This article discusses a broker’s or his agent’s use of finders to provide them with leads to sellers, buyers, or borrowers under California and federal law.
Agency relationships in real estate transactions
Three classes of real estate “agents” have been established in California:
- licensed brokers;
- licensed sales agents; and
- unlicensed finders.
Licensed brokers and sales agents owe fiduciary duties to the principals they represent. Fiduciary duties require licensees to perform on behalf of their client with the utmost care and diligence.
An unlicensed finder has no such fiduciary duty. A finder’s function as an “agent” is limited to soliciting, identifying, and referring potential real estate clients or participants to brokers, agents, or principals in exchange for the promise of a fee.
A finder working for a principal is distinguished from a licensed broker working for a principal. Limitations are placed on the conduct of a finder. A finder lacks legal authority to participate in any aspect of property information dissemination or other transactional negotiations. [Calif. Business and Professions Code §§10130 et seq.]
Although not licensed by the California Department of Real Estate (DRE) or admitted as members of a real estate trade association, finders are authorized by California statute to solicit prospective buyers, sellers, borrowers, lenders, tenants, or landlords for referral to real estate licensees or principals. Thus, they provide leads about individuals who may become participants in real estate transactions.
Soliciting to place or refer a match
A finder providing referral services in California for a fee may:
- find and introduce parties;
- solicit parties for referral to others [Tyrone v. Kelley (1973) 9 C3d 1]; and
- be employed by principals or brokers.
A finder may not:
- take part in any negotiations [Bus & P C §10131(a)];
- discuss the price;
- discuss the property; or
- discuss the terms or conditions of the transaction. [Spielberg v. Granz (1960) 185 CA2d 283]
A finder who crosses into any aspect of negotiation which leads to the creation of a real estate transaction needs a real estate license as he is both soliciting and negotiating. Unless licensed, an individual who enters into negotiations (supplying property or sales information) cannot collect a fee for services rendered — even if he calls it a finder’s fee. Also, he is subject to a penalty of up to $20,000 and/or a six-month jail term for engaging in brokerage activities without a license. [Bus & P C §§10137, 10139]
In addition, a broker who permits a finder or anyone else in his employ (or his agents’ employ) to perform any type of “licensed” work beyond solicitation for a referral, may have his license suspended or revoked. [Bus & P C §§10131, 10137]
RESPA’s limited authorization to split fees
The Real Estate Settlement Procedures Act (RESPA) prohibits brokers, with two major exceptions, from giving or accepting a referral fee if the broker or his agent is acting as a transaction agent in the sale of a one-to-four unit residential property which is being funded by a purchase-assist, federally-related loan. [24 United States Code §2607(a); 24 Code of Federal Regulations §3500.14(b)]
Thus, a broker and his agents are not involved in a RESPA transaction when negotiating transactions for the sale, lease, or encumbrance of any of the following types of properties:
- apartment buildings with five or more units;
- commercial buildings;
- agricultural properties;
- business opportunities;
- vacant land (other than those involving one-to-four unit residential construction loans);
- properties containing 25 or more acres;
- leases and rental agreements;
- all-cash transactions; and
- seller carryback transactions where no federally-related loan is originated. [12 USC §2606(a)(1); 24 CFR §3500.5(b)(1)]
Business development and RESPA
A broker and his agents need to develop methods for generating business. If not, their business model will not produce sufficient numbers of clientele to provide enough earnings to keep them from being driven out of the real estate brokerage profession.
Many methods for finding and soliciting clientele exist. The source of clients most often discussed, and cherished, is the referral. In fact, agents not employed by media/franchise brokers are said to live by referrals alone.
Also, brokers cooperate among themselves, as in agent-to-agent referrals between different segments of the brokerage community, such as the referral of a homebuyer by a property manager to an MLS sales agent and vice versa with a prospective tenant.
Brokers and agents in single family residence (SFR) sales rarely develop a client base of homebuyers sufficiently large enough to sustain a decent standard of living from sales fees generated by transactions handled on behalf of these homebuyer clients. Thus, a business model for finding and locating clients on a regular basis must include sources other than clients personally located, i.e., found by the broker.
Many methods exist to generate new clients. Advertising through printed and electronic/digital media to solicit clients is fundamental and universally understood and expected by all.Media advertising is a general blast at members of the public in an effort to locate those few among them who, at that moment, need the services of a real estate agent.
On the other hand, finding and locating a client becomes a more focused and arduous task when a broker’s business model expands beyond exclusive use of media, which develops name recognition for the broker/agents, into the time consuming task of personally soliciting clients. In a personal solicitation effort designed as an additional method for generating clientele, the agent places himself and those he induces to act on his (specifically, his broker’s) behalf, directly between the prospective client and the employing broker, e.g., when:
- the employing broker “refers” clients directly to his agent;
- an agent takes “floor time” to solicit new clients who call in response to media advertising and the “brand name” the broker has established;
- an agent canvasses a neighborhood or section of the community in a classic on-going farming operation to find and solicit new clientele (for his broker); or,
- an agent extends his reach to potential buyers and sellers of SFRs by inducing both licensed and unlicensed individuals to be “team members” who locate and solicit clientele for the agent (again, read that as for the broker), all being activities which comply with both RESPA and Department of Real Estate (DRE) regulations.
It is the employment of unlicensed locators of buyers and sellers to extend the reach of the agent to develop business which will bring his earnings to a level sufficient to sustain the standard of living the agent seeks. This is permissible. State and federal regulations addressing the relationship between the finder/locator and the broker/agent, and between the public and the finders/locators acting on behalf of the broker/agent, are straightforward and compliance is relatively easy.
All employees of a broker must be hired under written contracts of employment.Licensed agents are hired, administrative staff is hired, and finders are also hired by brokers, and written contracts are entered into to delineate the responsibilities each has undertaken and to limit their conduct to that permitted by regulations for their different licensed or unlicensed statuses. These employments, the finder included, are not casual connections between the broker/agent with friends, neighbors, past clientele, or social contacts which by their word-of-mouth are a network of “viral adverts” generating referrals for which no fee is paid . These are individuals employed to generate business for the broker/agent, the finder being limited by the nature of his employment to locating and soliciting new clientele for the broker/agent.
Fee sharing by a broker under RESPA
RESPA, like a title insurance policy, initially sets out a blanket rule regarding referral fees as the starting point for arriving at the final conditions. RESPA’s initial statement is that no referral fee can be paid or received by a settlement service provider (broker/escrow/lender) who will be rendering transactional services in exchange for compensation in a RESPA sale (mortgage financing on a one-to-four unit residential sale). Likewise, a title insurance policy’s initial statement proclaims no encumbrance of any type exists on the title being insured. The policy then starts to list exclusions, exceptions, and conditions which nearly neuter the initial general statement.
Here too, as with all initial statements and generalities, RESPA provides several exceptions. These exceptions permit the conduct of orderly business development which does not violate the RESPA principle of avoiding double dipping (referrals among providers) or surcharges which artificially drive up the cost buyers and sellers pay for services needed to close a sale by adding garbage fees which duplicate services implicitly included in the provider’s basic fee.
Two RESPA exceptions go to the heart of sourcing new clientele and sharing fees:
- referral fees paid to or received from other brokers, a horizontal disbursement from one broker to another, other than by loan brokers or lenders who are or will be involved in a resulting RESPA transaction [24 CFR §3500.14(g)(1)(v)]; and
- fees paid by the broker to the broker-employed licensed sales agents or unlicensed finders, a vertical disbursement within the broker’s office, not paid to providers or third parties connected or to be connected to a resulting RESPA transaction. [24 CFR §3500.14(g)(1)(vii)]
While both of these exceptions to RESPA permit payment of fees under federal law, DRE regulations under California law limit the conduct of these individuals when actually rendering services permitted by RESPA.
While the RESPA exceptions allow fee-splitting activity, the DRE regulations require the fee splitting to be limited exclusively to:
- payments between brokers (who then may split the fee with their agents); or
- payments between a broker and the agents he employs, licensed or unlicensed.
While RESPA allows agents and finders who are employed by a broker to receive fees for generating business, the DRE regulations (and statutory/case law) set forth the limits of conduct each type of employee of the broker may undertake with the clientele.
To satisfy RESPA, the employment of a finder must be under an agreement where the employee-finder is obligated to bring to the broker’s attention every prospect located of the sort the broker is looking for. The employee-finder’s sole purpose is to generate business for his broker and does not have the freedom, by contract, to refer a prospect to just any broker. [24 CFR §§3500.2(b), 3500 Appendix B, examples 11 and 12; Zalk v. General Exploration Co. (1980) 105 CA3d 786; see first tuesday Form 115]
There are three classes of finders under RESPA:
- friends or past customers who pass on tips to brokers and/or sales agents;
- individuals who sell “lead lists” to brokers; and
- bona fide employees of brokers who generate business for their employing broker, classified as financial services representatives (FSRs). [24 CFR §3500 Appendix B, example 12]
Referral fees to other fiduciariesprohibited
Anyone can be a paid finder, unless barred by professional regulations or code-of-ethics or conflict-of-interest policies controlling an individual’s conduct.
For instance, a licensed agent registered with the DRE as an employee of a broker cannot be a finder. The agent is employed to solicit clients on behalf of his broker, not others. In turn, only his broker can receive a fee generated by the agent’s real estate licensed activities. On the employing broker’s receipt of a fee, the fee is split with the agent under their written employment agreement. [Bus & P C §10132; Department of Real Estate Regulations §2726]
Certified public accountants (CPAs) are barred by regulation from being paid as finders and receiving a fee for the referral of their clients to others. [16 Calif. Code of Regulations §56]
A finder who advertises to locate leads he will place or refer to a broker or principal must not hold himself out as also rendering services which require a broker’s license. [Bus & P C §10139]
Thus, a finder may advertise as a “referral service.” He may state he will place an interested party with a broker or principal, or refer a principal to a match sought for a real estate transaction.
The finder’s fee bargain
Generally, a finder’s fee is a lump sum amount or a percentage of the fee received by the broker on a transaction which is closed due to the finder’s referral. Only sound economics and whether the transaction falls under RESPA controls the amount of the fee a broker, agent, or principal should pay a finder for a lead. Also, no limit is placed on the volume of referral business conducted by a finder.
For instance, a broker can compensate his finder with:
- a salary;
- a percentage fee; or
- a lump sum basis per closing. [Zalk, supra]
Also, while brokers may, finders may not collect advance fees from principals. Advance-fee operators, masking themselves as finders for principals, sometimes collect fees “up front,” a prohibited activity for an unlicensed individual. [Bus & P C §10131.2]
Entitlement to a fee under California law
A finder is entitled a fee as an unlicensed individual if he solicits, locates, places, introduces, or delivers up names of prospective clients to a broker or principal. [Tyrone, supra]
A finder’s fee agreement entered into between a finder and a principal regarding the finder’s referral services must be evidenced in a writing signed by the principal who employed the finder. If not, the finder cannot enforce his fee agreement with the principal. [Calif. Civil Code §1624(a)(4)]
However, the principal’s use and benefit of a finder’s referral under an oral finder’s fee agreement, such as closing a sale with an individual referred by the finder, will substitute for a written agreement. [Tenzer v. Superscope, Inc. (1985) 39 C3d 18]
Conversely, oral fee agreements between a broker (or his agents) and a finder are enforceable. No written agreement is required between a broker (or his agents) and a finder. However, a writing memorializes the agreement as documentation against memories to the contrary, and in conformance with DRE regulations. [See first tuesday Form 115]
Consider a nonlicensed individual who enters into an oral agreement with a broker to introduce the broker to prospective buyers or sellers in return for 10% of the broker’s earnings on any transaction put together with the “lead.”
The finder introduces the broker to prospects who close transactions with the broker. The broker refuses to pay the finder the agreed-to compensation since the oral agreement is not evidenced in a writing signed by the broker who retained him.
However, the finder can enforce the broker’s oral fee agreement. Oral fee-sharing agreements between brokers or finders are enforceable. [Grant v. Marinell (1980) 112 CA3d 617]
Entitlement to a fee under RESPA
Finders are also entitled to a fee for referrals under RESPA, dependent upon the type of finder they are and whether RESPA controls.
A friend or past customer type of unlicensed finder who is not under contract and therefore not employed by a broker would not be entitled to a finder’s fee if the broker to whom a new client was referred provided settlement services on a RESPA-controlled transaction. If RESPA did not control, this type of finder would be entitled to a fee under California law.
A bona fide employee, such as a FSR, of a broker is not barred from collecting a fee or salary from his employer-broker since employed individuals are exceptions to RESPA.
A person who sells lead lists are also able to legally collect a fee under both RESPA and non-RESPA transactions. Lead lists are considered “goods” and are perfectly legal in California, as well as under the RESPA exception for goods actually furnished. [24 CFR §3500.14(g)(1)(iv); see DRE Real Estate Bulletin, Spring 2006]