Courts Examine Brokers' Fiduciary Duties
Once an owner hires a broker to sell or lease a property, a fiduciary relationship is established. The term fiduciary describes a position of trust: The broker owes the seller loyalty and a duty to act in good faith during the entire deal.
Under the guidelines of fiduciary duties, a broker must disclose fully to the seller all relevant information about the property's sale, while maintaining ethical communications with others involved in the deal. If fiduciary duties are breached, a broker can be held liable for any money lost in the transaction, and the seller can sue to recover all costs and commissions.
The fiduciary relationship begins when a contract between the broker and the seller is signed. But when does it end? Is the fiduciary relationship terminated after a sales contract is signed or after a deal is closed? To complicate matters, what if the broker also is the buyer? Do the usual rules of disclosure apply if the broker is purchasing the property?
The Appellate Division of the New York Supreme Court tackled this issue in two cases. Dubbs v. Stribling & Associates explores what fiduciary duties entail and how far they extend. In TPL Associates v. Helmsley-Spears, the issue concerns whether a broker gave full disclosure of his role in the purchase of commercial property in Manhattan.
While Dubbs concerns a residential setting, the law and principles set forth apply equally in the commercial context.
The Dubbs owned a cooperative apartment in New York but desired more space. They wanted to buy the apartment next door, but their neighbor was not interested in selling. So the Dubbs listed their apartment for sale with Stribling & Associates.
A Stribling agent expressed an interest in purchasing the Dubbs' apartment. Before entering into a sales contract, the same broker recommended that the Dubbs again attempt to purchase the apartment next door. The neighbor remained unwilling to sell, so the Dubbs and the agent signed the contract.
It is undisputed that to this point no fiduciary duties were breached, as full disclosure was made by the broker, arms-length negotiations ensued, and all commissions were waived.
Several weeks after the contract was signed, the next-door neighbor listed her apartment for sale. Without notifying the Dubbs, the purchasing agent signed a contract to buy the apartment a few days after closing with the Dubbs. When the Dubbs learned of this transaction, they sued Stribling, seeking damages for breach of fiduciary duties. The Dubbs claimed that the broker owed them an ongoing duty to disclose that the apartment next door was for sale.
The court majority found it incongruous that a contract contingency or due diligence matter could require the buying broker to abandon or diminish his legal rights in order to continue to represent the seller. The decision implies that a contract, once properly entered into between a buying broker and a seller after full and adequate disclosure, should be recognized and not held to a different standard because of the involvement of the broker as purchaser. The only way to uphold the contract terms is to view the broker/client relationship as terminated once the sales contract is signed.
The dissenting judges vigorously disputed this decision, because they felt that the potential for abuse of trust was so great that it outweighed upholding a contract that was properly entered into between the parties. The dissenting judges would extend the broker's duty beyond signing of a sales contract to the date of closing. They did not address whether this would give a seller the right to rescind a properly signed contract or merely give rise to damages if a buying broker breached fiduciary duties. The dissent's position would prevent brokers from signing market or arms-length contracts with clients and then subsequently flipping properties to third parties for a profit.
Breach of Loyalty
TPL Associates owned a commercial property in Manhattan that it listed for sale with Helmsley-Spears for an asking price of $3 million cash. A Helmsley-Spears broker notified TPL that a buyer had been found who was willing to pay $2.7 million for the property and that a partnership had been formed by the potential buyer and his family to take title of the property.
A contract was negotiated for $2.7 million, which included a commission for Helmsley-Spears, but then TPL's lawyer learned that Helmsley-Spears might have an interest in the buying partnership. When confronted, the broker explained that he had a nominal interest in the partnership, which the buyer arranged to ensure that Hemlsley-Spears, acting as broker for the new owner, would be aggressive in pursuing tenants for the building. Helmsley-Spears agreed to a reduction in commission, and the contract was signed.
After closing, TPL checked the documents and found that an amended partnership certificate had been filed and that Helmsley-Spears brokers actually owned a majority interest in the buying entity. TPL refused to pay the portion of the commission not yet paid and commenced an action to recover the portion already paid, as well as the difference between the asking price and the sale price, alleging breach of fiduciary duty, fraudulent representation, and unjust enrichment.
The court concluded that a lower court's analysis of the contract as if it were an arms-length transaction was inappropriate when a broker was involved in the purchase. The court stated that the broker's duty of loyalty precludes having interests in the transaction adverse to the seller without full and complete disclosure. The court found that the broker did not make complete disclosure of the Helmsley-Spears brokers' interests in the purchasing entity, and that such failure was a breach of loyalty for which the broker owed both damages and a return of any commissions paid.
Other states, including Illinois, Maryland, Montana, Oklahoma, Pennsylvania, and Texas, also have considered the question of when fiduciary duties end if the broker is the buyer, and have concluded that where a broker properly contracts to buy a client's property, the principal/broker relationship terminates when the contract is signed. Many cases are not clear-cut, however, about whether full and adequate disclosure of the agent's role in a purchase has been given.
As these cases show, any contract between a broker and a client must be fully disclosed and is likely to be closely scrutinized or challenged, especially if the outcome of the deal favors the broker. Because a broker, as a fiduciary, is held to an extremely high standard, when entering a transaction with a client, the safest course is to disclose everything.