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Appraiser's liability: an overview.

As many accounting firms now offer appraisal as an auxiliary service, this may add to the liability problems the accounting profession already faces. In response to the bank and insurance crises, states are now regulating real estate appraisers. Prior to this, there was so little regulation that an individual could enter the business virtually by hanging out a shingle, with little more than a business license. The entry of the big six accounting firms into the appraising service in the 1980s increased competition and probably helped raise educational standards.(1) Originally, appraiser's liability was primarily rooted in contractual privity--which is the relationship between contracting parties--with very little responsibility to the public. Courts are now applying the concept of negligence and increasingly eroding the privity barrier. Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) establishes guidelines for state certification and licensing of real estate appraisers. Under these guidelines, states are encouraged to establish independent regulatory agencies to license and certify appraisers, with the ideal system being independent of other sectors of the real estate industry. According to the guidelines, an appraiser is required to pass an appropriate state examination and to meet the certification standards of the Appraiser Foundation's Appraiser Qualification Board. States are encouraged to recognize licenses or certifications already awarded under standards meet the Title XI requirements, but are not allowed to grandfather existing appraisers into the system. Due to conflicting state regulations, problems of reciprocity and multiple engagements are now surfacing.(2)

This article examines the current federal and state regulation of real estate appraisers. It explores various aspects of appraiser's liability and examines some current cases. Finally, some implications for the accounting profession are noted.

FIRREA Regulation

Title XI of the Financial Institutional Reform, Recovery, and Enforcement Act of 1989 requires that any real estate appraisal made in connection with a federally related transaction after July 1, 1991 be prepared by an appraiser who holds a state certification or license, issued according to a state-enacted law conforming to standards set forth in the FIRREA statute.(3) Furthermore, FIRREA enacted a concept of due diligence and vicarious liability which can subject appraisers to civil and criminal liability. Section 1121 defines federally related transactions as follows:

{any} real estate-related financial transaction which:

a. a federal financial institution's regulatory agency or the Resolution Trust Corporation engages in, contracts for, or regulates; and

b. requires the service of an appraiser.

The term real estate-related financial transaction means:

{any} transaction involving:

a. the sale, lease, purchase, investment in or exchange of real property, including interests in property, or the financing thereof;

b. the refinancing of real property or interests in real property; and

c. the use of real property or interests in property as security for a loan or investment, including mortgage-backed securities.

The intent of Title XI of FIRREA is clearly set forth in its preamble in Section 1101:

{The} purpose of this title is to provide that Federal financial and public policy interests in real estate-related transactions will be protected by requiring that real estate appraisals utilized in accordance with uniform standards, by individuals whose competency has been demonstrated and whose professional conduct will be subject to effective supervision.

In view of this intent to protect the public interest, court decisions will probably continue to erode the privity barrier as they have in other professions, such as accounting.(4) These guidelines may soon apply beyond real estate. Title XI of Section 1122 charges the Federal Financial Institutions' Examination Counsel (FFIEC) with studying whether Title XI's provisions should be extended to personal property appraisers in relation to federal, financial and public policy interests. Some states are also considering this extension and have already applied this legislation to all real estate appraisals, not just federally related ones. Still other states are considering requiring a real estate license for those who appraise businesses, without allowing an exemption for CPAs who do appraisals.(5)

Valuing Real Property

Property valuation is important to all parties in real estate transactions, including buyers, sellers, financiers and insurers. A real estate appraiser attempts to give an opinion as to the market value of the property. The Encyclopedia of Real Estate Appraising defines market value generally as "the price that a willing buyer will justifiably pay a willing seller with each being well informed, typically motivated, free of undue influence, financially capable, and allowed a reasonable time to compare the market."(6) There are three basic methods of estimating value. These are the comparative-sales method, the capitalization-of-income method and the reproduction-cost-new-less-depreciation method. They each use market data.(7)

The comparative-sales method infers value from the sales prices of comparable properties. This method assumes comparable property exists, which may not be the case. The capitalization-of-income method determines value by finding the present value of the future stream of income derived from the property, less expenses. This is used mainly when valuing commercial real estate. The reproduction-cost-new-less-depreciation method of valuing property involves calculating the cost to reproduce a building based on current market price. This is most often used when unique property is involved. The appraiser's opinion should disclose the method used, as value may vary with the method.(8)

Aspects of Appraiser Liability(9)

A number of problems may result from a faulty appraisal. One of the largest is that a purchaser or investor can become involved in a financing arrangement in which the value of payment obligations exceed the true value of the property. Further, when an appraiser erroneously overstates the value of property, a lender can be stuck with inadequate security for its loan. This was the case in Larsen v. United Federal Savings and Loan Association.(10) Here, the court found a savings and loan association, United Federal, owed a duty to home purchasers that gave rise to damages due to negligence in performing an appraisal of a home. The purchasers had paid too much and thus, the lender had inadequate security for its loan. The court stressed that, although the appraisal was made primarily for the lending institution, the appraiser should also reasonably expect the home purchaser, who pays for the appraisal and who has access to the results, will rely on the appraisal to reaffirm his or her belief the home is worth the asking price. The court also reasoned from the Restatement (Second) of Torts |Sec~ 552 that persons who negligently supply information for the guidance of others may extend their liability to more than one person, as long as the supplier intended to supply the information to that person, or knew the recipient intended to supply it. The court further reasoned the savings and loan association should be recognized as the paid supplier of the information, as the appraisal was made by its own employee. There was sufficient evidence of the association's negligence for the jury to consider the issue. The purchaser testified the officer and supervising appraiser of the savings and loan had remarked that the house should not have been appraised at such a value. There were also notations on the appraisal form indicating the exterior brick showed problems, the floors were uneven and the house was in terrible condition and settling. The appraiser testified he did not notice the uneven floors until the second trip, as he was in a hurry on the first visit. Moreover, an engineer testified the house had a number of defects which a competent appraiser should have noticed.

In Stotlar v. Hester(11) the court reversed a summary judgment for the appraiser except as to the damage issue of the roof condition. It found there was a factual issue as to the real-estate purchasers' reliance on the real-estate appraiser's appraisal of the property. The appraisal was for the purpose of refinancing the property and the sellers' willingness to sell depended upon receiving a price that would enable them to buy another residence. The sellers' real estate agent advised the purchasers the property was being appraised and the agent later supplied the appraisal to the purchasers, who based their offer on it. The court stressed the appraiser's affidavit stated his appraisal was transmitted to the financial institution which held the sellers' mortgage on the property and it was thus inferable that the appraisal was obtained so a purchaser could finance the purchase through the same financial institution. Furthermore, the court concluded the evidence raised a factual issue as to whether a prospective purchaser was an intended beneficiary of the appraisal and whether the appraiser knew of this. The court did find the purchasers could recover from the appraiser on the basis of negligent representation and quoted the Restatement of Torts (Second) 552, which provides the negligent supplier of misinformation is liable only to those persons for whose benefit and guidance it was supplied. The purchasers could enforce the contract between the sellers and the appraiser for an appraisal of the sellers' property, if the purchasers were third party beneficiaries of the contract; and the financial benefit of an accurate appraisal to the purchasers could be assumed. However, the court emphasized for perspective purchasers to be third party beneficiaries, the appraiser must have reason to know the sellers intended such a benefit for them and this could be shown through extrinsic evidence, if not specifically stated in the contract.

If an appraiser erroneously understates the value of property, however, the buyer can be denied favorable purchasing terms. A low appraisal constrains a lender to lending less than it would otherwise. In Gay v. Broder,(12) the court affirmed the dismissal of a complaint against an appraiser by a veteran, whose application for a Veterans' Administration (VA) guaranteed home loan to finance purchase of a home was denied. The appraiser had inaccurately appraised the home at less than its reasonable value and had allegedly caused the denial of the VA loan application, forcing the veteran to obtain conventional financing and thus causing him monetary damage. The court concluded the complaint failed to state a cause of action, since it alleged as the basis of the appraiser's liability to the veteran that the appraiser had failed to perform his contract with the VA for an appraisal to determine a reasonable value for the property and that the contract was for the veteran's benefit. The court further stated the plaintiff had failed to allege any privity of contract between the appraiser and the veteran and had failed to allege the appraiser had breached a duty he owed to the veteran to exercise reasonable care in order to avoid harming him by an inaccurate appraisal. The court took judicial notice of a federal statute regulating VA home loan guarantees and said this controverted the plaintiff's claim that the contract was for the veterans benefit, as the statute was for the VA's protection. Furthermore, the court pointed out there were policy considerations against extending the appraiser's liability to the veteran, as this would deter an appraiser from reporting to the VA his true opinion of the value of a property, thus causing him to breach his duty to the Federal Government.

Theories of Liability

Four theories of liability are generally raised in appraisal liability cases. These are: agency, contract, negligence in tort and public policy. In the Larsen case, the court found the savings and loan legally responsible for the acts of its employee, the in-house appraiser, performed in the scope of his employment.(13) Thus, the savings and loan could be held liable for the negligent appraisal regardless of whether the employee had express, implied, or apparent authority. Even if the employee's actions were unauthorized, United Federal's later use of his appraisal (in making the loan, informing the purchaser the appraisal was satisfactory and the property was not defective) constituted a ratification.(14)

In cases involving in-house appraisers, the lender can also be held liable for direct breach of contract with the purchaser, as the lender is responsible for the negligent appraisal of its employees. The loan contract usually requires an appraisal which will form the basis of the loan decision. Thus, the lender and its employees are under a duty to use reasonable care and skill when carrying out the loan services.(15) The lender can then be liable on direct contract to the borrower for injuries resulting from a negligent performance of the appraisal.(16)

Under a tort theory of liability, a borrower needs to show the lender breached its duty to conform to a reasonable standard of care in performing the appraisal. Under tort theory, the Larsen court found United Federal liable for losses caused to the purchasers who justifiably relied upon the information in the appraisal, as the lender failed to exercise reasonable care in obtaining the appraisal. The court emphasized the foreseeability of justifiable reliance under the circumstances and gave no weight to United Federal's claim the appraisal was solely for the lender's own use and security. However, if the purchaser has superior knowledge in real estate, his reliance may be less justifiable. Conversely, if the purchaser has little knowledge of real estate, the lender should be primarily liable to the borrower for losses proximately caused from reliance on the lender's appraisal.(17)

Public policy considerations may provide a fourth theory of recovery against lenders for negligent in-house appraisals. The lender is generally more sophisticated about real estate transactions and better able to bear the loss. They can spread the loss as cost of doing business among other transactions.(18)

Courts generally consider such public policy issues when determining how to apply contributory negligence as a defense in appraisal liability cases.(19)

Cases involving lender liability for the negligent appraisal of an independent contractor involve more difficult issues. As there is no privity of contract between the borrower and the independent appraiser, the borrower can not recover under contract liability.(20) Conversely, the lender who is in privity with the independent appraiser has no reason to sue, as he suffers no loss if the borrower keeps paying.(21) If the borrower contracted directly with the independent appraiser, then he could sue for breach of contract. However, if the borrower has not contracted with the independent appraiser, he could possibly recover as a third party beneficiary to the contract or under negligence in tort.

The third party beneficiary theory is used as a basis for allowing persons who are not parties to the contract, and thus have no privity, to recover for breach of contractual duty.(22) The Stotler court, as discussed above, got around the privity barrier by holding the purchasers could enforce the contract between the sellers and the appraiser for an erroneous appraisal of the seller's property, if the purchasers were third party beneficiaries of the contract. However, the California appellate court in Gay v. Broder(23) held Gay (the veteran) was not intended to be a third party beneficiary of the appraisal contract, based on a statutory construction of the VA loan requirement and the congressional purpose of the legislation.(24) If the purchaser sues for negligence in tort for an erroneous appraisal, he must show the defendant breached a duty to him to exercise reasonable care.(25) A lender who hired an independent appraiser should also be liable, if the lender is responsible for supplying erroneous information without exercising reasonable care or competence in obtaining or communicating the appraisal.(26)


If the appraisal liability action involves a breach of contract, typical contract remedies include reimbursement of the difference between the misrepresented price and the property's actual value or the reasonable cost of correcting the defects, as long as these costs are not disproportionate to the market value of the property.(27) A plaintiff may also ask for "benefit of the bargain" damages and consequential damages, if the loss from the negligent appraisal could have been reasonably contemplated by both parties at the time of the contract.(28)

If the suit is brought in tort for the negligent appraisal, damages would include compensation for the pecuniary loss caused by the misrepresentation, i.e., the difference between actual value and purchase price without "benefit of the bargain" damages.(29) Compensatory damages are determined by out-of-pocket costs.(30)


Appraisers, along with accountants and attorneys, are increasingly exposed to liability. As many accounting firms offer appraisals as auxiliary services, this will add to the liability problems the accounting profession already faces.

Given the past history of the appraisal industry, perhaps accountants will help raise educational standards. In the wake of a number of financial disasters, including the federal savings and loan debacle, the accounting profession is already in the process of tightening accounting standards, striving to educate the public about their work, and increasing their ethical awareness.(31)


1 Marie, Powers, "Appraiser Industry Rebounds with Quality-Insuring Regulation," National Real Estate Investor, Vol. 33, No. 1, (January 1991), at 71.

2 Id.

3 Pub. L. No. 101-73, 103 Stat. 511 (codified as amended in various sections of 12 U.S.C.). The deadline has been extended to January 1, 1992.

4 William E. Mariano, "FIRREA Rewrites Rules for Real Estate Appraisers," New York Law Journal, (February 26, 1991), at S-1.

5 Greg R. Trugman, "Consulting Services: A Threat to Business Valuation Practices," Journal of Accountancy, (December 1991), at 46.

6 Encyclopedia of Real Estate Appraising 20 (E. Friedman ed. 1959), cited in "Lender Liability for Negligent Real Estate Appraisals," by Robin Paul Malloy in the U. Ill. L. Rev., Vol. 53 (1984), at 86.

7 Id.

8 Id.

9 For a more detailed discussion on this section and the next see James L. Rigelhaupt, Jr. JD, "Liability to Real-Property Purchaser For Negligent Appraisal of Property's Value," 21 A.L.R. 4th 867 (1991).

10 300 N.W. 2d 281 (Iowa 1981).

11 92 N.M. 26, 582 P.2d 403, cert. den. 92 N.M. 180, 585 P.2d 324 (App. 1978).

12 109 Cal. App. 3d 66, 167 Cal. Rptr. 123 (4th District 1980).

13 Supra note 10.

14 Restatement (Second) of Agency |Sec~ 140 (1957) and supra note 10.

15 See Ultamares Corp. v. Touche, 255 N.Y. 170, 179, 174 N.E. 441, 444 (1931) (An accountant was involved to investigate the financial position of a firm.)

16 See Breckenridge Hotels Corp. v. Real Estate Research Corp, 452 F. Supp. 529, 532-33 (E.D. Mo.), vacated, 456 F. Supp. 385 (E.D. Mo. 1978).

17 Malloy, supra note 6.

18 Malloy, supra note 6.

19 Yianni v. Edwin Evans & Sons, 3 All E.R. 592, 600, 611 (1981).

20 Id.

21 Id.

22 See E. Farnsworth, Contracts 709-44 (1982).

23 Supra note 12.

24 Supra note 12. See also United States v. Neustadt, 366 U.S. 696, 696-98 (1941) where the government avoided liability for a negligent appraisal for an FHA loan by characterizing the negligence as arising out of misrepresentation and thus within the meaning of 28 U.S.C. |Sec~ 2680(h), precluding recover under the Federal Torts Claims Act 28 U.S.C. |Sec~ 2680(h) (1982).

25 Prosser, "Misrepresentation and Third Persons," 19 Vand. L. Rev. 231, 233-40 (1966).

26 Restatement (Second) of Torts |Sec~ 552(1) (1977).

27 Supra note 22 at 12.13.

28 Supra note 22 at 12.1 and |Sec~12.14.

29 Supra note 26 at 552B.

30 Supra note 26 at 552(B).

31 Patricia S. Wall and Eddy Burks, "Forensic Accounting and Information Management: Accounting Professionals Aid Attorneys," Practice Update, Vol. 6, No. 6, (June 1991), at 1.

Patricia S. Wall, MBA, JD, is an assistant professor of accounting and business legal studies at the University of Alabama in Huntsville. She received her JD from the University of Tennessee in 1979, and her MBA from the University of Tennessee (Chattanooga) in 1987. She has been licensed to practice law in Tennessee since 1979 and in New York since 1988. She has taught at Hoftstra University and St. John's University in New York. Her research interests include international and corporate law, accounting and taxation.

Lee Sarver, PhD, is an assistant professor of finance at Middle Tennessee State University. He received his PhD from the University of Tennessee in 1987. He has taught at Hofstra University in New York and the University of Alabama in Huntsville. His research interests include international finance, corporate control and fixed income securities.
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Author:Wall, Patricia S.; Sarver, Lee
Publication:The National Public Accountant
Date:Dec 1, 1992
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