Broker Commissions: Technical Requirements Trump Equitable Considerations

In re Oak Knoll Assocs., L.P., 525 B.R. 175 (Bankr. D. Me. 2015) –

A real estate broker sought allowance of an administrative expense claim for his commission in connection with a sale of real estate.  The debtor and its general partner objected and moved for summary judgment.

The dispute was whether the broker was entitled to a commission in connection with the sale of real estate owned by the debtor.  Prior to bankruptcy the debtor had hired the broker to market its low income housing apartment buildings.  In connection with financing the properties, the debtor had agreed to rent restrictions and prohibitions on prepayment or assignment of the mortgage.

Under the listing agreement with the broker, the debtor agreed to pay a commission if the property was sold for a designated amount.  If there were ongoing negotiations at the end of the six months, the listing agreement was automatically extended until the negotiations were completed.  The broker was entitled to a commission if the debtor accepted an offer during the term of the listing agreement or within six months after its termination.

The broker obtained a potential buyer.  After an extension of the due diligence period and a proposed change in terms, the purchase agreement was eventually terminated.  In the meantime, the debtor’s general partners got involved in litigation with each other that resulted in an injunction prohibiting one general partner from entering into a sale contract without the consent of the other.  At one point, the attorney for one of the partners threatened the broker with contempt sanctions if he continued negotiations for the sale of the property without disclosure to that partner.  Eventually the broker delivered an invoice for his services and recorded a real estate commission lien on the property.

The objecting general partner never consented to a sale, and the debtor filed bankruptcy.  Shortly after the case was filed the debtor filed an application to retain the broker to sell the property, but did not follow through.  Four or five months later the debtor’s attorney instructed the broker to negotiate a sale contract even though the court had not approved his retention.  A few months after that the debtor and the original proposed purchaser executed a sale agreement, and the debtor filed a plan of reorganization premised on the sale.  Several months later the plan was confirmed and the sale of the property closed.

As an initial matter, the court noted that claims in bankruptcy are generally determined based on the underlying substantive state law.  Under state law, the intent of the parties governs and clear and unambiguous language will be given respect.  With regard to a real estate listing, generally a broker has a right to a commission if either (1) it has procured a “ready, willing and able” buyer on the terms set by the seller, or (2)  it brings the buyer and seller to an enforceable agreement.  However, a listing agreement may add specific conditions.

In this case, as noted above, the listing agreement imposed certain time limitations.  The parties agreed the sale did not occur during the initial six-month listing period.  As for whether there was even an acceptance of an offer as required by the listing agreement, the purchase agreement that was signed during the relevant period did not constitute acceptance of the offer as required by the listing agreement.  Rather it was a new offer, and in any event the revised proposal was not accepted by both parties.  In addition the court concluded that there was a significant break between the initial negotiations and the eventual closing, so that the transaction did not come within the continuous negotiation extension.

Although the broker was not entitled to a commission under the listing agreement, he argued that the debtor was liable because it caused the delay.  However, the failure to close the initial deal was the result of the fact that the mortgagee would not agree to terms that were acceptable to the parties.

The broker also chose to argue the old standby that the court had power to grant the relief requested under Section 105 of the Bankruptcy Code, which provides:  “The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”  However, the court noted with approval another decision holding that this section “does not authorize the bankruptcy courts to create substantive rights that are otherwise unavailable under applicable law, or constitute a roving commission to do equity.”

The court acknowledged that the equities probably weighed in favor of payment.  The broker contended that the sale would not have occurred but for his services over the course of four years.  In addition, the case involved a 100% payout to all creditors, with an additional distribution to insiders.  The court found the broker’s “sense of unfairness in such a scenario is understandable.”  However, the court felt compelled to disallow the claim.  The court commented that there was nothing that would prevent the debtor or its principals from voluntarily paying the broker, but it could not order them to do so.

The broker also argued that he should receive payment of the commission as an administrative expense under the Bankruptcy Code.  However, generally a broker must be employed by the debtor with approval of the court in order to be entitled to compensation.

Lawyers sometimes look askance at a closing statement that shows a large payment for a broker or investment banker commission that seems disproportionate to the value added.  However, sometimes brokers do play a critical role, and it is hard to argue that parties should not be bound by the deal they make.  But brokers need to keep in mind that technicalities matter, particularly in bankruptcy. As a practical matter, the threat of refusing to release a broker’s lien may be effective leverage for getting paid outside of bankruptcy, but that doesn’t work in a bankruptcy.

Vicki R. Harding, Esq.


About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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