Why this matters: Learn the due diligence effort a broker employed under an exclusive representation agreement owes their client-seller or buyer when acting on their behalf and implement the best effort conduct owed a client under a non-exclusive open representation.
Follow along with an audio reading of this article adapted as a chapter from our upcoming Real Estate Practice course update.
An agent’s activities are performed with diligence
An exclusive representation agreement a broker enters into with a client, be they a buyer, tenant or owner, is an employment which establishes a client relationship. The type of relationship created is an agency which imposes special agency duties on the broker and their agents to:
- use due diligence when performing activities within the scope of the employment; and
- act as a trustee with the duty of a fiduciary in the employment.
Due diligence is not the specific activities an agent undertakes, as agents often erroneously infer in jargon-heavy conversation. Rather, diligence is the degree of effort an agent asserts when performing activities undertaken on behalf of a client or advising the client.
Diligence is a level of continuous concern the broker and their agents manifest to meet the objective of the employment regarding an interest in real estate, whether the goal is to:
- buy;
- sell;
- lease; or
- originate a mortgage.
To act diligently as an agent is to employ conscientious attention to the completion of each task necessarily undertaken for the client to achieve their objectives.
As a collateral agency issue, the required due diligence effort itself mandates the disclosure of any conflict of interest arising due to the representation of the client. The one ever-present conflict is the need for the broker to attend to the needs of other clients. This brokerage business condition is disclosed in a provision in all representation agreements to modify any client expectation they employed the broker to the exclusion of other clients. [See RPI Form 102 §4.6]
The promise of due diligence efforts is the consideration a broker and their agents owe their client when rendering services in exchange for employment and expectation of a fee earned as the exclusive representative of the client. When the exclusive representation agreement fails to state the promise to act with diligence in the employment, it is a duty implied as existing in every agency relationship.
Services performed by an agent requiring their due diligence behavior include:
- the advice and counsel the agent gives the client about a property;
- the real estate market pressures affecting the client’s expectations in a proposed transaction; and
- transactional negotiations and the likely consequences the client can expect.
The broker with authority as the exclusive representative of a client takes reasonable due-diligence steps to promptly gather all material facts about the property in question which are readily available to the broker or the broker’s agent.
After gathering information about the integrity of the subject property, the broker or their agent proceeds to do every reasonable and ethical action to pursue, with utmost care, the client’s purpose for the representation.
In contrast to an exclusive representation, a broker and their agents entering an open non-exclusive representation are not committed to initially perform any services at all. The broker undertakes no duty to provide services, until they do, which is labeled a best effort obligation.
However, when a broker or their agent employed under a non-exclusive, open representation agreement engages in preliminary negotiations, such as exchanging property information, the due diligence obligation arises. The due diligence obligation triggered by an inquiry requires the client’s broker to provide the utmost care and protection of the client’s best interests in managing the inquiry. Having acted on the open representation, the broker or their agent now gathers all readily available information on the property under consideration and advises their client on recommendations for best handling.
Once the broker begins to perform services under an open representation, the broker has acted on the employment. Thus, the due diligence standards of duty owed to the client apply to the broker’s future conduct flowing from an inquiry.
Related video:
Read more about due diligence activities.
Due diligence: a commitment to act properly
Once an agency is created, with or without a written representation agreement, due diligence is about efforts expended when doing whatever activities are necessary to meet the client’s objective for retaining the agent — sell, buy, lease or finance an interest in real estate.
Due diligence is consistent, continuing and persistent attention to the transaction events at hand. It’s the conscientious attention given to the details of the work done on the client’s behalf.
Even though the agent has due diligence duties, the duty is limited in all representation agreements by stating the agent may have a conflict of interest due to their employment by other clients that may take the agent’s time. [See RPI Form 102 §4.6, RPI Form 103.1 and 103.2 §2.2]
An agent’s due diligence remains unaffected when they represent other clients, though there may be some delay in completing the task, yes, with diligence.
Related video:
Read more about due diligence.
Due diligence and the fiduciary duty
Agency contains the components of two duties owed a client:
- due diligence in their performance; and
- a fiduciary duty of utmost loyalty.
Fiduciary duty is the ethical aspect in all activities of an agent that keeps due diligence activity from becoming prohibited self-dealing and outside of the fair dealing required of an agent.
As a fiduciary, an agent representing a client is barred from self-dealing, that is personally benefiting from the client relationship by other than fully disclosed earned fees, conflicts of interest and bias situations.
Related video:
Read more about fiduciary duty.
Due diligence activities
The first step an agent takes with a prospective client is to negotiate and enter into a written representation agreement when the broker expects to receive a fee earned for assisting the client. Whether or not a writing documents the agency, due diligence obligations arise when assisting a consumer of real estate services — buyer, tenant, seller or lender — in expectation of earning a fee which, if not documented in writing, is not collectible from the client.
Once an agency is created, due diligence is about all the efforts required when acting on behalf of the client to meet their objective for retaining the agent. An agent’s efforts subject to due diligence treatment include selling or buying an interest in real estate as well as mortgage origination, broker price opinion (BPO) and leasing activities.
Property related activities an agent undertakes to assist their client — buyer or seller — in achieving their objectives which require a diligent effort by the agent, include:
- property inspections: advise sellers or buyers to hire third-party service providers for pest, structural and component inspection reports;
- site visits: observe the property’s condition, potential issues and surroundings, though the seller agent produces the TDS, not the buyer agent;
- review reports: assist clients to understand and apply information in reports from engineers, inspectors and surveyors;
- title search: research and advise on the recorded property records for liens, easements, encumbrances or ownership issues;
- zoning and permits: verify permissible uses, check for zoning compliance and review building permits and occupancy certifications;
- document review: provide a clear explanation of contracts, disclosures and any pending litigation;
- financial statements: analyze income (rent rolls, leases) and operating expenses for investment properties;
- market analysis: provide comparable sales (through a CMA) and market trends to confirm value;
- financing: advise buyers to obtain mortgage pre-approvals and assess their financial capability;
- use risk assessment: look for potential environmental hazards (such as asbestos or soil contamination), in other words, human caused conditions adverse to use;
- recommend assessments: guide commercial clients to Phase I Environmental Site Assessments; and
- inform the client: explain the purpose and implications of all reports and documents relating to the property, physical (on the parcel) or environmental (surrounding the parcel).
Related video:
Read more about a broker lacking due diligence.
Due diligence behavior to brokerage activities
Brokerage activities requiring an agent’s attention to due diligence behavior include:
- Client advice: advising clients on market conditions, pricing and financing options.
- Marketing: advertising or locating properties as available for sale or for lease with multiple listing service (MLS) services, holding or attending open houses and otherwise exchanging property information.
- Property access: arranging with the seller for buyer or third-party service provider inspections or walk-through observations of the property.
- Valuation: performing comparative market analyses (CMAs) to help price homes. The seller agent completes a CMA to assist in setting the asking price while the buyer agent works up a CMA to determine the purchase price to offer.
- Negotiations: a seller agent has begun negotiations for a potential transaction when the seller agent has contact with either a buyer or a buyer agent who expresses an interest in the property offered for sale, which upon inquiry triggers delivery as soon as practicable (ASAP) of the seller agent’s marketing package for the property.
- Documentation: preparing and reviewing title profile information, property conditions such as the Transfer Disclosure Statement (TDS), Natural Hazard Disclosure Statement (NHD) and Home Inspection Report (HIR), mortgage application and transaction agreements such as purchase agreements, leases, escrow instructions and closing statements.
- Closing guidance: shepherding the deal through to closing, ensuring all contract terms are met and managing the necessary paperwork.
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The seller broker becomes the buyer
Consider a seller broker employed under an exclusive representation agreement to locate a buyer for property marketed as available for sale.
The broker prepares a purchase agreement naming themselves as the buyer and submits it to the seller, their client. The broker states the price offered is the fair market value of the property. Based on the broker representation of the property’s value, the seller enters into the purchase agreement.
Prior to the close of escrow, the broker locates a buyer who agrees to acquire the property via an assignment of the broker’s right to buy the property under the purchase agreement entered into with the seller. The amount the broker is paid for the assignment is equal to 10% of the price stated in the purchase agreement. Thus, the broker has essentially flipped the property before closing.
The broker asks the seller to consent to the assignment and substitution of a new buyer under the purchase agreement and escrow instructions. The broker advises the seller that the buyer is paying no more than the price stated in the purchase agreement. The seller, based on the broker’s representation of the amount paid by the substituted buyer, consents to the assignment of the broker’s right to buy the property.
After escrow closes, the seller discovers the buyer paid the broker an assignment fee to acquire the broker’s purchase rights under the seller’s purchase agreement with the broker.
The seller makes a demand on the broker for the assignment fee as undisclosed additional earnings on the sales transaction, and a return of the broker fees the seller paid. The seller claims the broker breached their fiduciary duty since the broker failed to disclose receipt of other earnings which flowed from the broker’s representation of the seller.
Duty to disclose benefits from a transaction
Continuing our previous example, the broker claims no duty existed to disclose the fee taken for the assignment of the broker’s right to purchase the property. The broker argues their status as buyer under the purchase agreement was as a principal acquiring an interest in the property the broker may sell.
Does the broker have a duty arising out of their representation of a seller to disclose to the seller the earnings the broker received on the assignment of the broker’s right to buy property they were employed to sell?
Yes! The purchase agreement did not extinguish the agency relationship created by the representation agreement when the broker, while acting on behalf of the seller, also became the buyer. The broker owed the seller an agency duty due to the representation to disclose any and all compensation or benefits of value received rising out of the representation of the seller.
The seller recovers from the broker the dollar amount of all the benefits received on the transaction, including the assignment fee and the fee earned on the transaction. Further, the California Department of Real Estate (DRE) Commissioner may revoke the broker’s license for receiving compensation in an agency relationship which the broker did not disclose to the client. [Roberts v. Lomanto (2003) 112 CA4th 1553; Calif. Business and Professions Code §10176(g)]
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Maintaining the client file
Typically, the agent who enters into a representation agreement (and thus their broker’s right to earn and collect a fee) normally becomes the agent in the broker’s office who is responsible to the broker or office manager for the care and maintenance of the client’s file. Sometimes, it is someone else on the seller agent’s team with administrative skills.
On entering into a representation agreement, a physical file is set up to hold client information, notes on activity and documents arising within the broker’s office due to the employment. For example, the file on a property available for sale is to contain:
- the seller representation agreement;
- any addenda to the representation agreement;
- all the property disclosure documents the seller and seller’s agent provide to prospective buyers in the process of marketing the property;
- advertising and marketing efforts undertaken to locate a buyer;
- correspondence and transmissions related to the representation; and
- an activity sheet for entry of information on all manner of activity relating to the property and the representation.
Any paperwork, notes, messages, billings, correspondence, email printouts, agent’s property inspection notes, disclosure sheets, worksheets, advertising copy, copies of offers/counteroffers and rejections and all other related documentation are placed in the file. Everything that occurs as a result of the client employment is retained in the file.
The file belongs to the broker, not their agent, although it will likely remain with the seller agent until close of a sale on the property or the representation expires un-renewed. The agent hands the broker the entire file on close of escrow, usually a condition precedent to payment of the agent’s share of the fee received by the broker.
All records of an agent’s activities on behalf of a client in connection with any transactions for which a broker license is required are retained by the agent’s broker for three years. [Bus & P C §10148]
The three-year period for retaining the buyer’s or seller’s activity file for DRE review begins to run from:
- the closing date of a sale; or
- the date of the representation agreement when a sale does not occur.
The records are made available by the broker for inspection on request by the Commissioner of Real Estate or their representative, or for an audit the Commissioner may order.
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Guidelines and checklists for a representation
Guidelines used to build a file’s content are available in many forms, such as:
- checklists prepared by a broker or their transaction coordinator (TC);
- a transaction coordinator’s closing checklist;
- escrow worksheets;
- work authorization forms;
- advance fee and advance cost checklists; or
- income property analysis forms.
Checklists belong in the file. The agent, office manager, transaction coordinator or employing broker periodically review the checklists for oversight and work needed to better service the client and earn a fee.
Following are some — but certainly not all — steps a broker and their agent may undertake to fulfill their employment responsibilities owed to the client. They include:
- A property profile of the seller’s title from a title company to identify all owners needed to enter into a seller representation agreement, contract to sell and convey the property.
- Copies of all the Covenants, Conditions and Restrictions (CC&Rs), disclosures and assessment data from any homeowners’ association involved with the property. [See RPI Form 150 §11.2]
- A visual inspection of the property and a survey of the surrounding neighborhood by the seller broker to become informed about readily available facts affecting the marketability of the property and noted in the TDS when adverse to value.
- A Transfer Disclosure Statement (TDS), also known as a condition of property disclosure sheet, filled out and signed by the seller and the seller agent. [See RPI Form 304]
A home inspection report (HIR) paid for by the seller and attached to the TDS before the seller broker signs the TDS, to mitigate disclosure risks of liability.
- A natural hazard disclosure (NHD) on the property from a local agency or a vendor of NHD reports, paid for by the seller, and reviewed and signed by the seller and the seller broker. [See RPI Form 314]
- An Annual Property Operating Data sheet (APOD) covering the expenses of ownership and any income produced by the property, filled out and signed by the seller, together with a rent roll and copies of lease forms which the owner uses, are included in the marketing package after a review of the seller’s data. [See RPI Forms 352 and 562]
- A termite report and clearance paid for by the seller.
- Any replacement or repair of defects noted in the home inspection report or on the TDS, as authorized and paid for by the seller.
- An occupancy transfer certificate (including permits or the completion of retrofitting required by local ordinances), paid for by the seller.
- A statement on the amount and payment schedule for any special district improvement bonds encumbering the property (shown on the title company’s property profile).
- Advising the seller about the marketability of their property based on differing prices and terms for payment of the price, and for property other than one-to-four residential units, the financial and tax consequences of various sales arrangements which are available by using alternative purchase agreements, options to buy, exchange agreements and installment sales.
- A marketing plan prepared by the seller broker and reviewed with the seller for locating prospective buyers. The plan includes distributing flyers, disseminating property data in multiple listing services, newspapers and periodicals, broadcasts at trade meetings attended by buyer brokers, press releases to radio or television, internet sites, posting “For Sale” signs on the premises, hosting open house events, posting on bulletin boards, mailing to neighbors and use of any other advertising media available to reach prospective buyers.
- A marketing package on the property compiled by the seller broker and handed to prospective buyers or buyer brokers before the seller accepts any offer to purchase the property. This consists of copies of all the property disclosures delivered to prospective buyers or the buyer broker by the seller and seller broker.
- A seller’s net sheet prepared by the seller broker and reviewed with the seller each time pricing of the property is reviewed with the seller. Net sheet events include setting or adjusting the asking price, reviewing the terms of a purchase offer or proposed counteroffer for disclosing net sales proceeds. [See RPI Form 310]
- Informing the client of the seller agent’s activities by weekly communications advising on activity during the past several days and what the seller broker expects to do in the following days, comments from buyers and their agents, and changes in the real estate market affecting the client.
- Keeping records in a client file of all communications, activities and documents generated due to the representation.
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Advising the seller, diligently
Consider an agent who, on behalf of their broker, solicits an owner of a rundown (deteriorated) single-family residence to perform a broker price opinion (BPO) of the property. The agent’s intention is to ultimately be employed to market the property for sale and earn a fee.
After gathering and analyzing data on comparable sales for the BPO, the agent advises the seller that the present condition of the property justifies a value and asking price of no more than $600,000.
However, the agent believes the property will sell for $700,000, an additional $100,000 in price, when the seller spends $25,000 to $30,000 to correct deferred maintenance and eliminate some obsolescence.
The agent is aware the current demand by buyers of a residence in this price range consists mostly of individuals who are looking for a ready-to-occupy home, with few speculators looking for “fixer-uppers” they can restore in that price range to keep or resell at a profit. Also, the agent determines the seller has the funds needed to correct the defects and appearance of the property.
Based on buyer demand and housing prices, the agent advises the seller to invest the time, effort and money to better stage the property for sale. However, the seller is not now willing to invest funds to fix up the property.
Rejecting the agent’s advice, the seller agrees to offer the property for sale at the asking price of $610,000, just above market value. The property will be sold without correcting deficiencies in the property’s physical condition as fully disclosed in the TDS and an attached home inspection report.
Since the client has rejected the agent’s advice, does the agent still need to explain the reasoning behind their advice?
Yes! Professionals as a risk mitigation effort explain the rationale behind their advice and the consequences which can result when advice is rejected. Here, the agent advises the seller (and confirms in a memo) that the resale value of the property after the property is fixed up for sale will increase. So, when a buyer fixes the property defects and resells it at a far greater price, the broker and their agent have evidence they advised the client about the consequences (costs) of their inaction. [Truman v. Thomas (1980) 27 C3d 285]
Related article:
Risk management practices by the sellers agent in a declining market
Advice and consequences
In a real estate transaction, brokers and their agents need to determine who is not their client, but instead is a customer:
- the broker is directly negotiating with; or
- another broker represents.
The seller broker owes a customer a general duty to deal fairly and honestly, rather than the special agency duty of a fiduciary owed a client.
For example, a seller broker owes a prospective buyer a general duty to provide them or their buyer agent with disclosures on all known or readily knowable property conditions adversely affecting a property’s value. That general duty does not include advice on what investigations, audits or additional reports regarding the disclosed defects a prudent buyer might consider. The general duty also does not require what reasons the broker may have or whether a prudent buyer obtains further reports.
Further, a seller broker does not owe a duty to the prospective buyer to explain the consequences of the customer’s failure to further investigate or analyze adverse facts disclosed by the broker. Investigations and inquiries into property disclosures are the customer’s duty of care owed to themself to exercise concern for the protection of their own interests. Of course, it is the buyer agent who assumes these duties as their advisor with special agency duties owed the buyer-client.
Also confusing for customers as illogical is the purpose behind the SFR brokerage community’s use of pre-printed suggestions, recommendations, and disclaimers of responsibilities, few being relevant to any one transaction. They are typically demanded of each buyer in a sales transaction by the seller broker using a preprinted, boilerplate set of statements, called advisory disclaimers.
The advisory disclaimers recommend the buyer independently check out and determine the consequences of the separately and specifically disclosed property information. However, the seller agent has no duty owed the buyer to advise them what to do, or not to do. That duty is owed solely by the broker representing the buyer, and it is never a disclaimer but is an affirmative recommendation to do or not do something with a discussion about consequences for not doing as advised.
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Advising the buyer
The duty of the buyer broker begins with (but goes well beyond) a review of the seller broker’s condition of property disclosure obligations made in the mandatory TDS and NHD.
More strategically, third party reports the buyer broker has reason to believe the buyer needs become the subject of a request for the seller broker to provide. When not forthcoming, the reports needed to determine the extent of noticed defects become the subject of a further-approval contingency provision in any purchase agreement offer submitted.
On receipt of the report needed to resolve the contingency provision, the buyer broker reviews the report with the buyer to determine what action to take on the transaction. Buyer brokers have a purpose in transactions continuing well beyond locating property to bring about a match.
All too often — frequently — the seller agent fails to conduct their inspection of the property and conform the seller-prepared TDS to their observations, much less provide the TDS and other disclosures for a prospective buyer review before the buyer makes an offer. This dilatory behavior of a seller agent severely complicates the work a buyer agent must undertake to protect their buyer.
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Seller disclosures trigger further investigation from buyer
A buyer broker has an affirmative duty of care to protect their buyer by explaining why a recommended activity or inquiry is undertaken in a transaction. The failure of disclosures in a TDS and NHD by a seller agent to put the buyer agent and the buyer on notice of a possible defective condition on the property when a buyer agent requests the information suggest conditions exits which may well interfere with the buyer’s expected use, occupancy and successful ownership of the property after closing.
Brokers and their agents nearly always know more about property conditions and transactional aspects (legal, financial and tax) which affect the client than the client does. With a broker’s knowledge of adverse property conditions, inclinations about a property, information about the principals involved, third-party providers, and documentation and provisions they contain, brokers have insight into the need for a particular inspection and report. This is particularly the case with seller brokers as they have full access to the seller and adverse property conditions which the buyer broker does not.
The third party reports a buyer broker wants address defects the broker suspects exist which may adversely impact the client’s sale or use of the property — and need resolution before entering into a purchase agreement, and always before closing escrow.
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