Property Owners and Brokers-Ensure You Understand What Entitles a Broker to a Commission

Real estate brokers plan an important role in a real estate transaction.  However, sometimes the parties do not have a clear picture as to how and when a broker is to be compensated for his or her role, which can lead to tiresome and costly disputes.  All parties to a real estate transaction should have a clear picture as to the elements that entitle a broker to a commission so the parties have appropriate expectations from the beginning of the transaction.

In Texas, there are three pri­mary criteria that a broker must meet to be entitled to a commission. First, a broker's claim to a commission must be based upon the employment of the broker by the party from whom the commission is claimed (i.e., the property owner). Second, any commis­sion agreement for the pur­chase of real property is sub­ject to the Texas "statute of frauds," which requires that the agreement to be in writing in order to be enforceable. Un­der the Texas statute, an agreement for leasing real property is included in the definition of “an agreement for the purchase of real property.” Third, in order to collect a commission, a broker must also prove that he or she performed the service contemplated by the terms of the employment.

Most commission disputes can be quickly resolved by evaluat­ing the first two criteria. If a broker seeking a commission does not have a written com­mission agreement, executed by the party against whom he or she seeks a commission, the broker is not likely to be successful in a claim for such commission. The evaluation of the third criterion, regard­ing broker performance, can be a much more involved process.

Generally, most commission agreements provide that a broker may earn a commis­sion in one of three ways:

  1. Procuring a valid, enforceable and executed contract (whether a purchase contract or a lease) on terms agreed by the property owner;
  2. Procuring a purchaser to whom the sale is, in fact, completed; or
  3. Much less common, by producing a prospective purchaser/tenant that is ready, able, and willing to purchase/lease.

In the context of these three options, it is clear that a party employing a broker must carefully review the terms of agreement to be sure that it understands the services for which it contracted. An agreement in which the bro­ker merely produces a "purchaser/tenant that is ready, able and willing to pur­chase/lease" could prove costly and unproductive to the property owner if the con­templated transaction is not ultimately completed – though this may be the default provi­sion in many broker-created forms. Likewise, broker-created terms will often pro­vide (if the property owner does not review and object otherwise) that the commis­sion is earned once the pur­chase contract is entered into (without regard to if the clos­ing actually occurs). What benefit is a ready purchaser or prospective tenant to an owner, or even an executed purchase contract if the prop­erty is not ultimately sold or if the lease is not executed?

A further consideration when evaluating a leasing brokerage agreement is potential future commissions. These usually arise during lease extensions or premises expansions. Logi­cally, if the lease is extended, the landlord receives more income from the tenant brought in by the given broker. However, landlords should ensure that brokers collecting commissions for extensions or expansions, particularly those contem­plated in the original lease document, are actively in­volved in negotiating, coordi­nating and documenting the process in order to earn any commission. A carefully drafted brokerage agreement should provide that the bro­ker does not receive an ef­fort-free stream of commis­sions simply because the leas­ing relationship continues to flourish and should document what the landlord expects to occur for the broker to earn his or her commission on re­newals or extensions.

Determining what should constitute being “actively involved” can be a key issue when commissions are to be paid to the broker on a lease renewal or extension.   Clarifying the agreement to state that the broker must be actively involved in the negotiations of renewal terms (e.g., the renewal rate and other terms) provides some guidance.  However, even with the preceding language, a landlord may need to also consider the possibility/desirability of a commission being paid on a renewal where the renewal rate is calculated through a predetermined process.  For example, if the renewal rate is to be determined by appraisers selected by the parties, should the brokers, while being otherwise involved in the discussions, received the same commission they would receive on a renewal where they helped actually negotiate the renewal rate.

The parties should also spe­cifically review and agree on the timing of when the com­missions (or portions thereof) are to be paid. In the event of a purchase and sale transaction, the commission provi­sion would typically state the commission is "paid at closing, but not otherwise". In the event of a new lease, it is oftenpaid in two installments -50% within a certain number of days following execution of the lease and 50% within a certain number of days follow­ing the tenant's occupation of the leased premises. A prop­erty owner should always review such provision to avoid the potential headache of pay­ing a broker commissions for a tenant who, since lease exe­cution, for whatever reasons,fails to take possession or has ceased operations and will not be paying the rent to the landlord.

Carefully reviewing and negotiating a proposed commission agreement in light of these considerations can help the parties avoid conflict and frustration later in the process.

By Jeff Mosteller and Brian H. Baker

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