Inking the handshake: the significance of a written employment agreement

This article discusses the need for a written employment agreement to assure payment of any fee anticipated for finding a match and negotiating a real estate related transaction, and reviews the fee assurance offered by provisions in various types of listing and purchase agreements.

Expectations lost for want of a signature

Real estate brokers and their agents habitually attempt to form strong personal bonds with potential clients while making themselves better known to likely buyers, sellers, borrowers, landlords and tenants of property. Indeed, all professionals require some level of self-promotion to attract and retain clientele.

Through FARM letter campaigns and social networking contacts, a broker and his agents seek to generate future business —employment — among potential clients looking for an agent to advise and act on their behalf. By sharing detailed market knowledge of current sales and pricing trends along with a demonstrated understanding of the various contractual aspects of real estate transactions, an agent’s worth to potential clients becomes apparent.

In practice, communications with potential clients via Facebook or newsletters are simply too casual and passive to be construed as a personal fiduciary service. Yet in the eyes of the prospective employer, these informal precedents set the tone for future representation.

When representation is undertaken, the sporty solicitations and branding efforts are legally transformed into a serious dedication of diligence and advice to meet the client’s objectives for a real estate transaction.

Most clients unfamiliar with real estate related transactions willingly follow the advice and recommendations of the broker or agent they select to assist them. Thus, the broker’s knowledge that real estate related agreements are to be formalized in writing sets a prudent precedent for a written employment agreement – commonly called a listing.

It may be acceptable for old pals to make promises based solely on their word, but for real estate brokers and agents acting on behalf of a client, the only appropriate deal maker is written documentation — a signed form prepared by the broker. Brokers who “document” the transition of a potential client into a principal to whom they now owe a duty of care with nothing more than a handshake act at their peril, risking loss of their well-earned fee and setting a terrible example for their agents and the industry.

The workings of an employment agreement

When a client agrees to representation by a broker for assistance in the purchase, sale or lease of property (or arrangement of a mortgage), the two parties enter into a listing agreement, an employment agreement worded to establish the expectations of their relationship as client and fiduciary agent. In doing so, the relationship created between the client and the broker has two separate and distinct legal aspects:

• an employment relationship; and
• an agency relationship.

The employment relationship created by the listing agreement specifies the activities a broker is obligated to undertake in his employment and authorized by contract to carry out on behalf of the client in exchange for a fee.

The agency relationship is imposed on the broker by law when he solicits or acts on behalf of another person. Agency carries with it the fiduciary duties of loyalty owed by the broker (and his sales agents) to care for and protect the best interests of the client against all competing interests. [See first tuesday Form 305]

The not-so-friendly oral fee agreement

An oral agreement to represent a client in a real estate transaction imposes an agency obligation on the broker and all his agents to act as a fiduciary to that client, no different than if a written and signed employment agreement existed. However, a client’s oral promise to pay a fee for the broker’s services (or cause one to be paid as with a client-buyer) does not entitle the broker to enforce collection of the fee from his client.

Thus, all fee agreements must be in writing and signed by the client before the broker can pursue the client for collection of the amount he has earned— no matter who was to pay it. [CC §1624(a)(4)]

In other words, an oral agreement obligates a broker to work diligently in the best interest of the client, but does not obligate the client to pay for the effort. However friendly a broker may be with his client, oral agreements do not provide adequate assurance a fee earned will be paid by anyone.

Consider a real estate broker contacted by a prospective buyer interested in locating and acquiring property. It is agreed the broker will assist the buyer in finding suitable property for purchase. The buyer orally promises the broker will be paid a fee in the event the buyer purchases any property submitted to the buyer by the broker.

The broker then proceeds (with diligence) to locate and present suitable properties to the buyer for consideration. The buyer, interested in a property submitted to him by the broker, contacts the seller directly and purchases the property without the broker’s involvement.

The broker, on discovering his client’s acquisition of the property, demands payment of the promised fee he has earned. The buyer refuses to pay, claiming no writing signed by the buyer exists between the broker and the buyer for payment of a broker fee.

Is the broker entitled to his fee on the sale as orally promised by the buyer?

No! The oral agreement obligated the broker to fulfill fiduciary duties owed the buyer, which he did.  However, it did not impose liability on the buyer to pay the broker a fee on his acquisition of property located and submitted by the broker as orally agreed. [Phillippe v. Shapell Industries, Inc. (1987) 43 C3d 1247]

A contract enforceable is prerequisite

Entering into a written employment agreement immediately upon establishing an agency relationship with a buyer or seller will ensure all parties are on the same page. [See first tuesday Forms 102 and 103]

The written listing contains the client’s promise to either pay a fee or cause a fee to be paid by someone else, such as the seller in a sales transaction. The promise is given in exchange for the broker’s promise to use due diligence in his efforts to meet the objectives sought by the client in the employment.

Consider a real estate broker who enters into a listing agreement with a seller employing the broker to locate a buyer for his property. The listing agreement, written and signed by the seller, entitles the broker to a fee should the property be sold within one year, whether or not the broker is the procuring cause of the sale, called an exclusive right-to-sell listing agreement.

Within one year after entering into the employment, the seller agrees to sell the property to a buyer the owner located.  The sale is closed without the payment of a fee to the broker. The broker demands payment of his fee earned on the sale under his listing agreement. The seller refuses, claiming the broker did nothing to “earn” a fee.

Is the broker entitled to a fee for the sale, even though he was not in any way involved in the solicitation or sale of the property to the buyer?

Yes! Documentation of an obligation to pay a fee in the form of a written agreement signed by a client is the legislatively mandated and judicial requisite to the right to enforce collection of a brokerage fee from the seller. [Crane v. McCormick (1891) 92 C 176, a moldy but enduring authority.]

Earned fee interference: prospective economic advantage

Regardless of whether a signed, written listing agreement exists, nobody may interfere with the prospective economic advantage a broker holds with his client — a relationship, written or oral, that would have earned a fee but for the interference.

Consider a seller who places a sign on his property stating, “For Sale — Contact Your Local Broker.” The sign constitutes an open listing with local brokers, who have the opportunity to procure ready, willing and able buyers and thus earn a fee should the buyer they procure purchase the property.

After seeing the property, a potential buyer approaches a local broker and they discuss the property. The buyer indicates he will contact the broker if he decides to purchase the property. The broker does not obtain an oral or written promise from the potential buyer to assure payment of a fee, but promptly advises the seller about the inquiry, identifying the potential buyer as his client.

The seller is then directly approached by the potential buyer with an offer to purchase the property without providing for payment of a fee to the broker, which the seller accepts.

The broker learns his buyer has purchased the property and makes a demand on the seller for payment of his fee earned on the sale. The seller refuses, claiming the broker is not entitled to a fee on the sale since the broker did not have a written agreement with either the buyer or the seller entitling the broker to his fee.

Is the broker entitled to a fee from the seller for procuring the buyer even though he had no written employment agreement with either party?

Yes! The seller owes the broker a fee on the sale. Here, the seller knew of the broker’s employment relationship with the buyer and intentionally avoided payment of the broker’s fee by selling the property without further involving the broker — an interference with the broker’s prospective economic advantage arising out of the broker’s employment by the buyer. [Buckaloo v. Johnson (1975) 14 CA3d 815]

Intentional interference with prospective economic advantage is considered tortious conduct which imposes liability on the person collaborating with the client to avoid the fee, not the subject of contract law as is enforcement of a breached writing. When a writing does exist, those entering into it typically perform as agreed giving no rise to collection enforcement.

Instead, a third party’s interference with a broker-client economic relationship is tortious interference with the broker’s potential to earn a fee on a transaction entered into by his client. The tortious misconduct relates to the disruption of an economic relationship rather than the breach of a contractual promise to pay a fee.

The seller knew of the broker’s relationship with the potential buyer and interfered with that relationship by selling his property directly to the buyer without the broker’s involvement. Thus, the seller’s conduct cost the broker his fee on the sale, a loss due to the disruption of his prospective economic advantage in the real estate transaction. [Zimmerman v. Bank of America (1961) 191 CA2d 55]

Open v. exclusive listings

To set the parameters of an agency relationship undertaken with a client, a broker must determine the type of services he will provide and the extent of assurances a fee will be paid for having entered into the employment.

A wide variety of listing agreements exist, each different in the extent of the representation and type of services to be performed by the broker and his agents, or the events which trigger payment of a fee as earned.

Listings are generally classified under one of two categories:

• open; or
• exclusive.

Under an open listing, also called a nonexclusive listing, the listing broker is not the sole representative of the client. The client can enter into open listings with as many brokers as he wants without becoming obligated to pay more than one fee. Worse, the client under an open listing is in direct competition with the broker since a client-seller may separately solicit, locate and sell the property to a buyer without incurring any liability for a fee to the broker.

For a broker to be entitled to a fee under an open listing, the broker must procure a ready, willing and able buyer and present the seller with an offer from the buyer to purchase the listed property.

In contrast to the open listing arrangement, an exclusive listing affords a broker the sole right to represent a buyer, owner or tenant. Under an exclusive right-to-sell listing, only one broker may market the property and negotiate with all potential buyers and their agents.

Likewise, an exclusive right-to-buy listing establishes a broker as the sole licensed real estate representative of a buyer. Further, and of great importance, a client who has entered into an exclusive-right-to-buy listing with a broker cannot act independent of the broker and avoid payment of a fee.

Exclusive listings offer a broker the greatest fee protection. Under the fee provision in an exclusive right-to-sell/buy agreement, the broker earns a fee no matter who produces the buyer or locates the property sought under the listing, be it the client, another broker or any other representative of the client.

Thus, exclusive right-to-sell/buy/lease/finance listings give a broker and his agents the greatest incentive (and obligation) to work toward attaining the client’s goal of locating a buyer or property. Both parties work together to accomplish the client’s objective.

Editor’s note — Agents representing buyers too often neglect to establish their employment in a written agreement before exposing the buyer to properties listed by other offices. Instead, they hope to write up a purchase offer, but when they do they use a purchase agreement form devoid of a fee setting provision.

Worse yet, buyer’s agents then rely on the inherently adversarial seller’s agent to set the amount, assure enforceability and disburse the fee earned on their buyer’s purchase. All the while, the buyer’s broker provides no assurance through escrow he will be paid on closing.

In the current housing market, buyers are a rare commodity and thus tend to dominate negotiations in sales transactions. An exclusive right-to-buy listing agreement between a buyer and a buyer’s agent guarantees no time, money and talent will be wasted locating property on behalf of this buyer, if they buy.