Commercial Real Estate

Preforeclosure Problems for the Licensee Acting as a Principal

April 1, 2018 By William Kozub

Preforeclosure Problems for the Licensee Acting as a Principal

Arizona has moved through the short sale era. The Arizona real estate investors are once again finding distressed properties, many facing foreclosure, that present attractive investment potential. These opportunities present great potential to those individuals with the skill and knowledge to locate such distressed and foreclosure properties, as well as an understanding of what it takes to close these nontraditional transactions. However, as many real estate investors who are also real estate licensees know, the pre-foreclosure transaction can present unique risks.

In today’s pre-foreclosure transaction, the licensee, acting as an investor, approaches the homeowner either prior to or during the pendency of the trustee sale and negotiates a purchase of the property that allows the homeowner to avoid foreclosure, and allows the licensee to make a profit for the effort involved.

Regrettably, a pre-foreclosure transaction has many characteristics that differ from a traditional real estate transaction. First, the transaction does not fit nicely into the AAR documents so commonly used today. Moreover, the timing of the transaction and the goals of the homeowner are often radically different from a traditional home sale transaction. Finally, the very nature of the pre-foreclosure transaction will often result in both the homeowner being unrepresented by either an attorney or a real estate broker, and dealing with a real estate licensee who is acting as a principal. These are all ingredients for a disaster.

Avoiding Inadvertent Agency

A common problem with a real estate licensee engaging in pre-foreclosure purchases made on behalf of the real estate licensee is the inadvertent creation of an agency relationship with seller of the real property who is facing foreclosure. Arizona law is very permissive in the creation of an agency relationship. An agency relationship can be formed merely by the words or conduct of the parties. A written contract is not required to establish an agency relationship. The mere fact that a real estate licensee is purchasing property on their own behalf, or on behalf of an entity in which they have an interest, does not necessarily mean that the licensee is not also representing the seller. Any real estate licensee may be rendered a dual agent if the licensee conducts himself or herself in such a way, either intentionally or unintentionally, as to be deemed an agent of the buyer.

This problem is compounded in the pre-foreclosure transaction because the only real estate licensee in the transaction is usually the one acting as the principal. Because the Department of Real Estate may suspend or revoke the real estate license of one who represents more than one party in a transaction “without the knowledge or consent of all parties,” caution must be taken. For the licensee’s protection, all conduct during a pre-foreclosure purchase transaction must be conducted with the express purpose of avoiding the inadvertent agency relationship. A well-written agency disclosure form, such as the form available through the Arizona Association of REALTORS, should be used. However, the mere existence of a disclosure form is not conclusive proof that an agency relationship does not exist.

Agency Arising From Written Solicitations

The agency issue is further complicated by the common business practice in the pre-foreclosure industry for individuals engaged in pre-foreclosure home purchases is to send out written solicitations to homeowners facing foreclosure. These solicitations will often contain offers by the licensee to help the homeowner and will request that the home owner contact the soliciting individual or company. Often, the real estate licensee will list the same information used to obtain a listing in this promotional material creating the mistaken belief in the recipient that they will have the same relationship with the licensee as the licensee’s other clients. This is a problem.

While these solicitations are a source of potential liability and can prove to be the document that actually creates the agency relationship, when properly drafted, they can also be used to provide the initial level of protection a licensee needs against an inadvertent agency relationship. Care should be taken to avoid language that appears that the licensee is seeking to represent the homeowner. Indeed, an express disclosure that the licensee is acting as a principal or investor is recommended.

Close Through Escrow

It is advised that the licensee close all pre-foreclosure transactions through escrow. There are several protections afforded the licensee when the transaction is closed through escrow. First, the licensee is able to obtain buyer’s title insurance. Pre-foreclosure deals often occur fast and furiously. Many times, the homeowner facing foreclosure does not being to seek assistance until days before the trustee sale. It is not uncommon for the homeowner to call prospective investors on the weekend before the sale. The homeowner will then be tempted to sell the home several times on one day to every prospective purchaser who comes to the door with a hand full of cash and blank quit claim deed. The Monday morning rush to the county recorder’s office then dictates who is the real owner of the property. Obtaining title insurance prevents the licensee as buyer from being burned by the homeowner who may have been selling his home to every prospective purchaser who has come to the door with a hand full of cash and blank quit claim deed.

Perhaps an even greater protection by closing through escrow is the benefit and security that can be obtained when a planned set of escrow instructions are used in the transaction. Often, the pre-foreclosure transaction occurs so rapidly that there is not time to obtain a proper purchase contract. A properly drafted set of escrow instructions should address the following issues:

Any necessary adjustments to the sales price based upon the amount necessary to cure the default.
Disclosure of licensee status.
Disclosure of financial interests in the transaction.
Disclosure of agency status.
Any indemnity and exculpatory language desired by the buyer.
Terms of any new rental agreement or purchase options that survive the closing.
Integration clause addressing any outstanding side agreements.
Disclosure of transaction terms and express acknowledgement the transaction is not a loan transaction.

Careful thought and drafting must go into the documents used in a pre-foreclosure transaction. A real estate licensee acting as a principal in such a transaction must be constantly aware of the issues involved and the potential sources of liability so that they may be avoided. Is it strongly recommended that licensees engaged in the pre-foreclosure industry consult a broker or attorney experienced in such matters so the licensee’s actions can be a source of protection, and not future liability.

Locking Out the Commercial Tenant

February 1, 2018 By William Kozub

The lock-out of a commercial tenant is one of the most powerful remedies available to any party in a real estate transaction. On the other hand, it is a remedy which can lead to catastrophic liability if it is misused by a landlord. The lock-out remedy is available to most commercial landlords under Arizona law. Most lease forms expressly allow the landlord to re-enter and seize possession of the premises. Even absent such language in a lease, as a general rule, the landlord can still lock-out a tenant unless the lease expressly prohibits such action. Also as a general rule, the landlord is allowed to seize personal property belonging to the tenant to hold (and sell) for payment of the rent. This article will discuss concerns of using a lock-out from the landlord’s perspective. Obviously, this article is limited to commercial property because under Arizona law, a landlord may never lawfully perform a lock-out against property covered by the Arizona Residential Landlord & Tenant Act.

When Can the Landlord Lock-Out a Tenant?

Assuming that the lease does not prohibit a lock-out, the landlord may re-take the premises upon any material breach of the lease by the tenant or if the tenant is in arrears on rent for five days. It is absolutely crucial that the landlord not attempt to lock-out the tenant for a breach which may be deemed by a court to be “trivial” (such as a dispute over a CAM charge which is small in comparison to the tenant’s other rental obligations). If the landlord desires to use a lock-out for any reason other than the tenant’s failure to timely pay its monthly rental payments, then the landlord should seek the advice of legal counsel before proceeding with a lock-out. When in doubt, file a forcible detainer action and do not lock the tenant out of the premises.

What Is a Landlord’s Lien?

Under Arizona law, a commercial landlord has the right to enforce a statutory “landlord’s lien” against the personal property of the tenant, subtenant or assignee which is located on the premises to the extent necessary to secure payment of the rent. The landlord has no right to seize property belonging to persons other than the tenant, a subtenant, or an assignee of the tenant. A landlord who performs a lock-out may find it difficult to accurately determine which personal property actually belongs to the tenant.

A lock-out is usually the only practical method for the landlord to seize the tenant’s personal property. Arizona law permits the landlord to sell the tenant’s property and apply the proceeds toward the rent. If the tenant does not pay the rent within 60 days after seizure of the property, the landlord may sell the personal property at a public auction in the manner provided by statute, which requires notice to the tenant, and sometimes, publication. Because the statutory procedure for the sale process is quite ambiguous, the landlord should consider bringing a judicial action to foreclose on the landlord’s lien, or better yet, if the landlord has already obtained a judgment for rent, the landlord could require the sheriff to execute against the tenant’s personal property to satisfy the judgment.

Priority of the Landlord’s Lien

Generally, a landlord’s lien against the tenant’s personal property relates back to the later of (i) the commencement of the tenancy, or (ii) when the tenant first brings the property onto the premises. Therefore, a landlord’s lien will not have priority against another creditor’s security interest in the tenant’s personal property if that other creditor perfected its lien prior to the time the tenant brought that property onto the premises.

To further complicate matters, the tenant may be able to void the landlord’s lien by filing bankruptcy, unless such lien is based upon some contractual agreement rather than merely the landlord’s statutory right under Arizona law. For these reasons, among others, a landlord is well-advised to require the tenant to execute a separate U.C.C. financing statement granting the landlord a lien for non-payment of rent (and other charges due under the lease) against the tenant’s personal property, including the tenant’s equipment, inventory and accounts receivable. The landlord should then record the financing statement with the Arizona Secretary of State. By obtaining such an agreement in connection with the lease, the landlord should be able to later foreclose on the personal property easier and quicker, and will not lose the priority of its security interest if the tenant files bankruptcy or physically removes the property from the premises before the lock-out.

How to Perform a Lock-out

A landlord cannot exercise its right of lock-out while the tenant is physically inside the premises, or if the landlord has to “breach the peace” to perform the lock-out. Thus, a tenant may avoid a lock-out simply by keeping a person in the premises at all times. In such case, the landlord must file a forcible detainer lawsuit to regain possession. Of course, this may give the tenant an opportunity to remove personal property or to file bankruptcy (which will certainly cause more delays in regaining possession), however, the landlord really has no other choice in that situation.

If appropriate, the landlord should contact the local police prior to the lock-out. A landlord should never perform a lock-out without an adequate number of witnesses in addition to the locksmith, to observe the condition of the premises at the time of the lock-out (and especially to observe the contents inside the premises).

Also, as quickly as possible, the landlord should make a complete itemization of all of the property located in the premises. The landlord should also take photographs and/or make a videotape of each room (it is best to do this at the same time of the lock-out). It is not unusual for a tenant or its employees to claim that property is missing or stolen. It would also be wise for the landlord to make sure that it is covered by insurance against any loss or claim relating to such personal property.

A landlord should post a notice on all of the outside doors, notifying the tenant and others of the lock-out. The notice should not slander or belittle the tenant (as it may be read by persons doing business with the tenant). The language of the notice will vary depending upon the circumstances.

If the landlord desires to hold the tenant liable for future rent, the landlord should be careful to avoid using language in this notice or any other notice that could be interpreted as “terminating” the lease.

Things to Consider Before Using a Lock-Out

A lock-out is an effective but drastic remedy and should be used cautiously, and usually only as a last resort. A lock-out could destroy the tenant’s business, therefore, the landlord’s potential liability for a wrongful lock-out is enormous. The landlord should never perform a lock-out where the tenant may have a valid defense to its breach of the lease. Also, the landlord should be absolutely sure that (i) any default notices required under the lease (or otherwise) have been properly delivered, (ii) all grace periods under the lease have expired, (iii) the landlord has not somehow waived its right to strictly enforce its remedies (e.g., by the landlord previously accepting late payments without reinstating “time is of the essence”), and (iv) that the lock-out can be accomplished without breaching the peace.

Ultimately, the landlord should consider whether or not the lock-out will help achieve the landlord’s goals (whether that goal is obtaining past due rent or simply getting rid of the tenant). For example, in many cases the lock-out will make it more difficult (or impossible) for the tenant to earn income to pay the rent. But on the other hand, by performing a lock-out, the landlord would seem to have made the payment of rent the highest priority of the tenant. Finally, the landlord must also consider whether or not it is really prepared to assume the responsibility of taking control of all of the personal property in the premises, and to possibly litigate issues concerning the tenant’s default as well as the priority of the landlord’s lien against other creditors.

Deferring Your Commission

January 1, 2018 By William Kozub

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.