The reduction of uncertainties for harm
The nature of the real estate brokerage business compels brokers and agents to interact with one another and members of the public as fluidly as possible. When working with others under the authority of their California Bureau of Real Estate (CalBRE) license, brokers and agents render services in the capacity of:
- an advisor to an individual who has retained the broker’s services in a real estate related transaction; or
- an agent dealing with another broker, their agents or a member of the public to find a match for the individual they represent regarding ownership, financing or the letting of real estate.
These services involve activities which may cause another person a loss, a risk inherent in activities conducted under agency relationships.
All activity undertaken by a broker and their agents exposes the broker to the risk of a liability caused by an:
- omission; or
- misunderstanding brought about by the activities of the broker or their agents.
All acts carried out by a broker or their agents present the possibility that a client or other person will be injured financially. This includes:
- the giving of advice; and
- the preparation of disclosures and agreements.
The broker needs to control the risk of loss by choosing activities which may be conducted with more certainty of a favorable result when relied on by the client or other person in a real estate transaction. Thus, brokers need to maintain a risk reduction program to keep claims from clients and others under control.
Components of a risk reduction program
The five steps necessary to establish a risk reduction program include:
- Identify all activities exposing clients, others or the broker to financial injury.
- Break down each identified activity into component acts and events which need to be properly performed to eliminate the risk of causing a loss to clients, others or the broker.
- Evaluate what sorts of loss clients, others or the broker may experience if the broker or their agents undertake the identified activity, or an alternative version of the activity.
- Adopt procedures and limitations to control the parameters of the agent’s conduct when performing activities that expose clients, others or the broker to loss, based on the broker’s comfort zone and the level of liability exposure acceptable to the broker.
- Track compliance by agents with activities authorized and limited by the broker’s policies and procedures, and establish ongoing remedial training and dispute resolution for claims made by clients and others.
Identify activities requiring management
To initiate an analysis for managing the risk of loss, a broker needs to identify and list all the activities agents perform which are potential sources of a claim of liability against the broker.
The nature of the services offered by brokers varies. Thus, the risks vary depending on whether the activities are classified as:
- sales of single family residences (SFRs), income property or land;
- financing of purchases, construction or equity; or
- leasing or management of residential or commercial property.
Other categories of broker activity are based on their duty owed to the client for the performance of services sought by the client. This includes the actions of a seller’s broker, such as:
- advising the client;
- inspecting the property to be marketed;
- collecting data for disclosures to prospective buyers;
- marketing the property to locate buyers; and
- negotiating the terms of a sale.
Likewise included are the actions of a buyer’s broker, such as:
- selecting qualifying properties;
- gathering property information;
- confirming the veracity of seller disclosures;
- evaluating the data collected;
- advising the buyer on acquiring the property; and
- negotiating the acquisition.
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 on information provided by the broker based on third-party sources such as the property owner, inspectors or public records.
The uncertainties in each activity
After identifying the type of broker and agent activities which expose the broker to liability, the next step is to break down each activity into all of its essential parts. This process narrows down the acts containing uncertain results that may lead to the client suffering a loss.
The broker needs to determine what it is about a particular activity that might expose the broker to liability or other adverse consequences. This question is to be considered when defining the handling of an activity, such as
- a diligent visual inspection of property and property inspection report;
- the preparation of the transfer disclosure statement (TDS) or other property improvement disclosures; or
- review of an annual property operating statement (APOD) and supporting documents.
Thus, a client or other person’s risk of loss is mitigated or averted completely.
For example, one of the activities to 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.
Many aspects exist in developing and giving an opinion. The failure to simply review each aspect creates exposure to liability. Thus, a checklist of actions to take regarding the process for the agent’s development of an opinion is needed.
Activities creating risk
Extreme 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 changes in the demands of buyers and sellers.
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. These can expose the seller to loss and the broker to liability. Listing and escrow arrangements, while routine and customary, are also to be evaluated for risk.
For example, agents often fail to advise sellers that property disclosures are mandated to be delivered to prospective buyers as soon as possible after the prospect first seeks further information about the property.
Likewise, seller’s agents often improperly delay the presentation of adverse information about a property to the buyer. Often, the first disclosure of adverse conditions is made only after a binding purchase agreement exists, escrow is open and the buyer has arranged financing.
Nondisclosure before entry into a purchase agreement creates an ambiguity about the buyer’s knowledge of the property’s conditions, and thus the proper price to pay. This conduct exposes brokers to liability when the buyer experiences lost expectations of value.
Other components of an identified activity also evaluated for risk of loss include:
- Who is the source of the information given?
- How credible is the source of the information?
- When does a broker need to start gathering information for their due diligence investigations?
- What is the proper time to release known information on a property to prospective buyers?
- Where is readily available information which needs to be obtained and reviewed for unknown (but knowable) defects?
- What other decisions might produce adverse consequences while performing the identified activity?
Evaluating the uncertainty of adverse results
Having created a list of brokerage activities and actions a broker’s agents will be engaged in, the broker then needs to assess the potential for loss posed by each activity.
Brainstorming needs to be undertaken to get this right. Market conditions are constantly changing and the nature of participants in real estate transactions shifts equally as fast.
If it is determined a loss might occur, the significance of the loss needs to be evaluated to determine its financial impact on the client or other person — and whether the broker is exposed to liability for the loss. 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.
This evaluation precedes any decision by the employing broker to authorize an activity. Only after the evaluation can a broker logically undertake the risk of their agents performing the service for clients and others.
E&O insurance offsets some risks
As a buffer against liability, a broker purchases negligence insurance known as errors and omissions insurance (E&O insurance).
With the payment of a premium, E&O insurance protects brokers from the full cost of defending against a negligence claim made by a client or others.
Similarly, auto insurance is in place to cover liabilities resulting from the agent’s use of their vehicle when conducting real estate activities authorized by their broker. Thus, the broker is to become a named insured on the policy for the vehicle used by the agent to render brokerage services.
Through both forms of insurance, the liability exposure for professional negligence and the cost of defense are shifted to corporate insurers willing to take on the financial burden of those uncertainties.
Avoiding unacceptable levels of conflict
Even with insurance, each broker hiring agents needs to determine what level of risk is acceptable for them when undertaking a chosen brokerage activity.
For example, risks in providing information to clients and others may result in minimal liability exposure for claims. These are absorbable risks the broker and their agents 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 needs to agree to contribute to any settlement paid out by the broker on claims generated by the agent’s conduct.
However, some conduct in the performance of agency duties are entirely unacceptable acts as they pose pure risks which lead to absolute liability. Pure risks include:
- withholding known or unknown but readily available information from the seller or buyer; or
- misstating or permitting the misstatement of facts or consequences of facts which cause the person who may rely 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 by an agent. Occasionally it is the activity itself which is considered improper and automatically imposes liability for any losses it may cause.
Each broker hiring agents will have a different level of acceptable risk they are comfortable with. Whatever that level may be, policy measures need to 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.
The management by the agent of a purchase agreement, deposit, disclosures and the dictating of escrow instructions needs to be detailed so the expectation of the agent about their conduct is well understood.
Tracking agent compliance with policy
Without an administrative structure to verify the broker’s agents are conducting themselves as intended, the broker will be exposed to an unnecessary risk of loss. Thus, continued oversight and policing are put in place to limit unilateral changes, distortions and deviations from agent conduct acceptable to the broker.
Oversight requires the commitment of financial and human resources to report unacceptable conduct, the holding of training meetings, and the maintenance of client files. In a word: continuing management.