Originally published November 22, 2004
Does creating a joint venture between a mortgage company and a title company (Joint Venture) violate the Real Estate Settlement Procedures Act of 1974 (RESPA)? In order to avoid violating RESPA there are several elements that must be considered when creating and operating a joint venture. To determine whether an entity is a bona fide provider or a "sham controlled business arrangement," HUD has indicated, through various regulations and advisory opinions, that HUD considers 10 elements and weighs them in light of the specific facts. This article will address these elements and what a joint venture must do to avoid a HUD determination that the joint venture is a sham controlled business arrangement.
HUD Elements of Bona Fide Providers
HUD will consider the following 10 elements to determine if a provider of settlement services is a bona fide provider:
1. Sufficient initial capital and net worth – The joint venture must have sufficient initial capital and net worth to conduct a settlement services business. The amount of capital and net worth must be typical in the industry and in the location where the joint venture conducts its business. Thus, the amount must be sufficient for the joint venture to perform the work of a full title service agency in the jurisdiction where the joint venture is located.
2. Staffed with its own employees – The joint venture should have its own employees, rather than employees "loaned" from one of the entities that created it (parents). Even if the joint venture has its own employee, if that employee is loaned or leased from a parent and continues to be supervised by a parent, this would be an indication to HUD that the joint venture is not a bona fide provider. Thus, the joint venture should have at least one employee who works exclusively for the joint venture and is hired by the joint venture.
3. Manage its own business affairs – The joint venture must manage its own business affairs. In the case where (a) the employees of the joint venture are former employees of either parent, (b) continue to do the work they previously did for the employer parent, and (c) the employer parent manages the employees, HUD could consider this as an indication that the joint venture is not a bona fide provider. Consequently, while the employees of the joint venture may be former employees of either of the parents, the employees must not continue to do the work they previously did for the employer parent, and the employees must not be managed by the parent.
4. Separate office or pay general market rent for shared facilities – HUD does not require that the joint venture have a different business address from the parents; however, if the joint venture does share office space with a parent it should pay fair market rent for such office space.
5. Provide substantial services – Each entity must perform actual services. If you are entertaining the idea of creating the joint venture as a wholly owned subsidiary of a parent whereby the joint venture would then enter into joint ventures with several established title companies, you will have to ascertain whether this arrangement would not provide sufficient work for the joint venture, the other joint ventures and the parent title company to meet the requirement of this element as each entity must provide substantial services. If there would be sufficient work for each entity in the proposed division of labor such a strategy could be successful.
6. Amount of services the joint venture performs – If the joint venture provides few of the essential functions of a settlement service agency and contracts out many of the core functions, HUD could determine that the joint venture is not a bona fide provider. However, if the joint venture performs a sufficient amount of services, such as processes all contracts, loans, and title orders procured by one parent, is the title agent on the HUD-1 and acts as the title insurance agent, the services provided by the joint venture would appear to be substantial enough satisfy this element.
7. Amount of services contracted out to a parent – In a case where the joint venture does little real work and contracts-out a substantial part of the core work to a parent, HUD could determine that the joint venture is not a bona fide provider. Thus, it is important to keep in mind that both the joint venture and the parent title company must provide real work. The parent title company must perform the necessary functions to bring any and all contracts to fruition with respect to closing or settlement including ordering a title commitment, preparation of settlement documents, conducting the closing, acting as escrow agent, disbursement of funds and title policy production.
8. Pay for contracted services are reasonable – The party performing the contracted services must receive a payment for services that bears a reasonable relationship to the value of services provided. If the parent title company charges the joint venture less than a reasonable amount for the services rendered by the parent title company, this would be an indication of a sham controlled business arrangement. HUD could view this discounted price as unearned fees or as a "referral fee." The joint venture must pay all third party providers a similar fee to that paid to a parent provider. Further, the parents must be paid solely (a) for the services rendered, and (b) a return on its investment that is not based on referrals of business. Under this second prong, the return on investment must be based on the amount contributed to the capitalization of the company rather than on referrals made. In cases where the percent of ownership interest is based on the amount of business referred, such payments are viewed not as bona fide returns on ownership interest, but as an indirect method of paying a kickback based on the amount of business referred and thus a violation of Section 8 of RESPA.
A member of the staff of the RESPA division of the United States Department of Housing and Urban Development, stated that, payment for actual services rendered is not prohibited by RESPA and the a reasonable outsourcing fee paid by the joint venture to the parent title company would not violate RESPA because the parent title company would be paid for actual services rendered, i.e., the necessary functions to bring contracts to fruition with respect to closing or settlement including ordering title commitment, preparation of settlement documents, conducting the closing, escrow, disbursement and title policy production.
9. Actively competing in the marketplace for business. The joint venture must compete for business in the marketplace. The use of the joint venture’s trade name and a marketing campaign using the trade name would satisfy this element. At first glance it would appear that in the event that all of the joint venture’s business is obtained from a parent, HUD would consider this as an indication that the joint venture is not a bona fide provider. However, HUD looks at both of the following:
(a) where the joint venture obtains its business
(b) where the joint venture outsources business
If the joint venture obtains all of its business from the parent and outsources only to the parent title company, this would indicate to HUD that the joint venture is a sham controlled business arrangement. However, if the joint venture obtains all of its business from the parent mortgage company and outsources to the parent title company as well as other title companies, this would indicate to HUD that the joint venture is a bona fide provider.
10. Sending business exclusively, or primarily to a parent – Elements 9 and 10 are closely linked. Under this element 10, the joint venture may exclusively outsource to the parent title company; however, the parent mortgage company must not be the sole source of the joint venture’s business. Thus, the joint venture may do one of the following:
(a) receive business solely from the parent mortgage company and outsource the parent title company and to other title companies
(b) receive business from many sources and outsource only to the parent title company
The bottom line is the joint venture may either receive solely from a parent or outsource solely to a parent.
There are benefits and burdens to creating a joint venture between a mortgage company and a title company. Parents can avoid violating RESPA and can create a bona fide provider rather than a "sham controlled business arrangement," provided, they keep in mind HUD’s 10 elements.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.