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Chapter 23 - Law of Agency
At the completion of this chapter, students will be able to do the following:
1) Explain the difference between a principal and customer.
2) Provide an example of a universal agent, general agent, and special agent.
23.1 What is Agency?
You may have noticed that I’ve been referring to your future role as a real estate salesperson and a real estate agent interchangeably. For the purposes of a license, your official title will be real estate salesperson. However, you will be an agent. And while, in real estate, its common phrasing to use the term “agent” to distinguish from broker the fact is that brokers are agents as well. In this lesson we’ll take a closer look at what exactly being an agent means.
To be called an agent refers to a relationship, this relationship is called agency. Agency is the relationship between what is referred to as the principal and the agent. The principal employs the agent and the agent carries out certain specified actions in dealing with a third party on behalf of the principal who has employed them.
The principal is not an employer in the traditional sense, certainly not in the way that the IRS would define an employer. The principal doesn’t owe the agent any of the federally or state mandated benefits that most employers are required to provide employees. This is why the principal is often called a client in real estate. The principal might be the buyer or seller who the agent is representing. The principal authorizes the agent to represent them to other people in working on a business transaction.
The agent enters into an understanding with the principal, this is a contractual agreement, either formally in writing, or more informally, orally. The relationship may even be established simply by implication. The agent agrees to represent the principal in a particular matter such as the buying or selling of a home. And in so agreeing, the agent consents not only to represent the principal when dealing with any third parties, but to also always protect and serve the best interests of the principal.
Now let’s take a closer look at how the different roles play out in agency relationships.
The agent is the person who has agreed to represent the principal. As we discussed previously in how people are paid in real estate, it is always the broker who is in a contractual agreement with the client. Just as only the broker can be paid by the client, it is the broker who enters into the agency agreement with the client. The broker then becomes the agent and the client becomes the principal. If the client is a seller, then when the broker becomes their agent, they are agreeing to represent them and to loyally serve all of their needs as best they can in selling their home.
There is also a subagent that is possible in an agency relationship. When a broker becomes an agent to a principal, they have been given the authority to represent the principal to best conduct the relevant transactions. This authorization allows them to confer the same powers they have received from the principal, in order to represent them, onto another person, the subagent, so that the subagent may also work to best serve the interests of the principal. Even though it is the agent who tasks the subagent with the responsibilities of serving the principal in the business at hand, the subagent is always representing the best interests of the principal (or client), just as is the agent (or broker). If the subagent comes across an instance where they must make a choice and one option would be most beneficial to the agent they are working under, while the other would be most beneficial to the client, they must always choose the option that best serves the client. We will discuss this concept more in a later lesson.
As you have likely guessed, you, the real estate salesperson are the most common subagent in the real estate agency relationship. It’s important to understand this because it can sometimes get confusing. In fact, as a subagent, you are always working first and foremost for the principal, and not for the agent/broker. Again, the topic of how important it is to accurately put business loyalty in the right place, and how to navigate what can sometimes be confusing situations will be further explored when we talk about fiduciary responsibility, but there’s also one other player in the world of agency relationships: the third party.
The agent has been hired to represent the principal to a third party, and in real estate, we usually call this third party the customer. If the principal is the seller of the house, then the customers are any potential buyers, including the person who ends up buying the home. Again, the most important part of the agency relationship, when it comes to the customer, is that the loyalty of the agent must always be to the principal and not to the customer. And that’s where things can become most confusing.
A good salesperson will always be helpful and truthful in working with customers, and while they must never forget that they are representing their principal, it can be easy for the customer to become confused that the salesperson is not putting their needs first. Depending on which state you practice in, there may be laws stating that you are required to disclose in writing who the principal is, and where your loyalty lies. Even in states that do not require this, there are agencies that choose to use signed forms so that the customer understands there is not an agency relationship making them a principal. As stated previously, an agency relationship can be established based on implication, and making sure, in writing, that the customer understands that they do not have the benefit of this relationship; this can be protection in the event of a lawsuit. It’s also worth mentioning that some states do allow for dual agency, where a single person is allowed to serve the interests of both a buyer and seller.
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23.1a Agency Relationships Infographic
Please spend a few minutes reviewing the Infographic below.
23.2 Types of Agency
There are many careers that require people to act on behalf of another individual or government or corporate entity. There are even legal situations where a person might need to act as an agent for someone in their family. So, as you can imagine, there are many kinds of agents, and many ways in which that role can be satisfied. In this lesson, we’ll be discussing all of the types of agents, as well as the different permutations in which a real estate salesperson or broker may fulfill their specific role as an agent.
There are three major types of agent. While you’ll mostly only be one of these kinds of agents as a real estate salesperson, it’s a good idea to understand what each type of agent means, how their roles are defined, in order to most clearly understand your own role as an agent. So, let’s take a look at all three broad categories of types of agents.
First let’s look at the Universal Agent. The universal agent has full authority over any activity related to the principal. You may have encountered this when you’ve heard of the concept of “power of attorney.” In that case, one person has signed a piece of paper that has bestowed another person with the legal right to act fully in all of their affairs. A universal agent even has the right to make medical decisions for the principal! Of course it’s very rare for a person acting in the real estate industry to be granted these agency powers unless the real estate agent in question was the principal’s son or daughter for example. As a person in the real estate industry, this is where you may encounter this type of agency.
For example, an older person is moving to a retirement community and needs to sell their home. They might make one of their children their universal agent, bestowing them with all the legal rights needed to fully execute the sale of the house. The principal, the person moving to the retirement community, doesn’t need to be consulted in any decision regarding the sale of the house, they don’t need to sign a single piece of paper, and they don’t need to be present at the closing. The universal agent may do all of those things instead. In that specific example, it’s common for the real estate salesperson to never even meet the principal; instead they conduct all business with the universal agent, although ownership and all profits from a subsequent sale still are the full property of the principal.
Next, let’s take a look at the General Agent.
A general agent will be granted full authority over a single property. A general agent is much more common of a role to see amongst professionals within the real estate industry. One of the most common jobs for which a general agent is used is for that of a property manager. If a property owner, who has an investment property, doesn’t wish to have hands on role, or have the hassle of dealing with tenants at all, they may hire a property manager to take care of the property. By making them the general agent for the property in question, the general agent is then authorized to make many of the legal decisions pertaining to the property and the business that is conducted there. For instance, the property manager may be able to approve tenants for a vacant apartment without consulting with the principal, and they might be authorized to sign the lease, so even though the actual owner does not sign the lease, the property manager, acting as their general agent for the property, has entered the property owner into the legally binding contract of the lease, for which they are just as fully liable as if they had signed it themselves.
Finally, let’s talk about the Special Agent.
A real estate broker or salesperson operates as a special agent which is the type of agent that is most common for a real estate salesperson or broker to be. The special agent is one who is only granted limited authority to act on behalf of the principal. A special agent in real estate will only be authorized to act on behalf of the principal when conducting very specific business transactions and these will most likely all be clearly laid out in a listing contract signed by both the agent and the principal. For example, most listing contracts will authorize the special agent to conduct advertising to market the property. All of the business which a special agent may perform on behalf of their principal should be spelled out in the contract that begins the official business transaction between a real estate broker and their client.
While universal agency does not have much application within the real estate agency, in certain situations, the difference between general agency and special agency can be extremely important. With special agency, the agent is only authorized by the principal to act on their behalf in carrying out specific activities. Usually these are all defined carefully in a written contract. If the special agent conducts business that is not covered by the scope of that contract, even if it is to benefit the principal, they are no longer acting as the principal's agent and are solely liable for any damage or illegal activity that might be associated with their activity. However, when a general agent is carrying out illegal activity to benefit the principal, without the principal's knowledge, for example illegally evicting a non-paying tenant, then the principal, or property owner might still be held liable. There are instances where a court decides a special agency has transformed into a general agency relationship. This would mostly happen in cases of fraud. If a broker commits fraud on behalf of their principal as a special agent, they will be solely liable. However, a court may decide that the principal knew the fraud was being committed or should have known that they were benefitting from fraud, so that though the broker was acting outside of the special agent relationship, the relationship had changed into one of general agency, and the principal may also be held legally liable for the fraud.
Now, let’s take a look at the different iterations of agency which a real estate salesperson and broker can take.
The most common type of agency that allows a brokerage to sell a client’s property is called single agency. In this instance, a broker will sign a listing agreement with the client, for this example, let’s use a property owner. The listing agreement will clearly lay out all of the responsibilities that the broker takes on, as a special agent, in agreeing to carry out these property agreements. And as a single agent, the broker also agrees that they will only act as the agent for the client, they will not act as an agent for any other competing interest. Their first loyalty will always remain undivided with the property owner.
The next type of agency is known as sub-agency. The most common example of a sub-agent is a real estate salesperson or associate broker working under a sponsoring broker. The sub-agent will work on behalf of the agent who has charged them with the responsibilities, in order to serve the best interests of the principal. So, while the broker is the single agent who has made an agreement with the principal, the salesperson or associate broker will be tasked with also fulfilling that agreement in the same way that the broker would, to serve the best interests of the principal.
The next type of agency is dual agency. As opposed to single agency, where a broker agrees to represent a buyer or a seller as the principal, but never both at the same time in the same transaction, a dual agency sets up a situation where a person enters into an agency relationship between two principals who are on opposing sides of a single transaction. In real estate, this primarily occurs when a broker or salesperson simultaneously acts as the agent of both the seller of a property and the buyer of that same property.
As you can well imagine, this can get complicated very easily. Because the entire purpose of an agent is to always act in the best interests of their principal, if an agent has agreed to serve the best interest of more than one principal, then conflicts of interests might arise. And if the two principals are on opposing sides of a single transaction, conflicts of interest will undoubtedly arise. It is always in the seller’s interest to receive the highest price for a sale. It’s always in the buyer’s interest to pay the lowest price. How can a single agent work to achieve those two goals simultaneously? Obviously, that’s not possible, but there are situations where it’s possible to properly fulfill fiduciary responsibility to both parties, and there are situations where it’s not possible. Because of the complex nature of dual agency, there are many states that have made that agency role outright illegal. In those states, to be a dual agent is to fail at fiduciary responsibility.
In states where dual agency is legal, the dual agency must be disclosed in-writing. Disclosed dual agency is what allows a single agent to represent two competing principals while still fulfilling their fiduciary responsibility. Most often, the disclosure will require that both principals give written consent that the brokerage will represent the two principals, making sure that both principals are fully aware of the arrangement. In order for dual agency to be practiced responsibly, a broker will often assign two different sub-agents in the office to each principal. The sub-agent assigned to the seller will treat them as though they are the single principal, while the sub-agent assigned to the buyer will treat the buyer the same way. These sub-agents are known as designated agents.
Undisclosed dual agency, where a broker has an agency relationship with two competing principals, but does not inform them of this is always illegal in every state. And while it might seem simple enough to avoid, a dual agency relationship may be formed unintentionally. Remember from the previous lesson, while it’s always best to define an agency relationship through a written contract, it’s also possible for an agency relationship, that is legally admissible in court, to be formed simply based on implication. Yes, that’s right; it can take less than an oral agreement to form a binding agency relationship! This is why it’s so important to be careful with dual agency. If you were to imply to a customer, a potential buyer, that you were there to serve their best interests first, then you might create a relationship by implication. If your brokerage has already entered into a single agency agreement with the seller of the property, then this has the potential to accidentally create an undisclosed dual agency. In order to avoid this, it’s a good idea to make clear, in writing, that when you are showing a customer a property, you are an agent of the seller or owner and must serve their best interest first.
23.2a Types of Agency Infographic
Please spend a few minutes reviewing the Infographic below.
23.3 Creation and Termination of Agency
As we’ve gone over in the previous two lessons, agency is serious business. And if you don’t get it right, it can lead to some pretty major and unpleasant consequences. However, while normally, it’s enough to follow the rules, to stay out of trouble, making sure that you stay above board while engaging in agency relationships is a bit more complex. That whole bit about it being possible to establish an agency relationship simply by implication is the issue. Implication is subjective, so what happens if you inadvertently enter into an agency relationship without realizing it? Or, if you believe you’re in an agency relationship with a client, but when it comes time to pay, the client insists that no agency relationship ever existed. Let’s take a look at the different ways that an agency relationship is established, and how one is ended. That way you’ll never find yourself accidentally falling foul of real estate laws, nor losing out a commission because of a misunderstanding.
There are three main ways that an agency relationship can be created, leading to express agency, implied agency and ostensible agency.
Express agency is the clear-cut version of the agency relationship; it’s when the agency relationship has been created by oral or written agreement between the principal and the agent. When a broker and a seller both sign a listing agreement, they have entered into an express agency relationship in which the broker is the agent and the seller is the principal. The listing agreement serves as a contract that clearly lays out the agency relationship, and will even put an end date on how long that relationship exists.
You might be surprised to find that there isn’t a distinction drawn between oral and written agreements, but an oral contract is a legally binding one. Of course, in a court of law, it’s always best to have written documents to back up your case, but in real estate you’ll find many instances when there is no written document. In many places, a lot of real estate relationships are initially established with a handshake, and particularly with deals that have smaller stakes, such as residential rentals; it’s not always necessary to have a signed agreement. If you’re representing a property owner for a rental, there may be other brokerages that are also representing the owner for the same property, and neighborhood landlords might be hesitant to enter into a signed agreement. As long as you agree to act as the agent to the principal, and uphold that agreement, including making it clear to any potential renters that you are acting as the agent of the property owner, then you will be engaging in express agency.
Now let’s take a look at implied agency. In its simplest terms, implied agency is an agency relationship that is created by the actions of the principal and the agent, rather than through any stated agreement that they may have. It is implied agency that can arise accidentally, and it is the kind of relationship which only one party, the principal or the agent, might believe exists, while the other is unaware of there being any agency relationship there. Of course, if the agent is unaware of their existing an agency relationship, then they will likely fail to fulfill their fiduciary responsibility to the principal, and if the principal doesn’t believe there is any agency relationship, then they are unlikely to believe that they owe any money to an agent who has dutifully carried out work for them. There are many ways that an implied agency relationship can be created. Let’s look at a couple of them.
If a friend or acquaintance asks you for some advice in marketing their property you might want to just help them out. You understand that in order to fully market the property there’s a certain protocol you go through, one that begins with the signing of a listing agreement. But your friend might believe that you are now responsible for selling the property, and liable for any advice that you give.
Conversely, when your friend asks for help, you might believe they’re engaging your services as the selling agent. You might diligently market the property, find a buyer, and while your friend gladly accepts all of your “help,” at closing they may not feel like they owe you any sort of commission.
Whichever way an implied agency is entered into, it’s always best to be avoided, and the way to avoid is to always make sure that both you and the principal are fully clear on the nature of the relationship. Additionally, to fully avoid implied agency, it can also be important to state when there is no agency relationship in existence. Oftentimes a potential buyer might take your helpful advice to mean that you are ‘on their side’ and that you owe them fiduciary responsibility. By making clear that you work for the seller, and while you want to help the buyer, your final loyalty is with the seller, then you are avoiding accidentally entering into an implied agency which would lead to an undisclosed dual agency.
Finally let’s look at the third sort of agency, ostensible agency. Ostensible agency is a specific kind of implied agency, but instead of the principal or agent believing that an agency relationship exists, it is a third party who believes the agency relationship exists. If a property owner knows that you’ve been driving by their property and mentioning that it is for sale at a particular price to potential buyers, then it would be reasonable for those potential buyers to believe that you are acting as an agent for the property owner. If there is a court case that arises due to this, then the existence of an actual agency relationship can be enforced by the court.
In creating express agency there are two main documents which are used: listing contracts and the buyer representation agreements. While we’ll be discussing these further in a later lesson, let’s look now at how they are used to establish express agency.
While a listing contract has many important components, it establishes an express agency relationship because it lays out what the broker, as a special agent, will do for the seller. All of the agent’s responsibilities and expectations in representing the principal will be clearly stated, and the monetary compensation that the principal will owe the agent upon successful completion of a sale is stated. There will also be an end date to a listing agreement which would cause a termination of the agency relationship unless there is a sale or extension, and there may be additional conditional reasons that would terminate the relationship included in the listing.
A buyer representation agreement works the same way as a listing contract, but it establishes the express agency relationship between the broker as the agent and the buyer as the principal.
Because of the important legal consequences of agency relationships, it’s important to know how you may terminate an agency relationship. There are seven main ways in which an agency relationship is terminated. Let’s take a look at each one.
Number 1: Full Performance
As a real estate salesperson, the very best way to end an agency relationship is with full performance or completion of the transaction. Once the closing is completed and the job was well done, then the house has been sold (or bought), the apartment rented or the commercial space leased and you’ve been paid the commission. The agency relationship is over and everyone walks away happy.
Number 2: Destruction or Condemnation of the Property
You know the clause that comes with every airline ticket you ever buy, releasing them of responsibility because of weather or other “acts of God.” Stuff happens, and whether it’s due to an accident, an earthquake or even negligence, sometimes a property is destroyed or condemned. If you’re the agent representing the principal for a property that no longer exists or is severely damaged, then that will be enough to terminate the agency.
Number 3: Expiration of the Listing Contract
As mentioned, any written contract will list an end date. And while the principal and agent can agree to extend that time, once the listing contract or buyer representation agreement has expired, then the agency relationship is officially over.
Number 4: Mutual Agreement of the Parties
Sometimes things aren’t working out, but when there’s a written agreement establishing the agency relationship, both the agent and the principal will still have to fulfill their end of the agreement. However, if both parties agree, they can officially terminate the agency.
Number 5: Breach of Contract
Sometimes only one party wants to exit an agency relationship while the other wishes to stay. If the party who wants to terminate the relationship can show that the other party has breached the terms of the contract, then they can have the relationship brought to a close.
Number 6: Operation of Law
There could be an operation of law which supersedes an agency relationship. Perhaps a property is seized as a tax asset by the IRS. In those instances, any agency relationship regarding that property will be nullified.
Number 7: Death or Incapacity of Either Party
Finally, in the cases of death or incapacity by either party to an agency relationship, the relationship is legally terminated.
Let’s return to one of our favorite topics: getting paid. As we’ve discussed what an agency relationship is, it might seem as though the agent is taking on a whole lot of responsibilities, duties and even potential liability, solely to serve the principal. But that’s before you factor in compensation. The agent is being paid by the principal to take on all of these responsibilities. In this lesson, let’s take a closer look at the details of how an agent is compensated by the principal.
In real estate, what the agent earns from the principal is called a commission. Another meaning of commission is being assigned a responsibility by someone else, which is in essence, the very nature of the agency relationship, but when you hear the term commission in real estate, you can count on it being in reference to the agent’s compensation.
Most often, the agent is compensated based on a percentage of the total closing costs, whether they are sales, rentals or leases. However, in the world of real estate, there is no standard commission. That is always a point of negotiation between a principal and their agent. The exact terms of what the commission is will be stated in the contract that lays out the agency relationship, either the listing contract or buyer representation agreement.
You should think of the 6% commission which you may have heard for sales as the high end, and many brokers will attempt to negotiate from 5 or even 4 to 6%, in order to stay competitive and win good listings, while still being assured a good commission. And there are even business models that operate on quantity, offering sellers commissions that are significantly lower than 4 and even 3%. It’s always a point of negotiation. For rentals, a commission will often be equal to one month’s rent. Although in an extremely competitive market, this could go up as high as 15% of a year’s lease, which is closer to two month’s rent, and in a slow market, the commission on a rental might be below one month’s rent. Since a commercial lease is often for an extended period of time, such as 10 years, a commission on a commercial lease may be based on the total cost of the lease over its full life, or it might be based on a percent of the first three years.
Let’s take a look at an example of how a commission is calculated.
In the case of a sale, where a broker has negotiated a commission of 5.5% on a house that sells for $250,000, you would find the full price of the commission by multiplying the selling price by the percent. In other words, 250,000 times 0.055 equals 13,750. The full commission, before factoring any splits to a buyer’s broker or agents who have worked on the deal is $13,750.
Sometimes a commission might be set as a flat fee. This is not nearly as common in real estate as it is in other industries, but as commissions are negotiable, it’s not unheard of. It’s something that we may see more of with tech based startups that make money by selling in volume. Currently, it’s more common in slow rental markets. For example, a real estate agent might offer to rent apartments for a flat fee of $500.
The commission is earned once the agent has found a “ready, willing and able buyer.” It is at that point that the agent has technically fulfilled their duties to the principal and earned their commission. However, the key point is that it is technically when they have earned the commission. In reality, most agents will only collect the commission upon the successful completion of a transaction.
Chapter 23 - Quiz
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