Picking sides: Representation in agency relationships

You’d think that defining or establishing just who you represent is an easy question to answer. In fact, you’re probably amazed that I’m telling you right now that many real estate agents, buyers, and sellers either are confused about what constitutes an agency relationship from the beginning or seem to forget about it along the way. I explain why this confusion exists at the same time that I give you information that clarifies who you represent in a real estate transaction.

Establishing the agency relationship (and doing it in writing)

Representing a party to a real estate transaction as an agent and (hopefully) getting paid for it are based on the agency relationship that you established with that party. The information in this section about how you can establish agency relationships is pretty universal, so it applies in most (if not all) states. Nevertheless, you need to check whether your state’s licensing law recognizes or prohibits any of the following ways of establishing an agency relationship and whether your state perhaps recognizes other ways that I haven’t covered.

An agency relationship can be established either by means of an agreement between the parties, an agent and a principal (client), or by means of the actions of the two individuals. The first of the bullet points that follow is the former, and all the rest are the latter. You should remember that although I give examples of agents selling houses to illustrate the following types of agencies, if the statute of frauds in your state requires that all real estate agency agreements be in writing, then it’s unlikely that you can collect a commission by any of the non-written agencies. (For more on the statute of frauds, see Chapter 11.)

• Express agency: Express agency is where the agency relationship is created through an agreement in which the agent and the principal state their intentions to enter into an agency relationship, that the agent will represent the principal. The parties state or express their intentions in words, either orally or in writing. Whether an oral agreement establishing an agency relationship is binding varies from state to state, so check it out. It may also be possible for an oral agreement to establish an agency relationship but not be enforceable by you, the agent, to collect a fee. The typical written agreement is a listing agreement or a buyer’s agency agreement, both of which I discuss in the next two sections. The written agreement is the most appropriate and legally safe way to create an agency relationship.

• Implied agency: Implied agency establishes an agency relationship through the actions of the two parties. Although nothing formal has been said or written down, the agent and the principal act as if they have an agency relationship. Creating an implied agency may not have been what the two parties intended, but an agency relationship can be created anyway. If you find these circumstances hard to imagine, check out what happened to Ms. Seller.

  Ms. Seller is selling her home by herself and puts up a for-sale sign on the lawn. You drive by, see the sign, and stop in. You identify yourself as a real estate agent and ask some questions about the house. Ms. Seller tells you she doesn’t want to list the house for sale with any brokerage. She does tell you to feel free to bring any possible buyers around who might want to see the house. The next day you bring Mr. and Mrs. Buyer, who really like the house and want to make an offer. You tell Ms. Seller and begin negotiating a deal. If the matter comes down to commissions and lawsuits, only a court can finally decide, but you and Ms. Seller probably have established an implied agency relationship because of both your actions.

• Agency by estoppel: An agency by estoppel is created when a principal doesn’t stop an agent from going beyond the agent’s normal duties, which thus gives the impression that an agency relationship has been established. Say you’re the owner of a building and you tell your agent to show an apartment to a possible tenant. The agent goes ahead and negotiates a lease even though you didn’t give the agent any direct authority to do so. The tenant assumes the agent has the authority and an agency by estoppel has been created.
• Agency by ratification: An agency by ratification is created by accepting circumstances that created the agency after the fact. Suppose a real estate agent, without authorization and without ever speaking to the seller, negotiates a deal for a house that’s for sale by the seller. One day the agent arrives with a completed contract simply awaiting the seller’s signature and acceptance of the deal. An agency by ratification probably has been created when the seller ratified what the agent had been doing by accepting the deal. I say “probably,” because the agent wants a fee for his services and may have to sue the seller to collect. When that’s the case, the courts determine whether an agency relationship existed from the beginning of the negotiations — based on the fact that the seller accepted or ratified the agent’s behavior by accepting the deal.
• Agency coupled with an interest: An agency coupled with an interest is a situation in which an agent has some kind of interest in the property that’s being sold. For example, suppose a part-time broker is also an architect. The broker/architect agrees to design some houses for a builder who’s giving the broker/architect the listings for the sale of the finished houses. In essence the broker/architect made an investment in the project, so the builder can’t cancel the agency agreement. If this sounds like a tie-in arrangement and an antitrust violation (see Chapter 3), remember that the broker/architect isn’t making one activity conditional on the other. A tie-in arrangement would’ve been created if the broker had said that if the builder wanted him to sell the finished houses, the builder also had to hire him (as in pay him) to design the houses. In an agency coupled with an interest, it’s as if the broker/architect was investing in the project.

Most agency relationships are established in writing with different agreements for buyer and seller agency relationships (see “One or the other: Single agency with sellers or buyers,” earlier in this chapter). Listing agreements involve sellers, and buyer agency agreements involve buyers. (How did you guess?) Within the two categories are different kinds of agreements. Many details within various types of agreements are similar with respect to the duties to be performed. The differences usually deal with circumstances under which an agent will or won’t get paid. The issue of payment of the broker’s fee, which is covered in more detail in “Making Money (No, Not at the Copy Machine),” later in this chapter, usually is related to who is the procuring cause of the buyer or seller. The procuring cause means the person who found the buyer or seller and made the transaction happen. Often it’s referred to as the person who brought about a meeting of the minds between a buyer and a seller. It also may be defined as the broker who brought a ready, willing, and able buyer to the deal in terms acceptable to the seller.

Who has the money? Accounting

As a real estate agent, you handle money and sometimes large sums of it. Most often you’ll handle the money that goes with the buyer’s offer to purchase a property that is variously called the binder or earnest money. These funds are credited to the buyer and become part of the down payment. Eventually they belong to the seller but may be held by the broker for a considerable amount of time. The check may be written to the broker. Other funds from the buyer or the seller also may be entrusted to the broker.

The duty of accounting for all the funds that are given to you for safe keeping (yes, that don’t belong to you) is part of your fiduciary responsibilities. Most states require that funds that belong to clients and customers be kept in a bank account that’s separate from the broker’s business account to avoid commingling or combining of client and customer funds with the broker’s business or personal funds. Commingling is illegal even if you don’t actually spend the money on yourself and can account for every penny. Conversion, or the act of using client or customer funds for the agent’s personal or business expenses, also is illegal.

Better be careful: Care

Care is a broad and general word that best can be described as agents using their best efforts and skills on behalf of their clients’ respective interests. Activities such as helping a seller client determine a fair asking price for a property and then making every reasonable effort to market the property are expectations of the client under the care provision of fiduciary duties. Advising a buyer to hire a home inspector and providing the buyer with information about pricing of other properties are normal parts of the care provision when the buyer is the client.

Shhhhh! It’s a secret: Confidentiality

The agent is expected to keep all information that can harm the client’s interest in the strictest confidence in addition to any personal information the client wants to be kept confidential, even if, in the agent’s opinion, the information won’t harm the client were it known. A seller client’s desperate need to sell a property because of a financial situation needs to be kept confidential. A buyer client’s equally desperate need to find a house before the school year starts needs to be kept confidential, and so does the buyer client’s ability to pay more for a property than he or she is offering. Any client information that can be used to benefit the interest of the customer over the client must be kept confidential.

In some places, the duty of confidentiality is considered to be part of the fiduciary duty of loyalty. (See “A friend to the end: Loyalty,” later in this chapter, for more information.)

You’d better tell: Disclosure

The fiduciary duty of disclosure requires you, as an agent, to reveal any facts you’re aware of that benefit your client. Disclosure applies to information that may benefit the client even if the client hasn’t asked about it. As the agent, perhaps you know that the town is undergoing a tax reassessment that drastically may change the taxes on all the houses in town and that your buyer client wants to buy a home for the first time and doesn’t have a clue what a reassessment is. (You, of course, can at least answer state exam questions about reassessment because you read Chapter 16 in this book, right?) As a buyer’s agent, you’re required to tell your client about the proposed reassessment, even though they didn’t know enough to ask about it.

Disclosure also applies to information that can hurt your customer’s interest and that your customer has asked you to keep confidential. Perhaps your buyer customer reveals to you some recent financial difficulty that may make getting a mortgage difficult. Regardless of whether your buyer customer asks you to keep the information secret, you need to tell your seller client about the possibility that the buyer may have difficulty getting a mortgage to buy the house. (See “Meeting Obligations: The Relationship Between an Agent and a Customer,” later in this chapter, for more on an agent’s responsibilities to a customer.)

Disclosure is interpreted broadly. For example, the agent’s duty to promptly give all offers to the seller client is considered part of disclosure. An agent who decides to buy his principal’s property is something that must be disclosed. An agent buying a house that he has listed for sale is called self-dealing. Other people involved in the transaction, like a family member of the listing agent who is interested in buying the property, is information that has to be disclosed. If the information can help your client in any way or might harm him if he doesn’t know it, it must be disclosed.

Keep in mind that the disclosure that is part of an agent’s fiduciary responsibility isn’t the same as a seller’s obligation to disclose latent and material defects. In many states, a seller (whether or not she uses a real estate agent’s services) must tell the buyer any bad news about the property that isn’t readily visible by a normal inspection (rather than a special professionally done home inspection) and/or would have a material impact on the buyer’s decision to buy the property. You should also remember that this type of disclosure isn’t governed by the fiduciary duty of confidentially (see the previous section) or obedience (later in this chapter). See “Discovering defects,” later in this chapter, for more.

One reason why states adopt agency disclosure rules, where agents must tell all those involved exactly who they represent and what that means, is the fiduciary requirement of disclosure to the principal. Too often, buyer customers begin to get so comfortable with the real estate agent that they reveal information that can hurt them in a negotiation and which the agent must reveal to his seller client. The customer either forgets that the agent represents the seller or never fully understands exactly what that means in terms of fiduciary duties. (For more, see “Letting everyone know: Agency disclosure requirements” earlier in this chapter.)

A friend to the end: Loyalty

Loyalty means always putting your client’s interests above everyone else’s, including your own. You may want to read that last phrase again — including your own. You must never profit by doing something against your client’s interest.

You represent a buyer who wants to offer $200,000 for a house. You know the seller will take $180,000, and you’re being paid a percentage of the total commission paid to the seller’s broker based on the final sale price of the house. That means the higher the price of the house, the more money you make as the agent, right? I’m going to be blunt: Even though disclosing the seller’s acceptable price is against your interest and you’ll make less money, you nevertheless have to advise your buyer client to make the lower offer. If you don’t, you’re violating the fiduciary duty of loyalty and profiting at the expense of your client.

Yes ma’am: Obedience

Obedience, as a fiduciary duty, requires you as an agent to follow the instructions of your principal. Obedience is sometimes referred to as faithful performance. The only limitation on adhering to the duty of obedience is if the client’s instructions are illegal or unethical. If your seller client gives you instructions that violate some provision of fair housing laws regarding marketing the property, your fiduciary duty of obedience doesn’t require you to break the law and obey the client’s order. I cover fair housing laws in Chapter 5.

The obedience requirement also doesn’t extend to keeping things confidential regarding problems with the property itself. If your seller client instructs you not to tell potential buyers about a leaky roof, you wouldn’t obey the client, because buyers have a right to have that kind of information.

Discovering defects

Latent defects are problems with the property that the buyer customers or buyer agents wouldn’t find out about through a normal inspection. Some states interpret latent defects to mean structural items and safety items. Structural items are things like problems with the foundation. On the other hand, the things that need to be revealed usually are called material defects. The word material, in this case, means important. A latent defect, such as a crack in the plaster in a closet, wouldn’t necessarily be a material defect because it’s not very important and probably wouldn’t affect the decision of the average buyer to buy the house.

Disclosure of environmental risks, particularly the ones that pose health hazards, may also be information that you have to disclose. A leaking underground oil tank or the presence of a nearby nuclear power plant has to be disclosed to the buyer customer.

The seller may also have an obligation to reveal material or latent defects. In some states real estate agent liability has been reduced by the adoption of specific forms that must be used as seller disclosure statements in which the seller is responsible for telling potential buyers about the condition of the property. Check this out in your state. These forms may more or less be mandatory or may carry financial obligations with them, as in money paid to the buyer if they’re not completed by the seller. The agent often advises the seller of these obligations or tells them to check with their attorney. Get the details on what disclosure forms your state may have.

Looking at stigmatized properties

Stigmatized properties are properties where events that make the property less desirable to some people have taken place. The event doesn’t have to be documented as fact (actually happened) for the property to become stigmatized, but an agent may still have an obligation to tell a customer about it. A known murder or suicide can stigmatize a property, because some people don’t want to live in a house where something like that occurred.

Reports of a house being haunted by ghosts can also stigmatize a property, even though no hard evidence proves the haunting. Stigmatized property is an extremely state-specific item of disclosure because of varying interpretations by different states and different court decisions regarding the requirement for disclosure. Be sure to check this out because you as an agent may have disclosure obligations and therefore may be tested on this on the exam.

Respecting Megan’s Law

The interpretation of Megan’s Law, a federally enacted law that requires registration of sex offenders with the police and possible notification of neighbors regarding the location of a sexual offender, varies by state. Interpretations regarding the responsibility of real estate agents with respect to providing this information to prospective buyers also differ. Some states may require disclosure of the sex offender’s whereabouts to prospective buyers. Some may require disclosure only in response to a direct question or providing a response that includes information about the sexual offender registry. Check out your local state’s requirements to be sure. And remember you may have different obligations depending on whether you’ve got a buyer or seller client or customer.

Finding out about fraud and negligent misrepresentation

“This is the prettiest house on the street.” When you, the seller’s agent, say that to a prospective buyer, they realize you’re giving them your opinion. They can also quite easily check it out for themselves. What you’ve just done is puff the property. Puffing is exaggerating the virtues or benefits of a property. It isn’t illegal, and it’s done all the time.

On the other hand, if you say property values are going to go up 10 percent a year for the next few years, you seem to be stating a fact, but the buyer has no way to check it out, because no one can predict the future. As the agent, you’re perceived to be the expert and customers have every reason to believe you. However, if you’re wrong, you could be in trouble. Worse yet is an outright false statement that you know is wrong: “No, sir, there are no plans to extend the six-lane road past your house.” In court, which is where you may end up, your actions in either of these examples can be interpreted as fraud or an intentional misrepresentation done in order to sell the property.

Negligent misrepresentation is a little trickier than puffing and fraud. If you don’t know something, you can’t be expected to disclose it. Sounds right but it isn’t. Negligent misrepresentation is when you don’t disclose something, because you don’t know it, but you should have known it. As a real estate agent, the public expects a certain expertise, knowledge, and level of care to be evident in your work regardless of whether you’re dealing with a customer or client. The location of the new highway that will bring truck traffic down the residential street of the house you’re trying to sell has been all over the local papers. Because you don’t read the local paper, you neglect to mention this information to your buyer from out of town. By not telling your customer, however, you may have committed an act of negligent misrepresentation because the buyer expects you to know about such things.

Pay up! Deciding who needs to pay an agent

In a normal business arrangement, the person who hires you pays you. But who said real estate is normal? In this section, I take a look at some possible fee arrangements.

In many, if not most, real estate transactions you’re hired by sellers to be their agent. You owe them your fiduciary responsibilities and they pay you. So far, so good.

But what about when you’re hired by the buyer as a buyer’s agent? You owe your fiduciary responsibilities to the buyer. Yet, in many buyer agency arrangements, you’ll still be paid by the seller. Feel free to read that sentence again; it’s correct. You owe your loyalty and all your other fiduciary duties to the buyer but will be paid by the seller, because of a simple rule that you need to remember.

Generally speaking fiduciary responsibility does not follow the source of the fee. This means that you can represent Person A and be paid by Person B even if your job is to represent Person A against Person B.

Looking at an example of a seller paying a buyer’s agent may help you understand. Broker A is hired by Seller A as a seller’s agent. Broker A will be paid a fee, usually in the form of a percentage commission based on the sale price of the house. To sell the house quickly and at the best price, Broker A puts the word out among other brokers in town that he has a house for sale, which is what usually is called a listing. Broker A may do this informally by phoning a few other brokers in the area or through a multiple listing service, which is a more formal arrangement for sharing listings (see “Looking at listing agreements,” earlier in this chapter), and he offers to split the commission with any broker who brings someone to him who buys the house. Most likely he eventually executes a written agreement for sharing the commission with the other broker. Broker B is acting as a buyer’s agent for Buyer B and brings Buyer B to Seller A’s house. Buyer B likes the house and buys it. Broker B will be paid a share of the commission that Broker A offered. Remember, Broker A gets paid by the seller, and throughout the transaction, Broker B represented the buyer.

The seller doesn’t always pay the buyer’s agent’s fee. The buyer can and sometimes does pay his broker’s fee himself, an arrangement that is particularly true in the case of a buyer signing an exclusive buyer agency agreement in which the buyer must pay a fee no matter how he finds a property. So even if the buyer ends up buying a house directly from an owner with no broker involved, he still must pay his agent a fee.

Finally, where a buyer’s agent and a seller’s agent are involved in a transaction, it’s always possible for the buyer and the seller each to pay their own agents. Just remember, your fiduciary responsibilities go to your principal, which is the person who hires you, even if you receive your fee from someone else.

Ready to go: Knowing when an agent should be paid

A question in the real world, and on state exams, is this: When, during the process do real estate agents earn their fees? The answer is when the broker produces a ready, willing, and able buyer. A ready, willing, and able buyer is someone who agrees with the seller to all the terms of the deal and is prepared to do whatever it takes to buy the property. For example, if the buyer doesn’t have the full price in cash, he gets a mortgage. The broker in this case is considered the procuring cause, a fancy term for the person who brought the deal together.

An interesting factor that you notice about this answer is that it talks about the transaction from the seller agent’s point of view, because most agents still represent sellers. Although a buyer’s agency is growing, buyer agents’ fees still are paid primarily by the seller (as the previous section mentions). So don’t grow confused or worried about a question that deals with when the agent’s fee is earned. The ready, willing, and able buyer answer should be fine.

Another factor to notice about the definition of when a fee is earned is that it says nothing about actually transferring ownership of the real estate from one person to another. A fee is earned when the minds of the seller and buyer meet in an agreement — a meeting of the minds — which simply is another way of saying that the buyer and the seller have agreed to the terms and are prepared to complete the transaction. A fee may well be owed to the broker, even if property ownership doesn’t change hands.

If a seller agent produces a ready, willing, and able buyer who’s ready to buy the property at the seller’s price and has the money to do so, and for some reason, the seller changes his mind and refuses to sell the property, the broker still is entitled to a fee. Generally, whenever the broker is the procuring cause of the transaction, and the seller client does something to cause the sale not to happen, the broker is entitled to compensation.

1. A real estate broker generally acts as what type of agent?

(A) Universal agent

(B) General agent

(C) Special agent

(D) Ratified agent

Correct answer: (C). Remember the fact that as a real estate agent, you usually handle one special transaction rather than all (universal) or some (general) transactions for a client.

2. To whom does an agent always owe her fiduciary responsibility?

(A) Buyer

(B) Seller

(C) Customer

(D) Principal

Correct answer: (D). The principal is always the one with whom you have an agency relationship and therefore is the person to whom you owe your fiduciary responsibility. Either the buyer or seller, in given situations, can be the principal. So neither buyer nor seller can be answered as “always” being the object of fiduciary responsibility. In terms of customer and client, it’s the client who’s the principal, not the customer.

3. A real estate broker takes a listing to sell someone’s house. What is the relationship between the broker and the seller?

(A) Agent-principal

(B) Client-customer

(C) Agent-customer

(D) Principal-principal

Correct answer: (A). Sorry folks, no fancy explanation here. The listing agreement is the usual way that an agency relationship is established between a broker and a seller. An agency relationship is between an agent and a principal. Remember that the principal is also called the client.

4. A broker will earn a commission on the sale of a property whether or not she was the procuring cause of the transaction under what type of listing agreement?

(A) Open listing

(B) Multiple listing

(C) Exclusive agency listing

(D) Exclusive right to sell listing

Correct answer: (D). Multiple listing is not really a type of listing. In an open listing and the exclusive agency listing, the broker gets paid only if she finds a buyer and makes the sale happen.

5. An agent representing both a client and a customer would be practicing

(A) single agency.

(B) dual agency.

(C) exclusive agency.

(D) open agency.

Correct answer: (B). Dual agency is the best answer. It can’t be single agency, because even though the situation may have started out that way, something that shifted the customer to a client status occurred. Exclusive agency is too vague, although exclusive agency listings exist. It isn’t open agency, because although open listings are a possibility, no such thing as an open agency exists.

6. What kind of relationship exists between an agent and a principal?

(A) Exclusive

(B) Special

(C) Compensatory

(D) Fiduciary

Correct answer: (D). You’ll have to remember this one. An exclusive relationship may or may not exist, depending on the type of listing agreement that is signed. Most agents in a single transaction are special agents, but you can also be a general or universal agent. No relationship called compensatory exists, although the word can confuse you, because you expect to be paid for being an agent. The question needs to be read in the broadest way possible. Any and all agents and principals have a fiduciary relationship.

7. What part of fiduciary duties requires the agent to use her skills and abilities in her client’s best interest?

(A) Obedience

(B) Care

(C) Disclosure

(D) Confidentiality

Correct answer: (B). All of the other choices are part of fiduciary duties. Obedience is following your client’s orders. Disclosure is telling your client everything he needs to know for his benefit. Confidentiality is keeping your client’s information secret. Reread “Keeping the Faith: The Relationship Between an Agent and a Principal” until you can distinguish among and between examples of each duty.

8. Accounting requires

(A) a monthly expense statement provided to the client.

(B) the conversion of funds to pay expenses.

(C) commingling of funds.

(D) no commingling of funds.

Correct answer: (D). You may not see a lot of questions like this one, but I wanted to give you one anyway. It isn’t a very good question in my opinion because the statement “Accounting requires” is too vague. Don’t forget that you’re taking a state real estate exam. Sometimes an assumption is made in the wording of a question such that you know that you’re dealing with a question in a real estate context. So an accountant may think a client needs to get a monthly statement of expenses, but a real estate agent wouldn’t think that unless he were a property manager and had specifically agreed to provide the statement to his client. Those circumstances are, however, too narrow for the monthly statement answer to be correct. Conversion is when a client’s money is used for broker’s expenses, and commingling is when the broker mixes a client’s money and his own business or personal money in the same account. Both are illegal.

9. Your seller client needs to sell his property quickly to take a job in another city. What do you do with this information?

(A) You tell buyers this so the house sells quickly.

(B) You keep this information confidential.

(C) You tell the buyers only if they ask.

(D) You reveal this information only to a buyer’s agent.

Correct answer: (B). Confidential it is. The confidentiality of this type of information is absolute. If the seller authorizes you to reveal the information to generate interest in the property, then you can reveal it only after explaining to the seller that he may end up with a lower price because of it. This information is personal to the seller’s circumstances. Remember that if the information is about the property (like a leaky roof), it may have to be revealed to the buyer.

10. Which of the following types of information does not have to be disclosed to the seller client?

(A) The buyer’s financial condition

(B) An offer that the agent feels is unacceptably low

(C) The fact that the buyer owns a part interest in a sailboat with the agent

(D) The occupation of the buyer

Correct answer: (D). You may have found accepting this answer tough. The buyer’s financial ability to go through with the deal is important information. The agent doesn’t have a duty to filter out offers. All offers need to be transmitted to the seller promptly. A partnership in a sailboat may not be a close relationship, but it nevertheless is a relationship that needs to be disclosed to the seller. The buyer’s job is an important piece of information only if it affects his financial ability to complete the transaction.