Mike W Smith, President and CEO of Axis Insurance Servces, LLC was recently a speaker at the annual NAI Global Asset Services Coucil in Cleveland Ohio. The topic of his presentation was relating to Errors and Omissions Insurance exposures for commercial real estate firms. In his presention he outlined how new services being provided by commercial real estate firms are increasing their exposure to E&O claims. Specifically, Mr Smith addressed receivership services, corporate services and asset management services that all fall outside of the traditional real estate expertise. His presentation was supplemented with real live example of claims scenarios and near misses. The presentation was enjoyed by all.

Mr Smith is a frequent speaker and writer on E&O related topics and available for other presentationsto the real estate Industry. Mike Smith is the President and CEO of Axis Insurance Services, LLC, a national Professional Liability Insurance Brokerage located in Franklin Lakes New Jersey.

Brokering Commercial Mortgages and E&O

Our Commercial Real Estate clients have begun brokering mortgages for investors and clients. The transaction conceptually is no different than an investment sale which finds a buyer and seller for a piece of investment property except in this transaction the real estate broker finds a seller of a distressed mortgage and and investor willing to buy this mortgage.

Traditional Real Estate E&O insurance policies will exclude coverage for this type of transaction. From an insurance perspective the risk lies somewhere between a real estate agent, mortgage broker and investment advisor. If the real estate agent takes a piece of the action on the transaction it creates an even greter risk. All three of these risks are typically written on a separate and distinct E&O policies. The E&O risk of a claim for this type of transaction can come from the seller, buyer, tenant or other third party. It can also futher be complicated by bankruptcy and foreclosure issues.

Axis Insurance Serivces LLC is on the cutting edge of developing new and innovative E&O insurance policies for commercial real estate organizations. We have, in conjunction with one of our carriers, developed a product to help protect the real estate agent in these transactions. Please feel free to call our office to discuss any needs you may have
MIke Smith
Axis Insurance Services LLC
201-847-9175

by Mike W. Smith President

The collapse of the real estate market and the high incidence of foreclosures has created a new service offered by many real estate agents and brokers; Receivership Services. It may seem like a natural extension of real estate services, but when it comes to your errors and omissions insurance policy that may be a different story as such services are often not covered by your current E&O policy. Receivership services often include additional services such as arranging for insurance, refinancing, construction management, maintenance and even redevelopment.  We encourage you to review your current E&O policy with an agent.

by Mike W. Smith, President

We are seeing an increase in the number of commercial real estate E&O claims due to foreclosure or business failure. Due to the economy many shopping centers are experiencing a loss of tenants.  As businesses in these shopping centers go under, their is loss of traffic within the shopping center which affects all other businesses in the shopping center.  What happens when a real estate agents leases a new space in a dying shopping center?  What obligation does the leasing agent have to disclose the financial condition of other tenants or the shopping center as a whole?  In many cases, none.  However, we are seeing increased claims from tenants seeking retribution from the property manager or leasing agent for failing to disclose just that.  In one case the settlement was over $200,000.

It is more important that ever to address your real estate agency or brokerage E&O policy. Further, given the size of the potential claims in commercial real estate, it is also a good time to consider the limits for your current E&O policy. A standard one million dollar policy may be fine for a residential real estate agent, however, a commercial real estate agent clearly should consider higher limits based on the size and types of transactions .

by Mike W. Smith, President

In July of 2007 I wrote an article about the rise of E&O claims related to the Real Estate industry.  We are still seeing an increase in reported E&O claims. There are a number of factors contributing to this trend, including:

1. Collapse of the Sub Prime market.
2. An increase in the stock market as investment dollars shift from real estate to equity investments.
3. Increase in interest rates.
4. Increase in foreclosure rates, both personal and corporate.
5. Stall of the residential real estate sales in major U.S. markets.
6. A slow down in the growth of increased rents.

Below are descriptions of some of the more significant areas of claims we have seen.

Mortgage Brokers
These claims relate primarily to suitability. Many E&O policies specifically exclude these types claims. Allegations contend that the underlying mortgages should have not been issued, given the financial creditworthiness and ability of the borrower to repay the related loans. When the borrower cannot repay loans, suits arise from the borrower, lender and others. These claims relate both to residential and commercial clients. Our largest mortgage broker claim is related to a commercial loan and is a $5 million claim, involving the mortgage broker and the real estate agent.

Commercial Real Estate Agents
These claims relate to practically every area of a real estate transaction. In several instances our broker was sued because a property failed to achieve a sales or rental price consistent with expectations. One recent claim involving this issue involved a suit for $20+ million. The case was ultimately dismissed against our broker; however, in excess of $200,000 was spent defending this claim and it was recently appealed. Another similar suit in our office was for $8 million and is still in litigation. Some of the more frequent claims involve the following:

a. Suitability of purpose claims. These claims can relate to improper zoning, easements or ADA related issues. In these cases, a property cannot be used for its intended purpose. This is a significant risk in land sales. Our largest claim relating to this issue was for $26 million.

b. Discrimination. These claims involve both residential and commercial clients. These claims frequently relate to property management or dual agency claims. Our largest claim relating to this issue was over $1 million.

c. Dual Agency. These claims can occur in any real estate transaction where dual agency is involved. Dual agency refers not only to the same agent, but also the same Firm with different agents. Our largest claim for this issue was in excess of $1 million.

d. Commissions. Many of our brokers bring suit against their clients in order to collect commissions owed. These suites almost always involve countersuits of negligence. Our largest claim for this issue was $23 million.

e. Corporate Services. Many of our commercial real estate clients step out of the box and perform non traditional consulting services. Often times the contracts are not tight and the agents are not qualified to perform the related services. To date we have had several claims in this area, however, most were less than $500,000. Many policies do not cover these services.

f. Pollution. Many of our broker clients are brought into suits relating to failure to disclose a contaminant which may include lead, asbestos, mold, etc. These claims typically involve failure to disclose by an owner which is imputed upon their agent. Our largest claim relating to this issue was over $5 million.

g. Owned Property. Most of our commercial real estate clients are involved in managing company or principal owned properties. Claims arise in the conflict of interest between ownership and management. We have had dozens of claims relating to this issue ranging from $35,000 to in excess of $1 million. Most policies do not cover these services.

h. Buyer/Lesser Financial Creditworthiness. These claims relate to the inability of a tenant or buyer to fulfill their financial obligations as a buyer or tenant. The claims address the issue of whether the broker has a responsibility to properly qualify a buyer or tenant and what obligation they have to disclose such information. Our largest suit for this is in excess of $50 million, however we have several down to as low as $250,000.

by Mike W. Smith, President

Many of our larger commercial real estate clients are involved in businesses other than their primary real estate brokerage.  Often our commercial real estate clients will create one company for property management, one for real estate sales and leasing and then also multiple joint ventures and partnerships which own real estate or interests in real estate.  Several insurance related issues occur in this situation.  I have addressed some of them below:

Most E&O policies exclude coverage for services provided relating to owned property.

If your company provides professional real estate services for one of these related companies, or a piece of property where any “insured” has a financial interest, then you may have a gap in your E&O coverage.  There is an inherent conflict of interest between an owner of a piece of property and that of a real estate broker who should independently represent a third party.  That conflict of interest is a fine line which is often crossed when an individual or Firm is on both sides of a transaction.  This is a similar conflict to that of a dual agency, however, insurers look at it less favorably. Courts look at it even less favorably.

Owned property exclusions in an E&O insurance policy usually apply not only to the Company, but its principals, employees and also independent contractor sales personnel.  Basically anyone covered as an “insured” on the policy.  Some companies may find themselves without any coverage for the sale of a piece of property owned by a sales agent, even if the company didn’t know that the agent had any financial interest in the related property.  This can be a big problem with any large real estate brokerage.

Take the example of an independent contractor sales person (IC) that has a 33% ownership interest in an LLC that owns a building with their best friend.  The IC sells the property as the licensed agent and a third party sues the brokerage. The suit will not only be against the agent, but also the brokerage that is responsible for the agent. Under most E&O policies the brokerage would not have any E&O insurance protection because of the ownership interest of the agent.
Common misconceptions regarding owned property exclusions in an E&O policy:

1. Property Owned by a family member is not owned property

2. The Company doesn’t own any properties, people do.

3. The ownership interest is in an LLC. The LLC owns property.

4. Ownership Interest is only a small percentage

Although policy provisions vary by carrier, each of the above owned property scenarios would cause a resulting claim to be excluded under most real estate E&O policies.  The exclusions in most policies include the wording directly or indirectly.  We encourage our clients to review their policy provisions very carefully and to call us to discuss any issues or concerns.

How can I help protect my brokerage in owned property transactions?

1.    Develop a written policy for requiring all agents\personnel to disclose in writing to the Company any listings (sales, lease or Property Management) for which they have a financial interest.  This would include owners, principals and other employees.

2.     Develop a similar procedure for transactions where your agents are not the listing agent.

3.     Develop a procedure and policy for informing all parties to a transaction of any financial interest.

4.     If your Brokerage has exposure, you should review your current E&O policy to determine how or if your E&O policy addresses this exposure.

Sale of Joint Venture Interest is not the sale of real estate.
Most of our clients form Limited Liability Companies (LLC’s) for the purpose of buying and selling real estate.  They own the LLC and the LLC owns the property.  This is often done to insulate owners from liability associated with the property and for tax purposes.  An insurance issue arises if real estate agents sell the ownership interests in the LLC as opposed to the underlying real estate.  It may appear on the surface to be the same thing, but from an insurance perspective it is not.  Selling the interests of a LLC is tantamount to selling a business, which is excluded from most E&O policies.

by Mike W. Smith, President

Two years ago I addressed a group of Professional Liability Underwriters in a panel entitled “E&O and the Real Estate Bubble.”  At that time I was criticized for predicting an insurance crisis related to real estate E&O.  In hindsight, I was not that far off.  The current mortgage meltdown and foreclosure issues affect more than just the housing market. Foreclosures are at an all time high, in many markets real estate values are on decline and E&O claims are on the rise.  These circumstances have an adverse affect on the Property & Casualty Insurance market as well as the coverage and pricing offered.