BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP
RISKS OF AGENTS ACTING OUTSIDE THE BROKER-AGENT RELATIONSHIP
In today’s challenging market, agents are trying to find more creative ways of earning income. Unfortunately, some of those agents have undertaken work failing to recognize that all work performed pursuant to their license is required to be performed pursuant to the Independent Contractor Agreement (“ICA”) with their broker. There can be dire consequences for acting outside that relationship. Consider the following scenarios.
SCENARIO NO. 1: Agent with a salesperson license lists a property for rent on behalf of the owners. The owners are friends of the agent and the agent does not run the transaction through the broker. Agent locates tenants and places them in the property. Agent receives compensation directly from the owners. The tenant subsequently files a lawsuit against the owners, broker, and agent. Broker learns about the underlying transaction when the lawsuit is filed.
RESPONSE: There are a number of legal issues with the agent’s handling of this rental. The agent is a licensed salesperson and therefore all real estate activity must be run through the broker pursuant to California law and Department of Real Estate (“DRE”) regulations. In addition, any compensation the agent receives from a client for real estate services must also be run through the broker. The agent’s acceptance of compensation without notifying the broker is a further DRE violation. In this scenario, a conflict of interest has now arisen between the agent and the broker. The broker’s defense will be that the broker had no ability to supervise the transaction as the broker was unaware of it. Therefore, the broker is likely to have no liability. In addition, coverage will likely be denied by the insurer given that the actions took place outside of the broker-agent relationship. The agent will be forced to retain their own attorney since that agent’s conduct does not fall within the broker’s risk management program nor errors and omissions insurance policy. Pursuant to the ICA, the broker will also have a right of complete indemnity from the agent requiring the agent to reimburse the broker for any adverse damages judgment, and can also require that the agent pay the broker’s attorney’s fees. The end result is that agent was forced to retain agent’s own attorney, reimburse the broker for all attorney’s fees and pay a settlement to the tenants.
SCENARIO NO. 2: Agent begins working with a seller prior to listing the property. Agent make recommendations regarding improvements and repairs. Seller then asks agent to manage those improvements and repairs. Agent enters a “Construction Management Contract” with seller. Agent is paid for those construction management activities. Agent then lists the property. Broker is aware of the listing but not the construction management agreement. A lawsuit is subsequently filed against the broker and the agent arising out of construction defects and non-disclosure of work performed without permits. Agent looks to broker to defend the action. Broker declines and seeks reimbursement from agent for all fees and costs.
RESPONSE: Agent is not entitled to insurance coverage nor assistance from the broker with regard to agent’s construction management activities. Agent will be required to retain an attorney on agent’s behalf to represent agent at agent’s sole expense. Broker has a right to seek indemnity against the agent for any activities and damages relating to the construction and any alleged non-disclosures. Broker’s E&O insurance company is unlikely to insure the agent given the agent’s construction management activities given that the insurance policy covers only services performed pursuant to a real estate license (construction management activities do not require real estate license; rather, they require a contractor’s license). Agent is forced to retain agent’s own attorney to represent agent. The result is that agent spends multiples of the construction management fee resolving the case.
DISCUSSION: Real estate salespersons are required by the DRE to perform all real estate related activities wherein compensation is expected under the broker’s supervision. If an agent fails to disclose a situation or a transaction to a broker, the agent not only risks the DRE taking action against their license, but risks having to retain their own attorney to defend them, a lack of insurance coverage, and a potential for paying all the broker’s attorney’s fees and costs.
All compensation for real estate activities relating to a real estate salesperson or any licensee for licensed activities must be run through the broker.
If a broker does not undertake certain real estate activities (e.g., property management), the agents cannot undertake that work. If the agent does and a claim arises, the broker can seek reimbursement for all attorney’s fees and costs and it is unlikely that there will be insurance coverage.
Real estate broker associate activities can be handled differently. If a broker associate is licensed with a broker, the broker associate must act within the course and scope of that relationship. However, in some instances, broker associates have reached agreements with their brokers to perform licensed activities outside that agreement. For example, when brokerages do not perform property management, some brokers will negotiate agreements with broker associates, allowing the broker associates to perform those services under certain conditions.
PRACTICE TIPS:
- Agents with a salesperson license must always handle every real estate related transaction where compensation is expected through their broker.
- Agents may not accept any real estate related compensation except through their broker.
- Agents should be cautious in undertaking real estate activities as favors for “friends and family,” as those activities may not be covered by the broker’s insurance and may lead to significant liability.
- If a broker associate wishes to undertake real estate related activities outside of the agreement with the broker, the broker associate should speak with the broker directly about amending the ICA contract to address these activities. Broker owner managers can contact BRM for assistance in drafting addenda.
WEEKLY PRACTICE TIP: DO NOT FORWARD TO CLIENTS. This Weekly Practice Tip is an attorney-client privileged communication for the exclusive use of clients of Broker Risk Management and their agents. It may not be reproduced or distributed without the express written consent of Broker Risk Management LLP. The advice and recommendations contained herein are not necessarily indicative of standards of care in the industry but rather are intended to suggest good risk management practice.