Some service businesses try to operate as simply as they can and out-source all services but their core competencies. Other businesses seek to provide one-stop shopping for customers. One stop shopping can enhance the quality of the services to the customer and help the business amortize its marketing resources over more revenue sources. Yet real estate companies that set up sister mortgage, title and other companies providing "settlement services" (as that term is defined by RESPA) do so in a highly regulated environment.

Question #1:   I am a licensed real estate broker and own a real estate company. My company spends time and money to capture consumers who wish to buy and sell real estate. Mortgage companies were profiting from these efforts because I would refer buyers to the mortgage companies for financing. To retain some of the profit that went to the mortgage companies, my business partner and I decided to create a mortgage brokerage company. My business partner owns a separate mortgage brokerage firm. May our new company outsource work to my business partner's separately owned mortgage company without violating RESPA?

Response #1:  Yes, as long as your mortgage company is performing actual work and does not up-charge for the services, the company may outsource work. However, if your company outsources too much of its work, it may be considered a sham ABA and will not be able to claim the ABA exception.

If a company collects fees for work it does not do, it is receiving unearned fees. RESPA prohibits the paying of unearned fees in relation to a real estate settlement service. Section 8(b) of RESPA, 12 USC 2607(b), states that "[n]o person shall give and no person shall accept any portion, split, or percentage of any charge made or received for the rendering of a real estate settlement service in connection with a transaction involving a federally related mortgage loan other than for services actually performed."

Payments that are unearned fees can occur in cases where (1) two or more people split a fee for services when only one person did the work, (2) a settlement service provider marks-up the cost of services provided by another provider without performing any additional work, or (3) a settlement service provider charges the consumer a fee where no, nominal or duplicate work is performed or the fee is in excess of the reasonable value of the goods provided. This list is not exhaustive, but it gives general guidelines for the types of payments that might constitute unearned fees.

One frequent RESPA violation occurs where one service provider performs services for a referring entity for a price that is much lower than market value. For instance, Mortgage Company A contracts out part of the work to Mortgage Company B. B charges A approximately 50% of what it would charge a non-referring title company to perform the same work. This reduction in fees may be classified as an unearned fee. HUD has stated that, when work is contracted out to another entity (be it an independent third party, a creator, an owner, or a participant in a joint venture), HUD looks at whether the contracting party receives payments from the new entity at less than the reasonable value of the services rendered. If so, then the difference between the payments made to the contracting party and the reasonable value of the services rendered may be classified as an unearned fee. In order to avoid receiving unearned fees, referring or affiliated service providers must pay reasonable value for any services contracted out to another party.

Further, the referring service provider should charge the customer the same price it was charged for those services. If a service provider outsources a service and then charges the consumer more for that service than it paid to the outsourced company for the service, the service provider has engaged in upcharging, which is a violation of RESPA's prohibition against unearned fees. An example of upcharging is the following: Mortgage Company X outsources work to Company Y. Y charges X $300 for the work. X then charges the client $600 for the services Y performed while X does not perform any additional services.

In a Settlement Agreement with Allied Home Mortgage Capital Corporation in September of 2003, HUD stated that it believed it was a violation of RESPA to charge customers more for credit reports than Allied had been charged by the provider for those reports. Allied agreed to pay $25,000 in that case. In 1999, by letter submitted at the request of the Superior Court of California, Los Angeles County, in the case of Brown v. Washington Mutual Bank (Case No. BC192874), HUD stated that a lender that outsources work may not mark up the third party fees for the purposes of making a profit. Such upcharging would be receiving unearned fees because the lender would receive additional money without performing additional services. HUD also noted that a service provider may not charge additional fees for another settlement service provider's services without providing additional services that justify the additional charge.

Question #2:

I own both a real estate company and a mortgage brokerage firm, and I refer some of my real estate clients to my brokerage firm, with the proper RESPA disclosure. Because I do not want to have high overhead costs in my brokerage firm, I outsource all of the brokerage firm work to other companies. Will my mortgage brokerage firm still qualify as an ABA under RESPA?

Response #2:

No. A company that does no actual work is a sham ABA, merely a conduit for referring business, and not entitled to claim the ABA exception. However, if only part of the work is outsourced, the company is more likely to be characterized as a genuine ABA.

Some business arrangements do not qualify as Affiliated Business Arrangements ("ABA") under HUD's interpretations. Such arrangements are called "sham ABAs" because they are not true business arrangements. Instead, they are attempts to get around RESPA prohibitions. HUD has issued a list of factors it will look at when determining if an arrangement is an ABA:

1. Does the new entity have sufficient initial capital and net worth, typical in the industry, to conduct the settlement service business for which it was created? Or is it undercapitalized to do the work it purports to provide?
2. Is the new entity staffed with its own employees to perform the services it provides? Or does the new entity have 'loaned' employees of one of the parent providers?
3. Does the new entity manage its own business affairs? Or is an entity that helped create the new entity running the new entity for the parent provider making the referrals?
4. Does the new entity have an office for business which is separate from one of the parent providers? If the new entity is located at the same business address as one of the parent providers, does the new entity pay a general market value rent for the facilities actually furnished?
5. Is the new entity providing substantial services, i.e., the essential functions of the real estate settlement service, for which the entity receives a fee? Does it incur the risks and receive the rewards of any comparable enterprise operating in the market place?
6. Does the new entity perform all of the substantial services itself? Or does it contract out part of the work? If so, how much of the work is contracted out?
7. If the new entity contracts out some of its essential functions, does it contract services from an independent third party? Or are the services contracted from a parent, affiliated provider or an entity that helped create the controlled entity? If the new entity contracts out work to a parent, affiliated provider or an entity that helped create it, does the new entity provide any functions that are of value to the settlement process?
8. If the new entity contracts out work to another party, is the party performing any contracted services receiving a payment for services or facilities provided that bears a reasonable relationship to the value of the services or goods received? Or is the contractor providing services or goods at a charge such that the new entity is receiving a "thing of value" for referring settlement service business to the party performing the service?
9. Is the new entity actively competing in the market place for business? Does the new entity receive or attempt to obtain business from settlement service providers other than one of the settlement service providers that created the new entity?
10. Is the new entity sending business exclusively to one of the settlement service providers that created it (such as the title application for a title policy to a title insurance underwriter or a loan package to a lender)? Or does the new entity send business to a number of entities, which may include one of the providers that created it?

In addition to these elements, HUD has listed factors which indicate that an arrangement might be a sham ABA. In an agreement with Land Settlement Services, Inc. and its affiliates in March of 2004, HUD indicated that the following factors contributed to the finding of a sham ABA:

1. Creator company has total managerial authority over the new affiliated business arrangement ("ABA")
2. ABA shares the same office space and business equipment as creator
3. ABA has no employees
4. ABA does not have its own office space, telephone number, facsimile number, or email address
5. ABA does not have an official lease agreement or sublet agreement for office space it is using
6. Initial capitalization of ABA was insufficient
7. ABA does not perform any core title services or any other substantive real estate settlement service
8. ABA outsources all of its work to creator
9. ABA does not actively compete for business in the marketplace

This list provides several tips for ABAs.

First, each company involved should have the ability to manage its own affairs and not be completely controlled by another entity. While some overlap in management between the ABA and the creator may occur, the ABA should be operated as a separate business with its own accounts and records.

Second, each company should have its own office space or equipment. If one company rents office space and equipment from another, there should be an official lease or sublet agreement concerning the space and equipment. These leases should be similar to market rate for leases of similar spaces and equipment. If the landlord leases to other companies and is affiliated with the ABA, the terms of the lease for the ABA should be similar to the leases made to non-affiliated businesses. Also, each company should have their own phone numbers and email addresses.

Third, the company should have its own employees and not "borrow" all of its employees from an affiliated company. Employees should be paid for the services they actually render for each company.

Fourth, each company should perform substantive services. While some outsourcing is permitted, total and complete outsourcing with no additional work should be avoided. The ABA should not be a pass-through entity; it needs to perform services.

None of these factors alone is conclusive. Rather, the overall picture will be used to determine if the arrangement is a sham ABA. For example, if an ABA does not have a formal lease, that does not automatically make it a sham ABA. Each factor will be weighed and all factors will be considered together.

Amanda S.P. Howe is no longer with Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm.  

Jonathan A. Goodman is a shareholder in Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm.   His practice areas include Real Estate, Brokerage Law, Contracts, Land Use, Leasing, Real Estate Title, Association Law, Business Law, and Finance.   He can be reached at contact Jonathan Goodman.

A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.

Disclaimer -- Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.