This article presents the components of a risk reduction program to be considered by a broker to regulate the activities and conduct of his agents with members of the public.


The reduction of uncertainties for harm

Licensed brokers and agents interact between themselves and with members of the public. Their involvement with the public when acting under their Department of Real Estate (DRE) licenses is either in the capacity of:

· an agent acting on behalf of an individual who has retained the services of a broker to be their representative in a real estate related transaction; or

· an agent dealing with another broker, his agents or a member of the public in an effort to find a match for the individual they represent regarding ownership, financing or the letting of real estate.

These two relationships brokers and agents engage in with members of the public require activities, such as investigating property conditions, negotiating purchase agreements and preparing documents, in order to attain a client’s objectives. All of these activities contain risks as addressed in this chapter.

The risk of causing another person a loss are inherent in all activities conducted in the context of agency relationships. Agency relationships exist as either special duties (fiduciary) or general duties which are owed, respectively, to the client or the other party.

The risks taken by a broker and his agents which expose them to liability due to an error, omission or misunderstanding are brought about by the activities of the broker or his agents. Investigations, inspections, negotiations, the giving of advice, and the preparation of disclosures and contracts, etc., carried out by a broker or his agents all present the possibility that a client or other party will be injured financially. It is the risk of causing these losses which the broker must control, limit or eliminate by choosing activities which can be conducted with more certainty of a favorable result when relied on by the client or other person in a real estate transaction.

Since all activities conducted by a broker and his agents pose a threat of liability for harm resulting from their actions, brokers need to maintain a risk reduction program to keep claims from clients and other people under control. One approach to managing risk is to develop a risk reduction program for identifying risks and tracking agent compliance with the guidelines set by the broker as the minimum acceptable conduct of his agents.

Components of a risk reduction program

The five steps necessary to establish a risk reduction program are as follows:

1. All activities which expose the broker to liability must be identified based on whether the activity runs the risk of causing the client or others to be injured financially.

2. Each identified activity must be broken down into its component parts, i.e., all of the acts and events that comprise the activity, which must be properly performed to eliminate the risk of causing a loss to a client, others or the broker.

3. An evaluation must be undertaken of what sorts of risk of loss the client, others or the broker could experience if the broker or his agents undertake the identified activity, or a modified or alternative version of the activity.

4. Brokerage activities must be chosen and procedures and limitations must be adopted to control the parameters of the agent’s conduct when performing those activities, based on whether or not they fall within the broker’s comfort zone and provide the level of exposure to liability acceptable to the broker.

5. Agent compliance with activities authorized and limited by the broker’s policies and procedures must be tracked, and ongoing remedial training and dispute resolution for claims made by clients and others must be provided.

Identify activities requiring management

To initiate an analysis for managing the risk of loss, a broker must identify and list all the activities agents perform as licensees which could potentially be the source of a claim of liability against the broker. The extent of the detail in itemizing a list of licensee conduct is a decision made by each broker. Also, the nature of the services offered by brokers varies by whether the activities are classified as the sale of single-family residences (SFRs), income property or land, the financing of purchases, construction or equity, or the leasing or management of residential or nonresidential property.

Other categories of broker activity are based on the duty owed to the client or others who might provide the match sought by the client. Included are the actions of a listing broker, such as advising the seller, inspecting the listed property, collecting data for disclosures, marketing the property and negotiating the terms of a sale. Likewise included are the actions of a buyer’s broker, such as selecting qualifying property, gathering property information, confirming the veracity of seller disclosures, evaluating the data collected, advising the buyer and negotiating acquisitions. Loan broker and leasing agent activities likewise have categories of duties owed to the participants in their real estate transactions.

Other risks of exposure to liability arise out of losses incurred by clients and others when they rely (to their detriment) on advertising, factual disclosures, advice or information relayed to them which the broker or his agent have received from other sources, such as the property owner, third-party inspectors, government agencies, other owners, opposing brokers or anyone else affiliated with the transaction.

The uncertainties in each activity

After identifying the type of activities a broker and his agents handle in the course of the broker’s business which expose the broker to liability, the next step is to break down each listed activity into all of its essential parts. This process narrows down the acts containing uncertainties in result that could lead to the client suffering a loss.

The deficiencies in an agent’s performance of a brokerage activity which might mature into a claim against the broker is usually the result of the agent’s failure to properly perform or complete an itemized component of the identified activity.

The question to ask when defining the handling of an activity, such as a diligent visual inspection, preparation of the transfer disclosure statement (TDS), the disclosure to a prospective buyer, or the timing of these actions, is what is it about the activity that could expose the broker to liability or other adverse consequences. This break down of the identified activity into its component parts becomes the checklist of proper and improper conduct for performing that part of the activity. Thus, a client or other persons’ risk of loss, which is created by the uncertainty as to just what performance or level of performance the broker and his agents must achieve to avoid personal liability, can be averted.

For example, one of the activities which should be identified in the first step of a risk reduction program is the giving of an opinion in response to an inquiry regarding a property’s covenants, conditions and restrictions (CC&Rs), income and expenses, operations, improvements, location, zoning, value, etc. Many aspects exist in developing and giving an opinion. The failure to consider each, or the ambiguity created by failing to diligently investigate to eliminate known and unknown uncertainties about these aspects of an opinion, creates exposure to liability. Thus, there is a need for a checklist of actions to take regarding the development of an opinion. [See Chapters 5 and 6]

The list of identified activities should also include an agent’s wayward and nonconforming conduct which occurs cyclically during hot, boom-style seller’s markets and periods of greatly diminished sales, loans and leasing numbers. These improper actions are typically the result of the individual greed of the agent for profit or the agent’s desperation for financial survival.

Excessive market conditions, manifested by the boom and bust phases of the real estate business cycle, produce dangerous aberrations in the conduct of agents when dealing with buyers and sellers.

These distorted actions of agents (and brokers) too often take advantage of clients and others by violating agency rules. One example includes an agent buying the listed property, directly or indirectly, for his own account or to relatives at a price less than the property’s fair market value. Further exposure to liability arises when the property is immediately relisted for sale at a profit.

The activities of negotiating purchase agreements and obtaining new listings are acceptable brokerage activities. However, risky actions are occasionally incorporated into an otherwise appropriate activity, which exposes the seller to loss and the broker to liability.

Listing and escrow arrangements, which seem routine or are considered customary and standard activities, should also be evaluated. However, these “customary and routine” actions may not have legal underpinnings. Thus, they may well lack certainty that no wrong will come of them.

For example, an agent often does not advise a seller when the listing is entered into that the disclosures which the seller, with the agent’s assistance, must initiate with the prospective buyer are to be made as soon as possible after the prospect first seeks further information about the property.

Likewise, listing agents routinely present adverse information about the property to the buyer at the last minute, right before the close of escrow. However, the marketing package of property disclosures is to be presented to buyers before a purchase contract is entered into.

Nondisclosure before entry into a purchase agreement may create ambiguity about the property’s conditions and is conduct which exposes the broker to liability should the buyer experience lost expectations of value. The use of some modified or altered conduct calling for timely delivery of the TDS, i.e., before acceptance, should be considered by the broker. [See Chapter 4]

Other components of an identified activity which must be evaluated for risk of loss include:

1. Who is the source of the information?

2. How credible is the source of the information?

3. How reliable is the information?

4. When should the due diligence information gathering activity be undertaken?

5. What is the proper time for releasing known information to prospects?

6. What readily available information needs to be obtained and reviewed for unknown (but knowable) risks so discoverable uncertainties can be resolved?

7. What other decisions could produce adverse consequences while performing the identified activity?

Evaluating the uncertainty of adverse results

Having created a list identifying the brokerage activities a broker’s agents will be engaged in and detailing the actions and events which comprise these activities, an assessment is then conducted of the adverse consequences the activities might generate which would cause a loss for the client or others. If it is determined a loss might occur, the significance of the loss must be evaluated to determine its financial impact on the client or others, and whether the broker becomes exposed to liability.

This evaluation must proceed any decision to authorize an activity, or an alternative or limited activity. Only then can a broker logically undertake the risk of performing the service for clients and others, such as the decision to give your opinion, on inquiry, of likely results based on your knowledge, observations and conclusions about a subject.

The evaluation process interprets, in terms of probable losses and liability arising out of an error or omission, the impact of risks taken when representing a client, conducting negotiations and giving advice and opinions to help them meet their objectives.

As a buffer against liability arising out of an error or omission, a broker can purchase negligence insurance, called errors and omissions insurance or simply E and O coverage, with the payment of a premium. Also, auto insurance can be purchased to cover liabilities resulting from the agent’s careless use of their vehicle to conduct activities within the scope of the brokerage activities chosen by the broker and authorized for the agent to undertake.

Thus, the liability exposure for professional negligence and the cost of defense are shifted to corporate insurers who are willing to take on the financial burden of those uncertainties.

Even with insurance, however, each broker hiring agents must determine what level of risk he will accept when undertaking a chosen activity.

For example, risks in providing information to clients and others might only result in minimal liability exposure for claims. These are absorbable risks the broker and his agents can take which are either uninsured or within the range of the deductible not paid by the insurer. When brokers authorize absorbable-risk conduct, an agent should by agreement be required to contribute to any settlement paid out by the broker.

However, some conduct in the performance of agency duties are pure risks which must be avoided since they lead to absolute liability as entirely unacceptable acts, such as deceit, withholding known or unknown but readily available information, or misstating the facts or consequences of facts which cause the person relying on the statements to suffer a financial loss.

Substandard activity, sometimes called a classified risk, needs to be given special emphasis. This activity generally leads to a lack of proper performance, or is an activity which itself is considered improper and automatically imposes liability for any losses it may cause. Unconditional statements as opinions about surveys, boundaries, and the condition of improvements turn into guarantees which clients and others are allowed to rely on, unless they know of facts to the contrary. These risks should be ruled out as impermissible conduct. [See Chapter 6]

Each broker hiring agents will have a different level of acceptable risks with which he will be comfortable. Whatever that level may be, policy measures must be adopted to provide guidelines and instructions on just what steps agents are to take when conducting a brokerage activity chosen by the broker as an acceptable risk. For example, trust funds must be defined and the handling of their receipt, recording, safekeeping and delivery to the intended recipients by the agent (or the broker) and the timely performance of each needs to be laid out in clear, concise language for agents to understand.

The management by the agent of a purchase agreement, deposit, disclosures and the dictating of escrow instructions, all within a framework of time, also needs to be detailed so the expectation of the agent’s conduct is well understood.

In the end, the broker makes a decision to allow agents to act within boundaries of defined conduct and restricted activities so the risk of a possible loss to the broker is not so great that the agents should not undertake an activity at all.

Tracking agent compliance with policy

Without an administrative structure to verify that a broker’s agents are actually conducting themselves as intended, the risk of loss sought to be reduced or eliminated by the broker’s stated policies will often go unexperienced. Thus, continued oversight and policing must be put in place to limit unilateral changes, distortions and deviations from the conduct acceptable to the broker. This requires the commitment of financial and human resources to report unacceptable conduct, hold training meetings, and to maintenance files, i.e., continuing management.

Office managers, staff transaction coordinators, packagers of property disclosures, and even attorneys, should be employed by the broker to lend a hand in policing the agents’ compliance with the activities authorized by the broker.

Dispute resolution management for effective damage control when potential and actual claims arise against the broker is a back- pocket consideration, programmed to be promptly engaged when conflicts arise between a client (or others) and the broker over an agent’s activities.