In the case, Carter v. Welles Bowen, the plaintiff, Erick Carter, had alleged that the affiliated business that supposedly provided the title services for his real estate purchase-- Welles Bowen Title, co-owned by Chicago Title and the owners of Welles Bowen Realty-- was just a sham, a shell company with no meaningful function other than to funnel money from Chicago Title to the owners of Welles Bowen Realty in return for referrals of title business.
This arrangement, according to Carter, amounted to Chicago Title paying Welles Bowen Realty a kickback for referrals. Providers of settlement services, including title companies, are prohibited from paying kickbacks for referrals under the federal Real Estate Settlement Procedures Act, or RESPA. Violators are subject to civil penalties of up to three times the charge for the services, and possible criminal penalties as well.
There was a lot of reason to believe that Welles Bowen Title was a sham, if the allegations are taken at face value According to Carter, Chicago Title did all the substantive title-related work-- performing the title search, conducting the underwriting, curing any title defects, and handling the closing and escrow. Welles Bowen Title did none of this work, despite the fact that many of these tasks would typically have been performed by a non-affiliated title agency. Yet Welles Bowen Title still reaped the same share of the title insurance premium that a non-affiliated agency that did all the typical tasks would garner.
Welles Bowen Title allegedly didn't even have its own employees or its own office space-- that was all supplied by Chicago Title or its corporate parent, Fidelity National Financial. And how could it possibly have much of its own? The company had been formed with a capital investment of only around $30,000.
What's more, virtually all of the work supposedly done by Welles-Bowen Title was for Welles-Bowen Realty customers-- it was all work referred to it by Welles Bowen Realty, in other words. Of course the work was actually done by Chicago Title.
The agency charged with administering RESPA had made it clear through a policy statement that sham affiliated businesses would not be tolerated, and had formulated a list of ten criteria that it would used to judge whether a particular arrangement was a sham. The ten criteria corresponded to the factors that allegedly made Welles Bowen Title a sham-- paltry capitalization, a lack of an independent location or employees, and other factors all pointing to a general one-sidedness in the arrangement in favor of the referrer of business, a deal too good to be true for one side and a terrible deal for the other... unless the value of referrals was taken into account.
But according to last week's appeals court ruling, HUD was never allowed to evaluate affiliated businesses by these criteria, or require them to satisfy any other test of its legitimacy. The court said that an affiliated business arrangement only needs to meet three bare requirements explicitly listed in the statute in order to be given safe harbor from RESPA's anti-kickback provisions. Those requirements are:
- the arrangement must be disclosed to the client
- the client must be free to reject the referral
- the person making the referral cannot receive any thing of value from the arrangement other than a return on the ownership interest in the arrangement.
To have an additional requirement that the arrangement not be a sham amounted to a fourth, government-agency-imposed requirement not in the statute, according to the court. An agency is not allowed to create such additional requirements, the court ruled. "[A] statutory safe harbor is not very safe if a federal agency may add a new requirement to it through a policy statement," the court said. Therefore, the sham test was ruled invalid, and Welles Bowen Realty's relationship with Welles Bowen Title was ruled to qualify as an affiliated business arrangement, without even considering the characteristics that would seemingly indicate that it was little more than a conduit for referral money.
Was the court right that a government agency can't impose a new and different requirement on par with those in a statute? Probably, unless the statute authorizes it-- agencies are allowed to make rules and regulations, but only to "fill in the gaps" within the statutory framework. But in this case, it's very arguable that the requirement that affiliated businesses not be shams is right in the RESPA statute-- in the statutory definition of an affiliated business arrangement. RESPA defines an affiliated business arrangement as
...an arrangement in which (A) a person who is in a position to refer business incident to or a part of a real estate settlement service involving a federally related mortgage loan, or an associate of such person, has either an affiliate relationship with or a direct or beneficial ownership interest of more than 1 percent in a provider of settlement services; and (B) either of such persons directly or indirectly refers such business to that provider or affirmatively influences the selection of that provider.
There's no question that affiliated businesses can be legal if they meet the requirements of the statute. But to even be an affiliated business arrangement in the first place, the affiliated business must be "a provider of settlement services". In the arrangement at issue here, there seems to be a strong argument that Welles Bowen Title was not actually providing the settlement services in a meaningful way. Chicago Title was providing the settlement services in all material respects, performing all the substantive work and providing the facilities where the work was performed.
This is not my original legal argument. Courts that have previously examined allegations of sham affiliated business arrangements have found that HUD's policy statement was clarifying what constitutes a legitimate provider of settlement services. (In fact, one such case was cited in the lower court's decision in Carter v. Welles Bowen, but for other reasons.) This kind of reasonable interpretation of a statute is precisely the kind of "filling in the gaps" that government agencies typically are and should be allowed to do. But in its decision last week, the appeals court did not even acknowledge the argument that the "additional requirement" they disallowed was actually just a requirement that the statutory definition be met.
But the appeals court ruling is what it is, and the decision is binding on the federal district courts in the 6th Circuit-- Kentucky, Michigan, Ohio, and Tennessee. At least in these states, if you are a referrer of title business, you can apparently now set up your affiliated business arrangement without any capital contribution at all. The office and employees for the venture can all be provided by your title company partner. There doesn't have to be any pretense that the venture is handling any business other than the business you refer to it. In short, it doesn't even have to pretend to look like a real, stand-alone business.
This is a decision that cries out for a fresh look from the Supreme Court.