required        from a state in which the property is not          OF CALIFORNIA LAW, Torts, §820, at 1183 (10th ed.
     although volunteers have the option       located and have little knowledge about the        2005).
     of representing their clients at the      area in question. Under what criteria should       24 Passanisi v. Merit-McBride Realtors, Inc., 190 Cal.

                                               they file a complaint and interfere with the        App. 3d 1496, 1503 (1987).
     time of their hearing.                                                                       25 Alliance Mortgage Co. v. Rothwell, 10 Cal. 4th
                                               appraiser’s business? While waiting for the
                                                                                                  1226, 1238 (1995).
                                               state board’s findings, an appraiser can lose       26 Passanisi, 190 Cal. App. 3d at 1503.

      FOR INFORMATION CONTACT                  a substantial amount of work, especially           27 Alliance Mortgage Co., 10 Cal. 4th at 1238.

                                               since many lenders will not give assignments       28 Home Valuation Code of Conduct, available at
              Deborah Kelly                    to appraisers with a record of a state board
            Directing Attorney                 complaint. A state board complaint also            _valuationcodeofconduct.pdf.
                                                                                                  29 Dodd-Frank Wall Street Reform and Consumer
                                               costs money to defend, and the stakes are
            tel 213.896..6491                                                                     Protection Act, Pub. L. No. 111-203, §1471, Property
                                               high, since an unsuccessful outcome can            Appraisal Requirements (2010).
         e-mail               cause a civil action to be filed against the        30 Id. at §1472, Appraisal Activities, adding §129E(e),

                                               appraiser.                                         Mandatory Reporting, to the Truth in Lending Act, 15
                                                   Although it is unknown how exactly the         U.S.C. §1601, ch. 2.

26 Los Angeles Lawyer January 2012

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