DEFERRING YOUR COMMISSION: Protecting the Broker

Real estate brokers are often asked to defer all or part of their real estate commission, in order to help facilitate the closing of a sale. A broker is under no legal obligation to defer his or her commission, unless such an arrangement was provided for in the commission agreement. Although a real estate broker is expressly prohibited by Commissioner's Rule A.A.C. R4-28-1101(A) from allowing a controversy over a commission dispute with another broker to interfere with the transaction, this Rule is limited to controversies between real estate licensees, and does not require a broker to accept less than full payment in order to facilitate a transaction. The remainder of this article will assume the broker voluntarily agrees to defer a commission, whatever be the motivation.

Treat the Commission Like it is a Loan. We have seen many situations where a broker has done a great job protecting the client, but a lousy job protecting himself. Like all professionals, it is awkward to negotiate fees with your own client. But once the broker agrees to defer a commission, it is important to treat the situation as if the broker has now become a lender. Therefore, the broker should expect to be protected in the transaction like a lender, rather than one who has gratuitously provided services. This means that the broker should seek to obtain the best possible security for repayment of the broker's "loan".

Get Security for the Loan. The most common situation in which the broker is asked to defer his or her commission is when there is not enough money at closing to cover the commission. This generally occurs for one of two reasons: (1) where the buyer is paying too little cash at closing (and this most often coincides with the seller taking a carryback); or (2) where the subject property is over-encumbered in relation to the purchase price. It is important to keep in mind that if the seller is not receiving enough money at closing to pay the commissions, then as a general rule the transaction is inherently risky. Although there will always be some element of risk in such a case, the broker can reduce the risks of non-payment by taking the proper security for the deferred commission.

Except in the most unusual circumstances, when the broker defers a commission the broker should take a security interest against the subject property. Of course, there is no rule against taking other forms of security, but it seems that if the seller possesses other collateral, then the seller has the resources to actually pay the commission at closing. Of course, whenever possible, the broker should consider taking additional security, perhaps against another piece of property owned by the seller or the buyer.

Use a Deed of Trust. The simplest and best type of security against real property is a promissory note secured by a deed of trust. The promissory note should contain a fair interest rate, a due on sale clause, and other loan terms to protect the broker in the event of a default. In most cases, both the seller (who owes the commission) and the buyer (who will own the property) should be personally liable on the promissory note. First and foremost, however, the broker should look to the property itself for protection. This is especially true where the seller also takes a carryback- for the broker to actually pursue the seller on the note if the buyer defaults could open the door to a wide range of ethical problems for the broker.

Obviously, the mere fact that the broker obtains a security interest does not guarantee payment. The broker must consider the value and marketability of the subject property, and the effect of any senior encumbrances on the broker's chances of recovering monies if the buyer should default. The broker should obtain title insurance on its security interest, the same as any other loan.

Competing For Priority With the Client. The Broker's Security Interest. First, there is the situation where the seller does not take a carryback. For the most part, this situation is easier to deal with because the broker is not "competing" with the seller for priority of the broker's security interest. Obviously, the broker should seek the highest priority possible under the circumstances.

On the other hand, when the seller is taking a carryback, a difficult issue will inevitably arise, and that is, will the broker's deferred commission have priority over the seller's carryback? This dilemma is compounded by the fact that if the broker has been representing the seller (as the seller's fiduciary) now all of a sudden the broker is essentially an adverse party. Regardless, the issue of the priority between the broker and seller's interests always remain a negotiable item (there is no law that the broker must take the back seat to the seller and remember, the broker is doing the seller a favor by deferring the commission). Certainly, the broker is in a better position if its lien is senior to the carryback, however, this does put the broker in a position in which the broker could actually wipe out the seller's entire carryback.

If the parties so agree, the seller and the broker can share an undivided interest in the same deed of trust. For example, the broker could end up with a 10% undivided interest in the seller's carryback deed of trust (even if there are two separate promissory notes). Although this is more likely to be viewed as "fair" in the eyes of the seller, if the parties do not plan ahead there will be potential problems if the buyer defaults. For example, when there are two lenders sharing priority under the same deed of trust, both will need to agree in order to initiate a foreclosure, and both need to agree on how to share the expenses of any such foreclosure. Also if there is a senior encumbrance in default, what are the parties' obligations or rights to contribute for reinstatement of the senior loan? In large part because the issue of the buyer defaulting is an unpleasant subject to discuss prior to closing, these issues are often not addressed up front. The same problems can arise if two brokers (e.g. the listing broker and co-broker) share a security interest.

Disclosure of Commission Reductions. A real estate broker is not prohibited from giving incentives to parties by reducing or deferring his or her commission for the benefit of a party to the transaction. However, the broker must make full disclosure to all parties of all such arrangements. For example, if the broker agrees to reduce or assign its commission in order to benefit a buyer who lacks the necessary funds to close, this fact must be fully disclosed to the seller. Also, the broker should be aware that under some circumstances, such as HUD loans, there are strict restrictions on the source of the buyer's down payment. Therefore, it may not be proper to assign a portion of the commission to the buyer where a HUD loan is involved. But in almost all other circumstances, a fully disclosed reduction or assignment of the commission should be legal.

Salesperson's Right to Be Named in Security Agreement. Although Arizona law requires that all real estate commissions must be paid to the broker (rather than to any salesperson or associate broker), Arizona law does permit a salesperson (and implicitly also an associate broker) to file a lawsuit for the collection of a commission. A.R.S. §32-2152. This statute allows a salesperson to lawfully file a suit even if his or her broker refuses to join in the action. By that same token, with regard to a deferred commission, we do not read into the law anything that would prohibit the salesperson from being named in the promissory note and deed of trust, along with the broker.

Conclusion. Unfortunately, the nature of the real estate business sometimes requires brokers to defer commissions in order to make a transaction work. Although deferring part of a commissions is better than eliminating part of a commission, brokers must carefully consider the risks associated with deferring commissions, and obtain the best security available.