Sunday, December 15, 2013

FYI: 6th Cir Holds HUD Policy Statement on ABAs Not Binding, Not Entitled to Deference

The U.S. Court of Appeals for the Sixth Circuit recently affirmed a district court judge's ruling holding that the 1996 Department of Housing and Urban Development ("HUD") policy statement adding a fourth prerequisite to the Real Estate Settlement Procedures Act's ("RESPA") affiliated business arrangements exception is not binding.


A copy of the opinion is available at:


This case involved a real estate agency and two title services companies ("A" and "B") respectively. The real estate agency and the two title service companies are related to one another along two dimensions: their ownership and their business. The people who own the real estate agency also own a holding company that in turn owns about half of Title Service Company A. Title Service Company B owns the other half of Title Service Company A.


The real estate agency often refers prospective buyers to Title Service Company A. Title Service Company A in turn contracts some of the referred work out to Title Service Company B. Title Service Company B gathers evidence relating to the title, and Title Service Company A evaluates this evidence to determine the title's validity.


The plaintiffs used the real estate agency as their real estate agent. The real estate agent referred the plaintiffs to Title Service Company A. Title Service Company A contracted with Title Service Company B to gather evidence relating to the title. To the plaintiffs' thinking, Title Company A was a shell corporation that improperly funneled referral fees between the real estate agency and Title Company B. The plaintiffs sued all three companies under RESPA. The district court dismissed the plaintiffs' claims and the plaintiffs appealed. The United States intervened in the appeal to defend the validity of HUD's 1996 policy statement.


As you may recall, RESPA prohibits giving or receiving "any fee . .  pursuant to any agreement or understanding . . . that business incident to . . . a real estate settlement service . . . shall be referred." 12 U.S.C. § 2607(a). Anyone who violates this provision commits a crime punishable with up to a year in prison. Id. § 2607(d)(1). A violator also faces civil liability through private-enforcement actions and public-enforcement actions.  12 U.S.C. § 2607(d)(2), (4).  HUD used to enforce these provisions, but this function has been transferred to the new Consumer Financial Protection Bureau. 12 U.S.C. § 2617.


Congress created an exception in 1983 when it added a safe harbor for "affiliated business arrangements." 12 U.S.C. § 2607(c)(4). The safe harbor provision covers arrangements where a person making a referral "has either an affiliate relationship with or a direct or beneficial ownership interest of more than 1 percent in" the settlement-service provider receiving the referral. 12 U.S.C. § 2602(7). A business arrangement qualifies for the safe harbor protection if it meets three conditions: (1) the person making the referral must disclose the arrangement to the client; (2) the client must remain free to reject the referral; and (3) 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." 12 U.S.C. § 2607(c)(4).  


There was no dispute that the defendants in this case (several realty companies and title companies) satisfied the three affiliated business arrangement prerequisites.


Despite this, the plaintiffs (three home buyers) claimed that the defendants fell outside the safe harbor's coverage because they failed to satisfy a fourth condition announced by HUD through a policy statement. The district court held that the policy statement was invalid and unenforceable.


The Sixth Circuit affirmed, holding HUD's 1996 policy statement does not supplement RESPA's existing safe-harbor conditions, and instead unacceptably created an ambiguity where none existed in a statute where a violation carries potential criminal liability. As such, the Court held that the 1996 policy statement is not binding on HUD or anyone else because it is not otherwise entitled to deference.


The plaintiffs argued that the profits earned by the owners of the real estate agency and Title Company B constituted prohibited referral fees because of their relationship with Title Company A. The Sixth Circuit found two potential ways to look at this claim: the easy way, and the hard way.


The easy analysis turns on RESPA's statutory safe harbor provisions. 12 U.S.C. § 2607(c)(4). The business relationship in this case qualifies as an "affiliated business arrangement." There was no dispute that the real estate agency had an "affiliate relationship" with Title Service Company A, that the real estate agency made referrals to Title Service Company A, and that Title Service Company A in turn provided settlement services. § 2602(7). This relationship satisfied all three safe-harbor conditions. The real estate agency disclosed the arrangement to the buyers, the real estate agency allowed them to reject the referrals, and neither the real estate agency nor its owners received anything of value from the arrangement apart from a return on their ownership interests. § 2607(c)(4).  Thus, the Sixth Circuit held that the real estate agency and Title Service Company A did everything RESPA required, and therefore qualified for RESPA's affiliated business arrangement exemption.


The more complicated way of looking at the claim, the Sixth Circuit observed, must account for HUD's 1996 policy statement. See Statement of Policy 1996-2 Regarding Sham Controlled Business Arrangements, 61 Fed. Reg. 29,258 (1996). HUD's policy statement announced that, in addition RESPA's three clear safeguards contained in § 2607(c)(4), affiliated business arrangements must also satisfy a fourth requirement: "[T]he entity receiving the referrals of settlement service business must be a . . . bona fide provider of settlement services." Id. at 29,262.  The statement continues, "[t]he Department will consider" a series of factors "and will weigh them in light of the specific facts" when separating bona fide providers from shams. Id.  The ten factors that HUD will consider include whether the provider has "sufficient initial capital and net worth," whether it has "its own employees," and whether it is "located at the same business address as one of the parent providers." Id.


The Sixth Circuit took a dim view of HUD's attempt to add a fourth requirement to a safe harbor provision that exempts individuals from potential criminal penalties stating that "a statutory safe harbor is not very safe if a federal agency may add a new requirement to it through a policy statement." More specifically, the Sixth Circuit found that HUD's "policy statement is not entitled to Chevron deference or Skidmore consideration, and as a result compliance with the three conditions set out in the statute suffices to obtain the exemption"


A policy statement is entitled to Chevron deference "only when an agency offers a binding interpretation of a statute that it administers." Chevron v. Natural Resources Defense Council, 467 U.S. 837 (1984). The Sixth Circuit held that HUD's 1996 policy statement's ten-factor test is not a binding interpretation of the Act. Instead, the Court held, the statement merely informs the public that HUD plans to "consider" these factors when separating bona fide providers from shams. As such, the Sixth Circuit held that the 1996 policy statement offers non-binding advice about the agency's enforcement agenda, not HUD's controlling interpretation of the statute, and that this type of agency recommendation, even when it expresses policy considerations or preferences, does "not bind courts tasked with interpreting a statute."


The government countered this analysis by arguing that the policy statement contains two parts. The first half announces HUD's binding view that only bona fide settlement services providers qualify for the safe harbor. The second half's ten factors to consider gives non-binding advice about how to separate genuine providers from shams. The government argued that the first part of HUD"S statement deserves deference even if the second part does not.


The Sixth Circuit rejected the governments' interpretation for several reasons.  First, the Court noted that RESPA "already contains three conditions that protect buyers against affiliated business arrangements involving sham providers." Viewed in this light, the Court held that the bare pronouncement from the first half of the statement that the safe harbor excludes shams, shorn of the ten-factor test to distinguish the genuine from the fake, adds nothing to the statute -- RESPA already protects buyers against sham providers. The Sixth Circuit held that the defendants already met the three criteria to separate bona fide providers from shams, and that by itself, a proclamation re-affirming this does not change anything.


The Sixth Circuit found another problem with the government's approach:  the point of Chevron is to allow agencies to resolve statutory ambiguities.  The Court held that HUD's 1996 policy statement does not resolve any statutory ambiguity, but instead HUD's policy statement creates an ambiguity where none exist.  The Court noted that, if the first half of the policy statement requires courts to conduct a freestanding inquiry into a service provider's genuineness, and this inquiry has nothing to do with the three requirements detailed in § 2607(c)(4), then how should the courts determine if a service is bona fide?  The Court further noted that, if the ten-factor test does not guide the courts' performance of this task, then what does? According to the Sixth Circuit, the government does not provide an answer, leaving courts to figure out the answer without any binding criteria -- which unacceptably creates ambiguity, instead of resolving it.


The Sixth Circuit also rejected the government's interpretation because agency interpretation receives Chevron deference only if "Congress delegated authority to the agency generally to make rules carrying the force of law, and . . . the agency interpretation claiming deference was promulgated in the exercise of that authority." United States v. Mead Corp., 533 U.S. 218, 226–27 (2001). Consequently, the Court held, because policy statements do not speak with the force of law, "interpretations contained in policy statements . . . do not warrant Chevron-style deference." Christensen v. Harris County, 529 U.S. 576, 587 (2000). However, this is a norm, not an "absolute rule." Barnhart v. Walton, 535 U.S. 212, 222 (2002). Although this is a norm and not an absolute rule, the Sixth Circuit found no persuasive reason to depart from the norm.


The Sixth Circuit also noted that RESPA's criminal penalties reinforce application of the Mead doctrine in this case.  A statute with civil and criminal penalties receives a single interpretation. Leocal v. Ashcroft, 543 U.S. 1, 11 n.8 (2004); United States v. Thompson/Center Arms Co., 504 U.S. 505, 518 n.10 (1992).  The government must give the people fair notice of what conduct it has made a crime. McBoyle v. United States, 283 U.S. 25, 27 (1931). The Sixth Circuit held that the government's duty of fair notice of conduct that it has criminalized precluded the Court from supplementing the clear safeguards expressed on the face of the statute with a multi-factor ten part test blend never expressed in the statute.


The Sixth Circuit also rejected the plaintiffs' argument, pursuant to Skidmore v. Swift & Co., 322 U.S. 134 (1944), that HUD's position enjoys deference because it is persuasive for the simple reason that it is not persuasive. The Court noted that, taken alone, the first half of the statement provides courts with no guidance about how to apply the requirement it seeks to include in the statute.  Nor is this ambiguous approach compatible with the imperative to provide fair warning in the criminal context, the Court held, but rather these shortcomings "rob the policy statement of persuasive force."


The Sixth Circuit also disagreed with the plaintiffs "most far reaching argument" that RESPA actually contains the policy statements' fourth requirement. The Court noted that the plaintiffs "find a textual hook for this argument hidden in a dependent relative clause" in RESPA's definition section. RESPA's definition for "affiliated business arrangement" includes the phrase "provider of settlement services." 12 U.S.C. § 2602(7). The plaintiffs asserted that the phrase "provider of settlement services" means "bona fide provider of settlement services." However, the Sixth Circuit held that the most natural definition of a "provider of settlement services" is "one who provides settlement services."  The Court noted that RESPA clearly outlines the three requirements that affiliated business arrangements must satisfy to obtain an exemption from the referral fee ban (12 U.S.C. § 2607(c)(4)), and the requirements are spelled out in "painstaking detail." RESPA's express inclusion "of these precise requirements counsels against discovering an additional requirement in the implications of a phrase tucked away in a dependent relative clause elsewhere in the statute." Bruesewitz v. Wyeth LLC, 131 S. Ct. 1068, 1076 (2011).


The Sixth Circuit also noted that the entire statute fortifies its ruling.  RESPA establishes other safe harbors from its ban on referral fees, separate from the affiliated business safe harbor provision. Significantly, one of these other exceptions uses the phrase "bona fide" that the plaintiffs want to read into the affiliated business safe harbor provision. The exception protects "the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually rendered." 12 U.S.C. § 2607(c)(2).  RESPA uses "bona fide" in the salary or compensation exception, but omitted the phrase in the affiliated business arrangement exception.  According to the Court, this disparity confirms that the business arrangement exception does not require "courts to conduct a freestanding inquiry into a provider's bona fides unconnected to the safe-harbor test already baked into the statute." Russello v. United States, 464 U.S. 16, 23 (1983).


The Sixth Circuit concluded that its decision is consistent with the purpose of RESPA's safe harbor provision. The statute initially created legal uncertainty about profiting from referrals to affiliated companies. As a result, "Congress created the affiliated-business-arrangement safe harbor to eliminate this uncertainty."  According to the Court, RESPA's precision in defining this exception's boundaries reflects this objective, and a multi-factor inquiry that would require courts to distinguish bona fide providers from shams in new ways would reintroduce the uncertainty that the safe harbor exception eliminated.  As the Sixth Circuit noted, this result is particularly unacceptable where there are potential criminal penalties.


In sum, the Sixth Circuit held that HUD's 1996 policy statement adding a fourth requirement to the affiliated business arrangement exception is not binding, and the arrangement between the real estate agency and the title service companies qualifies for the affiliated business arrangement exception.  Accordingly, the Sixth Circuit affirmed the lower court's ruling in favor of the defendants.





Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
(312) 551-9320
(312) 284-4751
(312) 493-0874


Admitted to practice law in Illinois



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