Concerned about your fees if a buyer fails to close escrow? Read on to find out how to handle a buyer’s breach of a purchase agreement.
A buyer’s broker is owed a fee if their diligent efforts result in the buyer acquiring a suitable property. But collecting a fee becomes more analytical when the buyer breaches the agreement. As always in real estate transactions, the answers are in the provisions or lack of provisions – for both the buyer’s broker and the seller’s broker.
Cancellation for a justifiable reason
The first step is identifying whether the buyer’s cancellation of a transaction is a breach of their obligation under a purchase agreement or escrow instructions to acquire the property. A buyer (or seller) who refuses to hand escrow the instruments (funds and documents) needed to close the transaction or otherwise comply with the escrow instructions has breached the agreement, unless their nonperformance is excused.
The buyer’s nonperformance is excused, and the refusal to close escrow is not a breach of the purchase agreement, if:
- a contingency provision exists authorizing the buyer, seller or person benefitting from the contingency to terminate the purchase agreement on the failure of an event to occur or on disapproval of data, information, documents or reports;
- the event fails to occur or the condition reviewed is disapproved for cause; and
- the person authorized or benefiting from the contingency provision acts to terminate the agreement by delivering a notice of cancellation prior to the expiration of their right to cancel. [See first tuesday Form 183]
The buyer’s right to exercise their option to cancel is triggered when a valid reason exists. However, they may choose not to cancel or simply fail to serve a notice of cancellation on the other party. Without a notice of cancellation, their option to be excused from further enforcement expires. Unless a separate justification for not closing and acquiring the property exists, the buyer is obligated to perform – close escrow.
Consider a buyer who enters into a purchase agreement containing a contingency provision calling for the buyer to review and further approve a property operating cost sheet to be provided by the seller, called an income and expense statement or an Annual Property Operating Data (APOD) sheet depending on the buyer’s use of the property. The buyer’s receipt of the data commences a period of review by the buyer during which the buyer will determine whether to exercise their right to cancel the purchase agreement as allowed by the contingency provision. [See first tuesday Form 352]
The property operating data provided by the seller confirms the general information received by the buyer before making the offer. However, the breadth and depth of the information seems inadequate for a large, long-term investment. Thus, the buyer has their agent ask the seller to supply additional data and information, including access to all supporting documentation regarding the property’s operating history.
The seller claims the information already handed to the buyer sufficiently discloses the property’s operating history and refuses to deliver additional information. The buyer cancels the purchase agreement for lack of sufficient information about the property’s income and expense history.
Has the buyer breached the agreement by terminating the transaction based on the seller’s refusal to provide more information about the property under the contingency provision?
No! The seller has not fulfilled their obligation to deliver sufficient information to allow the buyer to complete their review and make an informed decision about the acceptability of the property’s operations.
The seller’s compliance with the buyer’s request for more information on the subject of the contingency provision is an obligation owed the buyer by the seller. The seller who fails to comply with a reasonable request for more data, information, documents and reports made by the buyer in good faith to assist in their decision making process of approval or disapproval of the condition or event under review has breached their obligations owed the buyer.
Thus, the seller has materially defaulted on their obligations, a breach which excuses the buyer’s further performance until the seller complies with the requests. Alternatively, the seller’s breach of the provision allows the buyer to cancel the agreement by serving a notice of cancellation or pursue enforcement by a specific performance suit.
Remember: before a buyer may effectively cancel a transaction, they need to first “place the other person — the seller — in default.” Thus, the buyer may not be in default under the purchase agreement on the date scheduled for the seller’s performance or the event to occur if they intend to cancel based on the seller’s failure to perform.
For the buyer to place the seller in default, three transactional facts need to exist:
- a scheduled date for the occurrence of a condition or event crucial to continued performance of the transaction has passed;
- the condition or event called for under a contingency provision in the purchase agreement did not occur by the scheduled date; and
- the buyer has fully performed all activities required of them to close escrow on the transaction.
Here, the seller has not performed as agreed by the scheduled date, called a condition precedent to the buyer’s further performance. And since the buyer has performed or is ready, willing and able to perform at the time of cancellation all activities they were obligated to perform in order to close escrow, called conditions concurrent, the buyer may justifiably cancel the transaction.
Brokerage fee protection and the seller
When a buyer has not met their own obligations under the agreement and cancels, they have breached the agreement. On their breach, the buyer may be held liable for losses suffered by others.
Consider a buyer who contacts a real estate sales agent to locate suitable properties for review with the intent to buy. The agent agrees to undertake the obligation of locating the desired property, but fails to discuss or obtain an oral or written commitment from the buyer regarding payment by anyone of a fee for services provided the buyer by the agent and their broker.
The agent locates a property suitable for the buyer’s purposes. The agent prepares an offer to purchase, which the buyer signs. The purchase agreement form does not contain a fee provision calling for the buyer to be responsible for broker fees in the event the buyer breaches the agreement. Worse, the buyer’s agent does not disclose to their buyer client the amount of the benefits the buyer’s agent is receiving for their representation of the buyer, a breach of their fiduciary duties.
The seller signs the acceptance provision. Concurrently, the seller in a separate document agrees, directly or indirectly, to pay the seller’s broker and the buyer’s broker a fee on completion of the sale. The buyer does not sign and is not a party to this separate fee agreement. Again, the buyer is not told what fees their broker is receiving, an ethics violation.
The acceptance is returned to the buyer.
The separate fee agreement between the seller and seller’s agent is retained by the seller’s broker. The seller’s broker enters into an oral agreement (it’s enforceable) with the buyer’s broker to share any fee received on the transaction.
All is well until the buyer, without justification or excuse, fails to complete the purchase.
Is the seller protected? Indeed, the seller, due to the buyer’s breach of the purchase agreement, may make a demand on the buyer for their money losses incurred due to the buyer’s breach.
However, the seller’s money losses may not include the amount of the brokerage fee since the seller has not paid and does not owe a brokerage fee on a buyer’s breach.
Only the buyer’s broker is due a fee
Continuing with the above example, the buyer’s agent makes a demand on their buyer to pay the buyer’s broker their fee earned when the buyer entered into the purchase agreement. The buyer’s broker does not wait for the seller to make claims for the buyer to perform and close the transaction.
The buyer’s broker claims the purchase agreement offer signed by the buyer is also subject to an implied promise from the buyer to close the transaction so the broker will receive their fee to be paid by the seller.
The buyer claims their broker is not entitled to a fee from the buyer. The only fee provision which exists merely entitles the brokers to fees established in a separate fee agreement, which the buyer did not enter into with their broker.
But is the buyer’s broker able to collect a fee from the defaulting buyer who never agreed, orally or in writing, to pay any fees?
Yes! The buyer by their conduct retained the services of the broker but did not promise, orally or in writing, to pay a brokerage fee if the broker’s agent located suitable property sought by the buyer to purchase. However, on entering into a purchase agreement, the buyer knew the buyer’s broker was to receive a fee from the seller or the seller’s broker on closing. The buyer’s offer to purchase the property contained an implied promise by the buyer to their broker not to wrongfully interfere with the payment of their agent’s brokerage fee.
Here, the payment of the fee is the burden of the breaching buyer alone. The seller is not compelled to contribute since the payment of the fee by the seller was contingent on the close of escrow, which did not happen. [Chan v. Tsang (1991) 1 CA4th 1578]
Conversely, the seller’s broker has no contractual right, expressed or implied, to collect a fee from the breaching buyer. The seller’s broker lacks:
- a client relationship with the buyer which carries with it the implied promise to avoid interference with the payment of a fee; and
- a written agreement signed by the buyer to pay the fee in lieu of the seller on the buyer’s breach.
The purchase agreement provides the solution
A fundamental rule of real estate practice for judicial enforcement of fee arrangements requires brokerage fee agreements to be in writing and signed by the parties responsible for payment.
However, a common flawin the drafting and placement of brokerage fee provisions in many purchase agreement forms is the failure to include the entire fee provisions in the body of the buyer’s purchase agreement offer, i.e., above the buyer’s signature, sometimes referred to as “within the four corners of the contract.”
When the fee provision is placed within the buyer’s offer, the agreement explicitly states the seller will pay the fee if the transaction closes. Further and to protect all the brokers involved, it needs to state that if the sale does not close due to a breach, the breaching party will pay the agreed fees. Thus, all parties to the purchase agreement have agreed on what amount they owe, when they owe it and to whom it will be paid. [See first tuesday Forms 150 §15 and 159 §15]
Brokers as beneficiaries
When a buyer and seller agree in writing to the payment of a brokerage fee, their brokers become third party beneficiaries to the purchase agreement. For example, if either the buyer or the seller enforces the purchase agreement contract against the other by specific performance, the brokers will be paid on closing as part of the terms contained in the purchase agreement.
However, when the agreement is separately agreed to outside the buyer’s offer (or mutual escrow instructions) and only between the seller and the brokers, the seller can actually close the transaction without payment of the fee on unilateral instructions which escrow is bound to follow. To collect, the brokers are required to pursue the seller after closing for breach of the separate fee agreement. [In re Munple, Ltd. (9th Cir.1989) 868 F2d 1129]
A third party beneficiary is a person for whose benefit two other individuals place provisions in an agreement — such as when a buyer and seller under a purchase agreement or escrow instructions mutually provide for the payment of a brokerage fee by the seller or defaulting party.
A brokerage fee provision written into the purchase agreement gives both brokers a separate enforceable contract right to collect their entire fee, either as part of the closing or from the breaching party on a failure to close. The assurance for payment is due to the location and wording of the fee provision in the buyer’s purchase agreement offer. [Calif. Civil Code §1559]
Exclusive listing as a first magnitude safeguard
For brokers and their agents representing buyers, an exclusive right-to-buy listing is the initial and most effective step they can take to ensure a fee is paid for their diligence, talent and money spent to locate property for a buyer.[See first tuesday Form 103]
The exclusive right-to-buy listing is used by a broker and their agents when arranging to be employed by a prospective buyer to prepare and submit the broker’s offer to act as a buyer’s exclusive real estate agent. With a signed exclusive listing, the broker is formally employed to locate property sought by the buyer in exchange for the buyer’s assurance a fee will be paid the broker if the buyer acquires the type of property sought during the listing period.
Also, the exclusive right-to-buy listing provides greater incentive for brokers and their agents and on behalf of the buyer imposes a duty to work diligently and continuously to meet their buyers’ objectives of locating and purchasing suitable real estate.
The buyer as a client benefits under an exclusive right-to-buy listing due to the greater likelihood the broker will find the particular type of property sought. Brokers have continuous access to all available properties and the brokers involved. It is part of their services to investigate and qualify properties as suitable before they are presented to the buyer and then advise the buyer on the pros and cons of each property presented. Seller’s agents have no such duties owed to the buyer.
In exchange for promised brokerage services, the buyer is bound to cooperate in meeting the objectives of the written listing agreement, which also establishes the broker’s right to payment of the agreed brokerage fee when earned.
A broker or their agent who seeks out and locates properties at the request of their buyer negotiates the purchase terms as the buyer’s agent. The activity is undertaken regardless of who pays the fee, which is typically paid by the seller from the proceeds of the gross sales price paid by the buyer — unless the buyer or the seller owe it on their breach.