This is part one of a two-part series on joint ventures and affiliated business arrangements (AfBAs). Next week part two will focus on how to identify the right partnerships and how to make money with JVs.

Churchill Mortgage recently announced a new joint venture (JV) with American Home Title called Churchill Title Solutions. The new title company is intended to streamline the origination process and create a secure mortgage experience for borrowers, real estate agents and lenders.

But arguably, the real news was that JVs are being formed again – let alone announced publicly – by settlement service providers.

Such agreements began to be seen less frequently as the Consumer Financial Protection Bureau (CFPB) under former Director Richard Cordray became more and more active in RESPA enforcement.

However, the 2018 court decisions in CFPB v. PHH and CFPB v. Borders & Borders have created renewed interest in advertising agreements and affiliated business arrangements (AfBAs) – in particular, the District of Columbia Circuit Court’s interpretation of Section 8(c)(2), the cornerstone for all marketing and advertising activities.

Holly Spencer Bunting, partner at Mayer Brown, spoke recently in New Orleans about the latest trends in advertising agreements and AfBAs at the RESPRO spring conference session titled, “Operating a Successful JV and Advertising Agreement.”

Bunting reminded the standing-room-only crowd that RESPA’s Section 8 prohibits giving or receiving a thing of value in exchange for the referral of settlement service business.

“In order to avoid violating that prohibition when you’re structuring an advertising agreement or any other services agreement, you’re going to be looking at Section 8(c)(2) of RESPA, which is your exemption that permits payments for services,” she said. “Or if you’re talking about a joint venture affiliated business, you’re focused on the 8(c)(4) exemption to RESPA, which permits owners of those affiliated businesses to receive profits and distributions without violating the statute.”

Section 8(c)2 and PHH

The CFPB accused PHH of violating RESPA Section 8(a) by engaging in a kickback scheme for referrals of mortgage insurance business. Specifically, the CFPB had alleged that a mortgage reinsurance company created by PHH received in excess of fair market value for the reinsurance services it provided to the mortgage insurance companies to which PHH referred mortgage insurance business.

Section 8(c)(2) states: “Nothing in this section shall be construed as prohibiting the payment to any person of a bona fide salary or compensation or other payments for goods or facilities actually furnished or for services actually performed.”

In 2015, Cordray argued that Section 8(c)(2) would not provide protections when tied to business referrals – even if you’re paying for services.

However, a three-judge Circuit Court panel opinion – written by recently appointed U.S. Supreme Court Justice Brett Kavanaugh – overturned the bureau’s $109 million penalty against PHH Corp. In January 2018, the entire D.C. Circuit acting en banc reinstated the panel’s decision upholding Section 8(c)(2) of RESPA. The case then was dismissed by bureau acting director Mick Mulvaney.

“The language was pretty important in that PHH decision,” Bunting said. “It boils down to the fact that the exemption is an exemption. That’s not exactly the approach the CFPB had taken, though.”

Bunting added that the three-judge panel restored the industry’s faith in RESPA law by reaffirming that “nothing means nothing,” and that you can take advantage of the exemption as long as you are paying for services – not for referrals – based on reasonable market value.

“So when you have such strong language from the court, reaffirming this exception that permits payments, where does that leave you? I think you’ll see renewed interest in putting together arrangements or agreements that rely on the 8(c)(2) exemption,” she said. “Essentially, the court endorsed the two-part test for Section 8(c)(2) that we had heard from HUD when HUD was responsible for enforcing RESPA.”

Two-part test

Bunting said complying with the two-part test is a must when structuring advertising agreements to comply with RESPA.

“The first part, of course, is goods or services,” she said. “There must be something that’s provided that you’re paying for. Services should be actual, they should be real. They should be necessary. They should be useful, meaningful services that you’re paying for, and they should be distinct. They shouldn’t be duplicative services. They shouldn’t be made up.

“Same thing with the goods. If you’re going to rent office space, you actually have to have office space.”

The second part of the test is reasonable market value. The PHH decision reaffirmed the idea that bona fide payments are reflective of reasonable market value, or that the payment must be commensurate with the value of the services or the goods provided.

“Anything less than fair market value, you’re OK. From a RESPA perspective, anything more than fair market value is what gets you into trouble,” Bunting said. “The excess is considered an impermissible referral fee.”

Although it isn’t a requirement, Bunting also suggested making sure you have a business purpose when setting up service agreements.

“You’re not required to have a business purpose, but when regulators are taking a look at these kinds of arrangements, that’s always something I think is in the back of their mind,” she said. “Advertising agreements have a business purpose. You’re a business. You’re trying to sell your product. You need to advertise it. I don’t think from a business purpose perspective anyone can question the need for that kind of service.”

Past enforcement actions in an advertising agreement context is another key consideration.

“If you’re putting together an advertising arrangement, are you creating a quid pro quo? Are you essentially saying to your counterparty, ‘I will pay you to advertise me, but you have to require your customers to prequalify with me, or you have to require your agents to somehow require consumers to use my product.’ Those kinds of tradeoffs have been an issue in recent enforcement actions,” she said.

Bunting said how a company adjusts its fees is something else that is coming up in enforcement actions.

“Are you adjusting advertising fees because you are paying for more services or less services? Or are you adjusting them because you are calculating your capture rates internally and the agreement is just not going as well as you think it should, and you’re using that as your foundation to make the adjustment? You want to know if your advertising dollars are well spent,” she said. “You want to know if you’re getting the bang for your buck here, but you can’t use that analysis to actually make the changes to the payments for the services. That really should be based on if there are more services being performed, or less.”

Avoiding certain adjectives is also a must.

“At the end of the day, you’re being paid to advertise. You’re not being paid to refer,” Bunting said. “Using designations like ‘preferred’ or ‘premier’ or any other adjective that suggests superiority in some way, is itself a referral or an endorsement. So if you’ve told a consumer this is my preferred lender, or you’ve got a web banner on your website that identifies your advertising partner as a preferred lender, the concern is that you’ve just endorsed them by the mere use of that kind of language. But, you’re being paid for the service of posting the banner ad. You should not be paid for making that referral. It’s then necessary to avoid making the endorsement or referral.” 

There are also other considerations based on the limited guidance from regulators. For instance, HUD’s 2010 interpretative rule relating to home warranties mentions exclusivity, and regulators could interpret exclusive agreements to be more than just paying for advertising, Bunting said.

She also warned service providers against putting pressure on real estate agents to steer business, or risk appearing like you’re being paid for referrals.

Bunting suggested paying an experienced independent third party to determine reasonable value.

“It would be nice if there was a particular formula,” she said. “But it doesn’t exist.”

Another idea stemming from HUD’s home warranty interpretive rule is to advertise directly to the general public to help make the case that you’re paying for an actual service.

She also suggested giving yourself the ability to verify advertising agreements with your partner to ensure you’re paying for services. For example, having copies of advertisements sent to you within a certain time frame.

In addition, make sure you have a reason for changing fees.

“Let’s say you have an arrangement with a real estate broker,” Bunting said. “They’ve opened three new offices. That’s three new places to post your signage. That would be a reason to increase your fees, if they’re providing additional services.”

Borders & Borders and AfBAs

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.

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

The case originally was decided under 8(c)(4). The court relied on case law in the Sixth Circuit and originally found that Borders & Borders met the safe harbor test for affiliated business arrangements and, thus, complied with RESPA. The CFPB asked for reconsideration, and two months after the PHH decision, the U.S. District Court for the Western District of Kentucky upheld itself, but found the Borders & Borders joint venture lawful under 8(c)(2).

“The court initially upheld the joint ventures solely on 8(c)(4) standards under RESPA, but under HUD standards for bona fide businesses, the joint ventures were probably not legitimate,” Bunting said. “A single person who worked from home was doing all the title work for those nine ventures. There was no office, and no disclosure provided, except at the closing table, so it did not meet HUD’s 10-factor test. The key takeaway from this case is the importance of the statutory three-step safe harbor.”

The first step is to have an affiliated business disclosure provided by the party that is referring business to the affiliate at or before the time a referral is made.

“The regulations say it needs to be on a separate piece of paper, it needs to disclose the affiliate relationship, it needs to tell the consumers you’re not required to use the affiliate and it needs to provide an estimate of the fees,” Bunting said. “I can’t emphasize enough the importance of the disclosure.”

The second requirement is you cannot require a consumer to use an affiliated business you own.

The third requirement is returns flowing back to you as an owner must be based strictly on your ownership interests in that venture.

“So if you’re a 51 percent owner, you get no more than 51 percent of the profits from that venture,” she added. “If you’re also performing services as an owner of the business, you can be paid for your services. That’s your 8(c)(2) exemption.”

If you’re a business in Kentucky, Michigan, Ohio or Tennessee, which falls under the jurisdiction of the Sixth Circuit ruling in CFPB v. Borders & Borders, Bunting said to pay attention to the Sixth Circuit’s case law that relates to affiliated businesses.

For everyone else, she advocates HUD’s 10-factor test to structure affiliated businesses.

Those factors include:

• Capitalization: Do you have enough capital to get your business off the ground?
• Do you have at least one employee dedicated to the joint venture and is there enough work to support them?
• Separate office space dedicated to the joint venture, which must be paid for at fair market value and have signage for the general public.
• Core services are provided.
• The joint venture should be doing something to advertise to the general public.

“The CFPB has never formally reissued guidance on those 10 factors that HUD had put forth in their policy statement back in the ’90s,” she said. “But for all intents and purposes, that’s the expectation of compliance as it relates to affiliated businesses.”