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Builders Can Earn Income From Settlement Service Referrals
 As long as they comply with Section 8 of the Real Estate Settlement Procedures Act (RESPA), home builders have the opportunity to earn extra income by referring their customers to an affiliate settlement service provider, according to Phillip Schulman, Esq., a partner in the Washington, D.C. office of Kirkpatrick & Lockhart Nicholson Graham LLP.
“Home builders are in a position to refer their customers to a number of settlement service providers,” says Schulman, “including mortgage companies, title insurance agencies and closing attorneys, to name a few. Thus, builders often enter into affiliated business arrangements (AfBAs) with these settlement service providers to create joint venture mortgage companies or AfBA title insurance agencies.”
Builders tend to be merely investors in the AfBAs, he says, but “recent RESPA enforcement cases have targeted AfBAs and the builders who own them, making it imperative that these entities comply with the law’s requirements.”
To permit builders and other settlement service providers to receive a portion of the income generated from AfBAs, Congress in 1983 determined that dividend payments made in connection with AfBAs owned by builders and other providers do not violate the law as long as three requirements are met:
- First, no later than the time of the referral, the builder must provide a disclosure to the customer on a separate sheet of paper identifying the existence of the business arrangement along with a written estimate of the charge or range of charges imposed by the affiliated business entity.
- Second, the person being referred must not be required to use any particular provider of settlement services.
- Third, no payments, other than a return on ownership interest or payments otherwise permitted under Section 8, may be received under the arrangement.
However, to ensure that arrangements are bona fide even when they meet these three requirements, the Department of Housing and Urban Development has established additional criteria that a builder and its AfBA must consider.
HUD’s concern is that an affiliated entity could refer business to another affiliated entity, such as the AfBA, and accept referral fees masked as returns on its ownership interest. Section 8 of RESPA notably prohibits the giving or receiving of anything of value in exchange for the referral of settlement service business, which includes any services performed in connection with the sale of a house. (For more information, click here to read “Builders Beware — You Could Be a RESPA Target,” which appeared in the Sept. 11, 2006 issue of NBN.)
HUD’s criteria for ensuring that an AfBA that meets Congress’s three-part safe-harbor test is a bona fide arrangement include:
- Capitalization. The AfBA must have sufficient capital, typical in the industry, to conduct the settlement service for which it was created.
- Employees. The AfBA must have its own employees, who work exclusively for the AfBA.
- Management. The AfBA must either manage its own affairs, or if one of its partners provides management services, it must pay the partner fair market value compensation in return for the services.
- Office Space. The AfBA must have its own office space separate and apart from its partners so that the public can clearly identify the entity with which business is being done.
- Substantial Services. The AfBA must provide essential functions and types of services generally performed by the kind of arrangement it is.
- Subcontracting. The AfBA must provide all of the substantial services itself and is not allowed to subcontract out those services to AfBA partners or others. The joint venture, however, can subcontract out non-essential functions, such as those related to management, accounting, human resources and other administrative functions.
- Marketing. The AfBA must actively compete in the marketplace for business and attempt to market its services to others besides its AfBA partners.
If the arrangement complies with all of the above, then a builder can receive dividend fees from an AfBA without risk of violating Section 8.
However, Schulman advises builders to also consider their resources and business objectives before they decide to create an AfBA:
- “First,” says Schulman, “a builder should consider his available capital and how much the company can contribute to start an AfBA. Whatever this amount may be, when combined with capital from other AfBA partners, the amount should be enough to sustain the AfBA’s operations for 90 to 120 days without any income.”
- Second, a builder should be able to anticipate that it will generate enough deals each month to support at least one full-time AfBA employee, who is well-trained to complete the substantial services required to close the transactions.
- Third, a builder should carefully consider the other entities that could become its AfBA partners. “As another AfBA partner will likely manage the AfBA, the builder should ensure it partners with knowledgeable, well-resourced and responsible business partners with an eye to operating a compliant AfBA,” he said.
- Finally, a builder should consider the market within which the AfBA will operate. “Not only should the AfBA receive and process a substantial number of deals through the referrals of the builder and other AfBA partners,” says Schulman, “but the AfBA should attempt to receive business from other sources of referrals and general advertising leads.”
If the AfBA doesn’t look like it will be a profitable enterprise or there are concerns that it does not meet RESPA’s requirements, Schulman advises builders to seek other business opportunities, such as marketing agreements or work-share arrangements.
“As RESPA permits payments in return for actual services provided, a builder still can explore other avenues for ancillary income without the expense of an AfBA or the risk of violating RESPA,” he says.
For more information on RESPA and whether an affiliated business arrangement is right for your business and complies with RESPA, e-mail Bill Renner at NAHB, or call him at 800-368-5242 x8597. Or contact Phillip Schulman, 202-778-9027.
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