This article examines the penalties which may be incurred by brokers and their agents for the mishandling of trust funds.

Commingling, conversion and restitution

A California real estate broker who handles funds entrusted to him by others must deposit the trust funds as instructed by the person handing the funds to the broker.

Above all, a broker must not convert to his personal use any funds entrusted to him.

The trust fund handling requirements are backed up by a variety of penalties and consequences which apply when a broker misuses trust funds, including:

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

The penalties depend partly 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.

The advance fees statute allows a client to recover treble damages plus attorney fees from a broker who mishandles advance fees. Also, 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.

DRE discipline

If the commissioner of the DRE determines a broker has or is about to violate trust accounting rules, the commissioner may file an action and obtain an injunction against the broker to stop or prevent the violation. [B & P C §10081.5]

In the action, the commissioner may include a claim for restitution on behalf of individuals injured by the broker’s actions. [B & P C §10081(b)]

Also, if the DRE conducts an audit of the broker’s trust account and discovers the broker has commingled or converted to his own use 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 the broker may have had and may file a bankruptcy petition on behalf of the broker. [B & P C §10081.5]

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

Civil liability

At the very least, a broker who misuses trust funds must reimburse the owner of the funds for the amount wrongfully converted. Any person who is deprived of property entrusted to a broker is entitled to recover an amount of money which will compensate him for the loss. [Calif. Civil Code §3281]

However, a principal’s right to recover money from a broker who misuses trust funds is not limited to the amount or value of the funds the broker has wrongfully converted.

The principal, in addition to money losses, can be awarded punitive penalties based on a breach of the broker’s agency relationship with the client. Also, when a broker acts as the principal’s agent and uses the principal’s money for his own benefit, any profits earned by the broker’s misuse of the funds are presumed to belong to the principal.

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

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

However, 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 money difference between the price he paid the broker and the price the broker paid the seller. The broker claims the buyer is not entitled to recover the difference since the property the buyer acquired was worth at least what he paid for it.

However, the buyer’s recovery is not limited to actual losses since the broker used the buyer’s deposit to secretly make a profit for himself. Thus, the buyer is entitled to recover the profits realized by the broker. [Ward v. Taggart (1959) 51 C2d 736]

Additionally, 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 principal when the broker has wrongfully obtained assets from the principal, such as trust funds, by fraud or with malice. [CC §3294]

Any wrongful use of trust funds is automatically fraudulent since the broker’s breach of his 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 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 a broker enter into a listing agreement employing the broker to sell a property. Under 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 33% fee.

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

Here the seller is entitled to punitive damages, based not only on the wrongful conversion of gross sales proceeds held in trust for the seller, but on the broker’s fraudulent conduct. The broker could not honestly believe he was entitled to a 33% fee. [Haigler v. Donnelly (1941) 18 C2d 674]

In cases where actual money losses are small, punitive money awards are sometimes awarded as a deterrent to future fraudulent activity – to discourage the misuse of trust funds in the future. [Esparza v. Specht (1976) 55 CA3d 1]

Also, the broker who misappropriates advance fees can be held liable for a money award up to three times the amount of the missing trust funds, plus interest and attorney fees. [B & P C §10146; CC §3287]

The Real Estate Recovery Account

If an individual sues a broker for trust account violations and receives a judgment, the individual can 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.

However, the individual’s recovery is limited to $20,000 per transaction and is further limited to actual losses on the transaction which resulted from broker fraud. [B & 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 the tenants and arranges and pays 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 his personal account. Tenants pay their rents to the broker in cash. The cash is also deposited into the broker’s personal checking account. The broker then issues a check on his 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 pay the owner the rents collected and return the cash advanced for maintenance, or account for the funds if 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 (10%) on the rents and cash advanced from the date they were received by the broker;
  • post-judgment interest (10%) until the judgment is satisfied;
  • costs; and
  • attorney fees.

The owner attempts to collect on the judgment but is unable to do so since the broker is insolvent.

Can the owner collect all of his judgment against the broker for the misuse of trust funds from the Real Estate Recovery Account?

No! The owner can only recover his actual and direct losses on the transaction from the Recovery Account, up to the sum of $20,000. Thus, the owner’s recovery is not only limited by the $20,000 ceiling, but is limited to the actual amount of his lost rents and the cash advanced for maintenance. The tripled amount cannot be recovered from the Recovery Account as they exceed 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 as 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 $20,000 maximum recovery. [Nordahl v. Franzalia (1975) 48 CA3d 657]

Income tax

Taxes must be paid on all income, from whatever source, including income derived from illegal activities such as embezzlement. [James v. United States (1961) 366 US 213]

Thus, a broker who converts trust funds to his personal use exposes himself to tax penalties if he fails 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 must be reported as income even if 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 he has derived from converting trust funds, undiminished by his related expenses, costs and reimbursements. [Rev & T C §17282]


A broker who uses funds entrusted to him for any purpose other than as authorized may be held 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 return of the misused funds may be a factor mitigating the broker’s sentence, but he 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.


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

The developer gives the buyers credit for the down payments received and later conveys title to the buyers. Thus, the buyers are not harmed by the developer’s conversion of the down payments to his own personal or business use. However, the funds the developer accepted were not his to use as his own, but were to be held in trust for the buyers.

Even though the down payments are meant to ultimately go to the developer, and the buyers received what they paid for, the developer has no right under the purchase agreements to use the funds until he conveys title. Thus, the developer is guilty of embezzlement. [People v. Parker (1965) 235 CA2d 100]

The Parker case involves a developer, not a broker. However, the same reasoning would apply to a broker’s misuse of trust funds. Further, an embezzlement charge against a broker would be stronger since a major element of embezzlement is the breach of an agency or fiduciary relationship.

Finally, the broker who fails to account for advance fees is presumed to have embezzled the funds. [B & P C §10146]

For example, a broker is hired by a borrower to arrange a loan. The borrower hands the broker a check for advance fees for locating a lender. The advance fee check is deposited in the broker’s trust account.

However, the broker fails to keep any record of the receipt or disbursement of trust funds from the trust account. The loan is never arranged and the borrower demands the return of the advance. The broker refuses, claiming the borrower’s funds have been properly spent.

Is the broker required to return the advanced funds?

Yes! Even if the broker did not misuse any of the funds in the trust account, the broker is presumed to have misappropriated the funds since the broker failed to retain any record of the deposit or disbursements from the trust account and is unable to prove the money was not misappropriated. [Burch v. Argus Properties, Inc. (1979) 92 CA3d 128]