Wednesday, January 08, 2014

8 Issues for Brokerage Company Sales, Mergers & Acquisitions

By Steve Bochenek, Partner, Sorling Northrup Attorneys

Over the last five years we have seen a variety of transactions involving real estate brokerage companies often as a result of the difficult economic times. As the housing markets continue to improve there may be a renewed focus on the sale of real estate brokerage businesses but this time in an effort by baby boomer owners to benefit from any enhanced value of their companies.

This article will discuss the following list of eight issues that will be important in real estate brokerage business sales, mergers and acquisitions. These issues are an arbitrary listing by the author and may not include an issue of which would be a priority for some company owners and managers. However, the issues listed are typical of the types of issues that one would face in a sale, merger or acquisition of a real estate brokerage company and proper handling of these issues may enhance the value of your company.

1. Exclusive representation agreements / listing agreements
2. Independent contractor and employment contracts
3. Liabilities and third party, vendor and supplier contracts
4. Intellectual Property
5. Licensing and regulatory issues
6. Emails and website modifications
7. Transactions in process
8. Escrow accounts

1. Exclusive Representation Agreements / Listing Agreements

The handling and status of exclusive representation agreements or listing agreements will depend in large part upon the type of transaction being discussed. If a merger occurs between two or more existing entities or a company is merely selling all of its stock or membership units to a new third party owner, there will be little or no change in terms of the exclusive representation agreements or listing agreements. This is primarily because the entity continues to exist either in its own name but under new ownership or as a part of a merged entity. Thus, unless there is some provision in your exclusive representation agreement or listing agreement that provides for a party to have a right to terminate the agreement based on a change in control of the brokerage company, then those exclusive representation or listing agreements should remain in effect. This is one of the primary advantages of a transaction that would be in the nature of a merger or simply a sale of all of the stock or ownership units of a real estate brokerage company. The obvious downside to this type of transaction is that the buyer is assuming the liabilities of the selling company. Thus most buyers will want to purchase only the assets of the company and may be willing to do so at higher purchase price since they will not be taking on unknown or contingent liabilities.
If you are selling the assets of a real estate brokerage company to another entity, the question and resolution may be substantially different. In a sale of assets you would want to assign all of your exclusive representation or listing agreements to a third party. In such a transaction you would need to ascertain whether or not the exclusive representation or listing agreements of your company are assignable or transferable to a third party. If they are assignable or transferable to a third party, then in a sale of assets of your company you would be able to transfer or assign those agreements. If not assignable, you would need to obtain the consent of the client in order to transfer or assign an exclusive representation or listing agreement to which the client is a party. If the consent to assignment or transfer cannot be secured, then new agreements would actually have to be obtained with those clients by the party buying the assets of your company. This would obviously present the opportunity for those clients to sign agreements with other brokerage companies and diminish the value of your company. Thus, in order to enhance the potential value of your company, check your exclusive representation or listing agreement to make sure your company has the right to assign those agreements. At the same time it would be wise to include a provision indicating that the agreements are binding on the successors to your company.

2. Independent Contractor and Employment Contracts

The people working in a business are a key to the value of a business. Thus, the second key issue in any kind of sale, merger or acquisition involving a real estate brokerage company is the status of the independent contractor or employment contracts that the company may have with sponsored licensees. Once again, it is important to understand the terms of these contracts with your sponsored licensees. In particular, you will want to ascertain whether there are provisions in either of these agreements that allow for the agreement to be assigned or transferred to another entity. Also, you will want to check to see if the sponsored licensee has an option to opt out of any such agreement if there is a change of control of the brokerage company.

Generally, in a merger situation or in an acquisition of the company by a third party, all independent contractor agreements and employment agreements will remain in place. In a transaction involving the sale of assets of a real estate brokerage company, these agreements would need to be assignable and transferable by the real estate brokerage company to the purchaser. If they are not, then consent will need to be obtained from the sponsored licensee in order to transfer the agreement. However, in some situations you will see the acquiring company provide that all independent contractor and employment agreements are to be terminated (assuming they can under the terms of the contract) leaving the acquiring company to enter into new contracts with those sponsored licensees it chooses to retain.

3. Liabilities and Third Party, Vendor and Supplier Contracts

Brokerage companies have a number of other contracts besides exclusive representation / listing agreements and independent contractor / employment agreements. These contracts may include leases of office space, advertising contracts, insurance contracts, equipment leases and franchise agreements. There may also be a number of other liabilities not represented by contracts such as taxes, monthly bills and payroll. These are typically assumed by the third party buyer in any merger or acquisition of the shares and membership interests of a brokerage company.
If a third party is buying the stock or other equity of the brokerage company, these contracts will remain with the brokerage company and its new owner or owners. However, the new owner(s) may ask the seller to indemnify them as to any unknown or contingent liabilities. In an asset purchase transaction these types of issues will generally be controlled by the terms of the asset purchase agreement negotiated by the parties. In particular, check the terms of any franchise agreement you  may have to determine its term, whether a third party can assume the franchise agreement or whether there is an early termination penalty that will need to be paid by the seller.

4. Intellectual Property

One of the keys in any sale, merger or acquisition of a real estate brokerage company will be whether the brokerage company has a recognized brand. Protecting ones intellectual property rights is important to protecting and preserving that brand. This will include filings to protect copyrights and trademarks. Also, if the intellectual property was created by a third party, non-employee, there will need to be a “work made for hire contract” or an assignment of the intellectual property rights by the author or developer. A purchaser interested in the brand will want to know that these rights have been preserved.

Even if a third party is not interested in a brokerage company’s brand the protection of intellectual property rights can be very important. This would be true if the acquirer wants to use the forms or software used or developed by your company. Also, your independent contractor agreements ought to contain a provision by which your sponsored licensees assign to your company whatever rights they may have in works created such as photos they take or comments or advertising they create. These types of protections will assure a third party that they can successfully acquire the intellectual property of your company.

5. Licensing and Regulatory Issues

A key question in any sale, merger or acquisition deals with what matters need to be addressed with the Illinois Department of Financial and Professional Regulation (IDFPR). The regulatory or licensing changes needed will vary extensively based upon the type of transaction. A simple purchase of all of the stock of the company does not, in and of itself, necessitate any license changes with IDFPR. However, if the purchase of all the stock of the entity results in the individual previously managing the company leaving, then there will be a need to change the managing broker or to hire a managing broker for the company.

IDFPR will also want information regarding the new owners, whether they are licensees and, if needed, a non-participation affidavit. In any transaction in which a brokerage company no longer exists, such as a merger with the other entity being the surviving entity or dissolution of your brokerage company, IDFPR would need to be notified as regards the status of all sponsored licensees. In a merger situation the sponsoring broker will be different for the sponsored licensees so the licenses will need to be changed over to the new sponsoring broker. In a dissolution of a real estate brokerage company the Department would need to be notified and the sponsorships of the sponsored licensees would be terminated subject, however, to the licensees being sponsored by a new sponsoring broker.  Also, even if there is just a name change in a brokerage company or change of address IDFPR will need to be notified concerning those modifications. Another consideration would be that if two companies are combined into a new consolidated entity a new license will need to be obtained. This would be done in the same manner as obtaining a new license for a brokerage company. All sponsored licensees would then need to be changed over to the new entity. The various licensing and regulatory changes need to be considered as the structure of your transaction is developed. Also, preparation and planning are needed so there is no down time in operations as a result of a regulatory snafu.

6. Emails and Website Modifications

If there is any change in company name or location, changes to e-mails and web sites will also become necessary. There is a provision in the License Law Rules, specifically Section 1450.720, which deals with information that must be included on a web site or on certain e-mails with members of the public. This information will include the accurate name of  the company as well as the location of the principal office of the company. Sponsored licensees may have signature blocks set up that they traditionally use in sending information to a potential client or clients. These may well need to be changed or modified to reflect the new company name or location. Another issue with regards to web sites may be the control or ownership of a web site. In particular, if your company contracted with a third party to develop a web site and ownership of the web site has not been properly transferred to the ownership of your company, there may be issues with regards to whether a new company can take on the ownership of or use that web site. Contractual language may need to be reviewed with regard to the development and ownership of the web site. In a simple sale of stock or ownership units in your company, this would probably not be the case because your entity would continue to exist. However, you still need to review the pertinent contracts to see if there would be language dealing with change of ownership or control of your entity in terms of the rights in and to the web site that was developed by a third party.

7. Transactions in Process

Transactions in process will be a key in any sale, merger or acquisition of your company or its assets. Included in this category are not only listings on which there is a pending contract but also transactions in which you represent the buyer and will be entitled to a co-op commission. The issues are simplified in the sale of stock or ownership units to a third party or in a merger situation. These transactions would simply either remain with your existing company or become part of a new entity. In either case the handling of those transactions would probably remain very similar to what occurred prior to the merger or sale of your company.
This issue is not as simple when there is an asset sale by a brokerage company of the assets of its business or the sale of several of the offices of a company as opposed to the entire company. A detailed negotiation would need to occur and contract entered into with regards to outstanding transactions that might exist at the time of closing and whether those would be retained by the seller of the business or would be part of the assets purchased. Any agreement between the parties should designate the responsibilities, if any, in connection with the closing of the transaction, the handling of all pre-closing matters leading up to the transaction and payment of any co-op commission due on closing. Further, there should be a discussion or delineation as to how the commissions received from each transaction are to be split with sponsored licensees. Also, there may be expenses that have been advanced in connection with the transaction, including advances to sponsored licensees, and the handling of these will need to be negotiated as a part of the asset purchase agreement.

8. Escrow Accounts

There will be a series of issues that may need to be handled in connection with the earnest money held by a brokerage company involved in a sale, merger or acquisition. These will range from regulatory matters to business matters. The first item of business will be to determine what earnest money is held in escrow in connection with current transactions, what earnest money is being held for transactions which have not closed as scheduled, what earnest money is being held pending litigation, and what earnest monies can be turned over to the State Treasurer’s Office as unclaimed property. The sale of the stock or membership interest in your company presents the cleanest transaction in regards to handling escrow accounts. In this case the company will continue to exist and there really should be no change in the escrow accounts except for a possible change in signators or change in banks. Obviously, the IDFPR will need to be notified of any such change. In regards to a merger in which your brokerage company is not the survivor, there will need to be notification to IDFPR regarding any transfer of that earnest money to a different bank or account as is generally required when you open an escrow account.  Whomever may be taking over the earnest money accounts will want to make sure they have all the books and records of the brokerage firm who had held the earnest money in escrow so that questions can be answered if raised by IDFPR, or a client or if IDFPR conducts an audit.

The first thing to do before transferring any escrow accounts or earnest monies will be to try to clear whatever earnest monies out of the escrow account that can be cleared in accordance with the Real Estate License Act and its regulations. It would also be wise to notify any parties who have monies being held in an escrow account of any change to the account or to the name of the party that is actually holding the earnest money in escrow. Chances are that the contract that provides for the holding of the earnest money does not specify a specific financial institution but does call or provide for the earnest money to be held by a specific brokerage firm. Thus, to the extent that there is a merger or purchase of a company’s stock or ownership interests and where there is not an actual transfer of the accounts, that process should be able to be completed, simply with notice to IDFPR and the parties. However, in an asset purchase transaction there will need to be more detailed provisions in the contract concerning the handling of the earnest money in escrow. This may include obtaining permission from the parties to the contract to purchase to transfer the monies held in escrow to the buyer of your company’s assets. Another alternative for the company selling its assets would be to continue to hold those earnest monies in escrow, handle those transactions and wind down the escrow account as those transactions are closed. The potential problem with this plan is the need to have a managing broker remain at the purchased company to wind up the transactions and disburse monies held in escrow.

Keeping these points in mind is important to complying with all applicable laws and regulations. However, the value of your company can be enhanced by positioning your company and its key assets to be able to be sold or transferred with a minimum of regulatory and contractual entanglements. 
 

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