THREE RELATIONSHIPS IDENTIFIED AND DEFINED

THREE RELATIONSHIPS IDENTIFIED AND DEFINED

A party may be authorized to act on behalf of or in relationship to another in various ways:

1. The relationship is that of a principal and agent, whether that of a general agency or a special agency;

2. The relationship is that of an ordinary employer-employee between the principal and the second party;

3. The relationship is that of a principal and an independent contractor who is the second party performing
certain defined services.

1. General and Special Agents Defined

General Agents

A general agent is one who is authorized to conduct a series of transactions involving a continuity of service.
(Civil Code § 2295; Restatement (Second) of Agency, § 3(1)). General agents tend to be an integral part of a
business enterprise and do not require additional authorization for each transaction which they conduct on
behalf of their principal. For example, a branch manager of a company may have general authority to transact
the business of the branch on behalf of the company and is a general agent to that extent.

Special Agents

A special agent is one who conducts a single transaction or series of transactions not involving continuity of
service. (Civil Code § 2297; Restatement (Second) of Agency, § 3(2).) A real estate broker is usually a special
agent although, in appropriate circumstances, a form of general agency can arise. The distinction between a
general and special agent is important when determining the extent of an agent's authority to bind the principal
to agreements made by the agent with third parties, and when defining the course and scope of the agency
relationship.

Real estate brokers typically exercise limited authority as special agents to solicit and negotiate on behalf of
their principals from whom they must obtain ratification of agreements with third parties. Real estate brokers
and associate licensees they have engaged are neither licensed nor regulated to act as general agents. Rather
real estate licensees are licensed and regulated as special agents to carry out on behalf of another or others
certain defined activities for compensation or expectation of compensation in real property and real property
secured transactions.

A real estate broker is ordinarily a special agent who acts on behalf of the principal, but does not act in place or
instead of the principal. In order for a real estate broker to act in place and instead of the principal the agent
must be designated the attorney in fact pursuant to a power of attorney, which should only be used in
exceptional circumstances and with the advice of counsel. For example, the broker is not entitled to convey or
encumber title to the real property of his or her principal without the express written authority of that principal.
Such authority would typically require a power of attorney. While the listing agreement, known as an exclusive
right to sell, grants to the real estate broker the right to receive a commission regardless of whether the
principal, the listing broker or any other broker sells the property, such a listing agreement does not convey any
power to the listing broker to sell the property. Rather, the authority granted to the listing broker is the right to
solicit offers from prospective buyers (offerors) and the right to be compensated regardless of through whom
the property may be sold.

Broker Acting for Own Account Whether as a Principal Only or as a Principal and a Special agent of the Other
Principal

Not infrequently a real estate broker or salesperson will act in a real property transaction or real property
secured transactions for his or her own account. Because of professional background and contacts, a licensee is
more aware of investment and profit opportunities in real property or real property secured transactions than are

a majority of the people who do not possess real estate licenses. An effort to exploit these opportunities to
personal advantage may involve legal or ethical matters to be carefully considered by the licensee before
becoming involved in a transaction as a principal and, therefore, for the licensee's own account.

Even where a broker or salesperson is acting for his or her own account, i.e., as a principal to the transaction,
duties are owed to the other principal including the obligation to act honestly and fairly, in good faith, and
without fraud or deceit. These duties and obligations are expected of all parties to agreements. Real estate
licensees are generally subject to additional defined duties when acting as principals only in real property or real
property secured transactions. (Katz v. Departments of Real Estate (1979) 96 Cal.App.3d 895; Prichard v. Reitz
(1986) 178 Cal.App.3d 465).

In certain fact situations, brokers or salespersons have added duties to the principal to the transaction even when
acting only as principals for their own account. An example is when a broker or salesperson is acting as a
principal in a transaction who is an arranger of credit pursuant to Civil Code §§ 2956-2957. Licensees who are
principals in such transactions pursuant to Civil Code § 2957(a)(1) and (a)(2) must prepare and complete a
seller financing disclosure statement to be delivered to the other principal.

Civil Code § 2079.13(b) imposes a higher standard upon real estate licensees and upon the broker which whom
the licensee is associated (both salespersons and broker associates) even when acting as principals for their own
account. In particular, the Civil Code provides that: "The agent in the real property transaction bears
responsibility for his or her associate licensees who perform as agents of the agent. When an associate licensee
owes a duty to any principal or to any buyer or seller who is not a principal, in a real property transaction, that
duty is equivalent to the duty owed to that party by the broker for whom the associate licensee functions.”
(Civil Code § 2079.13(b) emphasis added.)

Numerous complaints are made to the Department of Real Estate resulting from the efforts of licensees to
secure profits in real property transactions by purporting to act as principals. In this connection they have
resorted to the use of options, net listings, guaranteed sales, and other types of agreements which combine
features of a listing with an obligation or right imposed upon or given to the licensee to act as a principal. The
use of options, net listings, and guaranteed sales is neither illegal nor unethical in California so long as a full
disclosure of the licensee's involvement in the transaction and the legal effect of such an agreement are
explained to the persons with whom the licensee is transacting business. The other party to the prospective
transaction must be advised and understand that the licensee may be acting as a principal, and potentially as
both an agent and a principal in the transaction, rather than simply as an agent.

When a real estate licensee is acting as a principal only in a transaction, it is essential that the other principal to
the transaction understand the role of the licensee. The other principal should be aware of the conflicts of
interest involved in such transactions and that the dealings with the licensee are at "arms-length" and not that of
a special agent and principal. Because of the potential for creating conflicts of interest between the agent and
the principal who is the other party to the transaction, some states such as Massachusetts and New York limit or
prohibit the use of net listing or agency agreements. Although net listings are not illegal in California, they can
easily lead to a breach of the agent's fiduciary obligations and should be used only with highly sophisticated
clients, or clients who are independently represented and, of course, with full disclosure of all of the conflicts
involved.

Since the broker or salesperson holds himself or herself out as a real estate licensee, the broker or salesperson
must be careful when acting as a principal only, or as both a special agent and a principal. It is easy for the
public to misunderstand the role of the licensee because the contacts between them usually arise out of the
marketing activities of the licensee. For example, office signs, signs on properties, stationery, newspaper
advertisements and business cards are all illustrations that the broker or salesperson is acting or intending to act
in a licensed capacity. Therefore, great care must be taken to dispel the agency image if the licensee chooses to
act as a principal only in a real property or real property secured transaction.

Also, it is important for the licensee to disclose and explain fact situations where the licensee may be acting
both as a principal and a special agent. An example of such a fact situation is when the licensee lists his or her
property on a multiple listing service, soliciting buyers through that medium, and the real estate firm with whom
the licensee is associated later becomes the agent of the buyer. Another example is where a real estate broker

has undertaken on behalf of the borrower to solicit for a lender to make a loan to the intended borrower. The
broker later decides to make the loan him or herself or out of broker controlled funds. As a result, the broker is
presumptively acting as both a principal and as a special agent in the loan transaction. (Business and
Professions Code §§ 10240(b) and 10241(j)).

It is particularly dangerous for as a licensee to start out as an agent in a transaction and then switch status before
the transaction is consummated to that of a principal only. In fact, it may not be possible to discharge the
responsibilities inherent in the agency relationship in the middle of a transaction. The usual result is the
licensee will be acting both as a principal and as a special agent of the other principal to the transaction. The
licensee must be scrupulous in informing the other principal of the inherent conflicts of interest when the
licensee is acting as a principal, and the licensee should recommend that the principal obtain independent
professional advice with regard to and before proceeding with the transaction.

Various court decisions indicate that the burden of proof under these circumstances is upon the licensee to show
that the principal was fully informed of this change of status. Obviously, such disclosures must be made in
writing (Civil Code § 2079.17 and Business and Professions Code §§ 10176(a) and (d)). Vague or ambiguous
disclosures will not be sufficient notice of a change of status by the licensee from special agent to principal
only.

Option to Purchase by the Broker as a Special agent

A somewhat similar situation arises when a broker who is employed as a special agent to find a buyer of real
property obtains an option to purchase the property by the owner which runs concurrently with the agency. In
such a case, the broker cannot ignore the interests of the principal and the broker may not take advantage of the
fiduciary relationship with the principal.

The law is well summarized in American Jurisprudence: "If a broker employed to sell property is also given . . .
an option to purchase the property himself, he occupies the dual status of agent and purchaser and he is not
entitled to exercise his option except by divesting himself of his obligation as an agent by making a full
disclosure of any information in his possession as to the prospect of making a sale to another." Again, a broker
should not proceed to obtain options to purchase from a principal for whom the broker is acting as an agent
unless the principal is highly sophisticated in such transactions, or is independently represented by a
professional, and receives full disclosure.

Disclosure of Conflicts and Profits by the Broker as a Special agent

In the language of The Restatement of Agency: "Before dealing with the principal on his own account . . . an
agent has as a duty, not only to make no misstatements of fact, but also to disclose to the principal all relevant
facts fully and completely. A fact is relevant if it is one which the agent should realize would be likely to affect
the judgment of the principal in giving his consent to the agent to enter into the particular transaction on the
specified terms. Hence, the disclosure must include not only the fact that the agent is acting on his own account
but also all other facts which he should realize have or are likely to have a bearing upon the desirability of the
transaction from the viewpoint of the principal.” (Restatements (Second) of Agency ' 390)

The very nature of combining listings, options, and guaranteed sale agreements place the licensee in a position
where he or she must exercise the utmost caution to avoid violating the fiduciary duties and obligations owed to
the principal. Additional problems arise in this context because the Real Estate Law and general principals of
agency require that the licensee make full disclosure to the principal of any compensation, commission or profit,
claimed or taken by the licensee with respect to the transaction. (Business and Professions Code § 10176 (g)).

2. Employer-Employee Relationship Defined

For centuries, the employment relationship was characterized as the law of Master and Servant. An employee is
defined in the Labor Code as one who renders personal services to the employer and who is performing the
service under the direction and control of the employer. For instance, a filing clerk in an office, or a machinist
in a factory is an ordinary employee. A broker is usually not an employee. Rather, a broker acts as a special
agent of his or her principal to accomplish the limited and specific purposes of the agency. In this relationship,
the broker is authorized to solicit, negotiate and to act on behalf of the principal within the course and scope of
the agency. However, the broker is not typically authorized to act in the place or instead of the principal. For

instance, an officer of a corporation often has the authority to bind his employer to agreements while a broker
must obtain a ratification or specific consent of the principal. Although there is some confusion in both the
statutes and reported cases, there is a distinction between an agent and an employee.

An employee is an agent of the employer but not all agents are employees. A real estate broker is an agent of
his or her principal but not an employee of the principal. On the other hand, the relationship between the real
estate broker and his or her licensees is that of a principal and an agent and employee. (Business and
Professions Code §§ 10032 and 10132, and Civil Code § 2079.13(b)). With regard to the liability and
responsibilities to third parties, it does not matter whether the salesperson or broker associate is classified as an
employee or agent. In either case, the supervising broker whether individually or through a real estate licensed
corporation is vicariously liable for the actions of the broker's agents and employees. Should the broker be a
corporation, the salesperson or broker associate is an agent and employee of the corporation, and not directly an
agent of the supervising qualifying broker in his or her individual capacity. (Walters v. Marler (1978) 83
Cal.App.3d 1, 35). However, the broker as the designated officer of the corporation is responsible to supervise
the agents and employees of the corporation to ensure full compliance with the Real Estate Law. (Business and
Professions Code § 10159.2).

3. Independent Contractor Defined

An independent contractor is one who, in rendering services, exercises an independent employment or
occupation and is responsible to the principal only for the results of his or her work. An important factor in
establishing independent contractor status is that the contractor determines the method of accomplishing the
work for which the contractor has been engaged. Salespersons and broker associates are usually characterized
as independent contractors of the broker for purposes of state and federal income tax reporting and for certain
other purposes such as Workers' Compensation Insurance coverage. (Unemployment Insurance Code § 650 and
26 USC § 3508). Accordingly, salespersons and broker associates are agents and employees of the supervising
broker in connection with dealings with the public but may, at the same time, be independent contractors for
income tax reporting and certain other labor related purposes.

To maintain independent contractor status for income tax reporting and related labor law purposes, it is
necessary for the supervising broker to specify in contracts with salespersons and broker associates that the
associates are independent contractors and not employees for income tax reporting purposes. However, the real
estate broker should not be confused by the implementation of independent contractor status for tax reporting,
Workman's Compensation, or other labor related purposes. The independent contractor relationship with
salespersons and broker associates does not in any way diminish the broker's responsibilities and liabilities for
the conduct of the broker's salespersons and broker associates who are acting as agents and employees for other
purposes. (Business and Professions Code §§ 10032, 10132, 10177(h) and 10159.2.) (Also, Manning v. Fox
(1984) 151 Cal.App.3d 531; Resnik v. Anderson & Miles (1980) 109 Cal.App.3d 569, 572-573; Gipson v.
Davis Realty Co. (1963) 215 Cal.App.2d 190, 206-207; Grand v. Griesenger (1958) 160 Cal.App.2d 397, 406).

4. Status of Mortgage Brokers

In view of the turmoil in the mortgage origination industry during the last 10 years, and culminating in the
mortgage meltdown of 2008, the legislature has enacted various specialized provisions pertaining to
independent contractors in the mortgage loan origination business. (Business and Professions Code §§
10133.1(c) (1) and (2) and 10177.6, § 10166.03; 10 CCR, Chapter 6, § 2841).

5. Interrelating Factors

A. Independent Contractor Status

For the most part, an independent contractor sells final results rather than time and the methods of achieving
those results are not subject to the control of the principal. The independent contractor agrees to do the work
contracted for in his or her own way. An independent contractor may also be an agent of the principal. For
instance, a real estate broker is typically an independent contractor acting as a special agent of the principal for

a defined limited purpose. On the other hand, office personnel such as secretaries, receptionists, and
administrative assistants are typically employees. At the same time, there are many independent contractors
who may not be agents. Examples of this relationship are building subcontractors, structural pest control
operators and other professionals such as architects and engineers who may be engaged to inspect and issue
reports on the condition of a real property, and who are not engaged to accomplish an activity on behalf of the
principal.

Many factors bear upon the issue of whether a given agent is an employee or an independent contractor.
Further, the agent may be an employee for certain purposes and an independent contractor for certain purposes,
e.g., the salesperson or broker associate engaged by the real estate broker. Some of these factors are: existence
or nonexistence of an independent calling; limited or unlimited right of principal to hire and fire; extent to
which the engagement agreement permits principal to give orders as to time and details; custom in the industry
as to scope of control; and payment by time or by job. In addition, real estate licensees have been given certain
statutory exemptions which allow salespersons and broker associates to be characterized as independent
contractors for income tax reporting, Workers' Compensation, and other labor related purposes when engaged in
brokerage sales and related services. (Unemployment Insurance Code § 650 and 26 USC § 3508.)

A legislative objective was pursued by the real estate industry to presumably allow real estate brokers and their
salesperson or broker associates to contract distinguishably from existing law regarding the employer’s
statutory obligation to indemnify the employee for acts occurring within the course and scope of the
employment. While the objective of having salesperson and broker associates indemnify the employing real
estate broker has not yet been tested in a reported case, this contractual relationship would not in any event
affect third parties, including the Department of Real Estate or members of the public. (Business and
Professions Code § 10032). These and many other elements will determine a person's status as an employee,
agent, independent contractor or some combination of the foregoing.

B. Public Liability: Broker’s Duty to Supervise

Even though an employer or principal may not be personally at fault, they can be held liable in damages for the
negligent conduct of their employees or agents who act within the general course and scope of their
employment or agency. This liability finds its most notable illustrations in cases involving automobile
accidents of employees while driving on the employer's business. If the wrongdoer is an independent contractor
for all purposes, the person who hired him or her would not ordinarily be liable for injuries caused by the
negligence of the independent contractor. Brokers should consider carrying general liability and Errors and
Omission insurance covering their salespersons, broker associates and office personnel regardless of their
contractual and employment relationships with the supervising broker.

The fact that the salespersons and broker associates may be independent contractors for income tax reporting
and labor related purposes does not alter the agency and employee relationship for other purposes. In Resnik v.
Anderson and Miles, 109 Cal.App.3d 569, 573 the California Second District Court of Appeals held, "a
salesman, insofar as his relationship with his broker is concerned, cannot be classified as an independent
contractor. Any contract which purports to change that relationship is invalid as being contrary to the law."

Some brokers may be unaware of their responsibilities to supervise the activities of salespersons and broker
associates even when the associate licensees are acting as principals. While the duty to supervise salespersons
and broker associates when acting as principals may be narrower than the duty to supervise these associates
when acting within the course and scope of the real estate license, the scope of the duty to supervise principal
transactions has wide-ranging implications. As aforementioned, the seller "carry back" financing is an example
of a principal relationship which would require broker supervision. Another example would be when a
salesperson or broker associate is acting as a principal to make loans through the supervising real estate broker
with the real estate broker being the arranger of the loan transaction. (Business and Professions Code §§ 10240
and 10241(j)).

Although many practitioners may be unaware of their obligations in this regard, the duty of the broker to
supervise the transactions of a salesperson or broker associate is well established. For instance, it is clear that
salespersons and broker associates are the agents of the broker by whom they are employed or with whom they

are licensed. A real estate salesperson does not have authority to act independently of the broker who employs
him. Rather, the salesperson acts on behalf of the broker, who is, in turn, the agent of the principal. (California
Real Estate Loans, Inc. v Wallace (1993) 18 CA 4th 1575; Manning v. Fox (1984) 151 Cal.App.3d 531; Resnik
v. Anderson & Miles (1980) 109 Cal.App.3d 569, 572-573; Gipson v. Davis Realty Co. (1963) 215 Cal.App.2d
190, 206-207; Grand v. Griesenger (1958) 160 Cal.App.2d 397, 406.).

Recent developments have expanded the scope of civil liability of brokers for the negligent acts of salespersons
and broker associates. (Business and Professions Code §10032; Civil Code § 2079.13 (b)) This is true
regardless of whether the salesperson treated by the hiring broker as an employee or independent contractor.
An employer is required by statute to indemnify an employee for all expenses or losses necessarily incurred in
the performance of his or her job or while obeying the directions of the employer, whether or not lawful, unless
the employee believed the acts to be unlawful at the time the directions were obeyed. (Labor Code §2802(a)).
Any contract made by an employee that purports to waive this right is null and void. (Labor Code §2804).

The Department of Real Estate has published comprehensive regulations pertaining to the broker’s duty to
supervise independent contractors and requires the supervising broker to establish policies, rules procedures and
systems to monitor the conduct of broker and salesperson associates (10 CCR, Chapter 6, § 2725).

C. Liability for Intentional Torts and Criminal Misconduct

Ordinarily, employers and principals are not liable for the intentional torts or criminal misconducts of the
employee or agent. However, the law recognizes various exceptions to this general rule. This is a complicated
and quickly evolving field and no effort is made here to fully explore the subject.

Under existing law, the supervising broker will be liable for the intentional torts or criminal misconducts of his
salespersons or broker associates where the supervising broker ratifies the misconduct, or where the broker
knew or should have known of the misconduct but failed to reasonably prevent it, e.g., the conduct was
reasonably foreseeable. (Alhino v. Starr (1980) 112 Cal. App. 3d 158, 173-175; also Inter Mountain Mortgage,
Inc. v. Sulimen (2000) 78 Cal.App.4th 1434). For instance, when a supervising broker knows a salesperson is
committing fraud, the broker must intervene and take necessary and appropriate steps to terminate the
misconduct, and the broker would be well advised to consider terminating the relationships with the perpetrators
of such misconduct.

D. Workers’ Compensation

Under the California Workers' Compensation Act, the broker may not necessarily be required to carry workers
compensation insurance covering salespersons and broker associates. However, the failure of the supervising
broker to carry workers' compensation coverage may result in liability to the broker if a court later concludes
that the real relationship between the parties for the purposes at issue was that of an employer and employee.
The broker will minimize the risks inherent in the uncertainties of the law in this field by carrying workers'
compensation insurance.

E. Social Security

A similar situation arises under the Federal Insurance Contributions Act and Federal Unemployment Tax Act.
Here the broker may submit broker's employment agreements with the salespersons or broker associates
together with detailed data as to operating methods to the District Director of Internal Revenue and obtain a
ruling whether the salespersons or broker associates are considered employees under these acts. The existing
exemptions available to real estate brokers have extended primarily to brokerage sales and related services.
Real estate brokers who are engaged in a broad list of licensed and non-licensed activities may wish to review
with legal counsel the effect of these activities upon the available exemptions from employee and employee
relationships for income tax reporting purposes. (26 USC § 3508; IRS Rev. Ruling 76-136, IRS Rev. Ruling
76-137, and California Attorney General Opinion 59 Ops. A.G. 369.)

The consequences of mischaracterizing the relationship in this context are serious. For example, if the IRS
rules that the salespersons or broker associates are employees for income tax reporting purposes, the supervising
broker may be liable for income taxes due from the salespersons or broker associates which should have been

withheld by the broker and timely paid to the IRS. Interest and penalties will be typically added to the amount
assessed by IRS. Supervising brokers should obtain the advice of a CPA and/or qualified tax attorney when
establishing policies and procedures in this regard.

F. Unemployment Insurance

The California Unemployment Insurance Act excludes brokers and salespersons who are remunerated solely by
way of commission from the definition of employee for purposes of maintaining unemployment insurance
coverage. (Unemployment Insurance Code § 650). The Employment Development Department (EDD) has
generally taken a more industry sympathetic view on this issue then has IRS. However, if IRS rules in a given
fact situation that salespersons or broker associates are employees of the supervising broker for income tax
reporting purposes, EDD is likely to follow the IRS ruling and impose the same relationships on the supervising
broker in the subject fact situation.

G. Personal Income Tax

In recent years IRS has been challenging the exemption available to real estate licensees under 26 USC 3508
when the activities involved are other then general sales brokerage and related services, e.g., licensed activities
such as mortgage brokerage, mortgage banking, and special project brokering such as new subdivision sales.
Real estate licensees may be still treated as independent contractors for both federal and state personal income
tax purposes, depending upon the fact situation.

This issue has been addressed in part by (1) the Federal Tax Equity and Fiscal Responsibility Act (TEFRA) and
(2) the amendment to § 650 and the addition of § 13004.1 to the California Unemployment Insurance Code.
Under these laws real estate licensees functioning on behalf of a supervising real estate broker, in certain fact
situations, are and remain exempt from treatment as employees for income tax reporting and other labor related
purposes provided that certain conditions are met.

Section 13004.1 provides that an individual will not be considered an employee for state income tax purposes if
all of the following conditions are met: (l) the individual is licensed by the Department of Real Estate and is
performing brokerage services as a real estate licensee on a commission basis; (2) substantially all
remuneration for such services performed is related directly to sales or other output rather than the number of
hours worked; and (3) the real estate services by that individual are performed pursuant to a written agreement
between the individual and the supervising broker and the agreement provides that the individual will not be
treated as an employee with respect to those services for state tax reporting purposes. Similar standards apply
for establishing independent contractor status for federal income tax reporting purposes.

It bears emphasis that the characterization of independent contractor status for state and federal income tax
reporting purposes has no effect upon the supervising brokers' (whether individual or corporate) civil or public
liability for the conduct or misconduct of salespersons or broker associates. (Business and Professions Code §§
10032, 10132, 10177(h) and 10159.2). (Also, Manning v. Fox (1984) 151 Cal.App.3d 531; Resnik v. Anderson
& Miles (1980) 109 Cal.App.3d 569, 572-573; Gipson v. Davis Realty Co. (1963) 215 Cal.App.2d 190, 206-
207; Grand v. Griesenger (1958) 160 Cal.App.2d 397, 406).

H. Employment Contract with Salespersons and Broker Associates

Commissioner's Regulation 2726 provides that every real estate broker must have a written agreement with each
salesperson or broker associate, whether licensed as a salesperson or as a broker. An engagement agreement
between the broker and salesperson is instrumental in establishing the relationship between them, but it is
ineffective to the extent that it conflicts with the Real Estate Law, other statutes, and applicable case law. It is
important to recognize that a written agreement is required with both salespersons and broker associates if either
is given access to and the ability to withdraw monies from the trust accounts of the supervising broker. (10
CCR, Chapter 6, § 2834).