The quest for “transparency” is a major driver in our world today so that people can make the best decisions. We saw it with banking reforms after the recession as well as with all the new disruptive technologies. In commercial real estate, we recently saw the push for transparency with the new lease accounting rules. Commercial real estate brokerage, is a sector in need of increased transparency, particularly given the continued consolidation of commercial real estate brokerage firms where it is increasingly common for opposing parties in a transaction to be represented by agents from the same firm. Beyond this conflict of interest issue, greater transparency is needed as to compensation and “incentives” offered by property owners to entice agents to show a particular property.
With recent headlines about conflicts of interest in real estate brokerage in the UK, as well as a California Supreme Court decision (Horiike v. Coldwell Banker Residential Brokerage Company, where it ruled a residential brokerage firm owed fiduciary obligations to both buyer and seller even though different agents within the firm represented the parties), this post addresses brokerage law as it pertains to Illinois, which is similar to many other states, and why more transparency is needed in commercial transactions.
In Illinois, like many other states (excluding California), there is a concept called “designated agency” where it is presumed that an individual agent is representing the client (“consumer”) with whom it is working with in the transaction. This concept arose to replace the common-law concepts of agency and fiduciary obligations which were not compatible with a typical real estate transaction. In many residential transactions, it is common for the same brokerage firm to have different agents representing both buyer and seller resulting in a “dual agency” situation with conflicting fiduciary obligations. Under designated agency, the firm’s sponsoring broker can designate different agents within the firm to represent the opposing parties while the firm itself is not technically considered to be an agent for either party. While each designated agent has “fiduciary-like” obligations, including as to confidentiality, this concept goes further to state that the sponsoring broker is not an agent of either party even though they can receive confidential information from each parties’ designated agents for purposes of “seeking advice or assistance for the benefit of the client”. While the sponsoring broker is required to “take ordinary and necessary care to protect confidential information” and cannot share confidential information with the opposing designated agent or its client, there should be some safeguards and disclosures to ensure that the sponsoring broker is not favoring one party over the other. Note, the Horiike decision is the result of California not having such a “designated agency” law and until the state legislature acts, tenants and landlords and their agents should proceed with caution.
“Dual Agency”, by contrast, is a unique arrangement where the opposing parties are represented by the same individual agent. While some states preclude such arrangements, it is allowed in Illinois and other states, but it requires written consent from each party and the agent’s role is very limited – more of a conduit than an advisor.
As the overwhelming majority of real estate transactions are residential, real estate brokerage laws are created to address the issues in such transactions. While there are some parallels between residential and commercial transactions, today’s commercial transactions (particularly office) have become increasingly complex involving millions of dollars. With such high stakes, landlords and tenants have looked to their agents to be more than “order takers” and rely upon them to provide deep financial analysis and negotiations of leases that commonly exceed 100 pages with a multitude of issues. Tenants, particularly small and medium-sized businesses, are less sophisticated in this area than landlords, whose core business is commercial real estate.
Recently in the United Kingdom, the real estate accreditation body, Royal Institutions of Chartered Surveyors (RICS), published a statement containing more stringent conflict-of-interest requirements which will go into effect January 1, 2018. Namely, informed consent of all parties shall be required for all dual or multiple relationships. Additionally, it requires clearer guidance on confidentiality. This RICS statement is based upon a study by the University of Leeds (“Leeds Study Commercial-Property-Agents-and-Conflicts-of-Interest“) which found: (a) potential conflicts of interest and lack of transparency are detrimental to less sophisticated small to medium-sized businesses; and (b) for firms that represent both tenants and owners, there is a lack of separation between their internal tenant and owner agency business units. The Wall Street Journal in 2014 discussed the issue of conflicts of interest in commercial real estate brokerage firms following a George Washington University study (“Conflicts of Interest in Commercial Real Estate Transactions: Who Represents the Tenant?“) by Peter Smirniotopoulos.
Recently I negotiated a lease for a multi-billion-dollar client with ties to many of the country’s top law firms. Before commencing lease negotiations, the landlord’s attorney (from one of these top law firms) first obtained a signed conflict waiver from my client who was represented in the lease by their in-house counsel and yours truly. That’s not the first time this has occurred with this client and others, but I asked myself, why don’t brokers have to obtain similar conflict waivers? As a lawyer by background, I’ve never heard of the same law firm representing opposing parties in a transaction or litigation. That’s due to the statutory rules of professional conduct for attorneys, rooted in the principle that one cannot serve two masters.
Beyond conflicts of interest, another industry practice that requires disclosure is compensation and other financial incentives. As brokers, we’re paid by the commissions embedded into the transaction. While the tenant doesn’t directly pay the fee, there’s “no free lunch”; but if the broker is doing her job, she’ll save the tenant multiples of her fee. Commission structures vary from market-to-market, as well as within markets. Some landlords (particularly, sublandlords) will offer higher commissions to attempt to influence the tenant’s broker. Any good tenant rep broker is not going to be influenced by such ploys, but they should be disclosed to the client. Along those lines, landlords will also provide gifts (cash, gift cards, trips, etc.) for touring a building with a client or requesting a proposal, etc… Again, a good tenant rep broker is not going to be swayed by these gratuities, but they should be disclosed to the client. Personally, I’d rather see the cash equivalent be reflected in lower costs for my client or donated to my client’s charity of choice.
I’m not going to self-servingly suggest that global commercial brokerages should spin-off their tenant representation practices. Being realistic and as a co-founder of Blackacre Advisors, where we only represent office tenants, I understand that some companies like the platform of these global brokerage firms while others prefer platforms of tenant-only representation firms. Instead, and like attorneys who are required to obtain conflict waivers, there needs to be more disclosure to the parties of exactly who is representing whom and how their information will be safeguarded. There also needs to be more transparency of compensation practices. As others have suggested and given the differences among 50 states, a model code of commercial real estate brokerage practice would have merit.
*As stated below, these posts reflect industry practices and do not contain any legal advice and should not be relied upon without advice from your legal counsel.