Federal Appeals Court Issues Decision in Carter v. Welles Bowen

The Federal Sixth CIrcuit Court of Appeals has issued its decision in the closely watched RESPA case, Carter v. Welles Bowen Realty, Inc., ruling in favor of the affiliated business involved. In its ruling, the court nullified a list of ten criteria used by the government to determine if affiliated business are shams.

The plaintiff in the case, Erick Carter, used Welles-Bowen Realty to purchase real estate. The title work for the purchase was referred to Welles-Bowen Realty's affiliated title business, Welles-Bowen Title Agency, which about half owned by Welles-Bowen Realty and half owned by Chicago Title. Carter alleged that Welles Bowen Realty had invested little in the joint venture, and that Chicago actually did most of the title work, yet Welles-Bowen, was reaping nearly half the profits of the joint venture, creating the functional equivalent of a kickback scheme. According to Mr. Carter, this arrangement seemingly favoring Welles-Bowen Realty was by design: Welles-Bowen Title Agency was a sham-- a shell company existing merely to funnel money for referrals from Chicago Title to Welles Bowen Realty.

RESPA, the Real Estate Settlement Procedures Act, states that affiliated settlement service businesses are permissible if certain criteria are met: the person making the referral must disclose the arrangement to the client; the client must remain free to reject the referral; and the person making the referral cannot receive any “thing of value from the arrangement” other than “a return on the ownership interest or franchise relationship.” RESPA does not explicitly state anything else about what constitutes a sham affiliated businesses, or even state that sham affiliated businesses are prohibited.

Over concerns that some affiliated businesses had been created solely to funnel referral fees, in 1996 the Department of Housing and Urban Development (HUD) published a policy statement seeking to distinguish legitimate controlled business arrangements from prohibited, sham controlled business arrangements. The policy statement said that HUD would determine the legitimacy of a controlled business arrangement through a set of ten criteria, including such factors as whether a controlled business had "sufficient initial capital and net worth" to conduct its business, whether it had its own employees or shared them with the partnered service provider, and whether it had its own office or shared office space with one of its owners.

The appeals court ruled that this policy statement effectively imposed additional requirements on affiliated business arrangements that were not present in RESPA. Adding these requirements was unfair to the affiliated businesses, according to the court, because "a statutory safe harbor is not very safe if a federal agency may add a new requirement to it through a policy statement."

The "easy way" to look at affiliated businesses-- and the correct way, according to the court-- is to permit affiliated businesses that comply with the letter of the relevant statutory provisions in RESPA, without any additional legitimacy test imposed by the agency responsible for enforcing RESPA. "Welles-Bowen disclosed the arrangement to the buyers, Welles-Bowen allowed them to reject the referrals, and neither Welles-Bowen nor its owners received anything of value from the arrangement apart from a return on their ownership interests. Welles-Bowen... in short did everything the Act asked of them. They thus qualify for the affiliated business arrangement exemption," the court wrote.

A copy of the court's decision can be found here.

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Common Sense - Wyatt Bell/FL

I think the court got it right-on with regards to HUD exceeding its authority. This is a major issue under our current system of governmental agencies. There are too many examples of congress putting off its duties and allowing non-elected bureaurocrats to run the show. Many may not like that title insurance underwriters make such arrangements, accepting the facts of this case, but this is for congress and elected officials to remedy and articulate.

There is a book, "The Death of Common Sense", by Philip K. Howard which examines this phenomena. We are placing upon ourselves such regulatory weight that the system is beginning to break under the strain. When a federal agency interprets the federal law passed by congress it does not assume a dynamic position in which it can rearrange the interpretation. The text of the statute is to be given the meaning and interpretation it bore when adopted by congress. If the governmental agency can dynamically modify this core where are we?

Congress by a majority should amend RESPA to be clear and unambiguous. Let's stop this "expansive dynamic interpretation" by bureauocracies as it is doing more damage than any affiliated business arrangements. We have methods and a system of government for such. It requires courage by our elected leaders!

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Re: Common Sense - Slade Smith/OH

Wyatt,

While there are plenty of examples to be found of bureaucratic overreach, I do not think that this is one of them, for reasons explained in a blog post I just put up. In short, I think HUD was merely offering a reasonable framework for evaluating affiliated business as to whether they meet the statutory definition of an affiliated business arrangement in the statute. The court failed to analyze this definition, and accordingly missed the implicit "fourth requirement" within it-- namely, that the affiliated business actually provide the settlement services (as opposed to one of its owners providing the service). I also think that its interpretation is close to what legislators had in mind when they passed these provisions-- I do not think Congress intended to allow sham affiliated business arrangements.

So, this was not a case where an agency created a whole new requirement that was absent in the statute, despite what the court said. If that would have happened, I'd agree that it would be up to Congress to amend the law. Nor do I think that HUD's criteria for evaluation were incomprehensible. While HUD did not provide a bright-line test, the underlying principles of HUD's criteria were clear: the more insubstantial, dependent, and/or one-sided an arrangement was, the more likely it would be determined a sham.

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Re: Common Sense - Wyatt Bell/FL

Slade,

If you read Sec. 2607(c)(4) there is no mention of "office space", "employees", "initial capital" or other criteria set-forth in the 10 point Policy Statement.

The court, "The statute establishes three prerequisites for this safe harbor, and everyone agrees that the defendants in this case (several realty companies and title companies) satisfied them."

The argument was that a "fourth condition" fashioned through a "policy statement" trumped the statute!

The court in the 3rd to last paragraph of the decision stated:

"Purpose at any rate is a two-edged sword, and in this instance it furthers our interpretation. Consider the purpose of the safe harbor. As the policy statement itself explains, the statute as first enacted created legal uncertainty about profiting from referrals to affiliated companies. Congress created the affiliated-business-arrangement safe harbor to eliminate this uncertainty. The statute’s precision in defining the boundaries of this exception reflects this objective. A multi-factor inquiry that seeks to distinguish bona fide providers from shams in new ways would reintroduce much of the uncertainty the safe harbor meant to eliminate."

My point is that governmental agencies are extending and modifying congressional legislative intent and not simply by rule promulgation but with such methods as policy statements. It's the method and application that fails, not that sham businesses are OK.

My simple contention is that congress needs to adopt the 10 points in Section 2607 should a majority vote be supported by the underlying constituency.

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Re: Common Sense - Slade Smith/OH

Wyatt,

I disagree.

The so-called "fourth requirement" was a not an additional requirement at all-- instead it was a requirement that the arrangement meet the definition of "affiliated business arrangement" in 12 USC § 2602(7)(a). The definition requires that the entity be a "provider of settlement services." HUD interpreted the definition as to exclude shams.

The landmark Supreme Court case Chevron v. NRDC was a dispute over exactly the same situation-- there was a federal environmental statute that contained a term, and the relevant enforcement agency, the EPA, interpreted it. The Supreme Court upheld the EPA's interpretation, saying the the courts were bound to uphold reasonable agency interpretations of statutes. Here's the test, as articulated by the court in Chevron:

When a court reviews an agency's construction of the statute which it administers, it is confronted with two questions. First, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If, however, the court determines Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction on the statute, as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute. "
...

If Congress has explicitly left a gap for the agency to fill, there is an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation. Such legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute. Sometimes the legislative delegation to an agency on a particular question is implicit, rather than explicit. In such a case, a court may not substitute its own construction of a statutory provision for a reasonable interpretation made by the administrator of an agency.

U.S. Supreme Court

Can a sham truly be a provider of settlement services? I suppose an argument can be made either way, but HUD did not think so and articulated a reasonable set of criteria by which legitimate businesses can be distinguished from shams. The appeals court was bound by Chevron to uphold the policy statement, but failed to do so. A bad decision.

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Re: Common Sense - george Hubka/MI

Don't look at the ruling so disgusted. Go out and start some "sham" companies and

make a few bucks like the other crooks (corporations) are doing.

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