Finder’s Fees: Legal Land Mine for Investors?

Paper house under a magnifying lens

Recently, I got an inquiry from a real estate investor who’d just come off an investment seminar and was “fired up” (or maybe that smoke was from the burn his credit card had taken!) about getting going. Like a gladiator looking to win ultimate freedom with one last fight, this investor wanted to jump into wholesaling property and make his fortune. And, as many a newly-minted investor before him, he was short on cash but long on enthusiasm. This is a great place to be…IF enthusiasm doesn’t drown caution!

Fortunately, in this case, he’d struck a balance between prudence and “fire in the belly.”  That splendid balance was what brought him to my virtual doorstep, wanting to know about investments and finder’s fees.

Fiinder’s Fees Are Illegal, Anyway. Short Answer, Right?

Not necessarily. Google “finder’s fee” and “real estate” and you might think so. As a new investor, too, you may be dismayed by what you read, feeling like half your “ammunition” has been taken out of your clip before you’ve figuratively fired a shot. But, as with everything, the devil is in the details. So pay attention!

FIRST, let’s be clear. There are two primary categories of wholesaling real estate transactions:

  1. Finder’s Fee Agreements
  2. Assignments of Contract

The Simpler Route

The first form of wholesaling is the simplest form — but also the most confusing. The KEY is in whom you’re dealing with. In most if not all states, a licensed realtor cannot pay a non-licensed realtor a finder’s fee. That’s the bad news. The good news is unless you’re dealing with realtors, it’s a non-issue.

 Why?

Simple. Provided a real estate agreement doesn’t cross the line into brokerage services, a real estate licensing board cannot regulate non-licensed individuals entering into PRIVATE real estate investing agreements. Sounds like common sense, but it’s an important distinction. And it was discussed in a case I read just last year:

What the Courts Have to Say

In Futersak v. Pearl (27 Misc 3d 897 New York Appellate 2nd Division), the Defendant sought to avoid paying a finder’s fee to Plaintiff on the purchase of property brought to the Defendant by Plaintiff. The Defendant argued that the Plaintiff was not a real estate agent; therefore, he was not entitled to receive the fee. The court disagreed and upheld the parties’ written agreement. In reaching its conclusion — which, by the way, the court did without any apparent struggle with the law — it stated:

The written agreement between the parties, and drafted by Defendant, explicitly refers to Plaintiff being compensated in the role of a finder. There is nothing in the agreement explicit or implied that Futersak was an agent of Defendants in the actual or functional meaning of that term and relationship. Futersak had no explicit or implied power to bind Defendants. He did not have the power to negotiate the transaction. Futersak did not have the power to do anything except finding and introduce prospects.

“Finding” the Prudent Course

This ruling contains several pertinent lessons to keep in mind.

  • Always have a written agreement between yourself and the cash investor you are working with. (This applies whether you’re talking about finder’s fees or not; it’s just plain good business.)
  • Said agreement should be simple and to the point and be worded correctly: that as the finder, you will be compensated for finding prospective business opportunities, researching an area, finding a willing seller, performing due diligence, researching market conditions, and the like. It should NOT contain any language that suggests or implies a brokerage arrangement.
  • Your agreement should also indicate that you will not negotiate with the seller or any party on behalf of the cash investor; that you do not have the ability to bind the cash investor; and that you will not serve in a fiduciary capacity to the cash investor.
  • It’s not a bad idea to think about forming a partnership with the cash investor. That way, in your finder’s fee agreement, you can state that the Finder is entitled to the ownership interest of X percent in any opportunity introduced to cash investor by Finder. This ownership interest should be convertible to cash at the election of the cash investor, or within X months after closing on the investment.

Check It Out to be Sure!

I need to put on my C.M.A. hat here — which means I’m also going to advise you to run any purported finder’s transaction by a licensed attorney to ensure you are compliant with state law. Don’t rely on one cited case here to “cover” you: get professional guidance so your proposed deal doesn’t “blow up” on a technicality!

 

4 comments On Finder’s Fees: Legal Land Mine for Investors?

  • Good post.

    In CA, I plan to operate an LLC with multiple managing partners where the company closeses traditional real estate transactions that require a license, and a investment side of the business that deals with assignment of contracts, rehabbing, lease options and seller financing.

    I’m a licensed agent in California but also starting this real investment company as we speak.

    My main question is, could one of my managing Partners within the LLC, who is not a licensed real estate agent, provide the finder’s fee since I cannot… or would I risk still getting in trouble because I’m a manager of LLC and a licensed agent?

    Thanks

  • Fyi -In California, a “finder’s exception,” allowing an unlicensed person to be compensated for introducing parties to a real estate transaction, has been judicially approved since 1923. As explained by California’s Supreme Court in Tyrone v. Kelley (1973) 9 Cal.3d 1.

  • I thought this and the other version in Bigger Pockets were excellent posts, and something I want to do this with one client when I de-activate my real estate license next month.
    But then I came across this piece about Finder’s fees Clint, which cites the same F v Perl case: http://www.itkowitz.com/booklets/FINDER-S-FEES-WHAT-YOU-SHOULD-KNOW.pdf

    It contradicts the outcome in favor of the Defendant…or at least the part of the case that was denied appeal. What I can’t discern is whether the ruling had to do with the fact that the FF contract aspects involved both a fee for finding the property, and ALSO a % of profit upon sale, or the fact that Plaintiff was unlicensed in a transaction involving real estate transactions as this document asserts. Your take?

    • Loni,
      That is a great article. Yes the attorney is correct and this is where I see a lot of wholesalers getting into trouble when they tie their finder’s fee to a percentage of the profit when the deal sells and they attempt to help with the transaction to ensure it goes through. A true finder’s fee is one that is a flat fee for the assignment of a PSA. The fee is payable regardless if the deal goes through (unless the seller backs out). Fees that are tied to the outcome of a transaction look like a real estate commission and should be avoided. Also each state has their own take on this activity and it is best to consult an attorney in the state where you are considering wholesaling.

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