Co-Author: David A. Farus, Esq.
This article explains the RESPA exception for Affiliated Business Arrangements (ABA’s). Another article on our site explains the exception for Payment for Services Actually Rendered.
Question: I own a real estate brokerage firm. Mortgage companies and others profit from the business I refer to them. Does RESPA prohibit me from receiving referral fees from mortgage companies?
Response: Yes, but there are at least two business models that allow you to capture some of the benefit from your referrals.
General RESPA Prohibitions
RESPA regulatory requirements apply to transactions that may involve a loan on residential real estate. RESPA generally prohibits payment of referral fees, unearned fees or kickbacks, as well as the splitting or sharing of fees or charges made or received for providing “real estate settlement services.”
The terms “federally related mortgage loan” and “settlement services” are both broadly defined. Virtually any institutional residential loan will be a federally related loan. “Settlement services” include:
any service provided in connection with a real estate settlement including, but not limited to, the following: title searches, title examinations, the provision of title certificates, title insurance, services rendered by an attorney, the preparation of documents, property surveys, the rendering of credit reports or appraisals, pest and fungus inspections, services rendered by a real estate agent or broker, the origination of a federally related mortgage loan (including, but not limited to, the taking of loan applications, loan processing, and the underwriting and funding of loans), and the handling of the processing, and closing or settlement
Absent some other “saving” provisions or exceptions, payments from the mortgage company to the builder for referrals are prohibited.Affiliated Business Arrangements. RESPA has particular provisions and regulations relating to affiliated business arrangements between real estate brokerage firms and affiliated mortgage companies or other settlement service providers, where there is a 1% or more common ownership between the companies. A referrer (who is a settlement service provider) may refer to affiliates (who are settlement service providers) if all of the following three requirements are satisfied:
(1) Disclosure/notice is given to the consumer at or before the time each referral is made (or, if the referral is made by a lender to a borrower, by the time the good faith estimate of closing costs is provided), in the form prescribed by the regulations;
(2) The consumer is not required to use any particular provider of settlement services (that is, the consumer is not steered or required to use an affiliated entity providing mortgage or other settlement services); and
(3) The only thing of value that is received from the arrangement (other than reasonable payments for goods, facilities or services actually furnished) is a return on the ownership interest (such as corporate dividends or LLC distributions, as applicable, in accordance with the owners’ percentage ownership interests).
An Affiliated Business Arrangement Disclosure Statement form should be developed and used to comply with the first of these three requirements. If the referral is made verbally, then the written disclosure must be given to the consumer within 3 business days after the referral, and in such case an abbreviated verbal disclosure of the existence of the arrangement and the fact that a written disclosure will be provided within 3 business days must be made to the consumer during the telephone referral. The disclosure form in any situation must be a separate document, and not combined with other forms. The consumer should be asked to sign a receipt or acknowledgment of the disclosure; and if the consumer refuses to sign the acknowledgment of such disclosure, that fact should be noted in the records maintain by the referor regarding such referrals. The RESPA regulations require that the referor retain each signed disclosure document for 5 years after its execution.
With respect to the second of the three requirements, the disclosure form will provide some assistance, in that it will contain a notice stating something like this: “You are NOT required to use [the specified affiliated service provider] as a condition for purchase, sale, or refinance of the subject property.” The reality, however, needs to track that advisement.
The last of the three criteria means that this “exemption” for affiliated business arrangements allows referrals between affiliated businesses, but does not create a mechanism for the payment of referral fees between affiliated businesses. Payment of referral fees between a real estate brokerage firm and its affiliated mortgage company is still prohibited. With respect to this third requirement, the RESPA regulations state that a return on ownership interest does not include payments that vary by the amount of actual, estimated or anticipated referrals or payments based on ownership shares that have been adjusted on the basis of previous referrals. In addition, when assessing whether a payment is a return on ownership interest or a payment for referrals of settlement service business, HUD will consider the following questions:
(1) Has each owner or participant in the new entity made an investment of its own capital, as compared to a “loan” from an entity that receives the benefits of referrals?
(2) Have the owners or participants of the new entity received an ownership or participant’s interest based on a fair value contribution? Or is it based on the expected referrals to be provided by the referring owners or participant to a particular cell or division within the entity?
(3) Are the dividends, partnership distributions, or other payment made in proportion to the ownership interest (proportional to the investment in the entity as a whole)? Or does the payment vary to reflect the amount of business referred to the new entity or a unit of the new entity?
(4) Are the ownership interests in the new entity free from tie-ins to referrals of business? Or have there been any adjustments to the ownership interests in the new entity based on the amount of business referred? Responses to these questions may be determinative of whether an entity meets the condition of the [affiliated business arrangement] exception.
Sham Affiliated Business Arrangements
Compliance with the three conditions discussed above does not necessarily end the analysis regarding affiliated business arrangements. HUD has said that “Congress did not intend for the controlled business arrangement…amendment [now referred to as the affiliated business arrangement exemption] to be used to promote referral fee payments through sham arrangements or shell entities…,” and in itsStatement of Policy 1996-2, Regarding Sham Controlled Business Arrangements, 61 F.R. 29258, at 29261 (1996), HUD listed the following factors that it will consider and balance in determining whether a joint venture created by two existing settlement service providers, is a bona fide provider of settlement services, or a sham entity designed to facilitate payment of illegal fees and thus not entitled to the benefit of the affiliated business arrangement exemption:
(1) Does the new entity have sufficient initial capital and net worth, typical in the industry, to conduct the settlement service business for which it was created? Or is it undercapitalized to do the work it purports to provide?
(2) Is the new entity staffed with its own employees to perform the services it provides? Or does the new entity have “loaned” employees of one of the parent providers?
(3) Does the new entity manage its own business affairs? Or is an entity that helped create the new entity running the new entity for the parent provider making the referrals?
(4) Does the new entity have an office for business which is separate from one of the parent providers? If the new entity is located at the same business address as one of the parent providers, does the new entity pay a general market value rent for the facilities actually furnished?
(5) Is the new entity providing substantial services, i.e., the essential functions of the real estate settlement service, for which the entity receives a fee? Does it incur the risks and receive the rewards of any comparable enterprise operating in the market place?
(6) Does the new entity perform all of the substantial services itself? Or does it contract out part of the work? If so, how much of the work is contracted out? (7) If the new entity contracts out some of its essential functions, does it contract services from an independent third party? Or are the services contracted from a parent, affiliated provider or an entity that helped create the controlled entity? If the new entity contracts out work to a parent, affiliated provider or an entity that helped create it, does the new entity provide any functions that are of value to the settlement process?
(8) If the new entity contracts out work to another party, is the party performing any contracted services receiving a payment for services or facilities provided that bears a reasonable relationship to the value of the services or goods received? Or is the contractor providing services or goods at a charge such that the new entity is receiving a “thing of value” for referring settlement service business to the party performing the service?
(9) Is the new entity actively competing in the market place for business? Does the new entity receive or attempt to obtain business from settlement service providers other than one of the settlement service providers that created the new entity?
(10) Is the new entity sending business exclusively to one of the settlement service providers that created it (such as the title application for a title policy to a title insurance underwriter or a loan package to a lender)? Or does the new entity send business to a number of entities, which may include one of the providers that created it?*****
Many of the themes of RESPA conflict with the instincts of real estate brokers who are used to receiving referral fees for work referred to other brokers (permitted under a specific RESPA exception). In a competitive market, aggressive settlement service providers push the RESPA envelope. The cat-and-mouse game between the regulators and aggressive competitors make the rules complicated. Each situation is different. Brokers should consult their own attorneys before accepting fees for services or entering into an affiliated business arrangement.
A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.