California Commercial Agency Disclosures: Failing to Comply Results In the Loss of a Broker’s Commission and Rescission of the Lease or Purchase Agreement.

If you are a broker or principal involved in commercial real estate in California, you're likely aware of California Senate Bill 1171, which as of January 1, 2015 requires commercial brokers to provide the same agency disclosures to their principals that residential agents have had to provide for years.

You know that a disclosure must be made, but depending on who you ask, you may get different answers on what disclosures must be made (there are actually two), and when and how these disclosures must be made (the Civil Code is very specific and in most cases requires that the landlord/tenant, buyer/seller acknowledge receipt in writing). Further, these requirements apply even if a broker is only representing one party (landlord, tenant, seller, or buyer). In fact, a broker representing only a tenant or only a buyer is required to make these disclosures not only to that tenant or buyer but also to the other principal, the landlord or seller.  For your reference, these points the what, when and how of making the disclosures are outlined below. 

What's more important, though, is that you know how critical it is that you make these disclosures properly. As you'll see below, the simple answer is this: If you are a broker, failing to provide the disclosures at the right time and in the right form will cost you your commission and very likely a lawsuit filed by your principal(s). If you are a principal and your broker fails to provide these disclosures at the right time and in the right form, you could lose your deal and be dragged into litigation. Hard to believe? Read the case below because that's exactly what happened – a seller rescinded a day after signing a purchase agreement because a broker, who the court found to have acted "in a fair and neutral manner" failed to provide one of the required disclosures at the right time. 

Senate Bill 1171 is unique because it is not new law. Instead, it expands existing law that used to apply only to residential agents. The benefit of this is that it is much easier to know how the law will be applied because there is already existing case law on the topic. Below is a summary of the Huijers v. DeMarrais case which illustrates why these agency disclosures must be provided strictly in accordance with the Civil Code and why "close enough" or "substantial compliance" may not be enough to save the broker's commission and the principal's transaction.  

What does SB 1171 do and why does it matter?

Because commercial brokers are required to make these disclosures, and because the Civil Code is so specific about the requirements, if not followed exactly, an unhappy buyer, seller, landlord or tenant will have a much easier time of rescinding a contract.

What does SB 1171 do? First, if you're not already familiar, feel free to jump below and read more about the specific disclosures required by the Civil Code. Since the early 1980s, the California Civil Code has required residential agents to make two agency disclosures, including an initial preprinted form disclosure explaining the types of agency relationships (seller's agent, buyer's agent, dual agent), and later a second disclosure specifying what type of relationship the agent and principal are going to have in a particular transaction. This framework was meant to ensure the principal gave its "informed consent" to the agency relationship. (The first disclosure "informs" or educates the principal, and the second disclosure gets the principal's consent.)  Additionally, although drafted to refer to a "buyer" and "seller", the disclosure requirements have always applied equally to transactions with landlords and tenants in leases exceeding one year.  

So again, with that background, what does SB 1171 do? All it does is require commercial brokers to make these same two disclosures to their principals in commercial transactions. Other than requiring commercial brokers to make these disclosures – at the specified times and in the specified forms – SB 1171 does not impose any additional duties on commercial brokers, even when acting as dual agents.  Dual agents, meaning agents representing both principals in a transaction, have always had the same duties to their principals and have always faced increased scrutiny by the courts, regardless of whether acting in a commercial or residential transaction.

What has changed, however, is that now because commercial brokers are required to make these disclosures, and because the Civil Code is so specific about the requirements, if not followed exactly, an unhappy buyer, seller, landlord or tenant will have a much easier time of rescinding a contract or fighting over a commission by claiming that it was not properly informed of the nature of the agency relationship and therefore did not properly consent. This is what happened in the Huijers v. DeMarrais case below.

Huijers v. DeMarrais – Fail to provide a disclosure on time, and get a rescission notice the day after the contract is signed.  

  "CLOSE" IS NOT GOOD ENOUGH

"CLOSE" IS NOT GOOD ENOUGH

A good example of how things can go badly by simply missing the timing requirements in the Civil Code is the Huijers v. DeMarrais case, 11 Cal.App.4th 676 (1992). Although this case involves a residential property (actually, a quasi-residential property it was a nursery with a residence on it), the court interpreted the same disclosure requirements that now apply to commercial brokers, and the parties involved were fairly sophisticated.

You'll be interested to read through the facts below, but here is the summary: A broker represented both a buyer and a seller and was found to have acted "in a fair and neutral manner." However, because the broker did not provide the seller with the agency disclosure form required by the Civil Code before the listing agreement was signed, even though the form was ultimately provided before the purchase agreement was signed, the California Court of Appeal held that the broker had no right to a commission and that the seller may have grounds to rescind the purchase agreement. That's noteworthy because all parties appear to have been sophisticated, negotiated at length (7-8 hours), and the broker's only failure was that she failed to provide a one page form disclosure to the seller at the right time. 

Huijers v. DeMarrais 

. . . If you're a broker, you have the same duties to your principals that you have always had; however, regardless of whether you actually satisfy those duties (as the broker in the Huijers case did!) you must make the disclosures required by the Civil Code when and in the form required by the Civil Code. And if you're a principal, you need to ensure your broker has complied.

In Huijers, a buyer engaged a broker to find a nursery property for an exchange.  The broker contacted an owner/seller that had a nursery property with a residence on a portion of the parcel.  The broker told the seller that she had a client interested in buying the property and the seller signed an exclusive listing agreement. There was one problem though – because the property had a residence on it, it was a residential property and the form disclosure statement required under the Civil Code had to be provided before the listing agreement was signed. (Note that the case references Section 2373 which was the numbering in effect at the time of the case but the requirements have not changed.)

The listing price was $325,000 and the buyer agreed to pay that price. The buyer, seller, and broker met in person and negotiated for about seven to eight hours.  At the end of the negotiation, the parties signed the purchase agreement, and the broker provided the seller with the form disclosure statement required under the Civil Code (so it was provided, but provided late because it was supposed to be given to the seller before entering into the listing agreement). The purchase agreement also documented that the broker was acting as a dual agent.

The next morning ­­– after the buyer and seller negotiated for 7-8 hours and signed the purchase agreement – the seller’s attorney called the broker and buyer and informed them that the seller was rescinding (i.e., cancelling the agreement just signed). The buyer sued for specific performance and damages, and the seller responded by counter suing the buyer and broker for among other things fraud and breach of fiduciary duty. (This is the typical course of things when transactions unravel, and if you sue, expect to be counter sued, and if you are a broker, expect to be sued by at least one, sometimes both principals.)

The trial court held that the purchase agreement was enforceable and that the broker and buyer had not made any misrepresentations or breached any fiduciary duties. In fact, the trial court expressly found that the broker committed no fraud and that she represented "... the interests of both plaintiff and defendants in a fair and neutral manner."  However, the seller appealed, and the court of appeal held that the seller had the right to rescind the listing agreement and (likely, pending further proceedings) the purchase agreement because the broker failed to provide the form disclosure statement when required under the Civil Code.

In its decision, the court walked through the Civil Code provisions – the same requirements outlined below that now also apply to commercial brokers – and found, correctly, that the timing requirements had not been satisfied by the broker. 

The buyer tried to defend against the rescission of the purchase agreement by arguing that the broker was in substantial compliance because, although the disclosure form was not provided before the listing agreement was entered into, the form was nevertheless provided when the purchase agreement was signed. However, the court found that providing the disclosure form after the time required by the Civil Code did not satisfy the objective of the statute.

The court explained the disclosure requirement, specifically with regard to timing, as follows:

The objective of a statute requiring a disclosure prior to signing the listing agreement is to allow the seller to make a more intelligent decision about whether to sign. For example, the property owner who is asked to sign a listing agreement because the broker has a buyer for the property may not fully comprehend that the broker intends to act as a dual agent. Because the seller pays the broker's commission, the seller may reasonably believe the broker has only the seller's best interest at heart and is working exclusively for the seller.

The disclosure form tells the property owner that a broker can act as a dual agent. Thus advised, the seller may wish to sell the property through his or her own agent or to seek independent advice on the price and terms of the listing.

The full measure of protection that the Legislature intended to provide to the seller cannot be achieved if the listing agent fails to provide the disclosure form prior to entering into the listing agreement. Because a reasonable objective of the statute is to give the seller information prior to signing the listing agreement, providing a disclosure form after the seller signs the agreement is not substantial compliance.

The court then imposed the rather harsh rule applicable to the broker's failure, which is essentially that the unhappy principal doesn't have to pay a commission and can avoid (i.e., rescind) the transaction, regardless of whether the principal was damaged by the failure:

The remedy for a real estate agent's breach of a duty to disclose a dual representation of both buyer and seller is that the principal is not liable to pay the agent's commission, and the principal may avoid the transaction. (McConnell v. Cowan (1955) 44 Cal.2d 805, 809) "... It makes no difference that the principal was not in fact injured, or that the agent intended no wrong or that the other party acted in good faith ...." (Id., at pp. 809-810.)

You might be thinking, "Yeah, but the broker told the seller from the beginning that the broker's 'client' was going to be the buyer, and the seller knew from then on that the broker was acting as a dual agent. However, the court clearly stated that the mere disclosure of dual agency was not enough:

[i]t is not enough to disclose only the fact of dual representation. The agent must also disclose all facts which would reasonably affect the judgment of each party in permitting the dual representation. . . . We read section 2375 [Now Section 2079.14 et seq.] as a legislative determination that the information required to be disclosed alerts the parties to the potentially harmful consequences of dual representation, so they can make an informed judgment."

And there you have it – Not only must brokers make the disclosures on time, but they must make the disclosures in the form required under the Civil Code because California courts have found this to be a legislative determination of the information required to be disclosed for a principal to give its informed consent.

The take away is this: If you're a broker, you have the same duties to your principals that you have always had; however, regardless of whether you actually satisfy those duties (as the broker in the Huijers case did!) you must make the disclosures required by the Civil Code when and in the form required by the Civil Code. And if you're a principal, you need to ensure your broker has complied.

Agency Disclosures Required Under the Civil Code – What, When, and How.  

Now that you know why complying with the Civil Code disclosure requirements is so important, below is an overview of what disclosures must be made, and when and how they must be made.  

Two disclosures are required: 

1. Preprinted Disclosure Form Regarding Real Estate Agency Relationship and Duties.

First, a form "Disclosure Regarding Real Estate Agency Relationship" (in the form provided in the Civil Code) must be delivered to the principals in the transaction. (A listing agent must deliver the form to the seller, and a selling agent must deliver the form to both the seller and the buyer.)

The agent providing the disclosure form must receive an acknowledgement of receipt *signed* by the principal receiving the disclosure (subject to limited exceptions noted below).

2. Disclosure Regarding Nature of Agency In Transaction.

Second, as soon as practicable, the principals in the transaction must be informed of the nature of the agency relationship, i.e., whether the agent is acting exclusively for the seller, buyer, or as a dual agent. (A listing agent representing only the seller must make this disclosure only to the seller. A selling agent must make this disclosure to both the seller and buyer *even if only representing the buyer*.)

In each case, the agency relationship must be confirmed in a writing executed or acknowledged by the disclosing agent and the principal or principals receiving the disclosure. (The writing may be the purchase agreement or lease, but better practice is likely to always include a separate disclosure form that is signed as soon as the nature of relationship is known.)

Changes Implemented By Senate Bill 1171.

The disclosure requirements implemented by Senate Bill 1171 are found in Civil Code Sections 2079.13 to 2079.24. Here is a link to the full text of Sections 2079-2079.24 (you'll need to scroll down to Section 2979.13).  

As noted above, since the 1980s, the Civil Code has required residential brokers and salespersons to make disclosures regarding the nature of agency relationships and in what capacity the broker or salesperson is acting in the specific transaction, and all that SB 1171 has done is to extend these requirements to commercial brokers. 

In total there are only three changes to the Civil Code:

First, the title of the article has been revised to refer to "Real Property" not just “Residential Property”:

Article 2. Duty to Prospective Purchaser of Residential Real Property

Second, Section 2079.13, which defines various terms, was revised to include a new definition for "Commercial Real Property":

(d) “Commercial real property” means all real property in the state, except single-family residential real property, dwelling units made subject to Chapter 2 (commencing with Section 1940) of Title 5, mobilehomes, as defined in Section 798.3, or recreational vehicles, as defined in Section 799.29.

Third, the previous definition for "Real Property" included under Section 2079.13 was revised to include the newly defined term, commercial real property:

(j k) “Real property” means any estate specified by subdivision (1) or (2) of Section 761 [i.e., meaning fee title or a life estate] in property which that constitutes or is improved with one to four dwelling units, any commercial real property, any leasehold in this type these types of property exceeding one year’s duration, and mobilehomes, when offered for sale or sold through an agent pursuant to the authority contained in Section 10131.6 of the Business and Professions Code [i.e., sale of registered manufactured home or mobilehome].

As you review the disclosure requirements, remember the following: 

  • All Real Property – The result of the changes above is that the disclosure requirements now apply to all real property in the state, other than certain unregistered mobilehomes. 
    .
  • All Leases Exceeding a Year – Although the disclosures speak strictly in terms of purchase and sale transactions and refer to sellers and buyers, Civil Code Section 2079.13(m) expands the definition of "sell", "sale" or "sold" to include "transactions for the creation of a leasehold exceeding one year’s duration." So remember that these requirements now apply to essentially all commercial leases. 
    .
  • Signed  Subject to few exceptions as noted below, the Civil Code requires the disclosure form to be signed. 

Required Disclosure 1 – Preprinted Disclosure Form.

First, Section 2079.14 requires agents to deliver the form "Disclosure Regarding Real Estate Agency Relationship" provided in the Civil Code to the principals in a transaction and to obtain a signed acknowledgement of receipt from the principal receiving the disclosure.  

1. The listing agent must provide the disclosure form:

  • To seller – before entering into the listing agreement [Section 2079.14(a)].  The listing agent need not provide the disclosure form to the buyer unless the listing agent is also acting as the selling agent. 

2. The selling agent must provide the disclosure form:

  • To seller – as soon as practicable prior to presenting the seller with an offer to purchase. (If the selling agent is also the listing agent and has already provided the disclosure form, there is no need to provide it again.)  [Section 2079.14(b)]
    • Here there is one exception where a selling agent does not need to obtain a signed disclosure form from the seller: If the selling agent is not in direct contact with the seller, the selling agent still needs to prepare and provide a disclosure form to the seller; however, (a) the selling agent can either prepare the form and give it to the listing agent to have the seller sign it and return it, OR (b) the selling agent can mail the disclosure form to the seller's last known address by certified mail. In the latter case, no further acknowledgement from the seller is required.  [Section 2079.14(c)]
      .
  • To buyer
    • If the selling agent prepares the offer to purchase, as soon as practicable prior to execution of the buyer's offer to purchase. [Section 2079.14(d)]
      .
    • If the selling agent does not prepare the offer to purchase, no later than the next business day after the selling agent receives the offer to purchase from the buyer.  

In each case, an agent is required to "obtain a signed acknowledgement of receipt" from the principal receiving the disclosure form. [Section 2079.14]  However, if the principal for some reason refuses to sign an acknowledgement, an agent must document the refusal by preparing, dating, and signing a written declaration stating the facts of the refusal. [Section 2079.15]   

Form of Preprinted Disclosure: 

The California Association of Realtors has long had a disclosure form complying with the requirements of Civil Code Section 2079.14; however, if you are preparing your own form, the exact text required is in Civil Code Sections 2079.13-.24. Section 2079.16 specifies that the disclosure form must have the text of Section 2079.16 on the front of the disclosure form, and printed on the back, have Sections 2079.13 to 2079.24, inclusive (excluding only Section 2079.16 which of course is printed on the front). The front and back of the form would appear (without much formatting) as follows:

Required Disclosure 2 – Nature of Agency In Transaction.   

Second, Section 2079.17 requires agents to disclose to the principals in a transaction what capacity they are acting in.  

Selling Agent. A selling agent is required to disclose to both the buyer and the seller, as soon as practicable, whether the agent is acting exclusively as the buyer's agent, exclusively as the seller's agent, or as a dual agent representing both parties.

Listing Agent. If a listing agent is also representing a buyer, the agent is by definition a dual agent and must make the disclosure noted above. However, even if a listing agent is only representing the seller, while the agent is not required to make a disclosure to the buyer, the agent must nevertheless disclose, as soon as practicable, to the seller that the agent is acting exclusively as the seller's agent. 

Documented in Writing Before or at the Time the Purchase Agreement/Lease is Entered Into. In each case, the agency relationship must be further confirmed in a writing signed or acknowledged by the disclosing agent and the principal or principals receiving the disclosure before or at the same time as the purchase agreement or lease is entered into. This "writing" documenting the agency relationship may be the purchase agreement or lease itself; however, it may be a better practice to always include a separate document apart from the purchase agreement or lease that is signed by the principals and brokers.

The confirmation of the agency relationship is required to be in the following form: 

_______________________________________________
(Name of Listing Agent)

is the agent of (check one):

( ) the seller exclusively; or
( ) both the buyer and seller.

_______________________________________________
(Name of Selling Agent if not the same as the Listing Agent)

is the agent of (check one):

( ) the buyer exclusively; or
( ) the seller exclusively; or
( ) both the buyer and seller.