§ 29A.04 The Calculation of Commission

• Jurisdiction: United States
• Publication year: 2022

§ 29A.04 The Calculation of Commission

Even before addressing the calculation of commissions, it is important to clearly state in the brokerage agreement when commissions are earned. In New York, for example, unless stated otherwise in writing, commissions are earned when the broker produces a party "ready, willing and able" to lease the property. Such a subjective standard should be avoided. Instead, the party hiring the broker should insist on language stating that the commission is not earned until the lease is executed. For example:

"Notwithstanding anything in the Agreement to the contrary, all commissions are earned and payable by the Company only upon execution and delivery of a lease [or other transaction contemplated by this Agreement]."

The company hiring the broker may want to include further limiting language, reserving the "right to reject any offer presented to it, regardless of price, for any reason or for no reason."¹ The company hiring the broker should also include a limitation stating that the commission is not earned if the new lease is merely the result of the company undergoes a merger, reorganization or assignment (or sublease) of its lease to a subsidiary or parent or some other such transaction resulting in a change of title to the property. For example:

"Broker shall not be entitled to any commission in the event the Property is transferred pursuant to a merger, consolidation, reorganization or dissolution of the Company, or a sale or exchange of all or substantially all of the assets of the Company, or by operation of law or the sale or exchange of all of the [corporate stock, membership interests, partnership interests] of the Company."²

[1]—Base Rent

In the case of a sale, commission is usually based on a percentage of the sale price. The commission in leasing transactions, on the other hand, is usually based on the lease rent. However, there are several other possible choices. Differing factors can affect the negotiation, depending first of all on whether a short-term or a long-term lease is involved. The amount of rent payable under a long-term lease, or the amount payable for an expensive location can actually exceed by far the sale price of many properties. Therefore, the question arises on what should a reasonable commission be based. In general, brokers initially expect their commission to be based on the entire amount of rent payable for the whole term of the lease. This amount, however, especially if it is expected to be paid all at once, could be large enough to adversely affect the landlord's ability to finance or operate the property. The landlord, therefore, will seek to limit the basis for the commission and also to negotiate its payment in installments. Sometimes, the commission payments are pegged to the receipt of rent from the tenant, either as received monthly or payable annually or quarterly and conditioned on the tenant paying all amounts due during such period. In this type of arrangement the tenant is, in effect, financing the landlord's commission obligation. The language of the brokerage agreement often dictates the outcome of later litigation. In a case where the broker was collecting commission out of the subtenant's monthly rent and the sublease was terminated in connection with the purchase of the fee interest by the subtenant, the court decided that the broker was owed the balance of the entire commission since the brokerage agreement did not make the subtenant's monthly payment of rent a condition to the payment of the commission.³

The landlord may try to limit the basis on which commission is calculated by limiting the length of the lease term on which the commission is based. This is almost impossible to do in the case of short-term leases. When a longer term is involved, however, the landlord can point out that the risk of the tenant defaulting increases over time, so that it is reasonable to base the commission on only a portion of the actual lease term, or on a decreasing rate over the length of the term.

Another factor to calculate into the commission formula is lease rent increases or "step-ups" over the lease term. These factors illustrate some of the complexities that can affect commission calculations. Close attention must be paid when applying the formulas and calculating commissions. Mistakes can be costly. Determining which factors to consider and which formula to apply will make all the difference. For example, while a landlord may think that application of a decreasing commission rate to the rent over the lease term will save him a lot of money, such savings may well be offset by rent step-ups over the same period.

[2]—Additional Rent: Reimbursement of Landlord's Costs

Other charges payable under a lease often include reimbursements of landlord expenses incurred to operate and maintain the property and provide services to the tenant. These can include such items as real estate taxes, insurance premiums, common area charges, operating expenses, and utilities. As many lease negotiators well know, however, these expense "reimbursements" often are transformed by landlords into profit centers. If these charges merely reimburse the landlord for costs, then there is no basis for them to be included in the calculation of a broker's commission. The landlord does not derive a profit. Moreover, such charges for the most part are not calculable when the lease is executed. Commission payments based on such charges would have to be structured and calculated periodically after such lease charges have been determined. The broker, however, could take the reasonable position that the reimbursement of such charges, although not providing a profit, nevertheless constitutes an economic benefit to the landlord, and so rightly forms some basis on which commission should be calculated. Payment of real estate taxes does benefit the landlord since he passes through the expense and thus saves money. However, while maintenance and other costs increase with the number of occupants in a building, often the costs increase minimally with each tenant. With only one tenant the landlord still has to maintain the landscaping, elevator service and have an attendant in the lobby, etc. Other than a small increase in cost for...