Member Legal Services Tel (213) 739-8282 Fax (213) 480-7724 Oct. 31, 2012 (revised)
Short pay transactions or "short sales" are transactions where the seller owes more on his or her home than the home is worth (i.e. where title transfers, where the sale price is insufficient to pay the total of all liens and costs of sale and where the seller does not bring sufficient liquid assets to the closing to cure all deficiencies). The distinct nature of these listings enable a third-party lender to intervene in the terms of sale and ask a listing broker to reduce the gross commission offered on the property. As such, NAR policy gives local MLSs the choice to allow listing brokers to condition their offers of compensation on lender approval for these types of transactions. They, along with probate listings subject to court approval, are the only allowable exceptions to NAR's policy prohibiting conditional offers of compensation in the MLS.
Up until C.A.R.’s October 2012 Business Meetings, the C.A.R. Model MLS Rules incorporated this short sale exception into its rules. However, at its October 2012 Business Meetings, C.A.R. decided to remove the short sale compensation exemption to the unilateral compensation rule and instead replace it with a mandatory disclosure of short sale status.
This legal article addresses C.A.R.’s decision to remove the short sale compensation exemption and the implications for MLSs and their participants in removing or maintaining the exemption in their rules.
Q 1. May a lender request that the brokers reduce their compensation as a condition of approval of a short sale transaction?
A Yes. Just like any principal in a transaction may request that the brokers reduce their compensation, a lender can also request the brokers to reduce their compensation in a short pay transaction. However, since the lender is not a party to the listing agreement between the seller and the listing broker, the listing broker is not obligated to reduce or modify his or her commission agreement with the seller. Even so, since the lender's approval is typically required in a short sale for the transaction to be successful, the brokers have a business decision to make as to whether or not to reduce or modify their compensation in order to close the transaction.
Q 2. If a listing broker wants to make the compensation offered to the cooperating broker through the MLS contingent on a lender's approval, can he or she do so?
A It depends on whether your local MLS allows conditional offers of compensation for short sales. NAR policy gives local MLSs the choice of allowing listing brokers to condition their offers of compensation in the case of short sales on lender approval.
Up until October, 2012, the C.A.R. Model MLS Rules had adopted such an exception for short sales, and most MLSs in California had adopted that exception into its local MLS rules. However, in light of increasing instances of abuse of the short sale compensation exemption in ways not intended by the rule, a Work Group of the C.A.R. MLS Committee recommended removing the exception. (To get an appreciation for the background on and implications of this change and why an MLS Committee Work Group recommended removal of the short sale compensation exemption to the unilateral compensation rule, please see the Issues Briefing Paper re C.A.R. MLS Policy Committee Short Sale Compensation – Work Group Report and Recommendations). C.A.R.’s MLS Committee and then the C.A.R. Board of Directors agreed and decided to remove the exception from the C.A.R. Model MLS Rules.
Now that the short sale compensation exception has been removed from the C.A.R. Model MLS Rules, Effective October 2012, it will be up to local MLSs to decide whether follow suit by (a) adopting the current version of the Model MLS Rules which has removed the exception, or (b) maintaining the previous version of the short sale rule which contained the exception. You should consult your local MLS prior to submitting a short sale listing to determine which standard is in place.
Q 3. Under the new C.A.R. Model MLS Rules, Effective October 2012, what is the new Model Short Sale Rule?
A The new short sale rule is set forth in C.A.R. Model MLS Rule 7.28 and provides as follows:
7.28 Short Sale (Lender Approval) Listings. Participants must disclose potential short sales (defined as a transaction where title transfers, where the sale price is insufficient to pay the total of all liens and costs of sale and where the seller does not bring sufficient liquid assets to the closing to cure all deficiencies) when reasonably known to the listing broker. This section does not allow Participants with short sale listings to place any reduction conditions on compensation offered through the MLS for items such as lender reductions of the gross commission, short sale negotiator fees or other administrative costs of the transaction. Any reductions from the commission for such items, if any, should be factored in as a reduced amount the listing broker initially offers to a cooperating broker and may not be made a condition of the offer.
Q 4. What are the implications of the new Model Short Sale Rule and how does it work?
A Under this standard, the ability to offer a conditional offer has been eliminated. With the short sale compensation exception removed, listing brokers will have to stand behind what they offer on the MLS. The listing broker will be obligated to pay the compensation offered, even if a request is made by a lender to reduce the gross commission. If the bank reduces the gross commission, listing broker has to absorb the loss or renegotiate with the cooperating broker (as in any traditional seller-request of a reduction, there are some ways to do it but the cooperating broker can always say no). If the cooperating broker refuses to work with the listing broker in reducing his or her part of the compensation, the matter is similar to any other sale where the principals cannot agree on price, and they ask the brokers to reduce their commissions. The listing broker then has a business decision to make as to whether or not to take the entire cut in commission or whether to refuse to take the cut, thereby making it unlikely the sale will go through.
Removal of the short sale compensation exception requires listing brokers to better project the likely commission that will be received and go ahead and make a judgment on the amount to offer the cooperating side. To that end, any considerations of the potential of a lender reduction or the use of a short sale negotiator, etc. would have to be factored in up front by listing agent in his determination of the amount of compensation to offer potential cooperating agents.
Also, instead of being alerted to the existence of a short sale listing by a listing broker’s indication that he is offering conditional compensation subject to lender approval (as was allowed under the old rule), the new Short Sale Rule requires an affirmative disclosure on the MLS of potential short sale status when reasonably known to the listing broker.
Q 5. Since removing the lender reduction conditional offer exemption could be harmful to listing brokers, what is the rationale for taking it out?
A While removal potentially could be harmful to listing agents, manipulation of it has been harmful to cooperating agents. In these instances, listing agents have used it to make their offers of compensation appear more generous on the MLS than they actually intended to honor. These listing agents have “spiked” up commissions in the listing agreement to a rate beyond the range market forces would typically bear so as to trigger lender reduction when they know (1) the seller will not be paying the commission as it is a short sale and (2) the lender will reduce it to a market rate and (3) cooperating agent (who was advised on the MLS of what appeared to be an “equitable” split of any lender reduction) will actually bear the weight of the reduction. In these instances, a cooperating agent may be unpleasantly surprised to get a lesser commission than reasonably anticipated from the MLS listing.
At this stage in the market, REALTORS® seem to report that commission ranges lenders will approve are fairly predictable and that short sale listing agents are generally in a reasonable position to anticipate what to expect, thus reducing the need to maintain the compensation exception. With this climate as a backdrop, and in light of increasing instances of abuses along the line referenced above, on balance C.A.R. decided that maintaining the short sale compensation rule was more hurtful than helpful to members.
Q 6. If my MLS wants to maintain the short sale compensation exception, what should it do? What information is the listing broker required to communicate to potential cooperating brokers in order to condition an offer of compensation on lender approval?
A Under the N.A.R. policy statement, compensation payable to a cooperating broker may be reduced upon the request of a lender or court if the following information is disclosed by the listing broker through the MLS prior to presentation of an offer by the cooperating broker:
the fact that gross commission is subject to court or lender approval (e.g. "short sale-subject to lender approval"; and
the potential reduction in compensation payable to the cooperating office (e.g., "potential reduction of 1%"), or the method by which any reduction in compensation will be allocated between the listing and cooperating brokers (e.g., "any reduction to be absorbed by cooperating broker").
An MLS maintaining the short sale compensation exemption may wish to use, or will likely be using, the now deleted language from the former version of the C.A.R. Model MLS Rules as follows:
7.15.2 Lender Approval Listings. Compensation offered through the MLS to cooperating brokers on listings which require lender approval (commonly referred to as “short sale” listings) is for the amount published therein unless the listing broker indicates on the MLS the following: (a) the fact that the sale and gross commission are subject to lender approval; and (b) the amount or method by which the compensation offered through the MLS will be reduced if the lender reduces the gross commission. This section does not allow an additional reduction from the commission offered for items such as a short sale negotiator fee or other administrative costs of the transaction. Any reductions from the commission offered for such items should be factored in as a reduced amount the listing broker initially offers to a cooperating broker and may not be made a condition of the offer.
Q 7. My MLS maintains the short sale compensation exception language. When listing a short sale, is there any specific language I need to use, and where should information regarding conditional compensation be displayed in the MLS?
A As long as the nature of the conditional offer is communicated clearly, the specific language and display will largely be determined by the MLS and local practice.
It is likely the required information will appear either in the "remarks" section or in a dedicated field created by the MLS. For example, the remarks may contain language such as "Short Sale. Compensation subject to lender approval. Any reduction split 50/50." The MLS may also choose to create a separate field which allows a listing broker to note that a particular listing is a short sale; compensation is subject to lender approval; and the allocation of any requested reduction. This could be accomplished by text or some form of code (e.g., "SS-75/25" means the listing broker will absorb 75% of the reduction). Keep in mind the allocation of any requested reduction is at the sole discretion of the listing broker. However, the cooperating broker must always be given notice of any conditions on the offer of compensation.
Q 8. If my MLS has maintained the short sale compensation exemption, what can a cooperating broker do to protect against getting a minimal amount of compensation?
A The most viable option is for the cooperating broker to enter into a buyer/broker compensation agreement. This will assure that the compensation will come from either the buyer or what is offered through the MLS, or a combination of both.
Q 9. How can brokers resolve their disputes if it is unclear whether the brokers agreed to modify their commission agreement in a short sale transaction?
A Such disputes can be submitted to local association mediation or arbitration in accordance with local rules.
Q 10. Where can I obtain additional information?
A This legal article is just one of the many legal publications and services offered by C.A.R. to its members. For a complete listing of C.A.R.'s legal products and services, please visit car.org.
Readers who require specific advice should consult an attorney. C.A.R. members requiring legal assistance may contact C.A.R.'s Member Legal Hotline at (213) 739-8282, Monday through Friday, 9 a.m. to 6 p.m. and Saturday, 10 a.m. to 2 p.m. C.A.R. members who are broker-owners, office managers, or Designated REALTORS® may contact the Member Legal Hotline at (213) 739-8350 to receive expedited service. Members may also submit online requests to speak with an attorney on the Member Legal Hotline by going to http://www.car.org/legal/legal-hotline-access/. Written correspondence should be addressed to:
CALIFORNIA ASSOCIATION OF REALTORS® Member Legal Services 525 South Virgil Avenue Los Angeles, CA 90020
The information contained herein is believed accurate as of Oct. 31, 2012. It is intended to provide general answers to general questions and is not intended as a substitute for individual legal advice. Advice in specific situations may differ depending upon a wide variety of factors. Therefore, readers with specific legal questions should seek the advice of an attorney. Revised by Elizabeth Miller-Bougdanos, Esq.