This new mini-series covers competing professional or personal biases which hinder a licensee’s ability to fulfill the fiduciary duties owed to their client.
Professional relationships compromised
A conflict of interest
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In a professional relationship, a broker’s financial objective of compensation for services rendered is not a conflict of interest.
However, fees and benefits derived from conflicting sources need to be disclosed to the client. This includes compensation in the form of:
- professional courtesies;
- familial favors; and
- preferential treatment by others toward the broker or their agents. [See RPI Form 119]
Similarly, the referral of a client to a financially controlled business, owned or co-owned by the broker needs to be disclosed by use of an affiliated business arrangement (ABA) disclosure. [See RPI Form 519]
A conflict of interest addresses the broker’s personal relationships potentially at odds with the agency duty of care and protection owed the client. Thus, a conflict of interest creates a fundamental agency dilemma for brokers; it is not a compensation or business referral issue. Unless disclosed and the client consents, the conflict is a breach of the broker’s fiduciary duty of good faith, fair dealing, and trust owed to the client when the broker continue to act on the client’s behalf.
Situations Involving a Conflict of Interest
A conflict of interest, whether patent or potential, is disclosed by the broker at the time it occurs or as soon as possible after the conflict arises. Typically, the conflict arises prior to providing a buyer with property information or taking a listing from a seller.
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The disclosure creates transparency in the transaction. It reveals to the client the bias held by the broker which, when disclosed, allows the client to take the bias into consideration in negotiations. The disclosure and consent does not neutralize the inherent bias itself. However, it does neutralize the element of deceit which would breach the broker’s fiduciary duty when left undisclosed.
Potential overlaps of allegiance or prejudice which cause a conflict that a broker or their agent need to disclose include:
- the broker or their agent holds a direct or indirect ownership interest in the real estate, including a partial ownership interest in a limited liability company (LLC) or other entity which owns or is buying, leasing, or lending on the property;
- an individual related to the broker or one of their agents by blood or marriage holds a direct or indirect ownership interest in the property or is the buyer;
- an individual with whom the broker or a family member has a special pre-existing relationship, such as prior employment, significant past or present business dealings, or deep-rooted social ties, holds a direct or indirect ownership, leasehold, or security interest in the property or is the buyer;
- the broker’s or their agent’s concurrent representation of the opposing party, a dual agency situation; or
- an unwillingness of the broker or their agent to work with the opposing party, or others, or their brokers or agents in a transaction.
Simply, a conflict of interest arises and is disclosed to the client when the broker:
- has a pre-existing relationship with another person due to kinship, employment, partnership, common membership, religious affiliation, civic ties, or any other socio-economic context; and
- that relationship might hinder their ability to fully represent the needs of their client.
Unfortunately, comprehensive rules do not yet exist which establish those instances where a conflict of interest arises and needs to be disclosed. [See RPI Form 527]
Thus, brokers are left to draw their own conclusions when situations regarding a property or a transaction with or involving third-parties arise. In practice, brokers, and especially agents, all too often err on the side of nondisclosure, putting their brokerage fee, and their license itself, at risk. [Calif. Business and Professions Code §10177(o)]
Generally, when a broker even questions whether it is appropriate to disclose a potential conflict of interest to a client, they should disclose it. The existence of any concern is reason enough for a prudent broker to be prompt in seeking their client’s consent to the potential conflict. By timely disclosing a conflict of interest and obtaining consent, the broker immediately creates an honest working relationship with their client.
Fundamentally, a broker who becomes aware they have a conflict of interest, but is reluctant to disclose it and seek the client’s consent, is advised to consider rejecting or terminating the employment with that individual.
Relative’s Participation in a Transaction
A sellers broker needs to disclose their acquisition of any direct or indirect interest in the seller’s property. Likewise, the broker also needs to disclose whether a family member, a business owned by the broker, or any other person holding a special relationship with the broker will acquire an interest in the seller’s property. [See RPI Form 527]
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For example, consider a broker’s brother-in-law who makes an offer to buy property the broker listed. The purchase agreement states the broker is to receive a fee and that they represent the seller exclusively.
The broker does not disclose to the seller that the buyer is their brother-in-law. The broker opens two escrows to handle the transaction. The first escrow facilitates the sale and transfers the property from the seller to the broker’s brother-in-law. The second escrow is for the sole purpose of transferring title to the property from the brother-in-law to a limited liability company (LLC) in which the broker holds an ownership interest. Both escrows close and the broker receives their fee.
The seller discovers the buyer was their broker’s brother-in-law and the true buyer was an entity partially owned by the broker. The seller demands a return of the brokerage fee, claiming the broker had a conflict of interest which breached the fiduciary duty they owed to the seller since it was not disclosed and the seller did not consent.
In this instance, the broker is not entitled to retain the brokerage fee they received from the seller. Further, the seller is entitled to recover any property value at the time of the sale in excess of the price they received. Alternatively, the seller may set the sale aside due to the failure of the broker’s agency with the seller and the conflict of interest with the buyer.
A broker cannot act for more than one party in a transaction, including themselves, without disclosing their dual agency and obtaining the client’s consent at the time the conflict arises. [Bus & P C §10176(d); see RPI Form 117]
Also, a sellers broker has an affirmative duty to disclose to the seller their agency or other conflicting relationship they might have with the buyer. The duty to disclose exists even when the seller fails to inquire into whether the broker has a relationship with the buyer.
Further, failure to disclose a broker’s personal interest as a buyer in a transaction when they are also acting as a broker on behalf of the seller constitutes grounds for discipline by the Real Estate Commissioner. [Whitehead v. Gordon (1970) 2 CA3d 659]
Disclosure of a direct or indirect interest
A buyers broker needs to disclose to the buyer the nature and extent of any direct or indirect interest the broker or the broker’s agents hold in any property presented to the buyer.
For example, a buyers broker shows the buyer several properties, one of which is owned by the broker and others, vested in the name of an LLC. The broker does not inform the buyer of their indirect ownership interest in the property.
The buyer later decides to purchase the property owned by the LLC. An offer is prepared on a purchase agreement with an agency confirmation provision stating the broker is the agent for both the buyer and seller. The offer is submitted to the LLC. [See RPI Form 159]
The broker, aware the buyer will pay a higher price for the property than the initial price offered by the buyer, presents the buyer with a counteroffer from the LLC at a higher selling price. The buyer accepts the counteroffer.
Here, the broker has a duty to promptly disclose their ownership interest in the property to the buyer the moment the conflict arises. The conflict of interest in the broker’s ownership is a material fact requiring disclosure since the buyer’s decisions concerning acquisition of the property might be affected.
As a result of the nondisclosure, the buyer can recover the fee received by the broker and the increase in price under the counteroffer.
Had the buyer known the broker held an ownership interest in the property when it was first presented, the buyer might have negotiated differently when setting the price and terms for payment. Alternatively, the buyer may have retained a different broker who was not compromised by a conflict of interest.
Conflicts of Interest when Acting as a Principal
A broker acting solely as a principal in the sale of their own property is not restricted in their conduct by compliance with agency obligations. The broker selling or buying property for their own account acts solely as the seller or buyer. The licensee has no conflict due to the existence of their license since they are not holding themselves out as a broker or agent acting on behalf of another person in the transaction. [Robinson v. Murphy (1979) 96 CA3d 763]
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However, when a broker-seller receives a brokerage fee on the sale of their own property, or on the purchase of their own property, the broker subjects themselves to real estate agency requirements.
For example, a broker sells their residence. The residence is in violation of safety requirements for occupancy due to known defects in the foundation. The broker does not tell the buyer about the foundation defects.
Out of the proceeds the broker receives on closing the sale of the property, the broker-seller pays themselves a brokerage fee, claiming to exclusively represent themselves (which is not an agency and does not require a license).
The buyer later discovers they have to demolish the residence and rebuild it with an adequate foundation. The buyer obtains a money judgment against the broker for breach of their general agency duty owed to all parties in a real estate transaction to disclose known property defects.
The broker is unable to pay the money judgment. The buyer seeks payment from the Real Estate Recovery Account.
Recovery is received from the Real Estate Recovery Account since the broker held themselves out as acting as a real estate broker in the transaction by receiving a fee. The broker’s license is then suspended. Before the broker can reactivate their license, they need to reimburse the Recovery Account. [Prichard v. Reitz (1986) 178 CA3d 465]
