Commission Protection Insurance Program Explained
Ontario Real Estate Source
By Brian Madigan LL.B.
The Real Estate Council of Ontario (RECO) has mandated the participation of all of its registrants in an insurance program that includes among other coverages, a “Commission Protection Insurance Policy”.
This policy is designed to safeguard registrants in the event of the theft, confiscation or mismanagement of their commission in a real estate transaction. So, if a commission is to be paid to a registrant, then it is protected under the insurance policy.
The policy arises out of a desire to protect registrants from the bankruptcy of brokerages. This occurred in the late 1980′s and early 1990′s when a significant number of brokerages went bankrupt. The creditors stepped in and took the money owed to other brokerages, and their own agents as well as the brokerages’ own money. These funds were shared pro rata among all the creditors, and the registrants simply ranked as unsecured creditors.
On the other hand, the deposit itself was held in trust for a particular party in a transaction. Because it was trust money, it was protected from other creditors. But, the moment the deal went through, the deposit became the funds of the brokerage and were to be distributed to the co-operating brokerage and its own sales representatives. The only problem, of course, was that this was the ideal time for the creditors to step in and share in the distribution.
The commission protection insurance policy is designed to respond to a claim only if the commission is protected under a commission protection trust arrangement. So, the insurer here will only pay if the commission was held in trust. What that means is the trust arrangement must be satisfied just like the deposit before payment. In most cases, the funds will rank as trust funds in a bankruptcy, and eventually when distribution is made, these funds will be forwarded to the insurer.
There are some additional limitations and requirements under the policy before a claim will be paid. The limits of liability are $100,000 for each claim and $1,000,000 for each occurrence. There is a $250 deductible.
Let’s have a look at some of the insuring agreements under the policy. First, there must be a loss of commission. Here, the insurer agrees:
· “to make payment on behalf of the insured
· the amount of any claim for loss
· sustained by a claimant
· in a trade in real estate
· in theProvince of Ontario
· arising out of an occurrence
· discovered during the policy period”
And, “payment shall only be made for the benefit of a claimant”.
The actual “named insured” in the policy is RECO. There is an extended definition of insured which includes:
1) RECO,
2) An employee, director or officer of RECO,
3) A registrant.
Loss is defined in the policy means:
· “loss of commission
· which has been entrusted to or received by
· one registrant in his/her professional capacity
· but is owed to another registrant
· in his/her professional capacity”
Consequently, the commission must be held by one registrant for another. The commission must actually exist. It cannot be a simple entitlement by way of contract to obtain a commission in the future. This is real money paid to a registrant which is later to be paid to another registrant. The usual arrangement would be a deposit on a real estate transaction, which following successful closing is to be utilized to pay commissions to the co-operating brokerage and the participating sales representative.
Trade is defined in the Real Estate and Business Brokers Act, 2002. It basically means a disposition or acquisition of real estate, including both offers and attempts to acquire or dispose of real estate. Consequently, any kind of advance payment on account of an opinion, or any other collateral issue would not be covered. Such activities are not considered to be “trades”, even though money may have been paid to the brokerage. This would apply to both partial payments on account, as well as the final payment.
The appropriate remedy here would be to have the brokerage agree to hold the money in trust, and although the insurance would not apply, the common law rules related to trust property would.
The entitlement to the claim is an occurrence which is defined in the policy as follows:
· “….the insolvency of a registrant
· or the theft, fraud, misappropriation or wrongful conversion
· directly or indirectly by a registrant
· or present or former employee, director, officer, or manager of a registrant
· of moneys or other property
· entrusted to or received by the registrant
· in the registrant’s professional capacity”
There is also an expanded explanation in respect to “occurrence”:
“Regardless the number of such incidents of insolvency or the number of such acts of theft, fraud, misappropriation or wrongful conversion, they will be grouped together as and amount to only one Occurrence regardless the number of Claimants who suffer a Loss.”
That provision has been recently added to the policy. The wording may indeed be rather awkward but nevertheless the meaning is clear. The insurer will only payout a maximum of $1,000,000 no matter what.
So, the intent here is to cover all moneys advanced to a registrant in the course of trading in real estate at such time as there is an obligation to hold such funds for another registrant. It applies to trust money (entrusted) and also money that was supposed to be held in trust but was not (received).
Clearly, it is the second part which may cause delay in investigation and settlement of any claims. Moneys placed in trust and removed without authorization can be traced. These are known transactions. Moneys which were delivered to the brokerage but never placed in trust may be elsewhere and present a much more challenging task for investigators. They are covered too.
Delays in processing settlements can easily arise where:
1) claims are not presented in a timely fashion, and
2) funds intended to be placed in trust, were deposited elsewhere.
There is another RECO insurance policy called the Consumer Deposit Insurance Policy which protects the consumer. This policy only responds to the commission aspect of those same funds.
There are some important exclusions in the policy. Let’s say ABC Realty is in difficulty and has been reported to RECO. The commission protection policy will not cover claims against ABC Realty. If that took place before the policy began, then there is no coverage. If the report to RECO takes place after the policy commences, then it will protect other registrants against loss of the commission through ABC Realty. Only RECO would be aware of any problem registrants. This situation is not that likely to arise in practice. The program has been in operation for several years and this exclusion is designed to protect the insurer and limit its exposure to just the claims within its policy period.
But, here is something that every sales representative needs to watch out for. The policy does not apply to any claim:
· By a salesperson
· Employed or contracted to a brokerage
· Where the brokerage fails to set up a commission trust account
· Unless the salesperson has used his/her best efforts
· To determine that the brokerage has set up
· And maintained a commission trust account
This refers, of course, to the salesperson’s own brokerage. There is a due diligence requirement. The salesperson must determine: is there a commission trust account? Is that account specified in writing under my contract of employment or my independent contractor’s agreement? Am I being paid out of that account? So, take a copy of all commission cheques, and photocopy them. Don’t just keep the stubs! This will show that the commission trust account has been “maintained”. It’s not enough simply to say that when I joined the company 5 years ago, it had a commission trust account. Did you appreciate that your last trade was paid out of the general account? At that point, you were at risk, and you didn’t notice, so, the problem is that once that payment was made, that was the “red light” that should have alerted you to a problem. The failure to recognize that problem precludes entitlement to benefit from insurance on your next deal.
A claim is deemed to have been reported to the insurer on the date that RECO becomes aware of evidence of an occurrence. RECO will then give notice to the insurer as soon as practicable, but no later than 36 months after the discovery.
RECO has a period of 5 years to investigate the claim. It is RECO’s obligation to submit a detailed proof of loss.
This policy of insurance is “second payor”. That means that if there is any other insurance policy or other indemnity available to satisfy this loss, then, this policy will only come into pay the excess leftover (if any) after the first policy of insurance has paid out.
The insurance company is subrogated to the rights of the insured. Subrogation is an insurance term referring to an “automatic assignment”. The insurer once it pays out under a policy has the right to sue in the name of the insured any party who might otherwise be responsible for the loss. So, the person who caused the loss doesn’t necessarily get off the hook. The insurance company makes a business decision as to whether it is feasible to commence litigation and recover the loss from the offending party. This, of course, includes any registrant whose dishonesty may have lead to the loss.
Remember that the policy said that payment can only be made for the benefit of a claimant, who is defined as a brokerage, broker or salesperson or their estates who has sustained a loss provided that such brokerage, broker or salesperson was not responsible for the loss.
There are several additional defined terms under the policy: commission, commission trust, and commission trust account:
a) commission – is the remuneration owing to, to be paid to, or earned by a registrant for a trade in real estate in Ontario.
The obvious exclusions would be fees, appraisals, and opinions. Referrals from out of Province transactions would not be covered.
b) commission trust – means a constituted trust where all deposits and other monies received by or due to a brokerage directed to satisfy commission payable or damages or other compensation in lieu of commission and applicable HST on any trade and real estate are received and held by the brokerage in trust.
The provision goes on to confirm that the beneficiaries of the trust shall be the listing brokerage, co-operating brokerage, the listing salesperson and the co-operating salesperson. You will find this particular document contained in the standard form agreement of purchase and sale. If it is not signed, then there is no commission trust established. And, if there is no commission trust, then the policy of insurance will not respond to the loss.
c) commission trust account – means a trust account maintained at a Canadian chartered bank or trust company and designated as a “commission trust account”. The commission trust account shall be used only for the receipt and disbursement of commission trust funds, and kept separate and apart from the statutory trust account that a brokerage is required to maintain for customer funds.
This provision is important because the salesperson is obligated to ensure that such account is both established and maintained. These two matters are both conditions precedent to recovery under the insurance policy
If the commission is over $100,000, only the first $100,000 is covered. Also, there is a $1,000,000 limitation upon the total amount of the insurance coverage per occurrence.
If XYZ Realty holds 10 deposits in trust in the total amount of $2,000,000 and steals all the money, then pro ration applies. The maximum liability for the theft (occurrence) by XYZ Realty is $1,000,000 under the policy. No matter how many actual thefts, there is just one occurrence, so the $1,000,000 overall cap applies.
Upon the assumption that there is one occurrence, or one single theft, at one time, then the claimants will share equally in the $1,000,000. That means that they would each only receive one half of their actual claims.
This creates a potential problem. If XYZ Realty goes under, and was spending the trust money, a $1,000,000 limit is not very high. If the average deposit is $25,000 on a $400,000 house deal, then XYZ Realty only needs 40 deals to reach the limit. Many successful brokerages would have over 100 transactions where deposits are held for sellers in mid June each year.
In my view, the upside limit for coverage is quite insufficient. The limit should easily be 5 times the present policy limits, in order to reach an adequate limit for insurance purposes. The purpose of insurance is “risk management” and the risk of commission loss through theft is still there.
So, if you are anxious to protect your commission:
1) Consider having your brokerage hold the deposit (knowing that your brokerage is under the $1,000,000 limit
2) Having the seller’s brokerage confirm that they do not and will not hold more than $1,000,000 in trust for all potential registrants entitled to share in commissions
3) Specify that the deposit in the real estate transaction is to be paid to the seller’s solicitor, in trust
4) Specify that the deposit in the real estate transaction is to be paid to the buyer’s solicitor, in trust
5) Specify that some other stakeholder, third party hold the deposit in the real estate transaction, in trust
From a risk management perspective, 3, 4, and 5 place the funds beyond the reach of the brokerages. They reduce the risk but do not afford protection under the commission protection insurance policy. Items 1 and 2, lower the risk but still permit recovery under the policy.
The best protection is to ensure that you are employed by an established, reliable, trustworthy brokerage with a proven track-record.
So, please beware that all commissions aren’t necessarily insured.
This is somewhat topical since the Real Estate Council of Ontario (RECO) has recently found it necessary to suspend the registration of Brekland Realty Group for irregularities in its trust accounts.
Brian Madigan LL.B., Broker is an author and commentator on real estate matters, if you are interested in residential or commercial properties in Mississauga, Toronto or the GTA, you may contact him through RE/MAX West Realty Inc., Brokerage 416-745-2300.
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