Trust funds 101

Funds belonging to others which a broker and their agents handle when acting as agents in a transaction are known as trust funds.

Trust funds include:

  • rents and security deposits collected under a property management agreement [See RPI Form 590];
  • good faith deposits tendered by a buyer or tenant with an offer to purchase or lease;
  • fees and costs paid to the broker in advance of their performance of agreed-to services [See RPI Form 107];
  • mortgage payments and funds on contract collection and mortgage brokerage; and
  • any other personal property of value.

Brokers who receive, transfer or disburse trust funds need to comply with strict recordkeeping and accounting requirements.

Related video:

Advance Costs are Trust Funds

These requirements are not to be treated casually — trust fund violations account for the vast majority of disciplinary action by the California Department of Real Estate (DRE), and may result in suspension or revocation of license. [Apollo Estates, Inc. v. Department of Real Estate (1985) 174 CA3d 625]

Handling cash and checks

When a broker receives funds in the form of cash or checks made payable to the broker — which may only be used for the benefit of the owner of the funds — those funds need to be:

  • deposited into the broker’s trust account;
  • held undeposited as instructed; or
  • endorsed and handed to others entitled to the funds.

Further, the broker needs to regularly update the owner on the status, expenditure and location of the negotiable trust funds, called an owner’s statement.

Prior to the end of the third business day following the day the broker receives negotiable trust funds, the broker needs to deposit the funds:

  • with the person or escrow depository entitled to the funds (as payee or by endorsement); or
  • in a trust account the broker maintains at a bank or other state-recognized depository. [Calif. Business & Professions Code §10145; California Bureau of Real Estate Regulations §2832(a)]

When an agent of the broker accepts trust funds on behalf of the broker, the agent needs to immediately deliver the funds to the broker unless directed by the broker to:

  • deliver the trust funds to the person or the escrow entitled to the funds; or
  • deposit the trust funds into the broker’s trust account. [Bus & P C §10145(c)]

An agent who negotiates the purchase or lease of real estate typically receives a check as a good faith deposit. The agent may hold the check undeposited until an agreed-to event occurs, such as when the offer is accepted or escrow is opened, if:

  • the check is made payable to someone other than the broker; or
  • the check is made payable to the broker and coupled with:
    • written instructions contained in the purchase offer to hold the check undeposited until acceptance of the offer or escrow is opened; and
    • notification to the person to whom the offer is submitted, typically the seller or landlord, that the check for the good faith deposit is being held by the broker when the offer is submitted. [DRE Regs. §2832(c)]

After a buyer’s offer is accepted, the agent may continue to hold the buyer’s check for the good faith money undeposited if the seller has given the agent written instructions to do so. Otherwise, the agent needs to deposit or deliver the funds no later than three business days after acceptance:

  • to the payee entitled to the funds, such as a title company or escrow;
  • into the broker’s trust account; or
  • to an escrow depository on the broker’s endorsement, if the broker is the payee and does not want to deposit and disburse the funds from their trust account to escrow. [DRE Regs. §2832]

Undeposited trust funds

Separate handling rules apply to funds not deposited in a trust account. The broker is to maintain a trust fund ledger separate from the trust account identifying:

  • the location of any undeposited trust funds received; and
  • the date the funds were returned or forwarded, such as a check, cashier’s check, cash or undeposited promissory note. [DRE Regs. §2831(a)(6)]

A broker is not required to keep records of checks for services such as escrow, credit reports or appraisal services when the total amount does not exceed $1,000 per transaction. [DRE Regs. §2831(e)]

However, the broker needs to account for the receipt and distribution of these checks on request from:

  • the DRE; or
  • the maker of the check. [DRE Regs. §2831(e)]

A broker is required to retain all trust fund records for three years after closing or cancellation of the related transaction. [Bus & P C §10148(a)]

The withdrawal of trust funds

A broker needs to know who owns and controls the funds held in their trust account at all times, since the owner is the only one who may authorize the disbursement of the funds. This is organized through the use of a subaccount ledger.

However, in certain cases the disbursement of trust funds requires the authorization of someone other than the owner who has an interest in the funds, such as a seller who acquires an interest in a buyer’s good faith deposit on acceptance of a purchase agreement offer. [Bus & P C §10145(a)(1)]

Withdrawals or disbursements from the trust account in the name of an individual broker require the signature of:

  • the broker named as trustee on the account;
  • a licensed broker or sales agent employed by the named broker under a broker-agent employment agreement, called a signer [See RPI Form 505]; or
  • an unlicensed employee of the named broker, provided the unlicensed employee is bonded for the total amount of the trust funds the employee can access. [DRE Regs. §2834(a)]

When the trust account is in the name of a corporate broker as trustee, withdrawals are made by:

  • the designated officer (DO) who qualified the corporation as a licensed broker; or
  • a licensed or unlicensed employee with the written authorization of the designated officer. [DRE Regs. §2834(b)]

However, a broker’s authorization to signers on the trust account does not relieve the broker from liability for loss or misuse of trust funds. [DRE Regs. §2834(c)]

To help prevent an improper withdrawal by an individual signer, the broker may require two signatures on trust account withdrawals. An insurance policy for the brokerage business needs to include coverage for theft by employees who have direct or indirect access to trust funds.

Improper commingling

When a broker deposits trust funds into an account used to receive and disburse personal or business funds — or when the broker places personal funds in a trust account — the broker has improperly commingled the funds. [Stillman Pond, Inc. v. Watson (1953) 115 CA2d 440]

A broker is only permitted to commingle personal or business funds with trust funds in the following two DRE-authorized situations:

  1. The broker may deposit up to $200 of their own funds in the trust account to cover bank service charges on the account; and
  2. Fees or reimbursement for costs due the broker from the trust funds may remain in the trust account for up to 25 days before being disbursed to the broker. [DRE Regs. §2835]

A broker’s improper commingling of trust funds may result in revocation or suspension of their license. [Bus & P C §10176(e)]

Related video:

Maintaining Trust Account Integrity

Monthly reconciliation

Brokers maintaining bank trust accounts need to reconcile the general ledger for the entire trust account against the separate subaccount ledger for each person and each transaction — at least once during each calendar month deposits or withdrawals are made.

The monthly reconciliation of the bank trust account contains:

  • the name of the bank where the trust account is located;
  • the account number;
  • the date of the reconciliation;
  • an identification of each subaccount in the trust account documenting the deposits, withdrawals and disbursement for each person; and
  • the amount of funds remaining held in trust on behalf of each person. [DRE Regs. §2831.2]

Violations subject to DRE discipline

When the DRE determines a broker violated trust fund accounting rules, the Commissioner may obtain an injunction against the broker to stop or prevent the violation. [Bus & P C §10081.5]

The Commissioner may also include a claim for restitution on behalf of clients injured by the broker’s misuse of trust funds. [Bus & P C §10081(b)]

When the DRE conducts an audit of the broker’s trust account and discovers the broker has commingled or converted more than $10,000 of trust funds, the broker’s license may be suspended pending a formal hearing. After the hearing, a receiver may be appointed to oversee the broker’s business. The receiver is allowed to exercise any power of the broker and may file for bankruptcy on behalf of the broker. [Bus & P C §10081.5]

Civil liability and punitive damages

A broker who misuses trust funds is required to reimburse the owner of the funds the amount wrongfully used. [Calif. Civil Code §3281]

However, a client’s right to recover money from a broker is not limited to the amount or value of these funds.

In addition to money losses, the client may be awarded punitive penalties based on a breach of the broker’s agency relationship with the client. When a broker uses the client’s money for their own benefit, any profits earned by the broker’s misuse belong to the client. Thus, the client is entitled to recover the funds wrongfully converted, plus any gain the broker derived from their use. [Savage v. Mayer (1949) 33 C2d 548]

Further, punitive damages, also called exemplary damages, are money awards given to a client when the broker wrongfully obtained assets, such as trust funds, from the client by fraud or with malice. [CC §3294]

Any wrongful use of trust funds is automatically considered fraudulent. The broker’s breach of their agency duty is defined by statute as constructive fraud. [CC §1573]

Thus, any broker misusing trust funds is potentially liable to the principal for punitive damages as well as reimbursement of the trust funds taken or misused. Whether punitive damages will be awarded depends on:

  • the severity of the broker’s misconduct; and
  • the agency relationship undertaken by the broker.

When actual money losses are small, punitive money awards are occasionally awarded as a deterrent against future fraudulent activity.

This article was originally posted August 2015, and has been updated.