This video covers the penalties for misusing trust funds and when individuals can satisfy a judgment against a broker through the Real Estate Recovery Account.

Commingling, conversion and restitution

Real estate brokers who handle trust funds need to deposit the funds as instructed by their owner.

Trust fund handling is regulated by a variety of penalties and consequences. A broker who misuses trust funds is subject to:

  • civil liability for money wrongfully converted;
  • disciplinary action by the California Department of Real Estate (DRE);
  • income tax liability; and
  • criminal sanctions for embezzlement.

The penalty depends on the nature of the funds which the broker misuses. For example, penalties for a broker’s misuse of advance fees held in trust accounts are specifically fixed by statute.

If the broker misuses advance fees, the owner of the funds may recover treble damages plus attorney fees from the broker. A broker who fails to account for advance fees is presumed to be guilty of embezzlement. [Calif. Business and Professions Code §10146)]

However, the existence of specific statutory provisions relating to the misuse of advance fees does not mean the misuse of other types of trust funds will go unpunished. Penalties for the misuse of trust funds for other purposes fall under more general statutory schemes.

Violations subject to DRE discipline

If the DRE Commissioner determines a broker violated trust fund accounting rules, the Commissioner may obtain an injunction against the broker to stop or prevent the violation.  [Bus & P C §10081.5]

The Commissioner may also include a claim for restitution on behalf of clients injured by the broker’s misuse of trust funds. [Bus & P C §10081(b)]

If the DRE conducts an audit of the broker’s trust account and discovers the broker has commingled or converted more than $10,000 of trust funds, the broker’s license may be suspended pending a formal hearing.

After the hearing, a receiver may be appointed to oversee the broker’s business. The receiver is allowed to exercise any power of the broker and may file for bankruptcy on behalf of the broker. [Bus & P C §10081.5]

Commingling of trust funds is grounds for suspension or revocation of the broker’s license. [Bus & P C §10176(e)]

Civil liability

A broker who misuses trust funds needs to reimburse the owner of the funds the amount wrongfully used. [Calif. Civil Code §3281]

However, a client’s right to recover money from a broker is not limited to the amount or value of the funds the broker wrongfully converted. In addition to money losses, the client may be awarded punitive penalties based on a breach of the broker’s agency relationship with the client.

Also, when a broker uses the client’s money for their own benefit, any profits earned by the broker’s misuse belong to the client.

Thus, the client is entitled to recover the funds wrongfully converted, plus any gain the broker derived from their use. [Savage v. Mayer (1949) 33 C2d 548]

For example, a seller’s broker presents the listed property to a buyer at a price exceeding the seller’s listing price. The buyer signs an offer to purchase at the price solicited by the broker and gives the broker a good faith deposit.

The broker never communicates the buyer’s offer to the seller. Instead, the broker purchases the property from the seller at the seller’s lower listed price, then deeds the property to the buyer. The broker keeps the difference between the listed price and the purchase price as a profit.

The buyer seeks to recover from the broker the difference between the prices paid for the property. The broker claims the buyer is not entitled to recover the difference since the property acquired was worth at least what the buyer paid for it.

Is the buyer entitled to the difference in price?

Yes! Further, the buyer’s recovery is not limited to actual money losses for overpayment on the price. Since the broker used the buyer’s deposit to secretly profit, the buyer is also entitled to recover the profits and fees received by the broker. [Ward v. Taggart (1959) 51 C2d 736]

Punitive damages

A broker who wrongfully converts trust funds may be liable for punitive damages. Punitive damages, also called exemplary damages, is a money award given to a client when the broker wrongfully obtained assets, such as trust funds, from the client by fraud or with malice. [CC §3294]

Any wrongful use of trust funds is automatically considered fraudulent. The broker’s breach of their agency duty is defined by statute as constructive fraud. [CC §1573]

Thus, any broker misusing trust funds is potentially liable to the principal for punitive damages as well as reimbursement of the trust funds taken or misused. Whether punitive damages will be awarded depends on:

  • the severity of the broker’s misconduct; and
  • the agency relationship undertaken by the broker.

For example, a seller and broker enter into a listing agreement. Under the terms of the listing, the broker’s fee will be any amount paid by a buyer in excess of the net sales price sought by the seller.

After the seller signs the listing agreement, the broker alters the fee provision to provide for a brokerage fee of one third of the sales proceeds.

The broker accepts cash from a buyer for the full sales price of the property. The broker handles the closing and retains one third of the sales proceeds as their brokerage fee. The balance handed to the seller is an amount less than the net amount agreed to in the listing agreement.

Here, the seller is entitled to punitive damages. The punitive damages are based not only on the wrongful conversion of gross sales proceeds held in trust for the seller, but also on the broker’s fraudulent conduct. The broker could not have honestly believed they were entitled to a fee equal to one third of the sales proceeds. [Haigler v. Donnelly (1941) 18 C2d 674]

In instances where actual money losses are small, punitive money awards are occasionally awarded as a deterrent against future fraudulent activity. [Esparza v. Specht (1976) 55 CA3d 1]

The Real Estate Recovery Account

If a client sues a broker for trust account violations and receives a money judgment, the client may satisfy the judgment through the state Real Estate Recovery Account if:

  • the broker is insolvent; and
  • the losses are directly related to the broker’s conduct.

The client’s recovery is limited to $50,000 per transaction. The recovery is further limited to the actual losses on the transaction which resulted from the broker’s fraud. [Bus & P C §§10471 et seq.]

For example, an owner of income-producing real estate enters into a property management agreement with a broker. Under the property management agreement, the broker collects rents from tenants and arranges for maintenance of the real estate.

The owner gives the broker a cash advance to cover maintenance expenses. The broker deposits the cash advance into their personal account.

Tenants pay their rents to the broker in cash, which the broker deposits into their personal checking account. The broker then issues a check from their personal account payable to the owner for all funds due the owner.

The check is rejected by the broker’s bank due to insufficient funds. The owner demands the broker to either pay the rents collected and return the cash advanced for maintenance, or account for the funds when they have been disbursed. The broker refuses to account to the owner.

The owner sues the broker and is awarded a judgment for:

  • three times the amount of rents collected by the broker and not paid to the owner;
  • three times the amount of the cash advanced for maintenance, as no evidence exists showing the broker expended the funds for the benefit of the owner;
  • pre-judgment interest at the legal rate of 10% on the rents and cash advanced from the date they were received by the broker;
  • post-judgment interest at 10% until the judgment is satisfied;
  • costs; and
  • attorney fees.

The owner attempts to collect on the judgment but the broker is insolvent.

Can the owner collect all of their money judgment amounts due from the broker for the misuse of trust funds from the Real Estate Recovery Account?

No! The owner can only recover their actual and direct losses on the transaction from the Recovery Account, up to the sum of $50,000. Thus, the owner’s recovery is limited both by the $50,000 ceiling and the actual amount of their lost rents and the cash advanced for maintenance. The tripled amount cannot be recovered from the Recovery Account since the amount exceeds the actual loss inflicted by the broker. [Circle Oaks Sales Co. v. Real Estate Commissioner (1971) 16 CA3d 682]

Also, no attorney fees award can be recovered from the Recovery Account since attorney fees are not direct losses. [Acebo v. Real Estate Education, Research and Recovery Fund (1984) 155 CA3d 907]

However, the owner can recover the interest and court costs awarded in the judgment from the Recovery Account as part of the $50,000 maximum recovery. [Nordahl v. Franzalia (1975) 48 CA3d 657]

Income tax

Income taxes to the extent due are paid on all income, from whatever source. This includes income derived from illegal activities such as embezzlement. [James v. United States (1961) 366 US 213]

Thus, brokers who convert trust funds expose themselves to tax penalties when they fail to report the converted funds as income and pay the appropriate taxes on the illegal income. [Calif. Revenue and Taxation Code §19701]

Further, embezzled money needs to be reported as income even when it is paid back. Thus, a broker embezzling trust funds cannot escape income tax liability by returning the funds and characterizing the embezzlement as an unauthorized loan. [Buff v. Commissioner of Internal Revenue (1974) 496 F2d 847]

In addition, no deductions of any kind are allowed to offset income derived from illegal activities. The broker is responsible for reporting the full amount of the income they have derived from converting trust funds, undiminished by their related expenses, costs and reimbursements. [Rev & T C §17282]


A broker who uses funds in any way not authorized by the owner is guilty of embezzlement. [Calif. Penal Code §506]

Whether the broker is merely “borrowing” the funds and intends to return them is of no import. The broker is still guilty of embezzlement. [Pen C §513]

For instance, a developer accepts down payments from buyers for homes in a subdivision. The purchase agreements state the down payments will be held in escrow until title to the homes is conveyed to the buyers.

The developer fails to deposit any of the funds received into an escrow or trust account. Instead, the developer uses the funds for their own business expenses.

The developer gives the buyers credit for the down payments and later conveys title to the buyers. Thus, the buyers are not harmed by the developer’s conversion of the down payments funds.

Even though the down payments would ultimately go to the developer and the buyers received what they paid for, the developer is guilty of embezzlement. The developer had no right under the purchase agreements to use the funds until title was conveyed to the buyers. [People v. Parker (1965) 235 CA2d 100]