The Agency Law Disclosure and agency confirmation has been expanded to include nonresidential transactions beginning in 2015. Read on for a discussion of the expanded role this pivotal disclosure will play in the commercial practice of tomorrow, and why the real estate trade union’s futile attempt to squash the disclosure’s expanded use retards implementation.
Protection of our people is fundamental
In 1988, the California legislature enacted the agency disclosure law to address inculcated misconceptions long held by licensees and the public about the duties real estate licensees owe to members of the public such as buyers, sellers, landlords and tenants. In its initial incarnation and through the present, agency disclosure law was concerned solely with targeted, one-to-four unit residential property and mobilehomes. For over 25 years it has fundamentally altered the treatment of buyers by multiple listing service (MLS) agents. [Calif. Civil Code §§2079.13(j), 2079.14]
Now part of standard real estate practice, the real estate agency disclosure law addresses two separate sets of agency-related disclosures on one-to-four unit residential property transactions:
- a Disclosure Regarding Real Estate Agency Relationships form, also known as an Agency Law Disclosure, setting out the “rules of agency” which control the conduct of real estate licensees when dealing with the public [See first tuesday Form 305]; and
- an agency confirmation provision contained in purchase agreements and lease agreements with a term exceeding one year confirming the agency relationships undertaken by the brokers with the principals in the transaction. [See first tuesday Form 150]
At its core, the Agency Law Disclosure form is a restatement of pre-existing agency codes and case law on agency relationships in all real estate transactions. It is an illustration of the generally accepted principles of law governing the conduct of brokers when acting as agents for an owner, buyer/tenant or both. [See Form 305]
The principle of agency, an integral component of real estate conduct familiar to all practitioners of real estate, has been limited in practice to one-to-four unit residential property for the past 25 years. A reverse assumption came to exist that agency was not of concern in commercial real estate deals since agency issues and disclosures were limited by statute to one-to-four unit single family residence (SFR)-type properties.
Effective January 1, 2015, the SFR-only Agency Law Disclosure assumption is no longer arguable. Agency disclosures and confirmations are also required of real estate brokers to principals in:
- all nonresidential real estate purchases; and
- nonresidential lease transactions with lease terms longer than one year. [CC §2079.13]
Editor’s note — As before, multi-family apartment sales remain uncovered by the agency disclosure law, an apparent legislative oversight.
With this legislative update, commercial brokers and agents now need to provide the same level of transparency that their residential counterparts have been providing for over 25 years. And in response, voices in the organized real estate community are crying foul.
Lobbying for obfuscation
The agency disclosure law was created to protect society from harm imposed by licensees while at the same time encouraging transactions to be economically beneficial for all owners and users. Transparency was the public policy goal then as it continues to be now.
So why would anyone in California push against greater public protection by taking umbrage to the same protections long provided to owners and users in residential transactions?
Unsurprisingly, the California Association of Realtors (CAR) came out in stark opposition to the bill. CAR operatives worked under the reasoning that this agency disclosure, a hallmark of residential real estate practice, “unnecessarily complicates commercial transactions.”
CAR holds that commercial transactions were deliberately excluded from the original agency disclosure legislation that went into effect in 1988 as commercial property principals are “relatively more sophisticated” than their typical residential counterparts.
Editor’s note — It needs to be mentioned that CAR originally lobbied against the agency law for SFRs also. Thus, their old strain of thought once put to rest has returned like a cockroach.
And this begs the question: are tenants and buyers of commercial property inherently more knowledgeable than buyers and sellers of residential property — so much so that they are protected by their own experience, expertise and acumen that no further disclosures (or duties) by their agents are helpful or needed?
CAR goes on to state that commercial property principals “are adequately protected by other prohibitions on conflicts of interest and disclosures of relationships.” Yup, you got it. Up to now, no legislation exists regarding such other unique disclosures for nonresidential transactions.
We ask: Is transparency that much of a threat to the commercial real estate industry? Or worse, is CAR supporting an inherent sluggishness among agents and brokers by not wanting to “complicate” commercial transactions with some sunlight? What — or who — are they seeking to protect?
Everybody works for the seller, right?
There’s a lot to unpack with this loaded premise, and perhaps a bit of context is needed.
This is not surprising behavior from CAR, California’s largest real estate trade union. CAR has a long history of laissez-faire favoritism in real estate practice going back to the basic dichotomy between the rights of agency for buyers and sellers.
Its forms and policies are structured to significantly favor sellers over buyers, if buyers are acknowledged at all. Look no further than CAR’s reluctance to publish a buyer’s listing agreement until the late 1980s. Only then did they create a monstrosity of an agreement in defiance over enactment of the agency disclosure law that confirmed buyer’s agents and buyer representation does indeed exist in law and economics.
CAR’s position then was that all MLS agents, regardless of their affiliation, work for the seller. Even the CAR purchase agreement in its acceptance provision named all the brokers as being employed by the seller. All licensees were believed to be motivated to close a sale, period. The buyer was a customer, not a client warranting formal representation.
Industry jargon still reflects this thinking. The agent of the buyer is referred to as the “selling agent,” not more colloquially (or logically for what they are doing) as the buyer’s agent or the buying agent.
Just as CAR illustrates a marked preference for sellers at the expense of buyers (and for singular nondisclosure of known information until after the property is under contract), its recent lobbying efforts display an analogous allegiance towards commercial landlords at the crippling expense of tenants – adverse facts which the tenant’s agent knows and does not disclose.
In the same manner that the boilerplate provisions in CAR’s lease forms push all obligations and duties onto the tenant for the sole benefit of the landlord, with rare exception, this obfuscation regarding agency representation benefits the landlord. It gives landlords yet a further edge in negotiations where they are already the dominant party.
Editor’s note —It’s ironic that CAR’s argument against agency disclosures in commercial transactions is couched in terms of avoiding complication. CAR itself produces an intentionally inscrutable 10-page (and growing) SFR purchase agreement, unreadable by design.
Asymmetry hurts nonresidential buyers and tenants too
Similar to the traditionally disadvantaged position of buyers in the chain of property information, commercial tenants are also not of equal bargaining power. The policies of CAR and the broader laws regulating commercial real estate disclosures have always favored landlords over tenants.
In nonresidential practice, this imbalance allows commercial brokers to stealthily represent both a tenant and a landlord in the same transaction as a dual agent without notifying the owner or user of their dual agency status.
Again, this dynamic typically works to the best interest of the landlord, with the tenant effectively left without proper representation.
Laws requiring disclosure of dual agency status have been a foundation in real estate practice long before the agency law disclosures went into effect. It’s a fundamental truism of real estate practice – the owners and users need to know, at the earliest opportunity in negotiations before the offer to lease or purchase occurs, who is representing them. Each agent is duty bound to give advice and otherwise look out for their client’s best economic advantage.
The absence of similar protections for nonresidential buyers and tenants has, until now, resulted in standardized conflicted representation in the commercial real estate market.
Commercial agency disclosures will act to align the required disclosure and confirmation of duties in both residential and nonresidential practice (with the patent exception of apartments, until corrective legislation is enacted). As a result, all commercial brokers are now required to give their clients a written disclosure outlining the “rules of agency” as attachments to listings and offers and, in offers to lease and purchase agreements, also confirm precisely who they are representing in the transaction.
Contents of the disclosure
The Agency Law Disclosure was created for use by brokers and their agents to educate and familiarize clientele with:
- a uniform jargon for real estate transactions, generally unfamiliar to the public; and
- the various agency roles licensees may undertake on behalf of their principals and other participants in a real estate transaction.
Further, the Agency Law Disclosure defines and explains the universal words and phrases used in nearly every transaction in the real estate industry. These industry terms are used to express:
- the agency relationships of brokers to the owner and user in the transaction;
- broker-to-broker relationships; and
- the employment relationship between brokers and their agents.
These situations and customs arise with the same frequency in nonresidential situations as they do in residential situations.
CAR posits that nonresidential tenants are inherently savvy, experienced and that they act rationally at all times. Thus, it is claimed, it is totally unnecessary to provide the same degree of protection from agent duplicity as extended to SFR buyers and tenants.
However, consider the typical business owner under a long-term lease who is not represented by an attorney in the lease or purchase negotiations. The only real estate related transactions the business tenant engages in is the renewal of their lease every four or five years — comparable to the length of time a residential owner or tenant stays in their property or engages in a real estate transaction.
Here, this commercial real estate user who operates a business is no more sophisticated than a typical residential buyer. They are equally deserving of knowing who, if anyone, represents their interests, and what duties are owed to them – without having to figure out they are compelled to ask if they are to get to the bottom of the representations.
Two categories of broker obligations arise in a real estate transaction, including:
- the special or primary agency duties of an agent which are owed by a broker and their agents to their client, known as fiduciary duties; and
- the general duties owed by each broker and their agents to all owners and users in the transaction, requiring them to be honest and avoid deceitful conduct with others who are not their clients.
In addition to the Agency Law Disclosure requirements, a separate agency confirmation is already mandated for inclusion in residential purchase agreements and lease agreements with lease terms longer than one year. This statement has now been expanded to be included in commercial transactions.
The agency confirmation confirms the agency relationships each broker has with the owner and user in the transaction. With the agency confirmation included in the purchase and lease agreements, this relationship is confirmed at the time the owner and user sign the agreements.
Editor’s note — The agencies to be confirmed by each broker in the purchase and lease agreements are not known at the time of the initial employment when the Agency Law Disclosure is first presented to the client. Thus, the agency in a potential future sale or lease transaction cannot be determined, much less confirmed at the time the seller’s broker first presents the seller with the initial and separate Agency Law Disclosure. [CC §2079.17(d)]
The agency confirmation in purchase and lease agreements discloses each broker’s actual agency relationship. It formalizes the relationship established by the broker’s conduct and the conduct of their agents with the owner and user in a transaction. The agency relationship confirmed is the broker’s legal determination of the actual agency created by their prior conduct with the owner and user.
When two brokers are involved in a real estate transaction (excluding those acting as a mortgage broker) each broker needs to disclose whether they are acting as the agent for the buyer/tenant/user or the seller/landlord/owner.
Alternatively, when only one broker is involved, they need to confirm whether they and their agents are acting as the exclusive agent for either the owner or user, or as a dual agent for both the buyer/tenant and seller/landlord.
An expanded target
Commencing January 1, 2015, commercial real estate transactions will also require the Agency Law Disclosure to be attached and signed by all owners, users or both involved prior to or concurrent with the following documents:
- a seller’s listing [See first tuesday Form 102];
- a buyer’s listing [See first tuesday Form 103];
- a purchase agreement [See first tuesday Form 159];
- an exchange agreement [See first tuesday Form 171];
- a counteroffer, by attachment or by reference to a purchase agreement containing the disclosure as an attachment [See first tuesday Form 180];
- a landlord’s authorization to list property for lease seeking a lease term for more than one year [See first tuesday Form 110];
- an exclusive authorization to locate space for a tenant seeking to lease real estate for a term greater than one year [See first tuesday Form 111]; and
- a residential or nonresidential lease agreement for a lease term greater than one year. [CC §2079.14; see first tuesday Form 550]
Editor’s note — All affected first tuesday forms will be updated and available online prior to the January 1, 2015 effective date.
The buyer/tenant’s broker perfects their right to a fee
Failure of the seller’s agent to provide the seller with the Agency Law Disclosure prior to entering into the listing agreement is a violation of agency disclosure law. As a consequence of this up-front failure, the broker will lose the fee on a sale if challenged by the seller prior to closing. The loss of the fee is not avoided by a later disclosure made as an addendum to a purchase agreement or escrow instructions. [Huijers v. DeMarrais (1992) 11 CA4th 676]
The Agency Law Disclosure is treated by the seller’s agent as a preliminary and compulsory listing associated event. If not made part of the listing agreement by attachment, the broker cannot reasonably expect to enforce collection of a brokerage fee when the property is sold or leased. This includes extensions, renewals and later sales of the property to the tenant in which fees will otherwise be due – but for the failure at the listing stage to attach the Agency Law Disclosure.
The Agency Law Disclosure is signed by the owner (or user) and handed back to the broker or their agent before settling down to finalize the listing to which it will be attached.
Further, when the broker or their agent fails to hand the seller the Agency Law Disclosure at the listing stage, the listing, and thus the agency, can be cancelled by the seller at any time. Also, the seller may cancel payment of the fee due their broker after the transaction is in escrow and the brokerage fee has been further agreed to.
For the buyer/tenant’s broker to protect themselves against loss of the fee due to the failure of the seller’s broker to timely disclose, the buyer’s broker needs to perfect their right to collect their portion of any brokerage fee to be paid by the seller.
Here, the share of fees earned by the buyer/tenant’s broker to be paid by the seller needs to be agreed to be paid directly to the buyer/tenant’s broker in a provision so stating in the purchase agreement, letter of intent (LOI), lease agreement and escrow instructions.
However, the buyer’s broker might, to their detriment, erroneously agree to let the seller’s broker receive the entire fee from the seller. Under this risky loss-of-fee arrangement, the seller’s broker pays the buyer/tenant’s broker a share of the fee under their separate fee-sharing agreement, to which the buyer or tenant is not a party as needed to protect their agent.
When the seller’s broker fails to obtain a signed Agency Law Disclosure before or concurrent with the listing agreement, the seller may legally avoid paying the seller’s broker their fee. Thus, when the seller has not agreed to directly pay the fee due the buyer’s broker, an unnecessary risk of a lost fee earned by the buyer’s broker is created.
If the seller refuses to pay their broker the entire fee as agreed, the buyer’s broker is left without a fee to share from the seller’s broker. To rely on the seller’s agent for payment of a fee is bad practice.
Put more bluntly, you do so at your own peril. It’s your fee, stupid.
For the user’s broker to protect their fee, the broker needs the owner to agree in a fee provision contained in the body of the LOI or purchase agreement that the seller will pay each broker’s separate share of the fee.
Greater transparency, greater public good
Full transparency in real estate transactions so transaction symmetry fully exists has always been a policy at first tuesday.
Even before SB 1171 designated commercial properties as included transactions, first tuesday advised brokers and agents – with implementing provisions in first tuesday forms – to prudently include and attach the Agency Law Disclosure to purchase and listing agreements used in the sale of all types of property, not just as mandated for use on the then targeted one-to-four unit residential sales or leases exceeding one year.
first tuesday nonresidential purchase agreements incorporated the Agency Law Disclosure long before disclosure became a legislated requirement. [See first tuesday Form 159 §15.3]
Then, as now, including the agency confirmation and attaching the Agency Law Disclosure in transactions for all property types – apartments included – works in the best interests of the agent and their client. Written disclosures eliminate later disputes over agency that may arise. More importantly, written disclosures have a far greater effect on agent conduct to better inform clients on other issues.
When one critical disclosure takes place — in this instance, agency rules and confirmation by avuncular legislative encouragement — that disclosure mentally affects the agent’s positive future conduct. In turn, the agent is primed to make immediate disclosure of known facts throughout the course of the transaction – a condition that is missing in many commercial transactions. [L. Byron Culver & Associates v. Jaoudi Industrial & Trading Corporation (1991) 1 CA4th 300]
Better late than never, but legislative corrections are still needed
California law has been slow to protect all, especially the buyer and tenant, by failing to level the playing field between residential and commercial real estate transactions.
The change giving near universal disclosures of agency representation has been long overdue, but is not yet complete. There is still a hole in the legislation as multi-family apartment complexes, which were not included in the original agency disclosure legislation, still are not included. Does the state of California actually believe the buyer of a five-unit residential property is demonstrably more competent than a buyer of a near identical four-unit residential property?
This oversight is similar to the needed change in the Transfer Disclosure Statement (TDS) law. A commercial TDS is not yet required as a statutory “condition of property disclosure” form on the sale of property other than a one-to-for unit residential property. Does California also side with CAR, presuming that a small, relatively immobile business tenant is unquestionably savvier than a buyer of a four-unit residential property, and thus does not need to receive a condition of property disclosure form consisting of what the owner and the owner’s broker/agent actually know about the condition and permitted use of the property? [See first tuesday Form 304]
Despite the imperfection in the updated agency disclosure law, it signals a conceptual step in the right direction in support of proper practice.
So who stands to gain the most from this legislative correction? The short answer: commercial tenants and buyers of nonresidential properties – those who were previously excluded. Thus, the impact of this change will be felt most acutely in the commercial property community, then ripple out to other segments of the real estate population.
The once sacrosanct and cloistered ecosystem of commercial real estate is opening up, but not without resistance. Where brokers were once able to keep their cards close to their chest and obscure their true allegiances and known adverse facts, commercial brokers and agents now need to play by the same rules as their residential colleagues.
And for this, the California market will be more stable — despite predictable misguided lobbying efforts to the contrary.