Many things in real estate can lead a broker straight to court and a costly lawsuit. Commingling of funds is one of those things.
Commingling is when a real estate broker’s funds and client funds are mixed. For example, if a broker deposits a buyer’s deposit in their brokerage’s bank account instead of a separate escrow account. Commingling funds opens up the possibility that a client’s funds could be spent on brokerage or other expenses, which is unlawful. This is called ‘conversion’ and is misappropriation and a type of theft.
The laws about commingling vary across states. But regardless of the rules in your state, real estate brokers should avoid commingling at all costs. In most cases, commingling is considered fraudulent and a serious breach of your fiduciary duty. The main exception to this is real estate investment trusts where investors’ funds are pooled together to purchase property investments. But any such transactions need to have transparent and comprehensive agreements in place to outline how the funds will be managed.
Here are some tips for real estate brokers to avoid litigation for commingling and strategies to keep your money management practices on the right side of the law.
Why separate accounts are important in real estate transactions
It’s essential to have client funds stored in a trust account separate from your brokerage business accounts and any personal funds. “Client funds” includes buyer deposits, security deposits for tenants, and all other funds.
Funding can only be legally commingled for investment purposes, for example, collecting funds from individual investors for a real estate investment trust. In this case, all investors need to be aware funds are being commingled, and you’ll need an agreement so all parties are aware of the purpose of the funding and under what conditions it will be spent.
What to do if you discover commingled funds?
Commingling can occur simply by honest mistakes. There is not always fraudulent intent. A security deposit for a rental property may accidentally be transferred into an account with rental income, or a staff member may withdraw from the wrong account by accident.
Also, keep in mind that commingling doesn’t always involve a client’s money being deposited into a brokerage account. There have been cases where brokerage funds have been incorrectly transferred to a trust account containing client funds due to human error. It is still commingling, whichever way the client and brokerage funds are mixed.
As a real estate broker, if you discover commingled funds, you need to take steps to rectify the issue.
Firstly, you’ll want to know how the funds were commingled. Was it human error? Was it potentially fraudulent? Investigate how it happened and put measures in place to ensure it doesn’t happen again. Secondly, you need to fix the issue and refund the appropriate amount ensuring you record the transactions in your accounting system.
Ensure you have a policy framework in place
The onus is on you, as the broker, to ensure you understand what laws are in place for commingling in your state. Proper bookkeeping and financial management procedures are essential to conducting your real estate business ethically and successfully.
Ensure you have a policy framework and procedures in place to keep client funds and brokerage funds separate. You should also have fraud prevention measures in place —and ensure it’s clear to your team that there will be no mixing of client and personal funds to avoid a commingling lawsuit.
It’s useful to have sufficient review processes in place for all transactions. If you have these in place and commingling accidentally occurs, you’ll be able to identify and fix the problem efficiently.
Educate your licensees
Brokers must educate their real estate licensees about the correct process for collecting client funds. They need to understand the consequences of commingling and fraudulent activity, which can include license revocation, charges of fraud, criminal charges and the need to pay damages to the aggrieved client. Education needs to go beyond just the induction process — regular education sessions for your team on high-risk issues can help prevent lawsuits and protect your business.
Get legal advice from a real estate attorney
If you’re concerned about commingling and fiduciary duty risks within your brokerage, contact a qualified real estate attorney who can advise on the best way to manage funds legally and effectively. With a CRES real estate E&O Insurance + ClaimPrevent® policy, you’ll have pre-claim access to experienced attorneys specializing in real estate 7 days a week. This offers a great resource for brokers to ask questions and manage risks before they become costly lawsuits.
Look for tailored Business Owner and Real Estate E&O insurance policies
As part of one of the largest insurance brokers in the world, CRES has unequaled access to more insurance options for real estate brokers than anyone else. We’ll find you the best real estate E&O coverage at the best price. And we can identify the best Business Owners Policy or General Liability policy for your brokerage as well.
Contact the friendly team at CRES at 800-880-2747 for a confidential discussion today.