February 2, 2010

Surprising Result in Recent Brokerage Commission Case

Arnold & Porter Advisory

By Kenneth A. Neale

A recent case should serve as a wake-up call to buyers and sellers of real property entering into so-called "standard" real estate brokerage agreements. In RC Royal Development and Realty Corporation v. Standard Pacific Corporation, (2009) 177 Cal.App.4th 1410, the California Court of Appeal held that the broker earned its commission at the time the buyer entered into the purchase agreement and that the close of escrow was not a condition precedent to the right of a commission. In a surprising result, the court concluded that the mere signing of a purchase agreement — even though close of escrow may be subject to conditions and may never occur — could nonetheless result in the buyer or seller having to pay a large brokerage commission. This case highlights the importance of conducting a careful legal review of all brokerage agreements before signing.

In this case, Standard Pacific Corporation (Standard Pacific) and RC Royal Development and Realty (RC), a real estate broker, entered into a brokerage agreement whereby Standard Pacific agreed to pay RC a brokerage commission in the event Standard Pacific purchased real property shown to it by the broker. (Although, typically the seller of real property pays the brokerage commission, it is sometimes the case that a buyer agrees to pay a commission to its broker.) The agreement defined "purchase" to include the acquisition of any "direct or indirect beneficial interest in the Property." The agreement also specified that the commission was to be paid through escrow at closing.

The broker showed Standard Pacific real property located in Los Angeles owned by a developer who would be constructing condominium apartments on the property. Standard Pacific entered into an agreement to purchase the property for $116 million to close following the developer's completion of construction. The contract contained several conditions to closing, including a review period, the issuance of a temporary certificate of occupancy, the recordation of a final map and the delivery of an architect's certificate. Although Standard Pacific elected not to terminate the contract during the review period, there was a delay in construction and the temporary certificate of occupancy was never issued. During the delay, the condominium market in Los Angeles declined significantly. Standard Pacific determined not to purchase the property and entered into a settlement agreement with the developer whereby Standard Pacific forfeited $4 million of its $6 million deposit. Standard Pacific did not pay RC a commission.

The broker argued that the commission was earned once Standard Pacific entered into the purchase agreement. Standard Pacific claimed that payment of a commission was conditioned on there being an actual closing.

The appellate court ruled that RC was entitled to a commission based on the definition of "purchase" contained in the brokerage agreement which included the acquisition of a direct or indirect beneficial interest in a property. The court found that, by entering into the purchase agreement, Standard Pacific acquired equitable title to the property and thus had a "beneficial interest" in the property. The court also relied on R.J. Kuhl Corp. v. Sullivan (1993) 13 Cal.App. 4th 1589, stating that "unless the contract provides otherwise, the broker earns his commission upon the principal's entry into a binding contract for a purchase subject to the brokerage contract, regardless of whether the sale is consummated." The court dispensed with language in the brokerage agreement indicating that the commission was to be paid at the closing out of the proceeds of sale by holding that this language related to timing only and was not a condition precedent to the earning of the commission. If the parties intended that actual closing be a condition precedent to the obligation to pay the commission, the court held, they should have used that language.

The most troublesome aspect of this decision is that the court seems to have completely disregarded the fact that the purchase contract here, as in most real estate transactions, was subject to conditions precedent, some of which were never met. It is hard to believe that parties would have intended that a commission be payable even though a condition to closing was not met. Given the somewhat contradictory language in the brokerage agreement, one wonders why the court did not consider further the intent of the parties. Furthermore, the court seems to have misconstrued Kuhl to support its conclusion that a commission is due on signing a purchase agreement, even though the contract may contain conditions to closing. The court failed to point out that Kuhl specifically held that where a purchased agreement is conditional, the commission is not earned if the condition is not satisfied.

It's tempting to believe that this case is not important because it turned on the particular language of the contract at issue, i.e., the definition of "purchase." The fact is, however, that many brokerage agreements are broadly written to cover a myriad of possible transactions other than a simple purchase and sale. This issue could easily arise under many of the other form contracts generated by the brokerage industry.

It is also important to point out that, even if the court ruled that no commission was due until closing, it may still have found that the failure of the closing was due to Standard Pacific's breach of the covenant of good faith and fair dealing. If so, the condition of closing contained in a brokerage contract could be excused and the commission would nonetheless be payable. In an unpublished portion of the opinion, the court held that there were triable issues of fact about whether Standard Pacific had acted in bad faith in failing to close the escrow. In this case, it is not clear that the conditions to closing were met and that Standard Pacific was obligated to purchase the property. Assuming it was, however, the issue is whether it breaches the covenant of good faith and fair dealing when it makes an economic decision not to purchase property due to deteriorating market conditions. The case does not answer this question.

Based on the RC Royal case, a party that desires to enter into a brokerage agreement with a real estate broker should do the following:

  1. Conduct a careful legal review of the proposed brokerage agreement. Attorneys for major brokerage companies or their industries have spent many hours honing their brokerage contract forms. Anyone hiring a broker should not hesitate to have a competent real estate attorney review the brokerage contract before signing. 

  2. Condition the earning of the commission on actual closing. If the parties intend that a commission is not earned or due unless and until there is an actual closing on the purchase of the property, then the contract must state that clearly.

  3. Address the consequences of buyer breaching its obligation to purchase a property. If no commission is to be paid if the buyer breaches its obligation to purchase the property, the agreement should make that clear. If a seller obtains a deposit due to the buyer's breach of a purchase agreement, the brokerage agreement should specify whether the broker is entitled to any portion of the deposit.

By addressing these issues up front in the brokerage agreement, a party hiring a broker may avoid a very unpleasant surprise down the road.

If you have questions about any of the issues raised in this article, contact Kenneth A. Neale at 415.677.6322 or your usual Howard Rice attorney.

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