Avoiding the brokerage 'black hole.' (commission agreements where real estate has no recourse against building owner or agent if commission unpaid) (Insider Outlook) (Column)
Under the typical scenario, the owner of a building employs a broker to act as the leasing agent for the building. It is the duty of the leasing agent to market the available space in the building. The agreement between the owner and the leasing agent commonly provides for a dual compensation structure if the agent is successful in attracting a tenant to the building -- if the tenant is not represented by a broker, the agent customarily receives the then current, market-rate commission payable for a lease as documented in its agreement with the owner, while if the tenant is represented by a broker the agent customarily receives one and one-half times such commission and is required to pay a portion (typically two-thirds) of such amount to the tenant's broker. If the latter situation applies, the portion of the commission payable by the leasing agent to the broker is usually paid to the broker pursuant to the terms of a commission agreement entered into between the agent and the broker.
The "Black Hole" is a result of wording commonly used in the respective agreements between the building owner and the leasing agent and the leasing agent and the tenant's broker. Taking the former type of agreement first, it is important to note that the customary reference to the broker employed by the building owner to market the building as a "leasing agent" is a deceptive one. Although an agent/principal relationship is deemed to exist between a real estate broker and its employer, such relationship does not as it would under a typical agency entitle a real estate broker to enter into contracts that would bind its employer; this is because the law considers the relationship between a real estate broker and its employer to be a so-called "special agency," and this means that the broker is only conferred with the authority specifically granted to it by its employer. Under most agreements between including owners and leasing agents, it is expressly provided that the agent has no authority to enter into any agreements that would bind the owner. It is typically the owner's intention that its leasing agent be restricted solely to acting in the capacity of an intermediary or negotiator. The owner does not want the agent to have the authority to do anything that might bind the owner. In addition, and as further protection for a building owner, the law generally holds that it is the burden of the party dealing with a broker to investigate whether the broker's employer has indeed authorized the broker to bind the employer. Therefore, in the absence of behavior on its part that would serve to ratify or otherwise make enforceable the conduct of a leasing agent in attempting to bind the owner to a contract, a building owner cannot be obligated under a contract by its leasing agent if the language described above is included in the agreement between the owner of the leasing agent. Consequently, even though a real estate broker hired a building owner is commonly known as a leasing agent, such broker would not have the power to bind the building owner to the commission agreement executed between such broker and the tenant's broker.
As set forth above, however, it is not solely the language in the agreement between the building owner and the leasing agent that creates the Black Hole. It is the effect of combining this language with certain language customarily included in the commission agreement between the leasing agent and the tenant's broker that causes the problem. Before a building owner will agree to pay a commission to its leasing agent to in turn be paid to the tenant's broker, the owner, as discussed above, typically requires the leasing agent to enter into a commission agreement with the tenant's broker. The purpose of such agreement is to set forth the terms and conditions under which the commission will be payable to such broker. The agreement, however, also contains language for the protection of the leasing agent, and such language commonly includes a provision similar to the following: "In no event shall the Leasing Agent be liable for the non-payment of the Commission to the Broker unless the Commission is first paid by the Owner to the Leasing Agent."
It is this provision, combined with the restrictive wording of the agreement between the building owner and the agent, that creates the Black Hole. A Black Hole results because if the owner fails to pay the commission to the leasing agent, the tenant's broker is prevented from recovering its commission from either the leasing agent or the owner.
The reasoning behind the foregoing conclusion is simple. The building owner is not a party to the commission agreement between the leasing agent and the tenant's broker, nor due to the "special agency" restrictions is the building owner deemed to be a party. Accordingly, the broker may not proceed against the building owner if the owner fails to pay to the agent the commission due to the broker. Likewise, the broker may not proceed against the leasing agent since, as a result of the language described in the preceding paragraph, the agent is not responsible for the payment of the commission to the broker until such time as the agent receives the commission from the building owner. The tenant's broker, therefore, if it is not careful, may find itself with no recourse against either the building owner or the leasing agent if its commission is not paid and, consequently, inside a Black Hole with no way out.
It should be noted that the scenario described above applies as well to subleasing situations. In a subleasing situation, the sublessor generally hires a subleasing agent to dispose of its space. A broker who brings a sublessee to the space is usually required to sign a commission agreement with the agent. If such broker is not careful, therefore, it may find itself in the same predicament vis-a-vis the subleasing agent/sublessor as a broker representing a tenant may find itself with respect to a leasing agent/owner. Accordingly, even though this article is directed at leasing situations, it applies with equal force to commission agreements involving subleasing agents.
Avoiding the Black Hole
There are number of ways for a brokers representing a tenant to avoid the Black Hole. The first technique, and the most simple, is to require the building owner to be added as a party to the commission agreement. If the owner becomes a party to the commission agreement, the broker can proceed against the owner if the commission is not paid. Alternatively, but with the same effect, the broker can require the building owner to authorize the leasing agent to bind the owner to the commission agreement. If an owner has so authorized its leasing agent, this is usually indicated by the leasing agent signing the commission agreement "as the agent of the building owner. If a leasing agent signs an agreement as the agent of the building owner and if it has been authorized to do so by the owner, it is as if the owner itself signed the agreement. On the other hand, if a leasing agent signs a commission agreement as the owner's agent yet it has not been authorized by the principal to do so,
the leasing agent itself [pounds] and not the owner, would be liable under the agreement for the payment of the commission. This is because the law provides that if an agent acts outside its authority, the agent and not the principal bears responsibility.
It should be noted that it is typically difficult to persuade a building owner who has employed a leasing agent to sign a commission agreement itself or to authorize its leasing agent to sign the agreement as the owner's agent. The reason the building owner requires its leasing agent to sign the commission agreement in the first place is to use the leasing agent as a legal buffer between the owner and the broker. In other words, the owner does not want the brokers to have the right to proceed directly against the owner. Accordingly, a broker representing a tenant may be required to resort to other means to avoid the Black Hole.
If the foregoing techniques do not work, a broker can attempt to persuade the leasing agent to agree in the commission agreement that it will proceed against the building owner if the owner fails to pay the broker's commission. At first glance, this request might appear to be superfluous since it would seem likely that if the owner failed to pay to the leasing agent the broker's portion of the commission, it would also be likely that the owner would fail to pay to the leasing agent its own portion of the commission. Accordingly, the agent would proceed against the building owner even without this requirement having been incorporated into the commission agreement. However, it should be remembered that it was usually more important for an owner to maintain a good working relationship with its leasing agent than with the tenant's broker; the owner is relying on its agent to continue to use its best efforts to market its building, while the owner might not have any further dealings with the broker. Taking this into account, as well as the fact that the commission payable to the agent is customarily one-half of that payable to the tenant's broker, it is conceivable that the owner might be willing to pay the agent its portion of the commission even if the owner could not afford to pay the broker its portion of the commission. In such event, the leasing agent would obviously have no incentive to proceed against the owner for the broker's portion. Therefore, it does indeed make sense to add language to a commission agreement requiring the agent to proceed against the owner for the broker's commission if such commission is not paid.
Alternatively, rather than require a leasing agent to proceed against the owner, a broker can require the agent to agree in the commission agreement to assign to the broker its right to proceed against the owner for the commission. By law, a party to a contract who has not received compensation for its performance can generally assign to a third party its right (a so-called "chose in action") to proceed against the other party to the contract for such compensation. This doctrine applies even if the contract itself is not assignable, such as when a personal services contract is involved. For two reasons, this type of provision should be more acceptable to a leasing agent than the requirement that the agent proceed itself against the owner. Firstly, if the broker rather than the leasing agent proceeds against the owner, the agent will not be required to incur legal fees. Secondly, since the agent would probably like to maintain its relationship with the owner as the leasing agent for the building, the agent would probably like to avoid directly "bumping heads" with the owner.
Commission agreements can be complicated and usually contain a number of traps for the unwary. One of the most dangerous of these traps results from the use of the language described above. The Black Hole created by this trap could result in a broker having no recourse if it fails to receive its commission. By being aware of this trap and of the techniques to avoid it, a broker can at least prevent itself from being unwittingly victimized. In any event, due to the complexity of today's commission agreements and the poor financial condition of many buildings owners, it would probably be advisable for any broker to submit its commission agreement to counsel for review.