Court deals real estate marketers a painful lesson.

Customers ruled the sole beneficiaries of fraud fund

Licensed real estate brokers and sales agents have much to learn from Laura Onate's legal woes. The Los Angeles real estate saleswoman got stiffed on a property deal in more ways than one -- and wound up on the losing end in court.

Onate claimed in court she was cheated by a colleague, broker Donald Smith. When she tried to tap a state recovery fund for broker-fraud victims, she got nowhere.

Most importantly for the industry, her travails have set a precedent of sorts: They have resulted in a Court of Appeal ruling ordered published in January. That means it has become part of case law governing all licensed brokers and sales agents in the state.

The bottom line came in a court ruling that the state Real Estate Recovery Fund can only pay off cheated members of the public. Cheated real estate industry people like Onate are out of luck.

According to Court of Appeals documents, Onate's problems started in November 1986 when she rounded up four clients who wanted to buy "bargain" properties touted by Smith. She collected offers from them, as well as deposits totaling $14,000, the court documents claimed. She turned the money over to Smith who, like Onate, was licensed by the state Department of Real estate to sell property. Smith, however, never sold the property to them, and he kept their money, the documents said.

Afraid she might be sued by her clients, Onate paid them in full for their losses and obtained assignments from them to go after Smith in court. She won a $25,000 judgment against him in municipal court, plus $11,000 in punitive damages, the court documents revealed.

Not able to get the money out of Smith, she filed a claim for payment from the recovery fund. But the state Real Estate Commissioner, who supervises that fund, decided to fight her, the court documents noted. His claim was that the fund doesn't protect licensees from unscrupulous colleagues.

Real estate attorney Debra Fink said Onate's losses don't surprise her.

"There are a number of things about the recovery fund that are not generally understood by members of the brokerage community, as well as the public at large and attorneys that represent them," said Fink, who is general counsel for brokerage Jon Douglas Co.

Fink said salespeople don't deal with such claims every day and can easily forget its nuances.

Fink noted, for instance, that after a payment is made, the licensee found liable in the deal must reimburse the fund, and until then his license is suspended. The fund is supported by mandatory contributions by all state license holders.

Fink noted victims must first sue in court and win. Then they must try to collect against the licensee by going to the state fund for the outstanding balance.

Also, she noted, coverage against any single licensee is limited to $100,000. That means claimants might have to take less than 100 cents on the dollar when their total tab against a licensee is more than $100,000 -- much like a bankruptcy resolution for creditors.

Smith, in fact, was approaching the magic $100,000 in claims against him when the real estate commissioner jumped onto the scene. He successfully swayed the L.A. Superior Court and the Second District Court of Appeal.

The appellate justices noted several significant and potentially foolish actions by Onate:

* She gave the clients' money to Smith, without investigating his honesty or trustworthiness, rather than deposit it into a trust account.

* She did not inform her clients their checks were going to be held by another person until their offers were accepted.

* She was neither "a client of Smith, buyer-consumer or an innocent member of the public victimized by licensee Smith," yet claimed standing as a victim to the fund.

Onate contended in court documents that she succeeded to the claims of her clients upon reimbursing them for their losses; that a fraud claim against the fund is assignable to a third party; and that to let her collect would promote the overall legislative purpose that prompted the fund years ago.

Appellate Justice P.J. Klein disagreed. In the case ruling he wrote, "To accept Onate's theory would result in the absurdity of making the Recovery Account the insurer of negligent licensees. . . . Onate was in a position to guard against her colleague's deceitful and fraudulent acts. The purpose of the statutory scheme is to protect the public against fraud in real estate transactions, not to protect licensees from their peers."

The reimbursement mechanism originally aimed to "raise the standards of the real estate profession by requiring its members to deal fairly and ethically with their clients," according to a 1975 ruling cited by the judge.