The U.S. Department of Housing and Urban Development (HUD) published an Interpretative Rule in the June 25, 2010 Federal Register, providing HUD’s long-sought views on the circumstances under which home warranty companies (HWCs) may compensate real estate brokers and agents for marketing their products. This Interpretive Rule follows HUD’s controversial, non-binding, and informal staff interpretation letter dated February 21, 2008, which raised numerous concerns and questions about HUD’s views on marketing agreements and the marketing of home warranties, and which led to various meetings between HUD and industry groups concerning these issues. While directed at agreements between HWCs and real estate brokers and agents, the rule likely will have implications for many other providers who offer services in the residential real estate market.
HUD regulations state that services performed by real estate agents and brokers on behalf of other settlement service providers generally are compensable as additional settlement services if the services are actual, necessary, and distinct from the primary services provided by the real estate agent or broker. See 24 C.F.R. § 3500.14(g)(3). HUD’s new Interpretive Rule further applies that principle to real estate broker/agent marketing services for HWCs but caveats that a real estate broker’s or agent’s sales pitches or other similar marketing activities that are “directed to particular homebuyers or sellers” are “referrals,” not services, and hence are non-compensable. Likewise, HUD says that, where the services justifying the fee are “nominal” or “duplicative” with services for which a separate fee is charged, the services are likewise non-compensable. In addition exclusive arrangements by which the broker or agent is precluded from performing similar services for other HWCs may render the program violative of Section 8 of RESPA.
A More Detailed Summary
HUD begins its analysis with its premise that home warranties are settlement services. As such, it applies a fairly traditional RESPA analysis to whether real estate brokers or agents can be paid by HWCs: If all the broker or agent does is make a referral, the answer is no; if the broker or agent performs services that are actual, necessary, and distinct from the primary services provided by a real estate agent or broker, then the services may be compensable so long as, in HUD’s view, the services are not nominal and there is no other duplicative charge made for such services. In that case, payments reasonably related to the value of such compensable services are permitted.
HUD further advises that in evaluating whether a payment is an unlawful kickback for a referral, HUD may consider whether the compensation paid is (i) “contingent on an arrangement that prohibits the real estate agent or broker from performing services for other HWC companies” and (ii) whether the payments made are “based on or adjusted in future agreements according to the number of transactions referred.”
HUD also states that time spent by a broker or agent to explain or promote a home warranty product to particular buyers or sellers is not a compensable service but a mere referral for which no compensation may be paid. It appears that the distribution of an HWC’s promotional material at a broker’s or agent’s office or even at an open house is included within this non-compensable conduct. By contrast, HUD’s Interpretative Rule does offer some examples of services that it regards as potentially compensable, including the following:
- Conducting actual inspections of the items to be covered by the warranty to identify pre-existing conditions that could affect home warranty coverage
- Recording serial numbers of the items to be covered
- Documenting the condition of the covered items by taking pictures and reporting to the HWC regarding inspections
Presumably, other services not explicitly mentioned such as co-op advertising, banner and Web site ads, signage, and so forth would be permitted but the HUD rule expects such services to be specified in a contract between the HWC and the broker/agent.
Other factors that HUD says will be evidence that compensable services have been performed are disclosure to the consumer of the services to be provided and the compensation arrangement with the HWC; documentation by the broker/agent that the services have in fact been performed; and contractual provisions that establish that the broker or agent is the legal agent of the HWC such that the HWC assumes responsibility for the performance by the broker/agent.
Finally, HUD requires that if the services are compensable, the value of the payment or compensation must be reasonably related to the value of the services actually performed by the real estate broker or agent. Significantly, HUD indicates that it “will review evidence on a case-by-case basis” in determining “whether compensation provided was a kickback or for a referral of a legal payment.” The practical effect of this type of case-by-case review (as in the mortgage brokerage compensation arena) should be that RESPA challenges to these types of marketing payments will be made as part of private class actions because of the individualized nature of the determinations.
Analysis and Discussion
The industry has been looking for guidance on this matter for more than two years. While the guidance offered does answer some of the questions raised, as is often the case, it raises many more issues that need to be addressed.
- What is the scope of the interpretation?
On its face, the interpretation is limited to payments by HWCs to real estate brokers and agents. Yet it appears that this interpretation could have application or import for marketing arrangements between real estate brokers and other vendors and/or between HWCs and other settlement service providers.
- Does or should the interpretation have retroactive effect?
HUD does not explicitly say whether the interpretation has retroactive effect, but its pronouncement that real estate brokers and agents never perform compensable services when they market to particular homebuyers and sellers will undoubtedly be regarded as a new and novel proposition, and arguably an erroneous one. Heretofore, many in the industry believed that while the mere recommendation of an HWC or the taking of a two-minute application was not compensable, a complete explanation of the home warranty process — including, for example, a review of the coverage and exclusions and pricing of a policy and comparison of those features against other policies, together with an explanation of the claims administration process and/or other services — certainly was compensable. Yet HUD appears to believe that none of the foregoing services is compensable and that the distribution of marketing materials is for some reason not a compensable marketing service — without regard to the extent of the service. Regardless of whether such an interpretation is correct and can be squared with RESPA, such new and novel interpretations should only be applied prospectively. And even if retroactive efforts were attempted, the case-by-case approach that HUD proposes to analyze reasonable compensation and the compensability of different services would likely preclude retroactive challenge by private class actions.
- Does the interpretation set a different standard for real estate agents and brokers than other settlement service employees, and what is the basis for such a standard?
As noted, HUD states that sales pitches by real estate brokers or agents to particular homebuyers or sellers are just referrals, in part because of the broker/agent’s unique position to make referrals and their “position of influence.” However, real estate brokers and agents are permitted to make referrals to each other and to be compensated for them by statute. Moreover, it is questionable whether real estate brokers are in any better position to make referrals or in any greater position of influence than are loan officers, title officers, escrow officers, insurance agents, lawyers, or any other provider that interacts with the consumer during the real estate process. And if none of these people can be compensated for making sales pitches, is HUD not making it much more expensive to market and sell needed settlement services — possibly impeding rather than promoting competition?
- What is the relevance of making the broker or sales agent the legal agent of the HWC such that it can hold the HWC responsible for the broker/sales agent’s conduct and representations if HUD is going in effect to prohibit compensated sales presentations by the brokers/agents?
The relevance is unclear. While such a requirement would be sensible if the broker agent were to be compensated for its sales pitch, it would not seem important for the broker to be the legal agent of the HWC if all they are going to do is to run advertisements for the HWC in the broker newsletter and Web site. Certainly, newspapers and popular Web sites are not the legal agents of the entities for the businesses that they market or advertise.
- How does exclusivity factor into the analysis of whether a broker is going to promote an HWC as part of a marketing campaign?
HUD says that if the broker forms an exclusive marketing relationship with an HWC, that would factor into the evaluation of whether payments that are reasonably related to the value of services (e.g., newspaper ads, Web site ads, signage, co-op advertising, inspections of the property to be covered, dual-sponsored marketing events, and so forth) are unlawful kickbacks. Yet the logic here and exactly how this would factor into the analysis is unclear.
Indeed, for years, people who were interested in promoting the convenience and accountability of one-stop shopping arrangements but who did not have the ability or level of business to form a joint venture would form a marketing relationship and, understandably, some such relationships are promoted by exclusive dealing. Exclusive dealing may bring greater trust, efficiencies, and accountability, among other things. HUD does not explain why exclusive marketing relationships are inherently bad, especially when they are not otherwise anticompetitive and consumers are free to use other providers if they so choose.
- What should you do now?
First, HUD has stated that it is interested in receiving feedback on the clarity and scope of its Interpretive Rule, so one thing you may want to do is to comment on the issues that are most meaningful to you. Comments are due on July 26, 2010.
Second, you may want to re-evaluate your marketing arrangements. Whether you agree with HUD and whether HUD is correct in its interpretation, absent a legal challenge, the most prudent thing to do is to conform your arrangements to this interpretation. This means that exclusive marketing arrangements may be problematic; it means that some type of legal agency relationship or at least legal responsibility for the marketer’s actions may be advisable. It also means that brokers or sales agents should not receive or be paid compensation for mere sales pitches or similar marketing activities to particular homebuyers or sellers. Other services can be compensated if they are actual, necessary, and distinct from the primary services provided by the real estate agent or broker and are not nominal or services for which there is a duplicative charge. Of course, the payment must be reasonably related to the value of such services and HUD advises that the services and compensation be laid out in a written contract.
Third, you may want to consult your advisors and try to determine the implications of this interpretation on related interactions that you may have with other settlement providers.
Finally, to the extent you believe you have valuable marketing relationships that do not square with HUD’s interpretation, you may want to re-think whether a viable joint venture can be structured.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and our colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:
Michael C. Lueder
Chair, Consumer Financial Services Litigation Practice
Jay N. Varon