Is The Next Landlord Liable For The Brokerage Commission?

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We’ve always been a little murky as to whether a successor landlord always becomes obligated to pay renewal commissions to the original broker responsible for the presence of an existing tenant. After all, there is no actual agreement between that later landlord and the broker whose original commission agreement calls for the payment of a renewal commission. The broker can’t point to where it and the successor landlord “shook hands.”

But, it is pretty common for leases themselves to include provisions such as:

Landlord agrees to compensate the Real Estate Brokers referenced in Section 1.17 above in accordance with a separate agreement, and agrees to indemnify Tenant against any claims, damages, costs, expenses, attorneys’ fees or liability for compensation or changes which may be incurred by Tenant as a result of any claim of non-payment made by Real Estate Brokers. In no event shall Tenant have any liability for Real Estate Broker commissions. In addition, in the event Tenant exercises its Option to Renew pursuant to Section 32 below, Landlord shall pay Tenant’s Broker a fee of $ 617,928.50, and Landlord’s Broker a fee of $ 463,446.37.

[That’s from a March 4, 2019 Court of Appeals of Maryland decision that can be seen by clicking: HERE.]

So, when a lease with language like that gets assigned to a new property owner, or the new owner takes the property “subject to” the lease, doesn’t that new owner become the “Landlord” referred to in the lease and thus automatically become liable to the broker(s)?

Well, for one, the lease is between a tenant and a landlord. The broker is not a party to the lease. But, perhaps the obligation to pay the commission is so intimately tied to an interest in property that it “runs with the land” as does the right of the tenant to occupy the property. If that is the case, then a new property owner, just by virtue of owning a property burdened with the commission obligation, would have it imposed on it.

Or, maybe, the broker was an intended beneficiary of the agreement between the tenant and the landlord such that it could enforce the commission obligation as if the broker were a party to the lease.

Well, in the Maryland court case noted above, those were two of the unsuccessful arguments made by the two brokers. In fact, they had no successful ones; they didn’t get to see their collective nearly $1.1 million.

It turns out that in most, maybe not all, states, a landlord’s obligation to pay a commission is a personal obligation. In legal parlance, it doesn’t “run with the land.” The next property owner doesn’t have an obligation to honor a commission agreement just by virtue of taking over ownership of the land where the tenant “lives.” In contrast, an easement enjoyed by a neighboring owner over the new property owner’s land “runs with the land” and the new owner (of the burdened land) must honor the terms of that easement just by virtue of the property ownership.

By the way, we’ve frequently pointed out that a lease is a “mixed” document. It has two characteristics. One is that it is a contract between the landlord and its tenant. The other is that it serves as a conveyance of an interest in real property. Contractual obligations, for the most part, are consensual. They constitute both obligations and benefits. An assignment of contractual rights can be shaped to cover only some of the obligations and some of the benefits. The obligations that arise out of ownership of an interest in real property follow that interest, but only if they are so associated with, i.e., “run” with the land. When a promise (a/k/a a “covenant”) is deemed to be personal, it doesn’t “run” with the land and is treated as if it is a “contractual” obligation.

Now, there is a good argument that the original landlord, in signing a lease with the commission language, intended that the broker(s) could rely on that language to get paid even after the property was sold. There is also a good argument that the intended beneficiary of the cited text was only the tenant or at least included the tenant. After all, the provision served to protect the tenant by “placing the obligation to pay the commissions solely on the landlord and exempting the tenant from any liability for those commissions.” Under Maryland law (and Maryland is not alone in this):

[A] person is a third-party beneficiary only where the promise sought to be enforced was intended for that person’s benefit and the parties intended to recognize that person as the primary party in interest with respect to that promise.

The key to that statement is the word “primary.” In this Maryland case, the court sidestepped whether the brokers were “primary” beneficiaries, but gave a good clue that, had it ruled on this question, it would have answered it with a “No.” The reason it didn’t have to reach a conclusion is that an “intended beneficiary” would only have the right to sue someone who had the obligation to pay in the first place. So, the remaining question was whether any agreement could be found where the later owner actually undertook the responsibility to pay the commissions in place of the original landlord. There was no such agreement. Here’s why.

In connection with a mortgage loan, the original owner not only gave its lender a mortgage (through use of a Deed of Trust), but also assigned the lease to the lender. The assignment carefully said that the lender had no obligation to perform any of the “covenants, conditions, or provisions” in the lease. Then, the borrower-landlord defaulted under its loan and the property was foreclosed. The lender purchased the property at the foreclosure sale. Thus, it acquired the “property rights” including the land and improvements but burdened by whatever obligations “running” with the land. We already learned that the obligation to pay the brokerage commission did not run with the land.

But, it also “owned” the leases in the sense that the lender was not only the “landlord” by virtue of buying the “property” rights at the foreclosure sale. It also “owned” the lease’s “contractual” rights that had been assigned to it. But, in that assignment, it did not agree to assume its borrower’s obligations. Those stayed with its borrower.

Now, the bank resold the property to the entity we’ve called the “new owner.” In those transfer documents, the new owner agreed to assume all of the obligations that the lender had with respect to the property. The lender did not have the “contractual” obligations under the lease, importantly not the commission obligation. Consequently, the new owner never “assumed” any obligation to pay the commission because the lender never had that obligation. Since an intended beneficiary can only sue someone with the “obligation” and neither the foreclosing lender nor it buyer, the “new owner” had an obligation; it didn’t matter whether the brokers were intended “third-party” beneficiaries under the cited provision of the lease.

So, were the brokers left without any remedy? Effectively, they were. The original owner remained responsible for payment of the commissions, but having lost its property in the foreclosure, it isn’t likely that any judgment against it would be collectible.

If any reader would like to suggest what the brokers could have done at the outset to protect themselves in this kind of situation, please share your thoughts with fellow readers by posting a comment.

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Comments

  1. If the tenant truly wanted to protect the brokers in this case, the tenant could have included in the Lease language saying: If Landlord doesn’t pay the brokers their future commissions, then Tenant shall have the right to pay them and claim an offset against rent. I have certainly seen that language more than once in some leases. Would it do the trick here? Also, in New York, some brokers have mechanics’ lien rights for unpaid brokerage commissions. Would that help? I have not researched the answer. Other states may also give brokers lien rights, and I have not researched those statutes either.

  2. Joseph M. Davis says:

    Perhaps it would be helpful if the Assignment and Assumption of Lease contained language stating to the effect: “Assignee hereby assumes all of the right, title and interest and obligations of Assignor as landlord under the Lease, except for any obligations to pay any brokerage fees in connection with the inception of or any past or future renewal of the Lease.”

    • Tim Scott says:

      Joseph Davis – That should work where the original landlord sells the property and assigns the lease to a new landlord. The distinction here is there was no assignment and assumption with the foreclosing lender. The lender acquired by foreclosure, and the property came subject to the lease – having assumed no obligations (new owner is lender’s (not original landlord’s) successor and has lender’s status). Consequently, while the tenant had a lease and rights to occupy the premises by complying with the lease, it is not at all clear that the new property owner had any obligation to perform landlord’s functions under the lease (apparently not in MD). Of course, if those functions weren’t performed tenant might have various rights to self-help or termination, but it may not be able to sue the new owner for failure to perform. Re the commissions, since the tenant is fully absolved of liability for commissions, there is no hook that gets tenant or broker any action against the new landlord for failure to perform an obligation it didn’t assume.

      • Joseph M. Davis says:

        Tim Scott — I guess I should have expressly stated that my proposed solution was intended neither to apply to the case cited by Ira nor to protect brokers, but was intended to apply to situations where an assignee is assuming a landlord’s obligations from an assignor who would be obligated to pay commissions under a lease, and the assignee wished to avoid such liability. However, I was posting quickly and thought my intention might be obvious and wished to avoid verbosity. Have a nice day!

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