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ANALYSIS

 

Profitability Threatened by New Risks

 

By William L. Jansen, Esq. for Real Trends, March 2003

 

OVERVIEW

 

Owning a residential real estate company has never been an easy proposition.  Recruiting and retaining agents has always been a challenge.  Weathering the vagaries of the economy, interest rates and new competitors is not for the faint hearted.  At the same time, the cost of operating a company keeps going up, gross commission percentages erode and agents command higher and higher percentages of the gross.  Margins diminish and profits shrink.

 

On top of this, the legal costs of operating a brokerage are increasing.  Each year there seems to be more claims and litigation than before.  Filing law suits has become a national sport.  And, law schools keep turning out lawyers, at a time when if two cars collide chances are one of them is an attorney.

 

In fact, the plaintiff’s bar has been focusing on the residential real estate business in recent years.  With our complex transactions, there are many moving pieces which have to be managed and executed with a high degree of care.  If one of these pieces, a disclosure for example, is not done timely and well, a plaintiff’s attorney has something to point to as evidence of a failure of the broker’s duty.  The result is more claims, new theories of broker liability, and increased broker expense.

 

THE PROBLEM

 

However, these increases in claims, and associated costs, are also the result of a more basic set of problems.  As home prices rise, the clients expect more from the home they are buying.  The home may be twenty, thirty or sixty years old but, because of the high prices, buyers have the same expectation as if they are buying a new car with a five year bumper-to-bumper warranty.

 

The advent of more disclosures not only contributes to this heightened consumer expectations, but also adds to the complexity of the transaction for the agent.  The demands on agents have never been higher.  Whereas the typical agent used to be able to succeed by having good sales skills, now that agent must also have the ability to manage and coordinate a team of assistants, inspectors, attorneys, contractors, lenders, title and escrow people.

 

Brokers must take affirmative steps to reduce their risks.  The first step is to identify the high risk areas and then implement risk management programs to address them.

 

HIGH RISK AREAS

 

Each area of the country, indeed each state, will have different high risk areas.  Some of these high risk areas are common to most areas however.

 

AGENCY:  Most states have laws regarding agency disclosures and confirmation.  Failure to follow these laws can result in allegations that the clients weren’t aware of their choices, and the ramifications of those choices,  particularly in dual agency situations.  Dual agency is hard for attorneys, judges (who also are attorneys) and juries to understand.

 

ADEQUATE DISCLOSURES:  A majority claims involve an alleged failure to disclose by someone in the transaction; either the seller, the agents or one of the inspectors.

 

CONTRACT DRAFTING:  In addition to filling in the forms completely and checking all of the appropriate boxes, agents must have drafting skills when they prepare addenda and counter-offers. 

 

CONTRACT TERMINATION:  Whether a contract is terminated or not is a legal determination.  Agents must be trained to understand that if the parties disagree as to whether a purchase agreement is terminated, or terminable, this is a matter for attorneys not agents.

 

MOLD:  Mold is the new hot topic, and it is essential that agents take adequate steps to make sure that buyers and sellers understand the issues surrounding mold and take appropriate steps to protect themselves.

 

PRACTICE OF LAW:  A growing area of litigation against brokers relates to allegations of unauthorized practice of law.  Agents must be trained on when they should not act and, instead, refer the matter to an attorney.

 

RECOMMENDED ACTIONS

 

Brokers must design and implement a well thought out, integrated risk management program which cuts across many aspects of the company from hiring and training, to policies and procedures.

 

1.  Hiring:  It starts with hiring.  At the time of the interview, whether for a new agent or veteran, emphasize your company’s adherence to the highest standards of practice and customer service.

 

Don’t assume that newer agents know something that we all take for granted.  In fact, don’t assume that the veteran you just hired from a competitor has the same high standards that you require just because that agent has been a top producer in the area.  Set up a new agent orientation for all new hires and emphasize your company’s standards, ethics and professionalism. 

 

2.  Training:  Continue with training for your agents on their technical skills, such as contract writing and contingency removal.  Then add in regular risk management seminars to keep this important aspect of the business on the top of the agents’ awareness.  Have at least two or three of these per year, with license continuing education credit if possible, which helps to increase attendance.

 

Keep your staff on top of changes.  Company newsletters do not work.  Busy agents may intend to read your newsletter, with your great risk management tips, but often that is as far as they get.  Instead, prepare, or hire a risk management consultant to prepare, regularly scheduled tips for discussion at sales meetings.  These “munchable” risk management tips, presented by branch managers, keep agents on top of current risk management issues.

 

Don’t forget to include ongoing training for your managers.  Their awareness of the high risk areas will allow your company to catch those mistakes before they go too far.

 

3.  Policies and Procedures:  Have a current policy manual that reflects your company’s actual practices.  Have a written risk management program that clearly identifies how claims are handled; the agent’s financial contributions, if any; which claims are covered and which are excluded.  Make sure that these policies dovetail with your E&O Insurance policy coverages and exclusions.

 

4.  Inspections:  Train agents to recommend that buyers have property inspections, and additional inspections when recommended, since these inspectors have a higher standard of care within their field, and provide more detailed information for buyers to use in making their buying decisions.  Recommend inspectors, contractors and other professionals who are members of professional societies and carry their own Errors & Omissions professional liability (“E&O”) insurance.

 

5.  Transaction Logs:  It isn’t what you did that counts; it’s what you can prove that you did that wins law suits.  Encourage agents to keep transaction logs to document the salient events of their transactions.  This avoids the inevitable “he said – she said” when a claim hits.  Agents should document all “decision points” not otherwise memorialized in a document or communication with the client or other broker.  For example, if a home inspector recommends a foundation inspection and the buyer demurs because of cost, that conversation should be in the transaction log.

 

Transaction logs can be in a spiral bound notebook; or they can be individual sheets placed in the transaction file, computer entries, or even dictated onto a hand held micro-cassette for later dictating only if necessary.  Check with your local attorney that the form used meet the test of your state’s evidence code for contemporaneous business records.

 

6.  Transaction Legal Backup:  Provide timely legal advice for your managers and agents for real time transaction related issues.  By having a resource to get it right at the outset, many claims are simply averted.  This is the best risk management.

 

7.  Claims Handling:  Agents and managers need to understand what constitutes a claim under your E&O policy, and what to do if one is received.  Most E&O policies of insurance are “claims made” and require that claims be tendered in a timely manner.  Failure to do so could result in denial of coverage.

 

Be sure your staff understands the escalation process:  Who responds to the claim internally?  Who decides whether to tender to the carrier?  When is outside counsel involved? 

 

Settle early if you can - before plaintiff, and you, have incurred substantial legal bills.  These attorney fees then become the barrier to settlement in many cases.  Defending because “It’s a matter of principle” is expensive. 

 

CONCLUSION

 

In the current environment, no broker can afford to take the risk management aspect of the brokerage business lightly.  Take risk management seriously.  Make it a center piece of your firm’s operations.  And discipline yourself and your staff to follow through with all aspects of a good risk management program.