Engaging a broker is a useful service for commercial tenants searching for space, but tenants should consider a few key points in navigating, and negotiating, brokerage agreements.
Most commercial tenants are not in the real estate business, so a Tenant Representation Engagement (also known as a Brokerage Agreement) is often a matter of first impression for a tenant. The Brokerage Agreement is usually the tenant’s first step in locating rentable space. By engaging the broker, the tenant outsources the responsibility of locating office space and leverages the experience and connections of the broker for a quicker and smoother leasing process. Despite the usefulness of engaging brokers, there are a few key items that tenants should be aware of, and should negotiate, prior to signing a Brokerage Agreement.
The negotiation of the Brokerage Agreement starts after the tenant identifies and decides to engage the broker. The broker, who usually generates the first draft of the Brokerage Agreement, typically provides a list of services it is offering the tenant. In representing the tenant, the tenant’s lawyer should discuss with his or her client what services the client desires from the broker. The tenant’s lawyer should be as specific and comprehensive as possible in describing the services to be provided by the broker. The ultimate goal is, of course, an executed lease. But, the services leading up to and continuing after an executed lease are often varied in nature. The categories covered in the list of services should include market analysis, due diligence, transaction analysis, recommendation of professionals, negotiations, delivery of the executed lease, and post–lease execution activities.
These categories of services can be further broken down into specific activities. The market analysis contains market averages, absorption, market size, comparable lease transactions, market trends, selected listings that satisfy the tenant’s needs, locations of competitors, location maps, and market updates. Due diligence might feature use restrictions, regulations, zoning, taxes, operating expenses, pending assessments, particular building rules and regulations, tours, physical inspections, leasing brochures, and information about the reputation and history of landlords. The transaction analysis would incorporate the broker’s recommendations, financial assumptions, and analyses of each offer and counteroffer; a chronology offer versus counteroffer including a financial summary showing the tenant’s savings; and preliminary budgets or estimated tenant improvement costs at each location. Professional recommendations, if requested by the tenant, should contain referrals for contractors, engineers, architects, space planners, designers, and other professionals and, if the client desires, the broker should assist in the interview and selection of these professionals.
While tenants should be directly involved in the negotiations and hire outside counsel to address the legal points for the negotiations of the future lease and Brokerage Agreement, brokers are helpful in understanding larger market trends and pushing deals to a close. The broker’s participation in negotiations entails preparation of a request for proposal or response to the same, negotiation and finalization of a letter of intent, negotiation between the landlord and tenant, and issuance of progress reports describing the status and nature of the negotiations. Once negotiations are finalized, the broker should deliver the executed lease and make sure that the payments made from the tenant to the landlord are consistent with the provisions of the lease. The broker might also be asked to prepare a spreadsheet showing the savings between the pricing of the landlord’s original offer and the pricing of the tenant’s accepted offer in the final executed lease.
The Brokerage Agreement should expressly state that the tenant will be in charge of the overall negotiation process, with the broker only participating in all phases of the negotiations and providing the services previously discussed. The broker is an expert in the real estate market, should have knowledge of the available space, and should participate in all phases of negotiations but only as approved by the tenant. The Brokerage Agreement should make clear that the broker is an independent entity and is not an agent of the tenant.
As an independent entity, the broker should not be able to bind or obligate the tenant to any third party, including landlords, other brokers, agents, or finders (even within the same brokerage company). Brokerage companies can be large and employ many brokers—the Brokerage Agreement should set forth the names of the brokerage team members representing the tenant. Once the list is set, the tenant should have the right to approve any changes to the brokerage team. If anyone from the team, or the larger brokerage company, also represents the landlord, the brokerage company should be required to disclose such representation and maintain a system, acceptable to the tenant, creating a wall between the brokerage teams. The tenant should understand what this system is in order to determine the acceptability and risks of any conflicts of interest.
The tenant should also have no liability for brokerage fees. The Brokerage Agreement should expressly state that the client will not owe any fees, commissions, or expenses and that those costs are the responsibility of the landlord. However, the tenant should require that the broker disclose its commission agreement with the landlord and should reserve the right to audit the commission agreement. This requirement allows the tenant to ensure that the rent being charged by the landlord is not artificially inflated by excessive brokerage fees passed through by the landlord as a hidden cost to the tenant.
Two additional items that the tenant should negotiate with the broker relate to the term of the Brokerage Agreement. A Brokerage Agreement should be negotiated to automatically terminate after a set period of time. Depending on the industry, it is standard to have the term of the engagement automatically terminate after 6–12 months. In all cases, the Brokerage Agreement should be terminable by the tenant for any reason, or no reason, and at any time, after prior written notice to the broker.
The Brokerage Agreement will also likely contain a “tail” at the end of the term. The “tail” is a period of time during which the broker or brokerage company will receive payment for the broker’s negotiations with landlords during the term of the agreement. If the tail cannot be eliminated, it should be narrowly tailored.
Two of the most critical items to narrowly tailor are the length of the tail and who can be considered a party for which the broker is entitled to receive credit. The latter item can be particularly contentious, with debates over whether all broker contacts should be allowed as part of the tail or only those contacts with whom negotiations are ongoing, or somewhere in between. The definition of negotiations is hotly contested. The tenant obviously desires that the negotiations be defined more comprehensively than the broker wants in order to reduce the number of landlords subject to the tail. No matter the result of the negotiations, the Brokerage Agreement should be drafted to require the broker, at the start of the tail, to provide the tenant a list of names to whom the tail applies, thereby avoiding unnecessary potential litigation.
In order to further protect the tenant, the Brokerage Agreement should provide that the broker will indemnify the tenant and limit the tenant’s damages under the agreement. The broker’s indemnity of the tenant should be for (i) all acts and omissions of the broker, (ii) any misrepresentation made by the broker, (iii) any breach of the Brokerage Agreement by the broker, and (iv) any claim against the tenant by any broker or third party alleging to have dealt with or through the broker. The indemnity should extend to protection of the tenant’s officers, directors, employees, and affiliates. Finally, the tenant should not be liable to the broker for any consequential, special, incidental, indirect, or punitive damages related to the broker.
The Brokerage Agreement is often the first step in locating rentable space. Set forth above are a few of the key items that a tenant should be aware of—and should negotiate—prior to signing a Brokerage Agreement in order to clarify the scope and length of the engagement of the broker and, hopefully, avoid unnecessary litigation.
J.J. Broderick, Kelly Kuschel, and Morgan, Lewis & Bockius LLP (the Disclaiming Parties) shall have no liability in connection with these materials. The Disclaiming Parties make no representation, express or implied, as to the accuracy, sufficiency, or completeness of the information supplied by the Disclaiming Parties.
If you have any questions or would like more information on the issues discussed in this Insight, please contact any of the following Morgan Lewis lawyers:
Richard A. Toelke