Why this matters: Learn the reciprocal obligations of a seller and their broker under an exclusive seller representation agreement and whether a buyer is ready, willing and able to buy when submitting an offer to purchase.
A seller broker fee earned on any sale
A broker or their agent solicits a seller of real estate to employ the broker for their services. The broker and the seller enter into an exclusive seller representation agreement authorizing the broker to market and sell the property.
The representation agreement contains broker fee provisions, obligating the seller-client to pay the broker a fee earned on a sale, exchange, option or lease of the property during the representation period.
The fee is earned whether the transaction results from the efforts of the broker, their agents, or others including the seller-client. [Carlsen v. Zane (1968) 261 CA2d 399]
Consider a broker employed by a seller-client under an exclusive representation agreement to market and sell their property. The broker and their agent diligently investigate and market the property to locate a buyer. After several weeks of marketing, they have not located a qualified buyer willing to make an offer to buy.
Before the representation period expires and independent of the seller broker, the seller-client enters into a purchase agreement — or an exchange, option or lease of the property — with an investor located by the seller or a different broker. Later, after the representation agreement expires without the seller broker locating a willing buyer, the seller-client opens a sales escrow with the investor. Escrow closes and the investor takes title.
On discovery of the sale, the seller broker demands a fee from the seller-client. The seller-client claims their broker did not earn a fee, since:
- the seller broker did not procure the buyer;
- the seller broker did not negotiate and close a sales escrow; and
- the sale closed after the representation period expired.
Here, the seller representation agreement entered into contains a broker fee provision with an exclusive representation clause. The exclusive aspect of the representation obligates the seller-client to pay the seller broker a fee as earned when the seller-client enters into negotiations, directly or through others, for a sale, exchange, option or lease of the property during the representation period.
The fee has been earned and is owed the broker regardless of who produces the buyer or a tenant during the representation period, or when the transaction closes. [See RPI Form 102 §3.1(a)]
Critical for a seller broker to earn a fee under an exclusive representation agreement is the performance by the broker and their agents in the exercise of due diligence to market the property and locate a buyer. On entering into an employment under an exclusive seller representation agreement, the broker becomes obligated to diligently gather data on the property conditions, market the property to locate buyers, and negotiate with prospective buyers to sell the property.
The seller broker employed under an exclusive seller representation agreement does not earn a fee when:
- the broker and their agents fail to faithfully perform their due diligence obligations owed the seller-client; and
- the seller-client cancels the representation before a buyer is located.
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Find out more about an agent’s right to a fee with the employment agreement with their broker.
Due diligence obligations
Consider a broker who enters into an exclusive seller representation agreement with a seller to market a property available for sale. The seller anticipates the broker and their agent will engage in all services necessary to market the property as customarily provided by brokers in the community.
However, the marketing efforts of the seller broker are limited to a “For Sale” sign placed on the property and publishing the availability of the property for sale on the multiple listing service (MLS).
None of the limitations in the broker’s marketing efforts or services to locate a buyer and close a transaction are disclosed to the seller.
Any review of the property is through a lock-box arrangement available only to MLS members. The broker refuses to assist buyers or their agents due to the current strong market conditions for sellers.
The broker does not prepare disclosures or provide a marketing package containing information on:
- the physical condition of improvements in a Transfer Disclosure Statement (TDS);
- the property hazards in a Natural Hazard Disclosure (NHD) Statement;
- unique Factors or Conditions affecting the property [See RPI Form 308];
- operating costs and any income in an Annual Property Operating Data Sheet (APOD); and
- other material facts about the property.
The broker also does not gather property title profiles, home inspection reports, pest control reports, area crime data or data on prior property insurance claims.
Basically, the broker does nothing beyond posting the property for sale.
All the property items and data available to the seller broker are left to a buyer agent to obtain to close the transaction when the seller enters into a purchase agreement.
The seller broker uses a transaction coordinator (TC) to prepare documents and obtain the seller’s signature prior to close of escrow. In addition to a seller broker fee, the broker charges the seller for the TC’s services used by the broker to administratively manage the client’s file.
None of these limitations on the seller broker’s marketing efforts or services are disclosed to the seller, except for the cost of the TC to close a sale.
Editor’s note — A marketing package of property disclosures for delivery to buyers before the seller accepts a purchase offer is essential due diligence conduct for a seller broker under an exclusive representation, with or without a due diligence clause. Further, a broker must bear any cost of hiring a “transaction coordinator” to administer client files since these services are an integral part of their due diligence duties, not additional services.
Collectively, conditions adversely affecting the value of a property marketed for sale are delivered to buyers seeking additional property information at the earliest possible opportunity (ASAP).
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No potential buyers located before agency canceled
Continuing the previous example, the seller unilaterally cancels the representation agreement with the broker. The seller employs another broker to market the property for sale. The property is sold by the new broker before the expiration of the canceled prior representation agreement.
The seller’s prior broker makes a demand on the seller to pay a fee claiming the property was sold during the original representation period. The seller claims the broker is barred from collecting a fee since the seller, prior to finding a buyer, canceled the broker’s representation agreement due to the broker’s lack of due diligence efforts to market the property and locate buyers.
Did the seller’s prior broker earn a fee under the canceled but unexpired representation agreement?
No! The seller broker’s efforts to market the property and locate buyers lacked sufficient due diligence activities, which justifies canceling the representation. A sale after a representation agreement is canceled, even a sale prior to expiration of the original representation period, does not earn a fee for the non-diligent broker.
When a seller broker or their agent solicits employment by a seller under an exclusive seller representation agreement, the broker and their agents obligate themselves to:
- inform the seller about the brokerage services which are and are not expected to be rendered; and
- diligently perform the agreed-to services in pursuit of buyers who are ready, willing and able to purchase the property.
Also, brokers are expected to locate and engage with prospective buyers who are not represented by a broker and not to improperly first demand the buyer employ the broker to receive property information. To meet this expectation, seller representation agreements authorize the seller broker to prepare purchase agreement offers and accept deposits from buyers. [See RPI Form 102 §4.4]
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Due diligence is an art form
A diligent effort to deliver on promised and expected real estate services is a requisite to a broker and their agents fulfilling agency duties owed the seller-client under an exclusive seller representation agreement. To meet exclusive representation marketing obligations, the broker and their agents need to engage in a continuing and concerted effort to meet the due diligence standard to locate a buyer.
Due diligence imposes duties on the broker to perform throughout the representation at a level reasonably expected by the seller-client based on the conduct of brokers in the community. Unless a lesser level of services is agreed upon, the client has good cause to terminate the agency and cancel the representation agreement based on failure of a due diligence effort. [Coleman v. Mora (1968) 263 CA2d 137]
The due diligence effort required for exclusive representation comprises the broker’s ongoing orchestration of a basket of activities including to investigate, market, solicit buyers, and negotiate and close a sale of the seller-client’s property.
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Get a quick refresher on due diligence.
Understanding the due diligence effort
The diligent efforts promised by a broker to meet the seller’s objective under an exclusive seller representation agreement are measured for sufficiency by the broker or their agent’s:
- analysis of the property, a responsibility imposed on the broker before marketing begins, to gather property information needed by prospective buyers to evaluate the property for acquisition:
- the standard for what information is gathered is the level of property information a competent broker includes in a marketing package;
- data collected from observations of adverse conditions during a competent inspection of the property by the broker or their agent and noted in the seller’s TDS;
- existing third-party reports on the property’s condition, including a title profile of public information and documents;
- the property’s operating expenses and any rental income;
- information about nuisances in the surrounding area; and
- marketing of the property, to include:
- publication in the MLS or other broker-accessible platforms for releasing information on properties available for sale;
- placing “For Sale” signs, distributing fliers, holding open house events;
- marketing the availability of the property for sale on generally used internet mediums;
- broadcasting the property at marketing sessions;
- responding to all inquiries ASAP; and
- delivering a complete marketing package to buyers or their agents when they seek further property information.
To facilitate broker oversight and ensure fee collection, an agent maintains an activity worksheet in each client file, on paper or digitally. Communications relating to the representation are entered consistently. Without a paper or digital record, a broker is unable to:
- easily supervise their agent’s activities;
- confirm the agent is diligent in their analysis and marketing of a property; and
- have sufficient evidence to earn or retain a fee.
To earn the fee expected for a seller representation, the broker and their agents enter comments in the client file on:
- information gathered for marketing;
- money spent in the marketing effort;
- copies of all advertising material;
- all solicitation efforts to locate prospective buyers;
- each contact regarding the property; and
- identification of each buyer and buyer agent contact who expressed an interest in the property. [See RPI Form 520]
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Form-of-the-Week: Identification of Prospective Buyers and File Activity Sheet – Forms 122 and 520
A ready, willing and able buyer at the asking price
Occasionally, during a period of rising real estate prices, a seller broker and their agent locate a buyer who submits an offer at the full asking price on substantially the same terms for payment called for in the seller representation agreement. The offer is reviewed with their seller-client. The seller rejects the offer despite the fact the offer meets all the terms for earning a fee under the seller representation agreement.
Rejection occurs when the seller:
- refuses to accept the offer; or
- counters seeking a higher price or better sales terms.
The seller now believes the property is worth more than the price offered. The seller instructs their agent to prepare a counteroffer at a higher price, which the agent does and the seller signs.
The counteroffer is submitted to the prospective buyer. However, the buyer rejects it and terminates negotiations.
The broker promptly makes a demand on their seller-client for payment of a fee as earned by producing a buyer willing to pay the asking price on terms set in the seller representation agreement. The seller refuses to pay. The seller claims a fee has not been earned since the counteroffer was rejected and a sale of the property did not occur.
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Counteroffers — practice dictated by buyer representation agreements
Earning a fee
In the above example, the broker earned a fee under either an exclusive or open seller representation agreement, since the broker or one of their agents:
- located a qualified — able — buyer to purchase the property who signed an offer — ready and willing — on the terms of sale stated in the representation agreement; and
- submitted a copy of the buyer’s written offer and reviewed it with the seller. [Barnes Osgood (1930) 103 CA 730]
The fact the seller rejected the offer by making a counteroffer the buyer rejected has no effect on the broker’s right to a fee under the representation agreement. The fee was earned on presentation of the buyer’s purchase agreement offer which met the seller’s asking price and terms for payment.
However, before the broker earns a fee for obtaining and submitting a full asking price offer, the broker needs evidence the buyer is financially and legally capable to close escrow on the purchase agreement offer. The prospective buyer making the offer needs to be ready, willing and able to perform for the broker to earn a fee. Specifically, the broker needs evidence the buyer:
- intended to enter into a binding purchase agreement with the seller by making an offer to buy, called ready;
- made an offer on substantially the same terms as the terms sought in the seller representation agreement, called willing; and
- legally and financially qualified to perform — close escrow — on the offer, called able.
Once the seller broker submits a full asking price offer to their seller, signed by a buyer who meets each of the ready, willing and able criteria, the broker has earned their fee. [Woodbridge Realty v. Plymouth Development Corporation (1955) 130 CA2d 270]
However, when a buyer offers to purchase the property on terms other than those sought in the seller representation agreement, the offer is treated differently. To earn a fee, the seller-client needs to accept the buyer’s offer made on terms substantially different from the asking price and terms agreed to in the representation agreement.
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Fee for purchase of replacement property
Often, the property available for sale is held by the owner as an investment or for use in their business. Investment property includes income property and vacant land held for profit. Business property is property used in the owner’s trade or business and held for over one year.
Taxwise, investment and business property are classified as like-kind (§1031) property for purposes of avoiding California and federal income tax reporting of any profit on its sale. [Internal Revenue Code §1031]
Property classified as the seller’s principal residence or held out for sale as dealer property, such as the resale of lots created by a developer, is not like-kind §1031 property.
When the net sales price on the sale of §1031 property is greater than the owner’s remaining cost basis in the property, the seller takes a profit on the sale which is not reported and thus not taxed in a fully qualified §1031 transaction.
A seller broker alert to an opportunity to provide additional fee-generating services coupled with the sale of investment or business property discusses a §1031 reinvestment plan with the client. The seller broker reviews with the seller-client:
- locating of suitable property for reinvestment;
- closing of the sale of §1031 property;
- proper transfer of net sales proceeds; and
- closing the purchase of §1031 reinvestment property within §1031 time periods.
On replacement of the like-kind property, the seller avoids reporting profits and paying income taxes on the profit taken on the sale. The §1031 formula for avoiding profit taxes is to acquire replacement property with:
- an equal-or-greater equity than the property sold; and
- equal-or-greater debt than encumbered by the property sold.
The net sales proceeds generated on the property sold are:
- directly disbursed to the purchase escrow for the reinvestment property acquired; or
- held by an intermediary for no more than the permissible time period before taking title to the reinvestment property.
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Earning a fee for locating reinvestment property
As in any employment of a broker by a buyer-client, the right to locate — buy — replacement property and earn a fee mandates the broker enter into a written buyer representation agreement with the client. The written agreement to employ is needed to both enforce collection of a fee and comply with DRE licensing law. [Calif. Civil Code 1670.50(e)]
An exclusive seller representation agreement achieves compliance with licensing law through its replacement property fee provision. An additional separate exclusive buyer representation agreement with the client is not necessary but might be best used when the seller-client decides to become, also, a buyer-client.
However, different retainer period rules apply when representing buyer-clients who are individuals, but not so for entities. The representation period for an individual buyer is inconsistent with the rules controlling retainer periods when representing individual sellers. No distinction exists for entities whether they are buyers or sellers. [See RPI Form 103.1 and 103.2]
Thus, to best protect their fee when representing an individual client in an exchange of properties, the prudent broker enters into two separate representation agreements:
- one is a seller representation agreement employing the broker to sell or exchange the individual seller-client property;
- the other is a buyer representation agreement authorizing the broker to locate property to be acquired by the client as §1031 reinvestment property.
In an exchange, the client takes on both the role of a seller — and a buyer.
Related video:
Review the critical rules surrounding buyer representation agreement retainer periods.
