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Conference Coverage

Borders & Borders: 'Clear as mud'

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Conference Coverage
Thursday, September 20, 2018

Hoping to find some guidance on a “clear as mud” ruling, a packed room eagerly listened to a trio of experts discuss the recent Sixth Circuit Court of Appeals decision in Consumer Financial Protection Bureau (CFPB) v. Borders & Borders.

Phil Schulman, partner at Mayer, Brown, LLP; Loretta Salzano, partner at Franzen & Salzano, and Brian Levy, of counsel at Katten Temple, were the featured panelists at the RESPRO/25 session, “Simple Geometry: The Intersection of Sections 8(c)(4) and 8(c)(2).”

The panelists addressed the crowd about how recent developments in case law, enforcement actions and the regulatory environment impact affiliated business arrangements and their payments for goods, facilities and services.

“In many ways, the Borders and Borders case was clear as mud,” Schulman said. “I would not rely on it. I think the rationale in that case was misguided.”

The beginning

Borders & Borders focused on the intersection of Sections 8(c)4 – the exemption for affiliated businesses and 8(c)2 – which addresses payment for services rendered and goods provided.

“So we know that affiliated businesses have to comply with the safe harbor test, but also there are instances when the owners of a joint venture provide that entity with services and when they do, they have to pass muster, at least with the providing of those services under 8(c)2,” Schulman said. “And so, this Borders & Borders case brought this concept home to us. Because originally, this court in the Western District of Kentucky had decided that Borders & Borders met the safe harbor test.

“Borders & Borders originally was decided under 8(c)4. The court said, Borders & Borders met the safe harbor test, therefore everything was copacetic. And then when the CFPB asked for reconsideration, they did a complete flip flop and said, forget about 8(c)4. This joint venture is lawful under 8(c)2.”

The Borders case began in 2010 with an investigation by the Department of Housing and Urban Development (HUD) before the CFPB existed, and was transferred to the bureau in 2011 when the CFPB became the controlling regulator of the RESPA statute.

In 1996, HUD came up with the 10-factor test due to the problem of real estate brokers who failed to create bona fide settlement service providers and instead had companies with no employees, no separate space and other issues that raised red flags that a partnership was not a genuine joint venture.

“But then, a case in the 6th Circuit called Carter v. Welles-Bowen Realty said that the 10-point test by HUD was unconstitutional,” Schulman said. “It was vague, it was ambiguous, and because RESPA is a criminal statute, the HUD statement also violated the rule of lenity, said the 6th Circuit.

“Then you have 8(c)2. It allows payments for services rendered and goods provided. This is the whole controversy over PHH. The section says nothing in this section shall be construed as prohibiting the payment of a bona fide salary or compensation for services rendered or goods provided. (Then-CFPB Director Richard) Cordray said, ‘It’s not an exemption. You can’t have an exemption when you’re paying somebody for services when that person or that company refers you business, because the payment is not bona fide salary or compensation,’ and he defined bona fide salary or compensation as payments on the merits.”

The PHH case was appealed to the U.S. Circuit Court of Appeals for the D.C. Circuit before a three-judge panel. Judge Brett Kavanaugh, who is being considered for the vacancy on the U.S. Supreme Court, wrote the majority opinion that brought RESPA interpretation back to HUD standards long recognized by the industry.

“Judge Kavanaugh said, ‘This isn’t even a close call. 8(c)2 IS an exemption, even if there are referrals going on, as long as you meet the safe harbor test that HUD created for 8(c)2, which was simple. It has to be an actual service, a necessary service, not a duplicate service, and it has to be at reasonable market value,’ ” Schulman added. “All of that brings us to the Borders & Borders case.”

The rationale

Borders & Borders was a Louisville, Ky., law firm with nine joint ventures with real estate brokers and builders, but no employees.

“They had one woman who served as an examiner for all nine joint ventures,” Schulman said. “She worked out of her home. And Borders & Borders referred her a deal that came from one of the real estate agents. She would do it and would be paid on a piecemeal basis.

“There was no office. There wasn’t any of the criteria that we see in a 10-factor test. However, the arrangement did meet the safe harbor test – the statutory test – because Borders & Borders gave out the disclosure, albeit at the closing table. They told the consumers they owned a piece of it, they told them how much it cost and they didn’t require the consumer to use it.

“So the case goes to the Western District of Kentucky and the court says Borders & Borders violated Section 8(a) because they made referrals to the joint ventures and they received a thing of value – the return of an investment. However, they looked at the 8(c)4 exemption and they said, ‘They do meet the statutory exemption. We decide in favor of Borders & Borders.’

“As for the 10-point test, the court deferred to the circuit court in the Carter v. Welles case, so they did not review the 10-point test. So the CFPB requested reconsideration.”

Last January, a 10-member en banc circuit court came down with the PHH ruling against Cordray’s interpretation of RESPA in a landmark anti-kickback case. Two months later, the Sixth Circuit Court of Appeals shocked experts by reversing its own decision in Borders & Borders.

“And so the court falls in love with 8(c)2,” Schulman said. “Remember they rejected it a few months earlier? But now, they say, ‘You know, we don’t think Borders and Borders did violate 8(a). Forget what we said a few months earlier. They did give out the disclosures. But because they did not pay the joint venture a thing of value, it’s really unnecessary to consider whether there was an actual referral.’

“Of course Borders and Borders wouldn’t be paying the joint venture for making the referral, payment is going the opposite direction. Borders and Borders would be receiving a thing of value,” he said. “But this was the court’s analogy.

“They then said, ‘You know, forget 8(c)4. Even if Borders & Borders did receive a thing of value for the referral of business, this activity by Borders & Borders was lawful under 8(c)2.’ Because in their view, the payments for the consumers made for the title insurance was reasonable market value. 8(c)2 is about a loan officer leasing an office from a real estate broker who refers him business and not paying him more than fair market value. It’s not about whether the loan officers’ rates are reasonable or not. In an 8(c)2 situation, the issue is whether or not the referee is paying more than fair market value to the referrer.

“The Borders & Borders rationale is a little shaky, and I wouldn’t take much confidence from it.”

Salzano agreed.

“Borders and Borders, I think we all agree, it’s a cockamamie case and you’d be crazy to rely upon it,” she said. “I feel that way also about Carter v. Welles.”

Risk vs. reward

The panelists also discussed various types of affiliated arrangements and provided practical tips for implementing them.

“Whenever we’re looking at affiliated business arrangements, it’s permissible not only for the owners to receive a return on their ownership interest, but any other RESPA-permitted compensation as well,” Salzano said. “Despite that permissibility, it again goes to risk. When you’re in an AfBA and you’re taking advantage of exceptions like the 8(c)2 exceptions, as you layer the different financial arrangements, it’s going to invite more scrutiny.”

Levy spoke about the allocation of cost and valuation.

“The key consideration is you want to avoid subsidizing your referral source in your cost structure,” Levy said. “One way to look at the cost structure is a fixed cost vs. variable cost. Is there even a cost to some variable items? Should there be a minimum fee? Does there need to be a profit margin in the relationship?”

Levy recommended making sure capital is borrowed at market rates, rather than at a discount, with joint ventures.

“Once you create a compliant joint venture, I think you’re fine,” he said.

Salzano urged the audience to make sure to consider every element to decide whether the risk is appropriate, which is going to be determined to a great extent not just on the type of service but how you value them.

“One of the factors in the 10-factor test is whether that venture manages its own affairs,” she said. “So I would rather see the management being done by the employees of the venture, and the owners and managers only from a strategic level, like a board of directors, as opposed to managing a venture in the trenches and then taking a 10 percent fee.”

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12 USC Section 2605 or Section 6 is titled Servicing of mortgage loans and administration of escrow accounts. It pertains to qualified written requests, notices of transfer of servicing and the administration of escrow accounts.
An arrangement that involves a person who is in a position to refer business as part of a real estate settlement service and who has an interest in a settlement services provider.

In the arrangement, the person, who has either an affiliate relationship with or a direct or beneficial ownership interest of more than one percent in a settlement services provider, directly or indirectly refers business to that provider or influences a consumer to select that provider.
An arrangement that involves a person who is in a position to refer business as part of a real estate settlement service and who has an interest in a settlement services provider.

In the arrangement, the person, who has either an affiliate relationship with or a direct or beneficial ownership interest of more than one percent in a settlement services provider, directly or indirectly refers business to that provider or influences a consumer to select that provider.
A mortgage disclosure that lists all estimated charges and fees associated with your loan. In addition to fees and charges, it will list your loan amount, mortgage rate, loan term and estimated monthly payment. Your escrows due at closing for insurance and taxes will also be outlined. Mortgage lenders are legally required to provide a GFE within three days of receiving your application.
A mortgage disclosure that lists all estimated charges and fees associated with your loan. In addition to fees and charges, it will list your loan amount, mortgage rate, loan term and estimated monthly payment. Your escrows due at closing for insurance and taxes will also be outlined. Mortgage lenders are legally required to provide a GFE within three days of receiving your application.
Under RESPA Section 2605(e)(1)(B), a qualified written request is a written correspondence that includes: 1) the name and account of the borrower, or has enough information to allow the servicer identify that information; and 2) a statement of the reasons for the belief of the borrower that the account is in error or provides sufficient detail to the servicer regarding other information sought by the borrower.

A QWR cannot be written on a payment coupon or other payment medium supplied by the servicer.
Under RESPA Section 2605(e)(1)(B), a qualified written request is a written correspondence that includes: 1) the name and account of the borrower, or has enough information to allow the servicer identify that information; and 2) a statement of the reasons for the belief of the borrower that the account is in error or provides sufficient detail to the servicer regarding other information sought by the borrower.

A QWR cannot be written on a payment coupon or other payment medium supplied by the servicer.
Under Regulation X, required use means a situation in which a person must use a particular provider of a settlement service in order to have access to some distinct service or property, and the person will pay for the settlement service of the particular provider or will pay a charge attributable, in whole or in part, to the settlement service.

However, the offering of a package or (combination of settlement services) or the offering of discounts or rebates to consumers for the purchase of multiple settlement services does not constitute a required use. Any package or discount must be optional to the purchaser. The discount must be a true discount below the prices that are otherwise generally
12 USC Section 2607 or Section 8 is titled Prohibition against kickbacks and unearned fees. It prohibits fees or kickbacks for referrals. It also prohibits accepting a portion of fee except for services actually performed. Section 8 provides information on what payments are allowed under this section and the penalties for violations.
12 USC Section 2608 or Section 9 is titled Title companies; liability of seller. This section states that a seller cannot require, as a condition of selling the property, that title insurance be purchased by any particular title company. Section 9 states that a seller who violates this section is liable to the buyer for treble damages.
12 USC Section 2609 or Section 10 is titled Limitation on requirement of advance deposits in escrow accounts. It governs escrow accounts including notifications and statements to borrowers. Section 10 also sets out penalties for those who violate the section.
Under RESPA, settlement service includes any service provided in connection with a real estate settlement. The statute provides a list of services.

Under Regulation X, settlement service means any service provided in connection with a prospective or actual settlement. The regulation provides an extended list of services as compared to the statute.
RESPA Section 3 provides that a thing of value includes any payment, advance, funds, loan, service or other consideration

Regulation X says thing of value includes: monies, things, discounts, salaries, commissions, fees, duplicate payments of a charge, stock, dividends, distributions of partnership profits, franchise royalties, credits representing monies that may be paid at a future date, the opportunity to participate in a money-making program, retained or increased earnings, increased equity in a parent or subsidiary entity, special bank deposits or accounts, special or unusual banking terms, services of all types at special or free rates, sales or rentals at special prices or rates, lease or rental payments based in whole or in part on the amount of business referred, trips and payment of another person’s expenses or reduction in credit against an existing obligation.
A form used by a settlement or closing agent itemizing all charges imposed on a borrower and seller in a real estate transaction. This form represents the closing transaction and provides each party with a complete list of incoming and outgoing funds. RESPA requires the HUD-1 to be used as the standard real estate settlement form in all transactions in the U.S. involving federally related mortgage loans.
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