Circular on Contracts, Settlement, and Client Fund Handling in Real Estate Brokerage

Circular Contracts, Settlement and Client Fund Handling in Real Estate Brokerage

CIRCULAR: 7/2014 DATE: 27.06.2014 THE CIRCULAR APPLIES TO: Real Estate Brokerage Firms Lawyers engaged in real estate brokerage

FINANS TILSYNET (The Norwegian Financial Supervisory Authority) Postboks 1187 Sentrum 0107 Oslo

Contracts, Settlement and Client Fund Handling in Real Estate Brokerage 2 | Finanstilsynet

1 Introduction This circular concerns the broker's duties in connection with the completion of the real estate transaction (contract and settlement), the handling of client funds, and the organization of the settlement function. The circular replaces previous circulars 9/2007, 6/2010, chapter 3 of circular 21/2011, and chapter 2 of circular 12/2012. With effect for mandate agreements entered into from 1 July 2014, certain new provisions regarding client funds and settlement have been adopted following amendments to the Real Estate Brokerage Act and Regulations.1

Pursuant to Section 6-9, third paragraph, of the Real Estate Brokerage Act, the broker is required to establish legal protection for the buyer's acquisition before the purchase price is disposed of on behalf of the seller. Certain exceptions to this are set out in the new provision in the Real Estate Brokerage Regulations Section 6-5.2

The previous provision in the Real Estate Brokerage Regulations Section 3-9 is repealed and carried over into the Real Estate Brokerage Act Section 3-2 regarding entrusted funds. The third paragraph is new and regulates the relationship to creditors' rights of satisfaction regarding the purchase price on the broker's client account. The provision states that the purchase price is exempt from creditor seizure until the conditions between the parties for release are fulfilled. This means, for example, that if the seller's creditors seize the property before legal protection has been established for the buyer and the buyer's lender respectively, these creditors will have priority rights to the deposited purchase price.

If a real estate brokerage firm or a lawyer loses the right to conduct real estate brokerage, the Financial Supervisory Authority has the power to freeze the client account, appoint an administrator to complete ongoing transactions, and grant this administrator disposal rights over the client funds.3 By adding to the Real Estate Brokerage Regulations Section 3-11, fifth paragraph, the Financial Supervisory Authority is also given the power to dispose of security bonds and similar instruments in such situations.

The basis for the guidelines in this circular is partly shown in the footnotes, and otherwise follows from the requirement for prudent risk management and internal control4 or from the provision on good brokerage practice in the Real Estate Brokerage Act.5

A broker may only undertake settlement assignments where the agreed settlement terms do not conflict with the regulation of the broker's duties. In the case of forced sales, the regulation and guidelines apply only to the extent that the matter is not regulated by the Enforcement Act.6

1 Act of 29 June 2007 No. 73 on real estate brokerage (Real Estate Brokerage Act) and Regulation of 22 November 2007 No. 1318 on real estate brokerage (Real Estate Brokerage Regulations) 2 Regulation of 26 June 2014 on amendment to the regulation on real estate brokerage 3 Real Estate Brokerage Act Sections 8-2, third paragraph, and 8-3, second paragraph 4 Regulation of 22 September 2008 No. 1080 on risk management and internal control 5 Real Estate Brokerage Act Section 6-3 6 Cf. especially the Act's Section 11-38, first paragraph, regarding payment of the purchase price

Contracts, Settlement and Client Fund Handling in Real Estate Brokerage Finanstilsynet | 3

The provisions regarding the broker's duties concerning contracts and settlement, cf. points 2 and 3 in the circular, are non-derogable when brokering commercial property.7 The same applies to the competence requirements mentioned in connection with the organization of the settlement function,8 cf. point 5. Rules regarding the handling of client funds etc., cf. point 4, are non-derogable.

2 Creation of Purchase Contract Unless both parties wish otherwise after a deal has been concluded, the broker shall create a written purchase contract between the parties in at least three copies, one for each party and one for the broker's archive.9 The contract may be created electronically if both parties consent to this.10

The contract shall be balanced and contain all essential terms for the transaction, including terms for the financial settlement between the parties, cf. point 3.11 It is not permissible to include onerous terms in the purchase contract that have not been approved by the parties through bid/acceptance or subsequent supplementary agreement.

Non-derogable legislation limits what can validly be agreed upon between the parties. The sale of housing under construction from business operators to consumers is regulated by statutory provisions that cannot be derogated from to the detriment of the buyer.12 In other sales of new housing from business operators to consumers, certain provisions of the Sales Act apply correspondingly.13 The sale of so-called contract positions is also subject to special regulation, depending on whether the seller is a consumer or is reselling as part of business operations. Reference is made otherwise to points 3.3 and 3.4 below.

Within the non-derogable frameworks, it may also be contrary to good brokerage practice to broker agreement terms that deviate from the standard arrangement in the contract laws. Under any circumstances, the broker's duty to inform is heightened regarding terms that deviate from the contract law's standard arrangement. The broker must be able to document their information and advice to the parties.

3 Execution of Settlement 3.1 General The broker shall ensure a correct settlement and ensure that neither party is exposed to financial risk in connection with the settlement. Except when brokering commercial property, the broker may not in the agreement with the client waive responsibility for the execution of the financial settlement.14

The broker must map out at the time of entering into the mandate whether there are special circumstances regarding the assignment that affect the settlement. This primarily concerns what is registered in the land register, but also other circumstances regarding the client's financial situation of which the broker is aware.

The main rule for the settlement of the purchase price between the parties is that no part of it may be disposed of on behalf of the seller before legal protection for the buyer's acquisition has been established.15 This also applies to the redemption of the seller's loans and the covering of the broker's remuneration and expenses.

For real property registered in the land register, legal protection is established when the legal act is entered into the land register. In the case of the transfer of rights that are not registered in the land register, for example shares, legal protection is established by notification to the company, or potentially the company's managing director.16

The provision implies that the broker, in sales under the Sales Act, cannot facilitate terms stating that the buyer shall pay an advance on the purchase price. The rules are, however, not an obstacle to agreeing within the framework of derogable contract law that the buyer shall provide security for their fulfillment of the purchase agreement.

The possibility to derogate from the main rule is limited, cf. point 3.3.

3.2 Disposal of Client Funds The broker's disposal of deposited purchase price and other client funds presupposes an agreement basis.17 This can be: • the purchase agreement between the parties, which normally builds on the sales prospectus, bid, and acceptance • supplementary agreements between the parties, such as handover protocol, agreements on deposit, etc. • special payment conditions set by the buyer or on behalf of the buyer • payment conditions set by the buyer's lender (guarantee liability) • the mandate agreement between the broker and the client • the settlement schedule (-power of attorney) from the seller

Before the broker establishes legal protection and disposes of the purchase price, the broker must ensure that there is documentation that all conditions for the transaction have been fulfilled. All agreements and powers of attorney must be in writing and signed by person(s) authorized for the relevant dispositions.

The broker may not cover their remuneration from client funds without consent from the client.18 Such consent can only be given after the deal has been concluded. Advance consent (for example in the mandate agreement) cannot be given.

To ensure that existing monetary encumbrances on the property that are not to be taken over by the buyer are deleted in the land register, the broker must as a starting point obtain the mortgage document cancelled for cancellation, before the purchase price is disposed of on behalf of the seller and used to redeem the underlying monetary claim. However, it will normally be prudent to make payments against a guarantee declaration from the mortgage holder regarding the deletion of the mortgage when the mortgage holder is financial institutions that have permission to conduct such business in Norway. The same applies where the state or municipality is the mortgage holder. The broker must, however, have previously obtained a written statement from the mortgage holder regarding the remaining balance and interest/expenses.

The broker's right to insurance coverage may imply additional requirements for settlement routines.

3.3 Exceptions to the Requirement for Legal Protection Registration Before Disposal of Purchase Price The main rule regarding the requirement for legal protection before disposal of the purchase price can be derogated from when brokering property located abroad.19 The general duty to conduct a secure settlement in accordance with good brokerage practice applies in these cases as well.

In the sale of housing under construction to a consumer, advance payment can be agreed upon, but only against the seller providing a primary obligor guarantee for the disbursed amount, cf. point 3.4.20

Furthermore, there is a possibility to agree on derogation from the requirement for legal protection if there are circumstances on the buyer's side that prevent such establishment within a reasonable time.21 This can, for example, be missing consent or other approvals necessary for the legal protection registration, which are agreed to be the buyer's risk. In these cases, a security bond must normally be registered or other security established for the purchase price.

The main rule regarding legal protection registration before payment of the purchase price does not apply if the buyer has conditioned the receipt of a deed document that is not registered, normally a blank deed (unregistered deed, signed by the owner, but with "blank" buyer).22 The broker must then document that information about the risk has been communicated to both parties, and that the parties have accepted the risk in the transfer without transfer of title.

3.4 Settlement of Housing Under Construction In agreements covered by the Housing Construction Act, the seller is required to provide a primary obligor guarantee for the fulfillment of the agreement.23 The guarantee must be provided immediately after the agreement is entered into, regardless of when the purchase contract is signed. The seller may not wait until any reservations are clarified.24 The broker must ensure that the guarantee is provided in due time. If the seller does not provide the guarantee after the broker's urging, the broker is required to inform the buyer as soon as possible about the seller's failure to fulfill and the buyer's rights as a result of this.25 The buyer has the right to withhold the entire remuneration until it is documented that a guarantee exists in accordance with the provision.26 The broker may therefore not collect payment of any part of the purchase price before the guarantee is provided.

In addition to the guarantee mentioned above, the seller must provide a special primary obligor guarantee if part of the purchase price is to be disposed of for the benefit of the seller before the buyer obtains title to the property.27 The guarantee amount shall correspond to the amount disbursed, and the guarantee cannot be released until the buyer has obtained title to the property. Until the guarantee is provided or the title is transferred to the buyer, the buyer has the right to instruct regarding the purchase price on the broker's client account, even if the buyer has taken over the apartment.28

The broker must ensure that the guarantor is an approved financial institution29 and that there are no restrictions in the contractual relationship between the seller and the guarantor that contradict the requirements of the Housing Construction Act. It is recommended that the guarantee document gives a general reference to the relevant provision in the Housing Construction Act. The original guarantee document belongs to the buyer. If the document is kept by the broker (on behalf of the buyer), the requirements regarding entry in the deposit journal and secure storage apply.30

If the seller is to deliver a completed apartment according to the agreement, the broker is required to ensure that a completion certificate exists before handover and settlement take place. The client (sales broker) is also responsible for such control, even if the settlement is outsourced to an external settlement firm. In addition, the settlement firm has an independent duty to control whether a completion certificate exists before the settlement is executed. This also applies to pure settlement assignments.31

If there is no completion certificate, and it is agreed that handover and settlement shall take place based on a temporary use permit, the broker must obtain this before takeover. If there are remaining works that the seller is to handle, the broker is required to protect the buyer's interest in establishing security for the seller's fulfillment. Normally, this will involve facilitating that the buyer withholds sufficient remuneration or that the seller provides a primary obligor guarantee.32

The broker may not facilitate or participate in housing being put into use in violation of the Planning and Building Act. If the broker is instructed by the parties to execute handover and settlement before the housing can legally be put into use, the broker must inform the parties in writing about any consequences of this, including the risk that a completion certificate may not be issued later and the loss of the right to daily penalties.

3 When the buyer is a consumer and is to pay installments as the building is constructed, title to the property must be transferred to the buyer without other encumbrances on the property than those the buyer is to take over.33 Furthermore, the broker must obtain documentation that the value of work performed on the property, together with materials added to the property, at least corresponds to what is disbursed to the seller at any given time. If an independent appraiser is not used for this, the broker must obtain the buyer's consent before each partial payment.

3.5 Settlement of Contract Positions (Resale Agreements) If the right under an original purchase agreement with a contractor for the construction of new housing is resold from a business operator to a consumer buyer before the housing is completed, the resale agreement is fully regulated by the Housing Construction Act.34 The same rules and guidelines for settlement apply as for housing under construction generally, cf. point 3.4.

The reseller has the same fulfillment responsibility as the original seller, including among other things the duty to provide guarantees based on the purchase price in the resale agreement.

If the resale is from a consumer, only the contract position is considered the subject of the transaction, which is then regulated by the Sales Act.35 The new buyer takes over the reseller's rights and obligations under the original agreement with the seller, and the reseller has no fulfillment obligation regarding the property.

If the buyer is also a consumer, the settlement is specially regulated. Any value added to the contract position may not be paid to the seller until the buyer has taken over the housing and legal protection for this acquisition has been established.36

If the buyer is not a consumer, the principle of performance for performance applies as a starting point, such that the remuneration for the contract position becomes due for payment upon transfer of the contract, and can be paid to the reseller when legal protection for this is established.37 The Financial Supervisory Authority assumes that legal protection for the acquisition is established in the same way as for a mortgage, by notification to the debtor (developer, contractor).38 The purchase price for the property in the original contractual relationship is settled directly between the new buyer and the original seller in accordance with the terms of the sold contract and the guidelines mentioned in point 3.4.

There is no detailed regulation of when the reseller is considered a business operator or a consumer. This raises a special problem where the reseller's original purpose was investment (speculation) and not own housing needs, but without such investment being the reseller's main business. The purpose of giving consumers the right to resell contract positions without having to assume fulfillment responsibility is the need they may have to get out of the agreement due to later changes in family circumstances, employment, or financial capacity.39

The broker must have routines that ensure that resale of housing under construction to consumer buyers does not fall outside the Housing Construction Act to a greater extent than the regulation and its intent suggest. Unless the reseller's original purpose with the purchase was to provide housing for own use, or for use by family members, the transaction should as a starting point be regulated by the Housing Construction Act. Unless the broker has or should have other knowledge about the reseller's circumstances, it can normally be assumed that the reseller's written declaration regarding their purpose with the purchase is correct.

4 Handling of Client Funds 4.1 Bookkeeping, Reconciliation, and Control Client funds shall be placed on a client account at a financial institution in Norway.40

Continuous bookkeeping must at all times show the handling of client funds, as well as the client liability in total and for each individual assignment. Reconciliations of client accounts and client liability shall be performed every month and as soon as possible after the end of the month.41

A complete reconciliation must contain the following documentation:

1. Bank statement showing the balance on the client account in the bank.
2. Extract from the general ledger showing the balance of client funds in the accounts (assets).
3. Setup showing and explaining deviations between no. 1 and no. 2 – the bank statement and the general ledger (bank reconciliation).
4. Extract from the general ledger showing the client liability (liabilities).
5. Setup showing and explaining deviations between the client fund balance and client liability according to the general ledger (liability reconciliation).
6. Balance list showing client liability in the assignments the firm has at the end of the month with marking of any negative balances.
7. Setup explaining the cause of any negative balances in individual assignments.

The documentation shall be kept together. The material is the basis for internal control regarding the handling of client funds. If the reconciliation is documented electronically, it must be clear who performed the reconciliation and the time of this. Any open items/deviations must be corrected within the following month.

The person with professional responsibility in the firm must have continuous control over the handling of client funds and must control the monthly reconciliation material. This also applies where settlement and accounting are outsourced to another firm. As part of the monthly control, the professional responsible should also review and update any powers of attorney. The professional responsible's control must be documented as part of the firm's internal control system.

Lawyers who conduct real estate brokerage by virtue of their lawyer license must keep client funds for real estate brokerage activities on a separate client account for each individual lawyer's real estate brokerage activities.42

4.2 Interest on Client Accounts Client funds shall be placed at the "highest possible interest rate".43 This implies that the broker must regularly, and at least annually, ensure that the interest conditions are market-based. Capitalized interest forms part of the broker's client liability and shall be distributed to each individual assignment.

Interest on client accounts shall be credited in full to the clients and cannot be derogated from by agreement. All deposits to the client account form part of the interest calculation basis, and the actual transaction dates shall be the basis for interest calculation. This also applies to the buyer's possible early payment of the purchase price and expenses. Interest amounts that for the individual client in the same assignment do not exceed half a court fee may, however, be transferred to the broker.

The interest shall be settled and paid out upon completion of the assignment. The client, however, has no claim to the interest until the interest amount has been credited to the client account (capitalized). If the broker chooses to pay interest before capitalization, the amount must be advanced from the brokerage firm's own funds, and refunded when the interest is capitalized on the client account.

The interest amount shall appear in the settlement statement to both the buyer and the seller, cf. point 4.3.

Which party in the real estate transaction the interest belongs to depends on the ownership of the funds. The ownership of the purchase price depends on the time of the transition from buyer to seller. In sales under the Sales Act, the purchase price is the buyer's funds until handover for use.44

After this point in time, the interest belongs to the seller unless otherwise agreed. In sales under the Housing Construction Act, the cut-off point is the time of transfer of title, cf. point 3.4.

Interest on the buyer's deposit to cover document tax and registration fees will always belong to the buyer. The period for this interest calculation will be from the time of deposit until the invoice from the Norwegian Mapping Authority is paid, normally at the due date.

The duty to keep client funds separate from own funds45 limits the broker's ability to keep own funds on the client account. If the broker sets aside funds for a so-called interest buffer, this must be limited to what is necessary to continuously pay out earned, but not capitalized, interest to customers. The amount must appear in the monthly reconciliation material, and the provision must then be adjusted to the level considered necessary to cover the interest payments for the coming period.

42 Regulation of 22 September 2008 No. 1080 on risk management and internal control Section 3-6 43 Real Estate Brokerage Regulations Section 3-10, first paragraph 44 Real Estate Brokerage Regulations Section 3-12 45 Real Estate Brokerage Act Section 3-2, second paragraph 46 Sales Act Section 1-2, second paragraph 47 Housing Construction Act Section 47 and Real Estate Brokerage Regulations Section 6-5, third paragraph 48 Real Estate Brokerage Regulations Section 6-5, first paragraph 49 Real Estate Brokerage Regulations Section 6-5, second paragraph 50 Housing Construction Act Section 12 51 Interpretation statements from the Ministry of Justice and Public Security dated 6 October 2006, 18 May 2011, and 5 September 2013 52 Real Estate Brokerage Act Section 6-3, second paragraph 53 Housing Construction Act Section 12, sixth paragraph 54 Housing Construction Act Section 47 and interpretation statement of 5 July 1999 from the Ministry of Justice 55 Cf. Rt. 2013, page 1541, paragraph 42 56 Bank or insurance company that either has permission from the Financial Supervisory Authority or has reported branch establishment or cross-border business in Norway in accordance with EEA rules 57 Real Estate Brokerage Regulations Section 3-6 58 NOU: 2006: 1 Real Estate Brokerage, page 129 59 Housing Construction Act Section 31 60 Housing Construction Act Section 47 61 Housing Construction Act Section 1 letter b, second sentence 62 Sales Act Section 1-1, fourth paragraph, first sentence 63 Sales Act Section 1-1, fourth paragraph, second and third sentences 64 Real Estate Brokerage Act Section 6-9, third paragraph 65 Mortgage Act of 8 February 1980 No. 2 Section 4-5, first paragraph 66 Prop. 130 L (2009-2010) point 4.4