Hey! That was “My Buyer” and “My Commission!”

Imagine that you have been working with some friendly buyers and have shown them multiple properties.  Then, you don’t hear from them for a while.  When you follow up, you find out that they have purchased a home using another agent . . . it may have even been a home that you had shown them previously.  You think:  Hey! That was “my buyer” and “my commission!”  Was it?

 

The MLS Offer of Compensation

After a listing broker enters into a listing agreement with the seller, the broker generally enters the listing information in the multiple listing service (“MLS”) of which the broker is a participant. The MLS is a means by which broker participants make blanket unilateral offers of compensation to other broker participants. A cooperating broker is entitled to a commission from the listing broker pursuant to the MLS offer of compensation when the cooperating broker is the “procuring cause of the sale.” In the event of a procuring cause dispute, if the brokers cannot resolve the issue informally or through mediation, REALTOR^® brokers are obligated to arbitrate.  

 

Procuring Cause

Unfortunately, determining which broker is the procuring cause of the sale can be difficult.   Some of the factors an arbitration hearing panel will consider when determining which broker is the procuring cause of a sale include:

 

• Who first introduced the buyer to the property? The broker who introduced the buyer to the property is not automatically the procuring cause of an ensuing sale, but who initially introduced the property to the buyer is generally an important factor in determining procuring cause.

 

• Was the introduction of the property to the buyer instrumental in creating the desire to purchase? Merely alerting a buyer to the fact that a property is available does not usually constitute procuring cause. 

 

• Did the introduction of the buyer to the property start an uninterrupted series of events leading to the sale or was the series of events interrupted in some way? If there was an interruption or break in the original series of events, a hearing panel will look at how the interruption was caused and by whom. For example, if a broker becomes aware that another’s efforts have broken down, steps in and finalizes a sale by removing an impediment, a hearing panel will consider whether the transaction would have occurred without the assistance of the second broker. If not, the second broker is the procuring cause. However, if a broker is aware of another’s continuing efforts and in bad faith interferes with the transaction, the second broker will not be the procuring cause. 

 

• Did the broker who made the first introduction to the property engage in conduct or fail to take some action that caused the buyer to utilize the services of another broker (estrangement or abandonment)? If the first broker said or did something the broker shouldn’t have, which caused the buyer to decide not to use the broker, that constitutes estrangement, which would break the uninterrupted chain of events. A broker not maintaining contact, not following up or not providing requested information to the buyer in a timely manner would be considered abandonment, which would also break the series of events. The second broker who steps in to assist a buyer to achieve a successful transaction after estrangement or abandonment of the buyer by the first broker would be considered the procuring cause of the sale. 

 

• Did the seller, buyer, or other broker act in bad faith to deprive the first broker of the commission? For example, if the first broker introduced the property to the buyer and brought the negotiations to a point where the buyer had made the decision to purchase, the first broker is the procuring cause. The first broker would prevail in a hearing even if the buyer and seller, with or without a second broker, conspired to take the property off the market and consummate the sale without the first broker or otherwise “froze” the first broker out of the transaction. 

 

Further, in determining which broker is the procuring cause, a hearing panel will consider only facts directly related to the sale of property at issue. The hearing panel will not consider a broker’s prior relationship with the buyer, the fact that the broker showed the buyer numerous other properties, or anything that happened after the buyer decided to make an offer. 

 

Due to all the factors discussed above, procuring cause disputes are best resolved informally or through mediation, which is often successful with the assistance the association’s volunteer mediators. For more information about procuring cause and the REALTOR® arbitration and mediation processes, go to:  https://www.aaronline.com/resolve-disputes/arbitration/

 

As with any potential dispute, communication is key. A salesperson with a procuring cause issue in a transaction, should talk to their broker or manager as soon as possible.  

                                                    Avoiding Procuring Cause Disputes

Not all procuring cause disputes can be avoided, but most can.  One way to avoid a procuring cause dispute is by using the AAR Buyer-Broker Exclusive Employment Agreement. The agreement benefits the buyer by setting forth the terms of the buyer-broker relationship. The agreement benefits the broker by assuring that the broker will be compensated the agreed upon amount if the buyer purchases a property during the term of the agreement.

 In the buyer-broker agreement, the buyer agrees to compensate the broker the specified amount or the compensation the broker receives from the seller or the seller’s broker, whichever is greater. In either event, the buyer authorizes the broker to accept compensation from the seller or the seller’s broker, which shall be credited against any compensation owed by the buyer pursuant to the agreement. If completion of any transaction is prevented by the buyer’s breach or with the consent of the buyer other than as provided in the purchase contract, the total compensation is due and payable by the buyer.

In the agreement, the buyer also agrees to work exclusively with the broker and be accompanied by the broker on the first visit to any property. If the broker does not accompany the buyer on the first visit to any property, including a model home, new home/lot or “open house,” the buyer acknowledges that the builder, seller, or seller’s broker may refuse to compensate the broker, which will eliminate any credit against the compensation owed by the buyer to the broker. 

Even if you choose not to use the AAR Buyer-Broker Exclusive Employment Agreement, which is your best protection as a buyer’s agent, educate the buyers about the real estate purchasing process, communicate with them often to avoid an abandonment or estrangement argument, and understand the basics of procuring cause.  You deserve to be compensated for your hard work.  You don’t want to find yourself in the situation of thinking:  Hey! That was “my buyer” and “my commission!”  

K. Michelle Lind, Esq. is an attorney who currently serves Of Counsel to the Arizona REALTORS®.  She is also the author of the book - Arizona Real Estate: A Professional's Guide to Law and Practice (3rd Ed.) 

This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.  11/18/2022

RISING RATES RESULT IN RISING INTEREST IN RISKY WRAPS

 

Rising interest rates result in a rising interest in risky wrap financing. A wrap may be beneficial to the seller if the current interest rate is high, and the seller’s loan is at a lower rate, as is becoming more common in today’s market. A buyer may consider wrap financing if the buyer cannot qualify for new conventional financing or is seeking to negotiate a lower than market interest rate.

However, there are significant risks with wrap financing for both buyer and seller, especially if the seller’s loan documents contain a due-on-sale clause (also known as an acceleration clause), which requires the loan to be paid off if the property is transferred.  Wrap financing also creates substantial risks for the real estate licensees involved in such a transaction.

What is a Wrap?

A wrap is an alternative to the seller paying off or the buyer qualifying to assume the existing loan on the property in a real estate transaction. The seller sells their property to the buyer and agrees to a carryback loan from the buyer for a purchase price that exceeds the seller’s existing loan. The seller does not pay off and the buyer does not assume the seller’s existing loan; the seller remains responsible to the lender for its payment. In other words, the seller “wraps” a larger loan around the existing loan. 

 

Wrap Example:  The seller has a home valued at $500,000 that is encumbered by an existing loan with a $300,000 balance and a 3% interest rate.  The seller sells the home to the buyer for $500,000, with a $50,000 down payment and finances the buyer with a carryback loan of $450,000 at a 5% interest rate.  The buyer makes the monthly loan payments to the seller on the $450,000 loan and the seller makes the payment on their existing $300,000 loan to their lender.  The seller also makes a profit on the 2% difference in the interest rates. 

Wraps are also referred to as wraparound financing, an all-inclusive deed of trust, or a blanket mortgage.

What are the Wrap Risks for the Seller?

• A Due-on-Sale Clause:  Loan documents often contain a due-on-sale clause, and this is almost always the case if the loan is not assumable. If the seller’s loan documents contain a due-on-sale clause, wrap financing is a breach of the seller’s loan documents with serious consequences.  If the seller breaches the terms of the loan documents, the lender is entitled to all available legal remedies, including acceleration of the loan or foreclosure.  Simply put, the seller may be responsible for paying their loan in full without the ability to collect the entire amount from the buyer because the seller is obligated to accept monthly payments under the conditions of the wrap financing agreement.

 

• The Buyer Fails to Make their Payments: The seller is still the primary borrower on the existing loan that was wrapped and is obligated to make the required payments regardless of whether the buyer makes the wrap payments to the seller.  If the seller cannot make their existing loan payments without the wrap payments from the buyer, it can result in past due payments to the seller’s lender, lowering the seller’s credit score or even default and foreclosure.

 

• The Dodd Frank Act:  Since the seller is providing the financing in a wrap, the seller should ensure that they are complying with all applicable laws, including the Dodd Frank Act.  The Arizona REALTORS® provides Dodd Frank Seller Financing Addendums which may need to be utilized in the transaction. 

 

What Are the Wrap Risks for the Buyer?    

• A Due-on-Sale Clause:  If the seller’s loan is wrapped in violation of a due-on-sale clause, the seller’s lender may foreclose on the property.  Because the wrap loan is in second position behind the seller’s loan, the buyer could lose the property if the seller’s loan is not paid in full.   

 

• The Seller Fails to Make their Payments:  Although the seller is responsible for making the payments on the existing loan, the buyer generally has no guarantee that the seller will make these payments. Thus, the property could be foreclosed upon if the seller fails to make payments on the existing loan, even if the buyer has made all their required wrap payments to the seller, because the wrap loan is in second position behind the sellers existing loan.  

 

What If the Parties Insist on Wrap Financing?

If the parties in a transaction insist on wrap financing, your first step is to talk to your broker or manager.  A legal interpretation of the loan to be wrapped is generally outside the area of a real estate licensee’s area of expertise, however your broker or manager can provide guidance on how to handle the transaction. 

Second, because wrap financing raises complex issues, buyers and sellers should be advised in writing to consult with independent legal counsel and tax professionals before entering any transaction with a wrap.

Because of the complexities involved in a wrap, the purchase contract must address numerous issues, such as: 

 

• The buyer should request and obtain a copy of the seller’s existing note and deed of trust to review the rights and obligations of the loan agreement.  The buyer should confirm that a wrap will not trigger a due-on-sale clause. 

 

• The seller must ensure that the buyer is financially capable of making the required payments. Therefore, the seller should require the buyer to provide financial information to the seller, such as a credit report and income verification and seek professional assistance in interpreting the information, if necessary.

 

• All payments should be made concurrently through a single servicing account maintained by a licensed escrow agent with adequate instructions regarding forwarding payments. Record-keeping for a wrap loan can be complex. The seller must keep track of the payments made by the buyer and how much of each payment is attributable to principal and how much is attributable to interest. The amount of interest paid must be provided to the buyer for tax purposes. Therefore, the use of a servicing agent in wrap financing, such as an escrow company, is advisable for record-keeping purposes.

 

How could a lender find out that the loan has been wrapped?

Lenders often discover that a loan has been wrapped by the recording of the transfer of the property, the change of the tax liability, or the change of the insured’s name on insurance policies. Lenders can also become aware of a wrap by receiving payments from the account servicing agent.

 

                                                         Possible Alternatives to Wraps

There may be alternatives to wrap financing depending upon the circumstances, such as: 

•  Loan Assumption:   A loan assumption is when the buyer takes over the seller’s loan and continues to make payments on it. Most conventional loans cannot be assumed because lenders do not allow it with a due on sale clause. However, FHA, VA, and USDA loans may be assumable.

Generally, to assume a loan, the buyer will need to qualify for the loan and will probably incur loan transfer and assumption fees. Additionally, the buyer will most likely have to pay cash (or a seller carryback) to the seller for seller’s equity in the property. A loan assumption is beneficial in that the buyer will inherit the lower interest rate that the seller received when they obtained the loan. Moreover, the term of the loan will likely be shorter than if the buyer were to obtain new financing. In agreeing to a loan assumption, the seller should ensure they are released from any future liability on the loan.   The Arizona REALTORS® provides a Loan-Assumption-Addendum that addresses these and other issues.   

 

•  Buying Down the Interest Rate:  A buyer or a seller through seller concessions, can buy down the buyer’s interest rate on a loan by paying discount points.  The cost of the discount point depends upon a variety of factors.  Additionally, the buydown can be structured in a variety of ways.  The interest rate can be lowered for the life of the loan, a set period of time, or structured in a way that the interest rate gradually increases over time. 

 

• Seller Carryback Financing:  Seller carryback financing occurs when all or a portion of the purchase price is financed by the seller. Generally, the buyer will execute a promissory note and deed of trust in favor of the seller, which will be recorded, at close of escrow. This creates an income-producing note for the seller. As mentioned above, The Arizona REALTORS® provides Dodd Frank Seller Financing Addendums which should be used in the transaction.  

• Loan Programs Other than Conventional Financing:  Non-conforming loans, in other words, loans that do not conform to Fannie Mae or Freddie Mac guidelines, but are government backed, may also be an option.  For example: 

• FHA Loans:  FHA loans may be an option for buyers with lower credit scores or not much money for a down payment.  And closing costs may be rolled into the loan.
•  VA Loans:  VA loan may be an option for active military, veterans, or surviving spouses.   These loans have lower credit score requirements, do not require a down payment, have lower interest rates, and do not require private mortgage insurance (PMI).
• USDA Loans:  USDA loans may be an option for lower income buyers purchasing a home in a qualified rural area.   These loans may have a lower interest rate, do not require a down payment, and may have a lower PMI, which may be rolled into the loan amount.

In conclusion, all the parties in a real estate transaction, including the real estate agents, are subject to an increased risk of liability and disputes in a transaction involving wrap financing.  Always explore other financing options and consult with your broker or manager before writing a contract that includes a wrap. 

 

Michelle Lind is Of Counsel to the Arizona REALTORS® and the author of Arizona Real Estate: A Professional’s Guide to Law and Practice.  This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.  11/2/2022