At the heart of every commercial real estate deal is a binding contract. This is a written agreement between all parties that describes the specific services to be offered and the compensation to be paid when services are complete.
This also holds true for commercial mortgage brokers. Having ironclad agreements with borrowers is an essential part of the business. Those who have such agreements must make sure they are enforceable as intended. When it comes to these contracts, the devil is in the details.
“The broker agreement should have a description of the services that will be provided, as well as those that won’t.”
Imagine a mortgage broker who is approached by a developer seeking an eight-figure loan on a commercial property that it’s planning to build. If the broker successfully connects the developer with a funding source and the loan is closed, the fee to the originator is likely to be substantial.
The agreement states, however, that it is not a commitment to fund a loan. After all, that would be the decision of the lender, and the broker might not find a willing money source if there are problems with the deal that are identified during the due-diligence process. Also, the broker might decide after looking closely at the proposed transaction that it’s not worth shopping around.
Nightmare scenario
In an actual legal case that had a similar fact pattern, the court decided that even though the broker connected the borrower with a funding source and the loan closed, the broker was not entitled to compensation. The reason is that, at the last minute, the developer terminated the agreement. As a result, there was no obligation to pay the broker because the agreement was not a commitment.
The moral of this story is that the agreement was unclear about what was (and wasn’t) covered under the contract. Of course, the broker does not commit to fund a loan no matter what. But the agreement should have been clear that the developer, once the broker connected their project with a funding source that led to a closed and funded loan, irrevocably agrees to pay the broker’s fees, even if the agreement is terminated by either party. Crystal-clear agreements are essential for safeguarding each party’s rights.
The business of putting people together to achieve an objective can be ephemeral. Contracts must be clear about which services are being offered and which are not. A broker (usually) does not guarantee that a client will find a lender. But if they do, the broker expects to be paid for the referral.
In the example above, the court determined that the payment of a due-diligence fee (essentially, compensation for the broker’s out-of-pocket expenses in vetting the borrower before approaching any lenders) was the only fee that needed to be paid. Since the agreement was terminated, it was judged that the broker should not profit from the 100-basis-point fee on the closed loan.
Time to act
No one would reasonably argue that this kind of agreement should not have a termination section, or even a term for the length of the services being rendered. After all, nobody wants to be bound forever to support a hopeless case.
In either the term or termination section of the contract, there should also be a survival clause in which each party agrees that the payment of a success fee is required even after the contract expires or terminates. The end of the contract should be the end of the broker’s search for a funding source, but it doesn’t mean that their success in locating a funding source does not merit a fee.
The survival clause needs to be based on any sort of closed transaction between the borrower and lender, or any affiliate of either party. The final deal could turn out much smaller, be unsecured, or even involve a different property that replaced the one originally intended. To ensure there is no confusion, mortgage brokers should make sure their email trails reflect the arrangement. Email is evidence, after all.
When writing a contract, be sure to include the important word “irrevocable.” In other words, the borrower must pay the subject fee without conditions. The broker did his or her job and should be compensated, even if there were five years of starts and stops on the deal. If there are any other fees in the arrangement (such as a due-diligence fee, attorney fees or expenses for lien searches), these should be carefully described as a reimbursement for the broker’s time and labor, rather than any sort of success fee.
Legal details
The broker agreement should have a description of the services that will be provided, as well as those that won’t. For example, the broker could agree to speak to at least 10 funding sources but not more than 15.
The broker may offer a proposed structure to a potential lender, but the final deal could be much different. There should be no implied promise of a lender accepting a proposal. After all, since the funding source bears the risk, it should be allowed to make any changes it finds acceptable.
Beware of applicable laws. For example, if a broker includes an equity component, they need to comply with any laws relating to the solicitation of a securities offering. They must also be aware of usury restrictions or any states with consumer disclosure laws that apply to commercial transactions.
Agreements can address these issues or be silent, depending on a broker’s strategy to govern their services. One approach would be to have both sides promise to obey the law (which they must anyway), and include an indemnification from the borrower if the originator unknowingly and non-negligently incurs civil penalties through the violation of applicable laws.
Whether this is enforceable will depend on the state involved, whether it is the broker’s, the borrower’s or the location of the project. A better approach, potentially, is to include a general indemnification from the borrower that it will reimburse the broker for any losses borne by them in the provisions of their services, except those resulting from the broker’s negligence.
A final piece of caution: Whoever signs the agreement must exist and have assets backing them. A promise of indemnification from an entity that does not yet exist is most likely worthless. If a special-purpose entity without any assets signs the contract, but the ensuing transaction is with a different special-purpose vehicle, legal entity or person, you may have great difficulty in obtaining any fees.
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Many businesspeople think that contracts exist purely to enrich attorneys. That view is, at best, ignorant of the facts. There are plenty of examples of businesses that have entered into oral contracts in which the transaction ended with one side taking advantage of the fact that no written agreement existed. If written properly, the contract binds the parties to the terms of the deal.
It is incumbent upon commercial mortgage brokers and the other members of a contractual agreement to ensure that their rights are protected. This requires the development of a properly written contract that clearly outlines all fees to be paid and the circumstances governing their payment. Without these legal protections, you may find yourself out in the cold. ●
