In a decision two years in the making, on Wednesday, November 27, 2013, the Sixth Circuit Court of Appeals brought some clarity to the use of affiliated business arrangements (“ABAs”) under Real Estate Settlement Procedures Act (RESPA). In doing so, the Court dealt a serious blow to what has become a veritable cottage industry for certain RESPA class action plaintiffs’ counsel. The Court affirmed the district court’s summary judgment ruling, and held that HUD’s RESPA Policy Statement setting forth certain guidelines as to what would be considered in determining whether an affiliated business is a “sham” (61 Fed. Reg. 29,258 (June 7, 1996) (“Sham Guidelines”)), was not entitled to deference and could not override Defendants’ showing that they had complied with RESPA’s section 8(c)(4) statutory safe harbor for affiliated business arrangements. See Carter v. Wells Bowen Realty Inc., Slip Op. No. 10-3922 at 5-9 (6th Cir. Nov. 27 2013). This decision—in which an amicus brief, authored by the authors of this article, played an important role—will have many implications for ABAs and for future RESPA class actions.
I. The Facts and Lower Court Decision
Defendant Wells Bowen Realty (“WB”) is a real estate broker. It has an affiliated title agency in which its owners and Chicago Title each have a 50% ownership interest. WB often refers customers to its affiliated title agency, which in turn often refers the customers to Chicago Title for certain additional title services. The Plaintiffs challenged this arrangement in a class action, claiming that the title agency was a shell entity and a sham designed to funnel referral fees between Chicago Title and WB. The companies, by contrast, defended on the basis that they could not be liable under RESPA because they satisfied the three prongs of RESPA’s 8(c)(4) safe harbor: disclosure of the affiliation; no required use of the affiliate; and that the only thing of value received was a return on an ownership interest. The Plaintiffs’ chief argument was that this safe harbor exemption could not save the companies because, under a ten-factor test set forth in the Sham Guidelines, the affiliated title agency was a sham rather than a “bona fide provider of settlement services.”
The district court sided with the Defendants and held that application of the HUD Sham Guidelines, which were vague and ambiguous, would be unconstitutional, stating:
HUD’s interpretation of 12 U.S.C. § 2607 in Policy Statement 1996-2 is unconstitutionally vague. It provides insufficient guidance to the regulated public, and it lacks identifiable standards under which authorities (or private parties) can enforce its provisions in a criminal or civil context.
Carter v. Wells Bowen Realty, 719 F. Supp. 2d 846, 854 (N.D. Ohio 2010). Accordingly, the district court granted the Defendants’ summary judgment motion based on their compliance with the 8(c)(4) safe harbor elements. Id. at 855. The Department of Justice (“DOJ” or “Government”) then intervened in the subsequent appeal in the Sixth Circuit Court of Appeals in an effort to defend its interpretation of the statute and HUD’s Sham Guidelines.
II. The Sixth Circuit’s Affirmance
In affirming the district court’s decision, the Sixth Circuit did not analyze whether the Guidelines were unconstitutionally vague. Rather, the Court dealt with an issue that the district court had found was unnecessary to reach: whether the Policy Statement containing the Sham Guidelines should be given the force of law (i.e., deference). Such a finding would essentially mean that a government agency like HUD could amend a statutory safe harbor for conduct with criminal consequences simply by issuing a Policy Statement, which future administrations also could later amend or modify. As the Sixth Circuit ultimately put it, “ a statutory safe harbor is not very safe if a federal agency may add a new requirement to it through a policy statement.” Slip Op. at 6.
A. Issues with the Government’s Position
The Sixth Circuit was troubled by several of the Government’s arguments. First, in its initial briefing, the Government conceded that the Policy Statement was not a “legislative rule” even though this is how the Plaintiffs were trying to utilize it in their case.
Second, in oral argument, the Government conceded that the ten-factor test set forth in the Sham Guidelines was only intended to provide non-binding advice about how to separate bona fide service providers from sham providers. See Slip Op. at 6. Notably, this was very close to the industry position that the ten-factor test was not binding, but rather only intended to explain how HUD would decide which enforcement cases to bring. In any event, either formulation demonstrated to the Court that “Chevron deference” was not applicable because such deference is only appropriate where an agency properly proposes a binding rule—that is, a rule with the force of law. See id. at 6-8.
Third, the Sixth Circuit also rejected the Government’s alternative position that the Policy Statement was interpreting a statutory ambiguity that deserved “Skidmore deference,” which would apply HUD’s interpretation to the extent it is persuasive. In this regard, the Government contended that the statutory definition of “affiliated business arrangement” called for a person in a position to refer, or an associate of that person, to have a one percent ownership interest in a “provider of settlement services.” The Government argued that this concept of a “provider of settlement services” was ambiguous and that the Sham Guidelines were intended to provide guidance to the courts and public on that issue. The Sixth Circuit, however, gave this argument short shrift. It found that the plain meaning of a “provider of settlement services” is “one who provides settlement services” and that WB’s affiliated title agent had provided some settlement services. The Court also found fault with HUD’s interpretation that the provider had to be “bona fide,” noting that this term was explicitly used in connection with section 8(c)(2)’s bona fide salary exception but was omitted from the affiliated business exception, thus confirming that “ the latter exception does not call upon courts to conduct a free standing inquiry into a provider’s bona fides unconnected to the safe harbor test already baked into the statute.” Id. at 9.
B. The Rule of Lenity
Finally, one of the most interesting aspects of the Carter decision was the discussion of the so-called “rule of lenity.” Under this legal principle, an ambiguous law with criminal penalties should be construed in favor of a defendant to ensure that (among other things) that there is fair notice of precisely what conduct is prohibited. The amicus brief, filed by the authors on behalf of Real Estate Services Providers Council, Inc. (“RESPRO®”), argued that the Governments’ position seemed contrary to the rule of lenity. The Sixth Circuit recently asked for supplemental briefing on this issue, which none of the litigants had addressed. It is apparent from the Sixth Circuit’s decision that the Court was troubled by the fact that RESPA carries potential criminal penalties, yet the Sham Guidelines contain ambiguities—and that this was an important factor leading the Court to affirm the district court. See Slip Op. at 7-8. Indeed, the author of the panel’s decision, Judge Sutton, wrote an extensive concurring opinion devoted exclusively to discussing how the rule of lenity could affect future cases. Id. at 11. The upshot of this concurrence was that the rule of lenity should almost always take precedence over a claim of Chevron deference where a statute, like RESPA, has both civil and criminal consequences for the same course of conduct and where ambiguities in the law continue to exist.
III. What Does the Carter Decision Mean for Industry?
The Carter decision provides a narrow construction of the RESPA statute based on its plain language and structure, much like the Supreme Court’s decision in Freeman v. Quicken Loans, 132 S. Ct. 2034 (May 24, 2012), which narrowed the scope of RESPA section 8(b). Like Freeman, Carter rejects efforts to read the statute broadly so as to supposedly promote a claimed consumer protection purpose that is not clearly expressed in the statute’s language. See Slip Op. at 9-10 (“elastic notions of statutory purpose have diminished value in interpreting a statute as precise and reticulated as [RESPA]”). Carter is likely to have a big impact on future RESPA and ABA cases, possibly along the following lines.
1. Carter will likely reduce, but not eliminate, Sham ABA Claims. This Sixth Circuit decision is only binding on the district courts in Ohio, Michigan, Tennessee, and Kentucky. Even if other courts do not disagree with the notion that the Policy Statement is not entitled to Chevron deference to the Policy Statement, they potentially could find that a provider of settlement services must be “bona fide” and that the Sham Guidelines set forth in the Policy Statement factors provide persuasive guidance on that issue. In addition, some state agencies, like the Ohio Department of Insurance, have incorporated the Sham Guidelines into their regulations. Moreover, the Consumer Financial Protection Bureau (“CFPB”) already has utilized many of the factors in the Guidelines in alleging that certain ABAs are in violation of RESPA and the CFPB may well continue to do so, particularly outside the Sixth Circuit. Finally, even if a direct RESPA attack were foreclosed by Carter, other state and federal laws (e.g., unfair and deceptive trade practice acts, consumer fraud laws, RICO type laws) still might provide the means to challenge entities in affiliated business arrangements that do not appear to comply with the Guidelines. Nevertheless, the use of the Guidelines to bring questionable claims for automatic and large treble damage demands should be significantly diminished.
2. Carter will give greater prominence to rule of lenity defenses. Although this defense is generally included among the defenses that are pled in RESPA cases, to date it has received limited attention and play. The Carter decision, and Judge Sutton’s concurrence in particular, may give greater prominence to the rule of lenity defense where a plaintiff seeks to proffer a novel or unprecedented interpretation of RESPA.
3. Carter could rein in expansive CFPB interpretations of RESPA. The CFPB has articulated several novel interpretations of RESPA. Not only has the CFPB asserted a new theory about the point at which the RESPA statute of limitations begins to run, but in a recently filed brief in the pending Edwards case, the CFPB appears to be suggesting that conduct that affirmatively influences the selection of a settlement service provider is only one, but not the only, definition of the term “referral.” However the CFPB does not suggest what other conduct could be a referral. If accepted, this new CFPB view of a referral—in the words of the Carter court—would create new uncertainties, not resolve them. See Slip Op. at 7. Indeed, the CFPB occasionally has appeared to take very skeptical, if not hostile, views of affiliated business arrangements and the elements that comprise the 8(c)(4) safe harbor. The Carter decision may cause the CFPB to rethink some of these positions.