How to Protect the Broker
Real estate brokers are often asked to defer all or part of their real estate commission, in order to help facilitate the closing of a sale. A broker is under no legal obligation to defer his or her commission, unless such an arrangement was provided for in the commission agreement. A real estate broker is expressly prohibited by the Commissioner’s Rules from allowing a controversy over a commission dispute with another broker to interfere with the transaction. This Rule is limited to controversies between real estate licensees, and doesn’t require a broker to accept less than full payment from the broker’s client in order to facilitate the transaction. This article will assume the broker voluntarily agrees to such an arrangement.
Treat the Commission as a Loan.
We have seen situations where a broker has done a great job protecting the client, but a lousy job protecting the broker. Like all professionals, it is awkward to negotiate fees with your own client. But once the broker agrees to defer a commission, it is important to treat the situation as if the broker has now become a lender. Therefore, the broker should expect to be protected in the transaction like a lender, not one who is gratuitously provided services. This means that the broker must seek to obtain the best possible security for repayment of the broker’s “loan”.
Get Security for the Loan
The most common situation in which the broker is asked to defer his or her commission is when there is not enough money at closing to cover the commissions. This generally occurs for two reasons: (1) where the buyer is paying too little cash at closing (and this most often coincides with the seller taking a carryback); or (2) where the subject property is over-encumbered in relation to the purchase price. It is important to keep in mind that if the seller is not receiving enough money at closing to pay the commissions, then as a general rule the transaction is inherently risky. Although there will always be some element of risk in such a case, the broker can reduce the risks of non-payment by taking the proper security for the deferred commission.
Except in the most unusual circumstances, when the broker defers a commission, the broker should take a security interest against the subject property. Of course, there is no rule against taking other forms of security, but it seems that if the seller possesses other collateral, then the seller has the resources to actually pay the commission at closing. Whenever possible, the broker should consider taking additional security, perhaps against another piece of property owned by the seller or the buyer.
The simplest and best type of security against real property is a promissory note (with a reasonable interest rate) secured by a deed of trust. In most cases, both the seller (who owes the commission) and the buyer (who will own the property) should be personally liable on the promissory note. First and foremost, however, the broker should look to the property for protection. This is especially true where the seller takes carryback financing. Many different ethical problems may arise when the broker pursues the seller for payment of commission when the buyer in the deal brokered by the broker goes into default.
However, the mere fact that the broker obtains a security interest does not guarantee payment. The broker must consider the value and marketability of the subject property, and the effect of any senior encumbrances on the broker’s chances of recovering monies if the buyer should default.
Generally, a broker will take a security interest in one of two types of situations. First, there is the situation where the seller does not take carryback financing. For the most part, this situation is easier to deal with because the broker is not “competing” with the seller for priority of the broker’s security interest. Obviously, the broker should seek the highest priority possible.
When the seller is taking a carryback, one difficult question will arises: Will the broker’s deferred commission have priority over the seller’s carryback? This dilemma is compounded by the fact that if the broker has been representing the seller, as the seller’s fiduciary, and now all of a sudden, the broker is essentially an adverse party. Regardless the priority between the broker and seller’s interests is negotiable (there is no law that the broker must take the back seat to the seller, remember, the broker is doing the seller a favor by deferring the commission). Certainly, the broker is in a safer position if its lien is senior to the carryback, but the seller may not agree placing the broker in a position in which the broker could actually wipe out the seller’s carryback. If the parties so agree, the seller and the broker can take an undivided interest in the same deed of trust. For example, the broker could end up with a 10% undivided interest in the carryback deed of trust (even if there are separate promissory notes). Although this is more likely to be viewed as “fair” in the eyes of the seller, if the parties do not plan ahead there will be potential problems if the buyer defaults. For example, when there are two lenders under the same deed of trust, both will need to agree in order to initiate a foreclosure, and both need to agree on how to share the expenses of foreclosure. Also if there is a senior encumbrance in default, what are the parties’ obligations or rights to contribute for reinstatement of the senior loan? In large part because the issue of the buyer defaulting is an unpleasant subject, these issues are usually not addressed up front. The same problems can arise if two brokers (e.g. the listing broker and co‑broker) share a security interest.
Unfortunately, the nature of the business sometimes requires brokers to defer commissions in order to make a transaction work. Although deferring part of a commissions is better than eliminating part of a commission, brokers must carefully consider the risks associated with deferring commissions.
Referral Fees to Non-Licensed Persons.
A real estate broker is prohibited from paying a referral fee to a non-licensed person. The payment of a commission to a non-licensed person is illegal, regardless of the label placed on the fee (e.g. “finder’s fee”, “consulting fee” etc.). There is one narrow exception to this rule, which allows a broker to pay compensation to an unlicensed residential leasing agent or manager for those type of services set forth under Arizona law relating to leasing activity.
Disclosure of Commission Reductions.
A real estate broker is not prohibited from giving incentives to parties by reducing his or her commission for the benefit of a party to the transaction. However, the broker must make full disclosure to all parties of all such arrangements. For example, if the broker agrees to reduce or assign its commission in order to benefit a buyer who lacks the necessary funds to close, this fact must be disclosed to the seller. Also, the broker should be aware that under some circumstances, such as HUD loans, there are strict restrictions on the source of the buyer’s down payment. Therefore, it may not be proper to assign a portion of the commission to the buyer where a HUD loan is involved. But in almost all other circumstances, a reduction of the commission should be legal.