Real Estate Reporter, January 2005

EYES WIDE SHUT: CONFLICTS POSED BY DUAL REPRESENTATION IN COMMERCIAL OFFICE LEASING

By  Lauren J. Katunich

Each year in Los Angeles County thousands of lease negotiations involving billions of dollars of rent payments take place between landlords and tenants. According to Jim Travers, President of Travers Realty/Oncor International, in more than 90% of all lease transactions, tenants will engage their own real estate brokers to represent them in finding new locations and conducting negotiations with one or more potential landlords. A look at recent market statistics reveals the potential for a systemic conflict of interest when national “full service” real estate companies dominate the local market by acting as representatives for both landlords and tenants. Because brokers owe both parties certain fiduciary duties, the legal and ethical ramifications of a conflict of interest are significant. According to Network Communications, Inc., publishers of “Black’s Guide” for real estate data, two of the most well-known “full service” companies were responsible for representing 39% of all major landlord space in Los Angeles County and Orange County/Inland Empire (a total of approximately 68 million square feet) in 2004. Most of these landlords are large sophisticated investors, and this concentration of control does not appear to be controversial from their perspective. However, a question arises as to whether prospective tenants are being treated fairly in their lease negotiations.

Data compiled by CoStar Group, Inc., the largest provider of market activity information and statistics in the United States, indicates that these same two companies represented tenants in 43% of all space leased in the 40 largest transactions completed in Los Angeles County in 2004. With office rent representing the second largest expense for most companies, almost every tenant wants to negotiate vigorously to attain the best possible terms for its new lease.

Lease negotiations, like poker, require that tenant strategy (what will I pay and what do I want) be a closely held secret, only to be shared with a trusted advisor. But what happens when that advisor, or his or her company, also represents the other side in the negotiations? What assurance can they offer their tenant client (aside from assurances that a “Chinese wall” is in place that prevents the sharing of sensitive information) that they will pursue the best available lease terms and are willing to push the envelope to attain them? Will they back off for fear of offending a landlord that might provide them with a future property listing or property management assignment?

This conflict over dual representation has existed in the market place for many years, and yet, there have been few challenges to the legal or ethical practices involved. The two large brokerage houses and, indeed, some tenants maintain that they are not troubled by this conflict. This seeming indifference is signaled by the fact that in California, as in many states, this issue has largely gone unexplored in reported case law.

Although conflict of interest litigation in the commercial real estate field is relatively unusual, brokers are cautioned not to attempt to test the limits. As a general rule, a broker or agent’s right to compensation will be affected by a violation of his or her fiduciary duties. Some courts have held that a broker who intentionally breached his or her duty must forfeit the entire commission, even where it is found that no actual harm was suffered by the client. To avoid such remedies, brokers that work in firms that serve in a dual representation capacity must be especially cautious not to open themselves to liability by disclosing otherwise confidential information.

Prospective tenants should be wary of the pitfalls of dual representation and can take steps to actively protect themselves. The most important steps include: (1) be aware of the potential for conflict and seek adequate assurances from your brokers that the conflict of interest issue has been addressed to your satisfaction. Leasing commercial office space is a monumental expense for most tenants; do not hesitate to require a brokerage firm serving in a dual capacity to answer all of your concerns about conflicts of interest; (2) if you become concerned that a possible conflict of interest is hampering you in meeting your objectives, seek out independent brokerage firms that do not take landlord property listings (exclusive tenant rep); (3) if you feel that lease negotiations have in some respect been compromised, consult legal counsel to review the course of the negotiations. Legal counsel will provide you with a “sounding board” on contentious issues and, if necessary, will properly evaluate any potential claim. Following these three logical steps will help prospective tenants get the best representation in their lease negotiations.

Many of the same principles hold true for landlords who are seeking to negotiate the most favorable terms for themselves and their investors. Although presumably most landlords are not as concerned with the ramifications of dual representation in lease negotiations, landlords too are owed a duty of fair dealing. Having a broker share details with its client of the landlord’s recent negotiations with other tenants, which in almost all cases are presumed to be confidential, may result in the landlord achieving less favorable terms than would have been available through a true “arm’s length” negotiation. Once again, any concern should be addressed first to the broker, and if still unsatisfied, legal counsel should be consulted. Tough negotiations frequently result in acrimonious debate between tenants who attempt to pit multiple landlords against each other to achieve the best terms possible, and landlords seeking to maximize the price and term on the lease. Although there is outward acceptance of brokerage houses that serve in a dual capacity as representatives for both landlords and tenants, with the expenditure of so much money and effort, all parties involved should expect that their lease negotiations are not compromised by the unauthorized sharing of information.