September 10, 2012
Short Sale Lender Required Pre-Approvals
Question: Is it legal for an REO seller to require a buyer as a condition of sale to obtain preapproval from a lender where the lender is either affiliated with the REO or is the same entity, and where there is no charge for the preapproval?
To put the question another way: To be illegal, a practice must violate some type of law. So what law, if any, might an REO that requires preapproval with a designated lender or with the REO itself be violating?
Quick Answer: It is unlikely that any law is violated when an REO seller requires a buyer to be preapproved by an affiliated lender or by the REO itself.
What follows is a brief analysis of the laws most pertinent to this issue.
I. RESPA
A. Required use exception
RESPA permits referrals between affiliated businesses as an exception to the broader prohibition against referral fee arrangements. However, to qualify for the exception there can be no required use.
"Required use means a situation in which a person must use a particular provider of a settlement service in order to have access to some distinct service or property, and the person will pay for the settlement service of the particular provider or will pay a charge attributable, in whole or in part, to the settlement service. However, the offering of a package (or combination of settlement services) or the offering of discounts or rebates to consumers for the purchase of multiple settlement services does not constitute a required use. Any package or discount must be optional to the purchaser. The discount must be a true discount below the prices that are otherwise generally available, and must not be made up by higher costs elsewhere in the settlement process." Reg. X sec. 3500.2.
A required use therefore only qualifies as such if payment must be made to the settlement service provider. But there is typically no charge for a preapproval. Therefore, the REO practice doesn't fall afoul of this RESPA prohibition.
B. Can you refer business to yourself?
Even if it was a required use we are still assuming that the lender is "affiliated" with an REO. This is probably a good assumption because large corporations often do business through a multiplicity of entities.
But if we suppose that they are exactly the same entity then there is a question as to whether RESPA even restricts an entity from requiring the use of itself. The Freeman v. Quicken Loans case recently decided that to be a RESPA violation, a share or split of fees requires two persons. The same conclusion is likely to be reached in regard to a "referral fee" paid to oneself. (A required use prohibition is essentially a prohibition against referral fees). Therefore, there will be no RESPA violation for this REO practice if the REO is "referring" business to itself.
C. Builder Incentivization
The builder issue is a slightly different question. In Spicer v Ryland, 523 F.supp2d 1356, it was alleged that a builder's incentive for the buyer to use its lending arm constituted a required use. A federal district court decided that it wasn't. The buyer could choose to either pay a lower price and use the builder's lender, or the buyer could pay a higher price and use his or her own lender. But the court determined that the buyer was not required to use the builder's lender, and therefore there was no RESPA violation.
Thus, both the builder case and the REO-demand-for-a-preapproval case fall into the affiliated business exception, and do not constitute "required uses," but for slightly different reasons.
II. California Anti-Trust
Are there other laws that come into play here? Possibly. There is the California antitrust statute that prohibits illegal tying arrangements. In the case of Classen v Weller 145 Cal.App.3d 27 a buyer was told that he couldn't purchase a lot unless he agreed to employ a particular broker exclusively at a specific commission rate. Such a demand was deemed improper under California anti-trust law (B&P C 16700). However, this case is clearly not applicable where the tying service is performed free of charge.
Even if a charge was made, this case is of limited value since it was based on the premise that owning a single piece of property constituted dominant market power. Such a conclusion goes against common sense. Should another court look at the same issue, it may very well decide the issue differently.
III. Unfair or abusive practices as determined by the CFPB (Consumer Financial Protection Bureau)
What about "unfairness?" An "unfair" act is illegal under prior federal law and currently under the Dodd-Frank Act. The FTC's (Financial Trade Commission) activity relating to new homes shows concern over this type of issue. In Kaufman & Broad, an FTC complaint alleged that a contract provision in the agreement of sale allowed the builder-respondent to designate the mortgage lender. Since the case involved a consent order and the FTB issued no decision, one must presume that it believed this was an "unfair" practice.
The job of the FTC regarding consumer protection was handed over to the Consumer Financial Protection Bureau in July of 2011. We do not have a clear idea how the CFPB will approach this issue. Not only has this agency been secretive in explaining how and why it will enforce "unfair" and "deceptive" business practices, but there is a new prong for "abusive" practices. However, if the FTC was concerned with a provision in a contract allowing a builder to designate the lender, then probably the CFPB will be similarly concerned.
The "abusive" prong of the Dodd-Frank Act is more open ended. It is defined as a practice that takes "unreasonable advantage" of, inter alia, the inability of the consumer to protect his or her interests in selecting or using a consumer financial product or service. Certainly, it is possible for the CFPB to conclude that the practice in question is "abusive." But is it really abusive to demand that the buyer engage a service at no cost? And also, if the preapproved lender is offering a competitive loan, would that still be considered "abusive?" My gut response to both questions is that the practice is not likely abusive.
In any event, these provisions of the Dodd-Frank Act do not create a private right of action in and of themselves. Instead, under the federal law, enforcement rests with the CFPB or the state attorneys general.
IV. Unfair Competition Law (B&P 17200)
In California the Unfair Competition Law (UCL) (B&P 17200) prohibits business practices that are unfair, illegal or in violation of public policy. The illegal prong allows a plaintiff to boot strap an existing law even if that law doesn't otherwise contain a private right of action. So it is possible that a plaintiff could claim a violation of the UCL by virtue of a violation of the "unfair" or "abusive" prong of the Dodd-Frank Act even though a private plaintiff would otherwise have no private right of action under that law. This works insofar as the practice is illegal under the Dodd-Frank Act. But as stated in the preceding section, this is unlikely where the preapproved lender is not charging anything or is offering a competitive loan.
To be "unfair" under the UCL, the conduct must be deceptive. But requiring a buyer to be preapproved by an REO seller is not likely to be deemed deceptive.
There are various other stumbling blocks that hinder application of the UCL, including whether federal regulation in regard to banks trumps the boot-strapping mechanism of the UCL. Also the remedies under the UCL are based on "restitution" rather than damages. In plain English this means that you can't sue and recover when you didn't pay any money. (You may still obtain injunctive relief) So, all in all, the UCL is not likely to be an effective legal vehicle for stopping the practice of REOs demanding preapproval from buyers.
V. Anti-Steering provisions of Title XIV to the Dodd-Frank Act ("Mortgage Reform and Anti-Predatory Lending Act"). The anti-steering provision was an amendment to TILA and is presently being enforced through Federal Reserve Board regulations*.
A. Steering
The Board regulations against steering are intended to put an end to the practice of paying yield spread premiums, that is, paying loan originators more to place borrowers into costlier loans on worse terms.
Is the anti-steering provision violated when an REO lender requires a buyer to be pre-approved by it or its affiliate?
Answer: Probably not. In general this law in not geared towards prohibiting this practice.
Analysis: Under this Board's regulation, a creditor is not a loan originator. Therefore, there is no "steering" solely on the basis that the bank demands a preapproval. (Although, this could change when the Dodd-Frank Act itself becomes effective)
Even though a creditor is not a loan originator, a loan originator who is an employee of a creditor may still be subject to its restrictions. Therefore, if an employee/loan originator steers the borrower, then it's possible that the bank could still be liable on the basis of respondeat superior.
But such liability is nonetheless unlikely for the following reasons: One, steering prohibits a loan originator to direct or "steer" a consumer to a loan based upon how much the originator makes out of the loan -- compared to other available loans made through the originator, or through others that the originator does business with. Moreover, the law doesn't require the originator to establish business ties with any other creditor. So you see that even if a better loan were being offered by some other lender, requiring preapproval is not necessarily steering because the comparison is based only upon loans that the originator him or herself ordinarily offers.
Lastly, the law isn't violated unless a loan is actually obtained through the originator in question. So demanding preapproval alone cannot violate this law, and you won't know for sure that the law has been violated until the borrower has obtained a loan through the REO or its affiliates.
So it's unlikely that the anti-steering rule could be used to prohibit an REO from demanding preapproval from a buyer.
B. Restrictions on Compensation.
Another part of this same regulation prohibits payments to the loan originator from any other person if the buyer is paying the loan originator's compensation directly. There could certainly be a problem here if the employee/loan originator for the REO seller or affiliate was receiving a commission directly from the borrower while the REO was receiving money from the sale of its property. I would imagine that if this scenario were to ever arise, the REO would refuse to allow the originator to receive direct compensation from the buyer. All payments made to the employee/originator would have to come from the REO (or affiliates) itself. So any possible violation could be easily prevented by the REO's adoption of a simple payment policy.
*On July 21, 2010 Congress enacted the Dodd-Frank Amendments which added Section 129B to prohibit loan originators from receiving compensation based upon the terms or conditions of the loan. It also contains an anti-steering provision. These provisions are not currently in effect. But because the anti-steering provisions were technically an amendment to the Truth in Lending Act, various agencies including the Federal Reserve Board and the CFPB have the authority under TILA to adopt regulations that mirror the Dodd-Frank Act. The Federal Reserve Board duly created and finalized such regulations in April of 2011, including an anti-steering provision. (See Reg. Z Sec. 226.36-(1))
VI. Conclusion
In summary it is likely that no law is being violated when an REO requires a buyer to obtain a preapproval from a lender where the lender is either affiliated with the REO or is the same entity, as long as there is no charge for this requirement.
