Fraud plays a major role in real estate lawsuits, but most of the time the issues aren’t intentional. Most people are sued for miscommunication and accidents, rarely over intentional negligence and purposeful fraud. It’s important to realize that everything that is stated will be interpreted by the listener. Courts have broken these issues into different “degrees” of fraud, to help define the problems they will create.
Description and Degrees of Fraud
It can be helpful to think of fraud as a spectrum. When we discuss the fraud spectrum, we’re discussing the intent of the person being accused of fraudulent activity. Here is a breakdown:
- Inadvertence. Something you do inadvertently is completely unintentional on your part. If we’re talking about a statement, it could be that you’re lying without even knowing you’re lying. See the example below for more details.
- Negligence. Broadly speaking, negligence is a failure to act. If reasonable precautions could have prevented a bad outcome, failure to take such actions is negligence.
- Gross negligence. Gross negligence is also a failure to act, but with a critical difference. Someone who is grossly negligent was aware of a possible hazard and took no action to correct it.
- Willful blindness. Someone who is “willfully blind” is aware of a problem but takes actions to appear not to know about it. They literally don’t want to know. Someone is willfully blind when they believe there’s likely a problem or danger, but they go out of their way to avoid direct knowledge of that problem.
- Deceptive intent. These are those obvious situations where a person sets out to deceive another, usually for money.
Understanding fraud is useful for understanding insurance. Most insurance companies will not cover gross negligence or fraud.
Examples of Different Degrees of Fraud
Now remember, most lawsuits you’re likely to face as a real estate investor are not the result of intentional fraud. But this spectrum is useful for showing how liability can attach with different levels of intention or involvement on your part. Here are some examples of what types of situations fall under different parts of this spectrum.
- Inadvertence. Let’s imagine you own a property for ten years, and a prospective buyer asks if there have ever been any problems with the flooring. You say no, and this is true to the best of your knowledge. You have never had any issues with the flooring in the ten years you have personally owned the property. But if it turns out that there were flooring issues prior to your ever owning the property, your statement could be considered inadvertent fraud.
- Negligence. The majority of claims against real estate investors have to do with negligence. A person may be found negligent for preventable, but not glaringly obvious and foreseeable, accidents. Insurance will sometimes cover negligence, but not the next level: gross negligence.
- Gross negligence. Gross negligence asserts that “you should have known and taken action to prevent this situation.” If you own a property in an area where mold is a common issue, failing to take action to prevent it could be considered gross negligence. Similarly, if your floor hasn’t been replaced in 50 years and someone goes crashing through it, gross negligence could apply. Or, at least that’s what your insurance company will say. The argument would be that a reasonable person would replace a 50-year-old floor.
- Willful blindness. Let’s stick with the mold example. This situation could escalate to willful blindness. Let’s suppose your tenant actually spots the mold, and you decide to not look into it at all. You ignore all calls from your tenant and maintenance staff, and take great measures to appear as if you weren’t aware of the issue. That is willful blindness.
- Deceptive intent. Once again, this is rare. The “Nigerian princes” and Bernie Madoffs of the world are operating with deceptive intent. In the real estate world, lying about returns on investments, selling properties that don’t actually exist, or otherwise knowingly and deliberately breaking the law are examples of deceptive intent. Deliberately covering up a known hazard instead of fixing it could also be interpreted as deceptive intent.
You might encounter any number of these situations as an investor. For now, the most vital information for you to know is that fraud and liability go hand in hand.
