The Liability of Real Estate Brokerage
Tips for Avoiding Legal Headaches
The last decade and a half has produced sweeping changes in the way most real estate agents do business. No longer is it simply a matter of bringing together buyers and sellers or tenants and landlords. Now, every aspect of each transaction is scrutinized-every i must be dotted and every t must be crossed-or trouble may ensue. As a result, more often than not, agents end up reducing their commissions or are not even paid their commissions. In the worst possible scenario, the commission is not paid and allegations are leveled, claiming an agent has done something wrong.
This article discusses some of the more common liability claims made against commercial real estate agents. Brief studies of actual cases are presented as well as tips on how to protect yourself. However, issues relating to particular state statutory requirements are beyond the scope of this article because they vary widely by state.
Unauthorized Practice of Law
Many agents believe-with some justification-that when attorneys get involved, deals often fall apart. Agents perceive attorneys as imposing conditions, giving negative advice, and generally creating obstacles-all of which casts a pall over a transaction's viability.
In response, instead of recommending a client retain a lawyer, agents often get involved in document preparation and even drafting, hoping to move things along quickly. What agents do not realize is that this conduct may lead to allegations of, and ultimate liability for, unauthorized practice of law.
What constitutes unauthorized practice of law? Ask the following questions about actions you are considering:
- What type of service is being rendered?
- Are legal rights and relationships created?
- What is public custom in your geographical area?
- Do attorneys routinely offer this service for a fee?
Perhaps the best example is to apply these questions to a fill-in-the-blank contract. Although legal rights may be created by inserting dates for a closing, it would be difficult to argue that an attorney would charge for such a service or that it is improper for an agent to do so.
Answering those four questions establishes general parameters for unauthorized legal practice. Beyond these, the particular circumstances of each case determine whether or not an agent's conduct is liable. As the guidelines indicate, the result may be different depending on the geographical area. For example, in the northeastern United States, only attorneys can perform title searches; however, in other regions of the country, non-attorneys can generate reliable title searches.
In awarding damage claims, the courts often treat unauthorized practice of law by an agent as legal malpractice. Even if the agent has errors and omissions insurance, it is unlikely to cover this type of claim.
The Case of the Confused Condition
Sally, an agent, listed a parcel of land zoned for residential use, which she believed could be rezoned for commercial use. John, the buyer, made an offer contingent on obtaining a zone change to allow commercial use.
The offer was brought in on a fill-in-the-blank form normally used for the purchase and sale of residential property. Sally added the following language on the form: "This agreement is conditioned upon the Buyer obtaining a rezoning of the property for commercial use." The offer was signed by John, then accepted and countersigned by George, the seller.
Both George and Sally thought that John would move swiftly to obtain the necessary approvals; however he waited almost 45 days to apply. The board took another 30 days to hear the application, which it then denied. When John appealed the board's decision, George protested, realizing that the appeal would tie up the property for several years. In anger and frustration, George sued both John and Sally.
In the case against Sally, George alleged that the contract's zoning contingency was "unartfully drafted." It lacked any time frame or deadlines and failed to address the possibility of appeal. The court agreed with George and awarded him damages.
Looking back at the basic questions that test the unauthorized practice of law, it becomes clear why the court imposed liability. The drafting of a condition in a contract creates legal rights and responsibilities, and it is something that an attorney would normally be paid to do. When Sally attempted to draft language as an attorney, she was held to the same standard of practice as an attorney.
A harsh result? Yes, but a sound one. Sally should have had George's attorney draft this provision, if not the entire contract. It is common for the seller's attorney to do so. The particularly careful agent may also have her own attorney look at the provision, but since the agent's attorney does not represent the seller, it is not appropriate for that attorney to get involved unless specifically requested.
More frequent than claims of unauthorized practice are claims purporting some form of misrepresentation.
Most states recognize that real estate brokers occupy a position of trust through a fiduciary relationship with the parties they represent. In most instances, of course, the broker represents the seller of a property.
A fiduciary relationship brings with it requirements of fidelity and good faith. These issues often are raised in claims that an agent has acted both as a real estate broker and a buyer (or seller) of a property. It is a potentially dangerous position for an agent to occupy.
The Case of the Bewildered Buyer
Tom, an agent, had a listing of a choice income-generating commercial property. Beverly, a subagent, showed Ron, a buyer, this property along with other properties. When he saw the property, Ron immediately said he wanted to make an offer at the full price. But Beverly told him that the property was under contract and he could not make an offer on it.
Subsequently, Ron determined that Beverly had made an offer on the property. At the time Ron wanted to make an offer, no contract had been signed-Beverly's offer was pending. But Catherine and Sam, the sellers, were never informed about Ron's interest and ended up selling to Beverly. When they found out about Ron's interest, Catherine and Sam brought a suit against Beverly claiming breach of fiduciary duty, failure to disclose, and breach of contract. The court found in favor of Catherine and Sam and against Beverly.
This case does not require an in-depth explanation-the way Beverly handled this matter was clearly improper. When faced with a possible conflict of interest, agents should always make a full disclosure in writing. This does not eliminate the conflict of interest, but a timely disclosure should eliminate the possibility of being sued because of it.
When allegations of misrepresentation are made, they are usually accompanied by allegations of fraud. The claims are similar, but they differ regarding damages.
Fraud usually includes an intentional statement of a material fact that the speaker knows is wrong when it is made. If the individuals who receive the misinformation act on it to their detriment, then fraud has occurred.
Negligent misrepresentation contains the same elements, except that instead of offering incorrect information intentionally, the speaker makes a careless statement that he or she should have known was wrong when it was made.
Because it is difficult to prove intent, fraud and misrepresentation are usually pleaded in the alternative. Negligent misrepresentation does not require proving intent and, therefore, may only lead to the award of actual damages. On the other hand, a finding of fraud may lead to the award of punitive damages in addition to actual damages.
A common issue in negligent misrepresentation suits is whether the statements in question are identified as opinion or fact. In sorting out this problem, courts often look to who has superior knowledge and who undertook responsibility for providing or obtaining the information. Three specific types of information that agents usually supply are targeted regularly:
- income stream;
- condition of property;
- size of property.
The Case of the Missed Disclaimer
Paula, an agent, listed a commercial property for sale. She prepared a marketing package indicating that the building contained 5,400 square feet of space and could generate $50,000 in income when fully rented, if the tenants paid for all expenses. Unfortunately, she obtained the information about the square footage-without further verification-from old records on file at the assessor's office. In addition, she did not state in the document that the income and expense figures were only projections, not actual numbers.
Prior to closing, it was discovered that the building actually contained 4,900 square feet. John purchased the building and shortly thereafter entered into written leases with the existing tenants, who occupied half the building. The leases stated that John, as landlord, would pay for utilities and taxes, and the tenant would only pay base rent. John's company leased the remainder of the building under the same basic terms.
Claiming that Paula had represented that the tenants would enter into leases where they would pay for all expenses and that the building was 500 square feet larger than it actually was, John brought a suit, claiming fraud, misrepresentation, and negligence against Paula. After three days of trial, the court decided the case completely in Paula's favor.
In this example, the defendant's attorney convincingly showed that the buyer knew the building's actual size prior to closing. The court, applying a legal principle known as estoppel and waiver, concluded that John should have raised the issue before closing; it was unfair to saddle Paula with possible liability for negligent misrepresentation after he had closed on the property.
Unfortunately, as many agents know, it is not always possible to avoid lawsuits from disgruntled buyers. All too often, agents become convenient scapegoats for determined plaintiffs who are driven by the disappointment of false expectations and denial of responsibility for less-than-perfect transactions.
Protect yourself when passing along income and expense information-actual or projected figures-that you did not personally prepare. Indicate, in writing, who did the actual preparation and include this information in a cover letter in simple, clear terms, explaining what the figures represent and how they were obtained. To further avoid misunderstandings, include a disclaimer in a separate sentence or paragraph. Although this may not prevent you from being sued by an obsessed owner, it will offer better protection against eventual liability if you do face a suit.
The Case of the Baffling Boundaries
Kim, an agent, listed for sale a building on a narrow, busy street. When showing it, Kim and the owner, Gregory, walked the property with Jack, the eventual buyer. As they walked around, Gregory pointed out the property's boundaries.
After the sale closed, Jack discovered that the lot was situated 30 feet closer to the street than he had thought. The lot was still the same size, just positioned differently. When the city wanted to widen the street, it condemned part of the property's front yard.
Jack sued Kim and Gregory for misrepresentation. At trial, much of Gregory's conduct was imputed to Kim-she was dragged down by his representations. Kim's counsel correctly evaluated this situation, and an affordable settlement was reached.
Ideally, after the showing, Kim should have immediately sent a letter to Jack recommending that he not rely on the walk around the property but have a professional survey of the property done.
In general, do not rely on information provided by sources over which you have no control. If it is necessary to use such information, make it clear that you are providing it without any assurance that it is correct.
How to Avoid Liability
This list of examples demonstrating possible agents' liability could go on forever. Guarding against all possible situations is impractical, but agents can take certain precautions to avoid liability or to defend themselv es successfully against claims.
At the outset, one general observation is in order. It may be excessively cynical to conduct yourself as if every transaction is a lawsuit waiting to happen, but if you consistently apply the following preventive measures, you can minimize your exposure to liability suits.
- Document everything. Leave a paper trail. If you agree to do something, confirm it in writing. If it is agreed that you will not do anything, confirm it in writing. If someone else has agreed to do something, confirm it in writing. In this regard, it is hard to imagine money better spent than by sending these letters via certified mail, return receipt requested.
- Use disclaimers whenever you provide any information. For example, a potential buyer of a rental property asks you to obtain income and expense information. You contact the accountant for the information and then pass it on to the buyer. You should, without question, include a cover letter to the buyer indicating that you did not prepare the figures, that you cannot confirm or deny their accuracy, and that to obtain additional information, the buyer should contact the accountant directly.
- Institute a tracking system to manage files. For example, some claims occur because the agent never provides all the information requested. A simple tracking or diary system means that agents do not have to rely solely on their memory for all the bits and pieces. For example, if an agent has assumed responsibility for obtaining zoning information, a note to the file and a tracking system brings the file to the agent's attention for completion.
- Use provisions. Inserting provisions into most listing agreements may either offer some protection to a listing agent or, if suit is instituted, provide a better probability of a successful defense. For example, every commercial property listing agreement should contain provisions that the agent assumes no responsibility for obtaining or verifying any property information and that the owner of the property is not relying on the agent to provide this information. This provision should cover zoning, size, boundaries, permitted use, income, expenses, and the like.
- Insert a provision in the listing agreement covering attorney fees. This may help compensate you if you are forced to bring a suit to recover a commission. Acknowledging your position upfront may also cause an owner to think twice before refusing to pay.
Prudent, careful planning and anticipation of possible problems will diffuse many situations before they reach critical mass. And, when in doubt, consult an attorney in whom you have confidence. It will cost you far less if you do it sooner rather than later.