RFC Case May Change Brokers’ Approach to Volume Based Incentives

Facts
RFC and Chicago Title had a standing agreement under which RFC agreed to deliver a substantial volume of business to Chicago Title in return for a 60% discount on title fees and a $300 flat fee for its portion of the escrow fee. Normally, Chicago Title based its escrow fee on the principal amount of the loan. As a result, that $300 flat fee could be below market rate on some transactions and above market rate on other transactions.

Jessie Lane bought a house form RFC. RFC financed the sale. RFC required Lane to use Chicago Title’s escrow and title insurance services. Lane wanted to use someone else, but went along because RFC insisted. Lane called Chicago Title and asked how much the escrow services would cost him. Chicago Title told him $600. However, this price quote was wrong. It represented a practice common in other parts of California to split the cost between the buyer and the seller. It turned out that the local custom in the region where the house is located was to have the buyer pay the full cost of the escrow. The actual fee turned out to be $900. Lane sued because the price was not $1,200 (apparently the cost Chicago Title would have charged in non-RFC transactions).

Read that last sentence one more time. Lane sued because he was charged $900 for a service he thought was worth $1,200. One more time, for those in the back who don’t believe their ears. Lane sued RFC and Chicago Title because they found a way to charge him $300 under the market price. How did we get here

Analysis
Lane alleged that Chicago Title’s agreement to charge only the $300 flat fee was a quid pro quo for the promise from RFC to refer escrow and title business to Chicago Title. He argued that the “referral in return for discounted fees arrangement” violated the prohibition against kickbacks and referral fees in Section 8 of RESPA. He noted that Section 3500.14(e) of Regulation X (HUD’s rules that implement RESPA) states:

• When a thing of value is received repeatedly and is connected in any way with the volume or value of the business referred, the receipt of the thing of value is evidence that it is made pursuant to an agreement or understanding for the referral of business.

Lane felt he proved his case when he tied the discount on fees received by RFC (a thing of value) to RFC’s agreement to refer a higher volume of business to Chicago Title.

The Ninth Circuit disagreed. It found that discounts related to actual cost savings caused by the volume of business are not discounts paid for referrals. To get to that point, it relied on HUD’s recent analyses of yield spread premium payments contained in the 1999-1 and 2001-1 Policy Statements. Applying the logic of those Policy Statements, you must first determine whether Chicago Title has performed real, compensable services or provided other goods or facilities to the settlement transaction. In this case, everyone agreed that Chicago Title performed actual services that are properly compensable. Next, you have to determine whether the fee paid represents the fair market value of the goods/facilities/services provided.

The court took a “cost-plus” or “time and motion” approach to determining market value. It determined that the discounted fees were justified based on Chicago Title’s lowered costs in RFC transactions. Chicago Title had lower costs because RFC was familiar with Chicago Title’s escrow process and incorporated standardized forms and procedures. These lower costs, or economies of scale, justified the discounts.

The Future
Where do we go from here? One thing is certain. The big title services companies will be emboldened and are much more likely to negotiate volume-based arrangements with major lenders. We can also expect mortgage brokers to start beating the drum for the flip side of volume-based discounts . . . the new and improved volume based premium. And they should be emboldened, particularly in California and other states located in the Ninth Circuit (Alaska, Arizona, Hawaii, Idaho, Montana, Nevada, Oregon, Washington, Guam and the N. Mariana Islands). However, the broker’s argument does not quite match up with what won the day in this case.

Mortgage brokers have argued that lenders have real cost savings if they enter into a relationship with a broker that guarantees a certain volume of business, or that has different price points based on the volume of business generated. They argue that they should be able to share in those cost savings by receiving higher broker fees — hence, the model of volume based premium compensation. However, that model does not match up with the logic in the Lane case. In Lane, the increase in the volume of business led to lower production costs for Chicago Title, which justified charging a lower price to RFC. Brokers would have to argue the opposite if they want to justify higher fees. They must argue that an increase in business volume will drive their costs up thereby justifying a higher broker fee. That is not going to work.

The other argument brokers have historically made — that by doing more business with a particular lender they become better at servicing that lender (more knowledgeable about procedures and idiosyncrasies) and therefore should be entitled to a higher fee — was not addressed in Lane. Of course, that won’t stop the drumbeat among brokers who will press lenders to start paying volume-based compensation. Ultimately, to be successful, they will need to apply a “market survey” approach to establishing the fair market value of their service, rather than the “cost-plus ” approach applied by the court in Lane.

Finally, none of this will matter if HUD’s “guaranteed mortgage package” invention ever sees the light of day.

For more information, look for Lane v. Residential Funding Corporation, No. 01-16269 D.C. No. CV-96-03331-MMC/JL (9th Cir. March 13, 2003).