The Big Kickback?!

 

Over the past several months the Firm has received several inquiries from concerned Agents and Brokers questioning the legality of proposals they have received to join an affiliated business/joint venture arrangement for the purpose of referring settlement services to their customers. We are not at all surprised by this as we often see new title companies and this type of proposed arrangement resurface time and time again during hot real estate markets and the current market is red hot.

An affiliated business/joint venture arrangement exists when a person in a position to refer settlement business, such as a real estate broker, or agent, has an affiliate relationship or a direct beneficial ownership interest in a title agency. The expectation is that agents will refer real estate clients to their jointly owned title company and in return share in the profits of the business. This model has been around for a long time and is heavily regulated. For that reason, it is vital that agents fully understand what they are getting themselves into so that they can avoid somewhat severe sanctions.

There are two basic considerations. The first is whether the venture is RESPA compliant, and the second involves typical business and legal considerations.

RESPA: The general rule of Section 8 of RESPA prohibits a person from giving or accepting anything of value in exchange for the referral of settlement service business, with limited exception. This concept is fairly well understood throughout the industry and the rule is designed to prevent agents from steering their clients to certain vendors for compensation. The exception is that a real estate broker or agent who has an interest in a title company or some other service provider can refer a client or customer to that entity and not violate RESPA, but only if the following requirements are met:

1. Upfront, written mandatory disclosure statement is required;
2. Use of affiliated title business must not be required; AND
3. There can be no compensation to the referring party other than return on an ownership interest or other payment permitted by RESPA.

It is this last requirement that usually creates the major issue. If an agent is being promised a return based upon the number or amount of referrals to the title agency, that is likely a RESPA violation. The only thing of value that can be received by an agent from the title agency is a return on the actual ownership interest or franchise relationship between the affiliated providers. So if the title business is suggesting that your return will be based upon your referrals and nothing else, run away fast. You are headed for big trouble.

GENERAL BUSINESS CONSIDERATIONS: Whenever anyone is considering entering into a business relationship, you need to know what you are getting into and with whom. Some of the more important considerations include:

1. Who is running the business and what are their qualifications? Have you minimized your risk of a negligent referral, which risk is heightened when you are referring to your own title agency?

2. What sort of insurance will the title business maintain and will it protect you?

3. How and when are other partners admitted or removed and will you have a say in those decisions. It is your partners who will dictate your return if any. Remember you can only be compensated based upon the overall performance of the title business, and not your individual contributions to the business. In other words, your partners are extremely important and if they underperform, so too will your returns, if any. So ask yourself, who are or will be my fellow partners? If you are one of the first in, will you be able to control the others who follow? Also, this means you cannot be compensated on a per deal basis that is tied to the transaction or title premium that is referred in.

4. What are the economics of the title business and how/when do you get paid? You were probably presented with glossy high-level representations about the business, but were you provided with enough information to do a truly deep dive into the economics of the business. For example, how do the people running the business get paid, and is their compensation fair and reasonable? Who owns the building that the business will be operating out of and is rent fair and reasonable. Will the business also be servicing other title agencies and if so, will you be able to track that? Will any partners get paid before me, and if so who and how much. Remember, you cannot and will not get paid until all of the expenses of the business first get paid. And it’s not cheap to run a quality title business!

5. What happens if the title business is underperforming? Are you prepared to make capital calls to subsidize the business (and if you are being told you do not have to, that could be a RESPA violation)? Will you have any input as far as cutting expenses in lieu of capital calls?

6. How do you ensure that each member is contributing equally and/or fairly to the title business so that no one agent is receiving a disproportionate share of the profits against their referrals to the title business?

7. What happens if a member stops referring to the title business? RESPA still requires that partner to receive its share of the profits of the business, if any.

8. Will there be referral requirements, and if so, how does the title business plan to get around CFPB rules preventing that? If a member can be removed for not referring business (or not referring enough business), that is akin to requiring the member to refer business to the title business. And that’s a big legal problem.

9. Will the partners in my title business be restricted from owning or operating competing title businesses or commingling resources from your title business with another title business? If not, how does the business address that conflict of interest in a way that is completely transparent?

10. Will you have any input as far as the operations of the business, such as decision-making concerning loans, capital calls, office locations, the timing of distributions, staffing issues, capital expenditures, incurring or limiting expenses, and/or admission or removal of partners?

11. How can you remove yourself from an underperforming business or a business that did not perform as represented. Are you stuck or is there an easy mechanism to withdraw?

12. Was there a legitimate “buy-in” to purchase membership units in the business and was the amount paid based on the actual value of the units? If not, the gifting of membership units is likely a violation under RESPA.

13. Have you considered FREC ethical requirements when referring clients to the affiliated business? Negligent referrals to an affiliated business may be treated with a higher level of scrutiny.

14. Brokers cannot mandate that an Agent, Buyer, and/or Seller use its own title business.

And remember the old adage: sometimes if something seems too good to be true, in many cases it is. Given the complexity and risk of these business transactions, we strongly urge you to consult with your real estate lawyer and your tax advisor before you consider entering into such an arrangement, and make sure everything is carefully reviewed by them. The failure to follow the very specific RESPA/CFPB requirements/guidelines or to fully comprehend the nature of the business relationship involved can set you up for a massive financial letdown, or worse yet, can get the unsuspecting broker, agent, and title company into extremely hot water.

 

 

Sincerely,
William C McComb, Esq. wmccomb@berlinpatten.com
Berlin Patten Ebling, PLLC

This communication is not intended to establish an attorney client relationship, and to the extent anything contained herein could be construed as legal advice or guidance, you are strongly encouraged to consult with your own attorney before relying upon any information contained herein.

All rights reserved. This copyrighted material may not be re-published without permission. Links are encouraged.

www.berlinpatten.com

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8433 Enterprise Circle, Suite 100, Lakewood Ranch, FL 34202
P (941) 907-9022 F (941) 907-9024

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P (813) 467-7500 F (813) 251-1662

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525 1st Ave North, St. Petersburg, FL 33704
P (727) 822-2505 F (727) 822-2909

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