Both Federal and State Law Could Restrict Them
By Phillip L. Schulman, Esq.
RISMEDIA, March, 2009-With record numbers of homeowners facing foreclosure, more and more mortgage lenders are using loan modifications as a method to keep consumers in their homes. At the same time, credit service organizations are expanding their focus from credit repair services that help consumers obtain financing to services designed to assist consumers in negotiating loan modifications and new loan work-out companies seem to pop up every day. As a result, these entities are looking to real estate professionals as a source for customers who may be in danger of defaulting on their mortgage loans. In exchange for the referral of customers, many credit service organizations are willing to pay a fee. But, this fee may not be permissible, and real estate professionals should be aware of the risks in accepting such payments. Not only could the fees raise issues under the Real Estate Settlement Procedures Act (“RESPA”), but state law could require certain disclosures or prohibit the fees altogether. This article provides a brief summary of the issues one should consider before entering into any referral arrangement with a work-out company or a credit service organization.
Although Section 8(a) of RESPA clearly prohibits the payment or receipt of a fee in exchange for the referral of settlement service business, the permissibility of a fee for the referral of loan modification customers does not lend itself to black or white interpretation. Arguably loan modification services do not constitute “settlement services” under the statute and, therefore, any payments for the referral of loan modification services are not prohibited by RESPA. However, loan modification services could result in a refinancing, which could trigger RESPA’s prohibitions. This would require a referral-by-referral determination as to whether a fee to a real estate agent is prohibited under RESPA. This determination may be extremely difficult to make.
Section 8(a)’s prohibition on referral fees applies to “business incident to or a part of a real estate settlement service. (12 U.S.C. § 2607(a)).” Thus, loan modification services must constitute “settlement services” to be covered by RESPA. There are at least two reasons to argue that loan modification services are not “settlement services” under the statute.
First, the statutory definition of “settlement services” does not explicitly encompass loan modification or related loan servicing services. It includes, among other things, title searches and examinations, the provision of title certificates, title insurance, services rendered by attorneys, document preparation, property surveys, services rendered by real estate agents and brokers, the origination of federally related mortgage loans, the handling of processing, and closing or settlement (12 U.S.C. § 2602(3)). Although the origination of a federally-related mortgage loan is considered a “settlement service” under RESPA, as long as loan modifications are made under an existing mortgage and note documents without resulting in a new loan, arguably such services are not encompassed within the definition.
Second, the definition of “settlement services” arguably is limited to those services that “are necessary for the closing” and to “costs payable at or before settlement (Bloom v. Martin, 77 F.3d 318, 321 (9th Cir. 1996)). For example, absent title searches and examinations, property surveys, pest and fungus inspections, and other services listed in the definition of “settlement service,” a closing would not occur. Yet, loan modification services occur after the loan has closed, which is different from the mortgage origination, processing, and closing services that are essential to close a transaction. In addition, any fees that consumers may pay for loan modification services are not paid “at or before settlement.” All such fees are paid post-closing during the servicing process. Couple these arguments with the idea that loan modification services may not result in a “new” federally-related mortgage loan, and there is a reasonable basis to argue that such services are not “settlement services.” Any referral fee paid under these circumstances by a work-out company or a credit service organization to an agent is not covered by Section 8 of RESPA.
All that said, these arguments assume that a loan modification will not result in changes to the consumer’s mortgage and note documents or a new loan origination. But, this may not be the case, and there is likely no way to know the outcome of a customer’s loan modification at the time the referral is made. If there is any chance that a loan modification could be considered to constitute a “refinancing” under RESPA or as defined by the Truth in Lending Act (“TILA”), an agent’s receipt of a fee in exchange for a customer referral to a credit service organization would violate Section 8(a) of RESPA. Based on RESPA’s definition of “refinancing,” this could occur if “an existing obligation that was subject to a secured lien on residential real property is satisfied and replaced by a new obligation (24 C.F.R. § 3500.2).” According to the Official Staff Commentary to Regulation Z (TILA), a refinancing “may involve the consolidation of several existing obligations, disbursement of new money to the consumer or on the consumer’s behalf, or the rescheduling of payments under an existing obligation. In any form, the new obligation must completely replace the prior one (12 C.F.R. Official Staff Commentary § 226.20(a)(1)).
This possibility of a customer’s loan modification resulting in a new mortgage loan is a significant risk under RESPA, especially when the agent has no way to gauge the extent of a customer’s eventual loan modification at the time it makes the referral. Given the criminal and civil penalties for non-compliance with RESPA, agents may wish to avoid these referral fee arrangements.
State Law Concerns
In addition to the possibility that fees paid to agents could constitute prohibited referral fees under RESPA, state laws could restrict agents from receiving such fees. Real estate professionals must be conscious of laws that could restrict fees paid to licensees, require the disclosure of the fee to their customers, or subject them to laws designed to regulate the activities of persons and entities assisting consumers in avoiding foreclosure.
In addition, agents should be aware that state laws may require the real estate licensee to disclose his receipt of a fee from credit service organizations to its customers. Although not directly related to loan modification services, California’s real estate regulations deem it a misrepresentation for a real estate licensee to fail to disclose to its customer any compensation the licensee may receive in connection with the securing of financing for a transaction (Cal. Code Regs. tit. 10, §2904). Similarly, California’s Real Estate Law provides that the “claiming or taking by a licensee of any secret or undisclosed amount of compensation, commission or profit” could be grounds to suspend or revoke a real estate license (Cal. Bus. & Prof. Code § 10176(g)). These provisions provide further examples of why agents should think twice before accepting any compensation offered by loan work-out companies or credit service organizations.
Finally, unrelated to whether the receipt of a referral fee from a credit service organization is legal, agents should consider the reputational risk of recommending loan work-out companies to their customers. Many of the foreclosure rescue laws enacted in the states were a reaction to unscrupulous individuals and companies that sought to take advantage of homeowners desperately trying to stay in their homes. While we recognize that many legitimate and law-abiding companies provide valuable services to homeowners every day, unfortunately, news of fraudulent companies tend to overshadow these success stories. Should an agent find himself aligned with one of these fraudulent companies, the damage to their reputation could be significant. At the end of the day, in addition to these legal concerns REALTORS® also must ensure that they honor their duty as expressed in the very first Article of the REALTOR® Code of Ethics that they promote and protect the interests of their clients.
Phillip L. Schulman, Esq. is a Partner at Kirkpatrick & Lockhart Preston Gates Ellis.