DRE Defense Attorney Education Series – Legal definition of comingling trust funds.
As a DRE defense attorney (now “BRE” for California Bureau of Real Estate), one of the hottest areas of real estate law right now is property management trust fund accounting. Both random and “complaint-drive” audits continue to dominate the legal landscape. One of the big questions that comes up is “what does it mean to comingle trust funds?” Another question is “what happens if I am found by a trust fund auditor to be comingling trust funds with personal funds? This blog will attempt to address some of the legal issues that can arise in this regard.
What are “Trust Funds?”
One of the most important thing for a California property management company to do in order to take step one in legal compliance is to be able to differentiate “trust funds” from “personal funds.” What is a trust fund?
Under California real estate law a trust fund is money or property maintained for the benefit of others and the control and disbursement of such is to be determined and at the direction of the owner. Common examples of trust funds in real estate include, but are not limited to:
- Security deposits (ex. earnest money deposit on a residential or commercial real estate action)
- Rents received by tenants and delivered to property managers
- Security deposits held by property managers for the benefit of the property owners
- Promissory notes held for the benefit of others
These are but a few examples. In short, a trust fund is money that belongs to other people (not the broker). The owner decides how trust funds are to be disbursed and often a contract or written authorization will dictate what to do with trust funds.
What is the legal significance of money or property being deemed a trust fund?
Real estate brokers who handle trust funds must understand their legal duties and obligations regarding the receiving, handling, and safeguarding of trust funds. In general, the TOP FIVE a broker needs to know about trust accounts are:
1. Trust funds must be held in a trust account that is “designated as a trust account” and thus is beyond the reach of a judgment creditor of the real estate broker. This means, if you have property or money held in a designated trust account, if you are sued and a Plaintiff in a lawsuit or judgment creditor wants to “levy” your bank account, (ex. where a Plaintiff seeks a pre-judgment writ of attachment in a financial elder abuse case against a real estate broker or salesperson) if it is in a “TRUST ACCOUNT” then the money is protected, and the Plaintiff or other creditor cannot seize or levy the money. Another common example of a creditor who might seek to go after broker trust funds is the IRS. If trust funds are held in a proper bank account, then even the IRS cannot seize it. So having a properly designated trust bank account is a common violation we see as many brokers state that their banks did not understand what a trust account was.
2. The bank account should be located in the State of California.
3. Trust funds should be placed in a NON-INTEREST BEARING ACCOUNT. The real estate broker is NOT entitled to receive interest on their Client’s money.
4. The broker needs to keep proper trust fund accounting records. The main types of records being:
a. Separate beneficiary records for each client / property owner
b. General control record indicating all funds coming in and going out of the trust account
c. Monthly reconciliation records
5. The broker should not comingle personal funds with trust account funds
“Compliance with Section 10145 of the Code requires that the broker place funds accepted on behalf of another into the hands of the owner of the funds, into a neutral escrow depository or into a trust fund account in the name of the broker, or in a ficti- tious name if the broker is the holder of a license bearing such fictitious name, as trustee at a bank or other financial institution not later than three business days following receipt of the funds by the broker or by the broker’s salesperson.”
Section 10145 (in part) states:
10145. (a) (1) A real estate broker who accepts funds belonging to others in connection with a transaction subject to this part shall deposit all those funds that are not immediately placed into a neutral escrow depository or into the hands of the broker’s principal, into a trust fund account maintained by the broker in a bank or recognized depository in this state. All funds deposited by the broker in a trust fund account shall be maintained there until disbursed by the broker in accordance with instructions from the person entitled to the funds.
If you are concerned about facing a real estate audit and complying with these code sections, you should review these sections in complete detail. The broker (who has a duty to supervise trust accounting) also has to be aware of issues such as how long you have to get trust funds into your broker account, who can withdraw, and the 25 day rule for withdrawing personal funds from the trust account.
In regard to the broker’s fiduciary duty to avoid comingling, it is important to understand what the term comingling actually means, and how it is defined under the law. Generally speaking, comingling of trust funds is prohibited by California Business & Professions Code Section 10176(e) which prohibits:
“(e) Commingling with his or her own money or property the money or other property of others which is received and held by him or her.”
Basically, this rule means:
1. A broker cannot conduct personal business through his trust account (i.e. do not deposit your personal broker funds into a client trust account). This will result in a charge of comingling funds. A broker is allowed to have no more than $200 personal funds in the trust account to pay for routine account fees.
2. “Trust funds” should not be deposited into a client’s general business account or personal account.
3. Property management fees or other fees or commissions earned by the broker should be removed from the trust account within 25 days from the date such funds are earned (often called “the 25 day rule”).
Any of these types of violations can trigger an accusation and result in license discipline action by the Commissioner’s office.
Non-interest bearing accounts
Section 10145 of the Cal Business & Professions Code (cited above) states: “(5) Interest earned on funds in the account may not inure directly or indirectly to the benefit of the broker or a person licensed to the broker.”
This section appears to indicate that “interest” earned on trust funds cannot benefit the property manager or other real estate broker. One question that has arisen in the past is whether a bank analysis “credit” (ex. a reduction in banking fees) violates BRE trust fund accounting rules? This is an open question, but since it is not technically a “interest” payment the broker is being paid or earning, this might be acceptable. However, the point is that the broker should not benefit financially by earning interest on property owner funds.
What happens if I have violated one of the California BRE trust fund accounting rules, will I lose my real estate or NMLS lending license (MLO)?
Getting a property management audit letter and/or having a formal accusation filed against you is not the end of the world. We have helped many California real estate brokers and salerpersons in defending their real estate licenses and to avoid loss of the license. In some cases, real estate compliance violations involving trust funds can be resolved in a “cite and fine” case, where fines up to $2,500 can be imposed, along with the “reasonable costs of the audit” and costs of investigation. These are things we can help you try to negotiate and we do our best to avoid a formal hearing with the OAH (Office of Administrative hearings). Here is a video of possible outcomes of a DRE accusation and an overview of the BRE real estate accusation process. Contact us for a free 15 minute consultation.
California Real Estate Trust Fund Accounting Compliance Resources
Contact a California DRE Defense Lawyer
For more information about our broker compliance and accusation services, including broker self-audits, accusations, real estate licensing issues, or other real estate arbitration or litigation matters contact us at (877) 276-5084. We offer flexible fees, including affordable flat rate legal fees. You may also fill out the form below to have one our our real estate lawyers contact you. Please leave you phone number and best time to call you.
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