If some consumers and real estate agents aren’t happy about the flat fees many brokerages are slapping on top of their traditional percentage-based commissions (see Part I), there are also unresolved questions about the legality of the practice.

A recent ruling allowing a class-action lawsuit to proceed against an Alabama-based brokerage has captured the attention of other companies that could face similar claims that they are violating the Real Estate Settlement Procedures Act, or RESPA.

Editor’s note: This is Part II of a three-part series exploring the legal, ethical and competitive issues surrounding flat fees being instituted by many brokerages on top of their traditional percentage-based commissions. Part I explored the industry’s rationale for instituting the fees, and Part III will look at the online backlash from consumers and real estate professionals.

If some consumers and real estate agents aren’t happy about the flat fees many brokerages are slapping on top of their traditional percentage-based commissions (see Part I), there are also unresolved questions about the legality of the practice.

A recent ruling allowing a class-action lawsuit to proceed against an Alabama-based brokerage has captured the attention of other companies that could face similar claims that they are violating the Real Estate Settlement Procedures Act, or RESPA.

The case involves JRHBW Realty Inc., a Birmingham-based company that does business as RealtySouth, and the $149 "Administrative Brokerage Commission" it instituted in 2003.

One year after being acquired by Berkshire Hathaway affiliate HomeServices of America Inc., RealtySouth added the so-called "ABC Fee" to its traditional percentage commission, charging both buyers and sellers and sharing none of the proceeds with sales agents.

In September 2004, RealtySouth was hit with a class-action lawsuit, claiming the brokerage was violating RESPA by charging a fee for which "no service is rendered," or "a duplicate fee for services already rendered."

The named plaintiff in the case, Vicki Busby, had purchased a home in Trussville, Ala., for $187,000. A $149 "ABC Fee" was added to her HUD-1 settlement statement, in addition to the $4,675 in commissions RealtySouth had earned as its half of the 5 percent total commission representing the buyer in the transaction.

Busby’s lawyers estimate more than 30,000 other buyers and sellers have paid RealtySouth’s ABC fee, and are seeking triple damages plus attorneys’ fees — meaning RealtySouth could be liable for more than $13 million in damages.

In an affidavit filed in a previous lawsuit, C. Tyler Dodge — RealtySouth’s chief operating officer at the time — explained the rationale for instituting the fee. Until March 2003, he said, the company’s commission structure "had been essentially the same for many years."

But consumers were "demanding a higher level of services and new services," and the cost of providing such services was "steadily increasing," Dodge said. Meanwhile, he said, RealtySouth was "paying out an ever-increasing percentage of its revenues to its sales agents in the form of higher commission splits."

Dodge maintained that the ABC fee was "not intended to cover any specific service. On the contrary, it simply was an increase in the price or fee that RealtySouth charged for all of its brokerage services rendered to both buyers and sellers."

In the Busby case, RealtySouth’s lawyers have argued that RealtySouth collected the fee for an "array of services," including costs associated with regulatory compliance; increased overhead costs; facilities, offices, equipment, and an enhanced Web site and other technology; and time spent locating and buying Busby’s home.

In an April 20 opinion, U.S. District Court Judge Virginia Hopkins declined to throw the case out, rejecting RealtySouth’s arguments that the company had provided an "array of services."

Hopkins said she had "difficulty accepting RealtySouth’s proposition that a closing charge attributable to an ill-defined or non-specific set of services … could ever be legally sufficient" to defeat a claim that the fee was unearned.

If that were the case, Hopkins said, a settlement-service provider could always defend itself by "tying an extra fee to the overall body of services already provided" when the extra fee "really had no direct underlying basis for being separately listed as an earned item." …CONTINUED

The array of services RealtySouth claimed to have provided were not settlement services, Hopkins said, because either they were not provided at or before the closing, or because "any direct benefit to the borrower is nonexistent or negligible."

Hopkins also said RealtySouth could not show how a customer’s ability to access an enhanced Web site is part of the loan-closing process. Similarly, increased overhead costs also "fall outside the parameter of a loan settlement" and "the borrower received no benefit."

Finally, Hopkins said, "the court struggles to see how charging Busby for helping her to find a house" was not a duplication of the brokerage’s separate percentage commission charge.

Although Hopkins’ ruling leaves open the possibility that brokerages that charge flat fees may be violating RESPA, the Busby case has yet to run its course.

Conflicting opinions

Further complicating matters, federal courts of appeals have issued conflicting opinions on whether a RESPA violation has occurred unless fees are being split.

In enacting RESPA in 1974, lawmakers were intent on stopping settlement services providers like title insurers from splitting fees with real estate brokers, agents and others in a position to send businesss their way. Under RESPA, such fee-splitting is tantamount to an illegal kickback in the eyes of the law (although companies may still form joint ventures in order to share profits).

Some federal appeals courts — the 4th (North Carolina, South Carolina, Maryland, Virginia and West Virgina), 7th (Illinois, Indiana and Wisconsin) and 8th (Minnesota, Iowa, Arkansas, Missouri, North and South Dakota, and Nebraska) Circuit Courts of Appeals — have ruled that unless fees are split, they can’t be considered unearned under RESPA. Others — the 2nd (New York, Connecticut and Vermont) and 11th (Alabama, Florida and Georgia) Circuits– have ruled that fees don’t neccesarily have to be split in order to be considered unearned.

In a 2001 policy statement prompted by conflicting court rulings, HUD took the latter view. Under HUD’s interpretation of RESPA, fees may be found to be unearned regardless of whether or not they are split.

In passing RESPA, HUD said, Congress meant not only to protect consumers against kickbacks, but "uneccessarily high settlement charges."

HUD said settlement-services providers — including mortgage lenders, title insurers, and real estate brokerages — can run afoul of RESPA’s prohibitions on unearned fees in three ways:

  • By splitting a fee for settlement services in which any portion is unearned.
  • By marking up the cost of services performed by another settlement services provider without providing any additional services justifying the charge.
  • By charging consumers a fee where no work is done, or duplicative work is done, or "the fee is in excess of the reasonable value of … the services actually performed."

To Varon — a Washington, D.C.-based lawyer who specializes in RESPA issues — HUD’s interpretation that the act prohibits "excessive" fees goes beyond the legislation’s original intent. Congress, he said, never intended for RESPA to be a price-control statute.

"I think most of the industry believes HUD shouldn’t be dictating what prices to charge," Varon said. "But the law is murky. If you go from court to court, and jurisdiction to jurisdiction, you get different answers."

In some jurisdictions, appeals courts have ruled that fees can’t be unearned unless they are split. So real estate brokerages charging flat fees may have some protection from RESPA lawsuits in those jurisdictions, because the fees aren’t split with other companies.

In other areas — like the 11th Circuit, where RealtySouth does business — appeals courts are in agreement with HUD’s interpretation that fees may be unearned whether they are split or not, and brokerages charging flat fees may find themselves vulnerable to charges they are violating RESPA.

Unless a lawsuit on RESPA’s prohibitions on unearned fees makes it all the way to the Supreme Court, the law of the land will continue to vary from district to district, Varon said. …CONTINUED

Taking precautions

But Varon and another lawyer who’s considered an expert on RESPA, Phillip Schulman of the firm K&L Gates, say there are ways for brokerages who want to charge flat fees to defend themselves against lawsuits.

In those jurisdictions where appeals courts have ruled fees may be considered unearned even if they are not split, brokerages should make clear that the fees are part of the brokerages’ overall commission, and not a separate fee for specific activities like record-keeping, operating a Web site, or administrative services, the lawyers said.

The way to do that is to spell out that a commission will be equal to "X" percent of the sales price plus "Y" dollars on buyer agreements and listing agreements, and to put the total dollar amount of the resulting commission on a single line of the HUD-1 settlement statement, they said.

Because real estate brokers and agents are free to negotiate their commissions with buyers and sellers, there’s no reason for HUD to object to a percentage plus flat-fee commission structure if brokerages and their clients want to do business that way, the thinking goes.

One issue in the Busby case, Schulman said, was that while RealtySouth stated in its agreements with buyers and sellers that the fee was part of the commission, the fee was listed as a separate line item on the HUD-1 settlement statement. That left the door open for Busby and other consumers to argue that they were being charged an additional or duplicative fee for which no services were performed.

On Busby’s HUD-1, the $149 ABC fee was entered on line 704, a space HUD advises "may be used for additional charges made by the sales agent or real estate broker, or for a sales commission charged to the borrower, which will be disbursed by the settlement agent."

RealtySouth disclosed the flat fee on a separate line on the HUD-1 (line 704) because that made it easier to calculate the division of the portion of the commission based on a percentage of the sales price between the buyer’s agent and seller’s agent, Varon said.

Varon and Schulman say that brokerages using a percentage plus flat-fee commission structure should instead add the flat fee to line 700 (total broker fees), and lines 701 and 702 (the share of the commission going to the buyer’s and seller’s brokers) — not line 704.

The new standardized HUD-1 settlement statement form that will become mandatory on Jan. 1 seems to facilitate this approach, because it calls for commissions to be entered as dollar amounts rather than percentages and dollar amounts.

Varon said the primary concern remains disclosing the flat fee as part of the commission on the buyer agreement and listing agreement. But combining the flat fee and percentage commissions on line 700 of the HUD-1 provides an additional measure of clarity.

"We do not believe that the manner in which a title agent discloses the fees on the HUD-1 should be controlling, especially in light of a clear contractual agreement to the contrary," Varon said.

But Scott Powell, the Birmingham-based lead attorney for homebuyer Vicki Busby and thousands of other potential claimants, questioned whether combining the flat fee with the percentage commission on the HUD-1 provides any additional immunity from RESPA suits.

"I don’t know that that solves the problem," Powell said. "If you are charging percentage plus a dollar amount, I don’t care if it’s on one line, two lines, or five lines — you are charging two commissions."

The question is, Powell said, "Do they provide a service for the fee charged? The fact that the fee is charged makes it incumbent for them to provide a service for the fee, wherever they put the fee on the form."

HUD hasn’t ruled on the issue, and in the end it may be up to courts to decide if it matters where flat fees are disclosed on the HUD-1 settlement statement.

When contacted by Inman News, Dodge said RealtySouth was limited in what he could say because the lawsuit is ongoing. Varon, who is one of the attorneys representing RealtySouth, agreed to discuss the issue of flat fees in general but not issues that remain in dispute in the case.

"We have always clearly disclosed our compensation at the beginning of the process, early and in writing, and we’ll continue to do so," Dodge, now the company’s president and chief executive officer, said in an e-mail.

Dodge said RealtySouth has disclosed its ABC fees in its property-listing agreements, buyer-agency agreements, transaction-brokerage service agreements, for-sale-by-owner agreements, and net sheets.

"We firmly believe that by setting a small portion of our commission as a fixed rate, people benefit. The consumer benefits and is protected from paying a larger percentage commission. The agents benefit because this small administrative compensation does not affect their reasonable and fair commission. Our company benefits because we can continue to afford to provide the exceptional quality of service to our clients," Dodge stated.

Next: Part III explores the the online backlash from consumers and real estate professionals.

***

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