Your broker just helped you find terrific space in a new building and you’re feeling great about the whole transaction. He has assured you that he pushed the landlord to the limit and got everything he could have out of the deal; taking full advantage of the leverage you had as a large tenant. However, a month after you move into your new space, you find out the landlord has now hired your broker to represent them in the sale of the building. What are you thinking now?
In many professional service businesses, the ultimate compliment is when the other side hires you based on your performance in a transaction. Many attorneys have built significant books of business by outperforming their counterpart in the courtroom or at the negotiating table. Sometimes it’s only by seeing your advisor’s work in the context of a competing advisor that you can put their relative performance in perspective.
The problem is that law is very different from brokerage in two key respects. First, in law, a client can prevent its attorney from representing an adverse party. Before an attorney can represent a new client whose interests are adverse or potentially adverse to an existing client, the existing client must sign a formal conflicts waiver consenting to the new representation. The legal profession abhors conflicts of interest, actual or perceived, and, therefore, has strict safeguards to ensure that a client never has to worry about the loyalties of its counsel. In brokerage, however, a client is only entitled to notice of a conflicting representation; it cannot prevent it. Second, when one party loses a major lawsuit and then decides to hire the opposing attorney who beat them in the courtroom, there is no question as to their motivation. They simply want to retain the best advocate so they don’t lose the next time. Motive is not always so clear when your landlord hires your brokerage firm after your lease deal is completed.
Example: An example will help illustrate this problem. Let’s present two different hypotheticals. In the first, ABC Company is suing XYZ Company for breach of contract and seeking $100M in damages. ABC Company hires Sarah Smith, Esq., as its attorney and she wins the case by securing a plaintiff’s verdict for $75M. In the second hypothetical, ABC Company agrees to settle the above lawsuit for $75M based on the strong recommendation and counsel of attorney Smith. In both hypotheticals, following resolution of the case, XYZ Company approaches attorney Smith and asks her to represent them in future cases not involving ABC Company.
If you are the General Counsel of ABC Company, do you feel differently under scenario 1 and 2 when told by Smith that she will now be representing XYZ Company? In scenario 1, it’s clear that you won the case and the only reasonable explanation for why XYZ Company would be hiring Smith is because she got a better outcome than their attorney did. However, in scenario 2, it’s not so clear. Is Smith’s emphatic recommendation that you settle the case now called into question by the fact that the other side is hiring her? Even if it was the right risk assessment and Smith’s legal judgment was unassailable, wouldn’t the General Counsel now have no choice but to wonder about the objectivity of the advice? Is Smith being rewarded by XYZ Company for engineering the settlement? Certainly, XYZ Company had to shell out $75M; however, maybe they were very worried that it could have been a lot worse.
Brokerage is a lot more like hypothetical 2 in the foregoing paragraph. Assume a broker negotiates a 100,000sf lease on behalf of a tenant to take half of a building. Two months later the landlord engages the tenant’s broker to be the listing agent on this Tenant’s building as well as two of its other properties. Even if the tenant’s broker negotiated a very strong deal for its client, the lease created significant value for the landlord and may have turned a distressed investment into a viable one. Like with the hypothetical involving the litigation settlement, it’s not clear that there was a winner or a loser in this lease transaction, therefore, it’s not entirely clear why the landlord engaged the broker after the fact. Was the engagement an acknowledgement that the landlord was very impressed by the performance of the tenant’s broker or firm or is it a reward for bringing the landlord a very valuable deal that still had some fat in it?
When the landlord hires the tenant’s broker after they conclude a lease deal, it creates two major problems for the tenant. First, it raises doubt about the broker’s objectivity and loyalty during the transaction and, therefore, creates questions about whether the lease deal was really as good as the tenant thought it was. Second, the tenant’s broker now works for the landlord. That means when it comes time to renew its lease, its broker is completely conflicted and can no longer, credibly, represent the tenant.
Most tenants hire a broker because they want to make sure they are getting the most aggressive economic terms on their lease deal. For many companies, real estate can represent one of its largest line item expenses. Thus, lease negotiations can have a major impact on a company’s bottom line. Because leasing is a zero-sum game between the respective economic interests of the landlord and tenant, the tenant needs to know that its broker’s loyalties are not compromised.
Unfortunately, in full service brokerage (where a firm represents both landlords and tenants), every tenant transaction represents an opportunity for the broker to impress the landlord or curry favor with them for future business. Even if the broker does not currently represent that landlord, you can be 100% sure that it would love nothing more than to represent the landlord in the future because that’s where the real money is. Whereas most tenants only need a broker’s services once every five or 10 years, landlords need their services every day. This inherent tension between what is best for the tenant and what is best for the broker’s long term financial interests creates problems for the tenant client regardless of how the broker resolves the internal conflict. Once the tenant’s broker is hired by the landlord—regardless of the reason– the tenant is left to wonder.
Conclusion
Following a major lease transaction, it is not uncommon to see the landlord engage the tenant’s broker (or brokerage firm) as a listing agent, sales agent or managing agent either on the building in question or some other assets in the landlord’s portfolio. The problem for a tenant in these situations, just as it was for the General Counsel in our above example, is that it may now be left to wonder about the objectivity of the advice it received and the merits of the deal it agreed to. The legal profession prohibits conflicts of interest (unless expressly authorized by the parties) so that clients never have to second guess their decisions. Unfortunately, because no such protections exist in brokerage, tenants are too often left wondering and with a bad feeling.
For more information contact Glenn Blumenfeld