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In a recent decision, the Supreme Court gave the New Jersey brokerage community new ammunition in its quest to collect leasing commissions. The decision is also a cautionary tale for attorneys and buyers of commercial property. Henceforth, the buyer who does not directly confront the status of leasing commissions during due diligence may discover that it has unwittingly assumed the obligation to pay them after closing.

In Pagano Company v. 48 South Franklin Turnpike, LLC, the seller of commercial property delivered a general assignment of lease agreements that was silent as to the obligation to pay commissions after closing. The broker later sued the buyer for unpaid commissions. The buyer defended on the grounds that it was not a party to the commission agreement and that it never assumed the seller’s obligation to pay commissions to the broker.

In a groundbreaking decision, the Supreme Court departed from well established law that states a buyer of commercial property will not be liable for leasing commissions unless it affirmatively assumes the obligation to pay them. The Supreme Court rendered this decision in 1994 in VRG Corp. v. GKN Realty Corp. By virtue of this holding, the Appellate Division in Pagano dismissed the broker’s claim against the buyer. In reversing, the Supreme Court reviewed the circumstances surrounding the transaction and concluded that the buyer had indeed affirmatively assumed the obligation to pay the commissions.

In Pagano, the lease agreements identified the broker and provided that the lessor would be responsible to pay the broker pursuant to a separate commission agreement. The lease agreements also contained an assignment provision, making them binding upon the lessor and its assigns. At closing, the seller executed a general assignment of all lease agreements for the property. Significantly, the buyer reviewed the lease agreements during due diligence but never requested additional information about the broker identified in the leases.

Under these facts, the Supreme Court concluded that the buyer had assumed the obligation to pay the broker because the assigned lease agreements expressly referenced the obligation to pay commissions, the buyer had reviewed the lease agreements during due diligence and both the contract of sale and the title closing documents failed to carve out commissions from the deal. Effectively, the Supreme Court penalized the buyer for failing to inquire about the status of commissions during due diligence–particularly after reviewing the lease agreements–but then accepting a general assignment of those lease agreements at closing, which included the obligation to pay commissions. Under such circumstances, the Supreme Court concluded that the buyer had affirmatively assumed the obligation to pay leasing commissions to the broker.

Pagano is important because a buyer can now be held liable to pay leasing commissions even without an express written assumption of that obligation. Under Pagano, a court will review the totality of the circumstances to determine whether this obligation was transferred at closing. Under this analysis, a general assignment of lease agreements can now be interpreted as having transferred the seller’s obligation to pay leasing commissions.

What, then, is the lesson to be learned? For brokers, Pagano illustrates the critical importance of including in all lease agreements a clause that expressly identifies the broker and recites who is responsible for paying the commission. While it would be helpful to also recite the commission amount, most landlords are reluctant to include such information. But a recitation that the landlord will pay the broker pursuant to a separate commission agreement should be sufficient to transfer the obligation to a buyer who assumes the seller’s rights and obligations under those lease agreements. After Pagano, the courts will no longer favor a buyer who reviews lease agreements containing such language during due diligence, but then fails to affirmatively disclaim any obligation to pay commissions at the closing. Ignorance, whether willful or negligent, will no longer be rewarded.

As for buyers and their attorneys, they should make a concerted effort to inquire about the existence of commission agreements and the status of leasing commissions for both the original lease term and renewals. The contract of sale should include representations on this issue, and lease agreements must be carefully scrutinized during due diligence. The Supreme Court has squarely placed this burden on the buyer. Even if a lease agreement does not identify a broker, or if there are tenants with oral agreements, the buyer must still make the inquiry. If there is a tenant, there may be a broker; and if there is a broker, there will probably be an obligation to pay commissions.

Having made the inquiry, the buyer must also exercise prudence with respect to the title closing documents. Liability for leasing commissions must be addressed. If the buyer does not intend to assume the obligation to pay leasing commissions after closing, this understanding must be clearly spelled out in the contract of sale, if possible, and certainly in the closing documents, particularly any assignment of lease agreements. Under the new “totality of the circumstances” approach, the only surefire way to avoid liability for leasing commissions is to clearly disclaim this obligation in writing at the closing.

Pagano should not be interpreted as a rule that leasing commissions run with the land, or that the obligation to pay leasing commissions automatically follows an assignment of lease agreements. Parties to a transaction remain free to allocate this obligation and to negotiate how a broker will be paid, even for renewals. The key is for such an agreement, whatever it may be, to be memorialized in writing as part of the closing documents.

Real estate practitioners are familiar with the concept of the “innocent purchaser,” particularly in the environmental context. Similarly, for a buyer to be cloaked with such protection in the leasing context after Pagano, the buyer will need to create a record that clearly demonstrates it was not the intention of the parties for the buyer to assume the obligation to pay leasing commissions after the closing.

For brokers interested in safeguarding their commissions, it is now more critical than ever to be expressly recognized and identified in lease agreements, and for those lease agreements to recite either the commission amount or that it will be paid pursuant to a separate commission agreement. By taking such precautionary measures, brokers should no longer be left empty-handed when lease agreements are renewed and the new landlord refuses to pay the commission.

Craig Alexander is an attorney with Mandelbaum Salsburg in West Orange. He can be reached at 973-736-4600 or emailed at [email protected] The views expressed in this article are the author’s own.

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