Examining “Affiliated Business Relationships” in Real Estate Practice

Introduction

A growing practice among real estate brokers, attorneys, and mortgage brokers in the State of Georgia is the “affiliated business arrangement” or “affiliated business relationship” which we will refer to as ABRs.  The financial nexus between these professions is frequently the title insurance premium and the very high commissions that are paid to sellers of title insurance.  The three professions are highly regulated as is the insurance business.  Real estate agents are regulated by the Georgia Real Estate Commission, attorneys by the State Bar of Georgia and the Supreme Court of Georgia, mortgage brokers by the Department of Banking and Finance,  and the insurance business is highly regulated by the Insurance and Fire Safety Commissioner.  On top of this thick layer of Georgia law and regulation looms the Federal Government with a seemingly endless stream of law and regulation most prominently including the Real Estate Settlement Procedures Act (“RESPA”).  12 USC § 2601 et. seq.  Lurking within this complex regulatory web lie the ABRs of those that underwrite, sell, and split title insurance and its commissions.  

When lawmakers make a decision to regulate a profession one of the common themes is to provide for licensure.  Typically a candidate for admission to the regulated profession must obtain some education, take a test, and in some instances, serve something akin to an apprenticeship.  Licensure grants permission to practice in the profession and the unlicensed are excluded.  An important consideration becomes the meaning of exclusion and the enforcement structure.  If the unlicensed are permitted to freely earn referral fees, commissions, or the like, then the significance of obtaining the license is diminished.  For example, if a real estate agent could freely pay referral fees to non-licensees then the licensee could employ several non-licensees that would show houses and negotiate contracts, and the licensee could simply pay the lion’s share of the commission to these “assistants” who might not qualify for the professional license.  The State’s ability to effect consumer protection would be significantly diminished.  Therefore it is observed that how a professional licensure body of law deals with referral fees sometimes becomes a central part of the regulatory scheme. 

Title Insurance is Big Business

Premiums charged by title insurance companies are an interesting and somewhat arcane topic.  In the highly regulated world of insurance the premiums and commissions charged and paid by title insurance companies are essentially unregulated.  Some title carriers charge $2.50 per thousand dollars of purchase price for coverage to the buyer, so-called owner’s coverage.  They may charge $0.50 per thousand dollars borrowed for coverage to the lender, so-called lender’s coverage.  Those carriers frequently allow an agent to sell the lender’s coverage for as much as $1.00 per thousand dollars borrowed.  Other carriers have a schedule with rates typically set somewhat lower than $2.50 per thousand for owner’s coverage and $1.00 per thousand for lender’s coverage.  These carriers will typically allow an agent to sell their coverage at the $2.50 and $1.00 respective rates.  These rates have become something of an industry standard or benchmark.  The interesting part comes when considering the impact on commissions of selling the coverages at prices higher than the rack rate.

Title insurance is a lucrative business for some.  Title insurance commissions are high.  Small agents, that write relatively small volumes of coverage annually, get a 50% - 90% commissions, $200 - $400 for an average transaction.  Larger law firms are able to negotiate better commission percentages.  Some firms retain all of the overage between the scheduled rate and the price charged to the borrower or lender, other firms settle for 70% of the difference, give or take a few percentage points.  

Title insurance is big business.  The First Multiple Listing Service (“FMLS”) reports total 2003 sales volume of single family detached homes at almost 12 billion dollars.  If one assumes “standard” rates, over fourty-one million dollars of title insurance is being sold annually in the FMLS coverage area, that includes the metro Atlanta area and a large part of North Georgia .  This does not include the title insurance on condominiums, commercial deals, land, other non residential transactions, and, importantly, transactions outside the FMLS coverage area or not reported within the FMLS system.  With commissions at 70% and higher the cut for title agents in excess of thirty million dollars annually. 

The Regulatory Environment

Lawyers

The complexity of residential real estate closings and the economics involved have made mandatory lawyer involvement in closings an issue for quite some time.  Basic residential real estate closings are quite standardized.  The documents are not overly complex, and terms are typically not negotiable.  A typical fee paid to an attorney in a real estate closing in metro Atlanta is $450.00.  At that market price, attorneys are not able to spend an appreciable amount of time on any particular closing.  Closing attorneys rely on significant volume and often refer to their practices as a “mill”.  Whether an attorney should be required to conduct a real estate closing is an issue nationally and in our state. 

Georgia is one of the last lawyer only closing states remaining in the United States .  The regulatory framework in most state permits non-lawyers to conduct closings.  The Federal Trade Commission has been on something of a mission in recent years to change the law of the last few remaining lawyer only closing states and open up the closing business in those states to non-lawyers.  The issue of whether or not to permit non-lawyers to conduct closings has received some considerable attention. 

Lawyers in Georgia are regulated by the Supreme Court of Georgia.  The Court exercises its authority over the profession in part through the State Bar of Georgia.  The practice of law is governed by the Georgia Rules of Professional Conduct and statutes at O.C.G.A. 15-19-50 et. seq.  O.C.G.A. 15-19-50 defines the practice of law to include “… (2) conveyancing; (3) the preparation of legal instruments of all kinds whereby a legal right is secured; [and] (4) the rendering of opinions as to the validity or invalidity of titles to real or personal property…”  O.C.G.A. 15-19-51 forbids the unauthorized practice of law, and O.C.G.A. 15-19-56 makes the unauthorized practice a misdemeanor.  O.C.G.A. 15-19-53 provides an exemption for title examiners and for title insurers issuing title insurance. 

Through Formal Advisory Opinions, the Supreme Court of Georgia has declared that conducting closings is the practice of law and must be performed by a lawyer.    The Supreme Court provided that “[t]his does not mean that certain tasks cannot be delegated to non-lawyers, subject to the type of supervision outlined in State Advisory Opinion 21.  The lawyer cannot, however, delegate to a non-lawyer the responsibility to “close” the real estate transaction without the participation of an attorney.”  Supreme Court of Georgia , Formal Advisory Opinion No. 86-5.  When asked to clarify whether a lawyer could “participate” in a “closing” telephonically the Court said “no”.  Supreme Court of Georgia , Formal Advisory Opinion No. 00-3.  The State Bar of Georgia, Standing Committee on the Unlicensed Practice of Law has recently restated and amplified the law of the State and the previous opinions of the Supreme Court in concluding that so-called “witness only” closings, in which the person conducting the closing merely presides over the execution of deeds and other closing documents, are the practice of law and it is improper for an attorney to assist is this practice. 

A lawyer cannot practice law in an entity with a non-lawyer owner.  Also a lawyer cannot split legal fees with a non-lawyer.  Georgia Rules of Professional Conduct, Rule 5.4.  These two rules are important and the first distinguishes the legal profession.  In many regulated professions the payment of referral fees is forbidden, but non-licensees may be owners of entities that have licensed professionals performing the work for which a license is required.  Law stands as one of the few or perhaps the only profession in which the licensed professional may not practice his profession in an entity that has non-licensed owners.  Medical and dental practices may be owned by those without the respective licenses.  Nail salons may be owned by those not possessing the beautician’s credentials, but lawyers have to practice only with lawyers.  This standard provision of lawyer ethics is currently under attack at the national American Bar Association model rule level but the principle forbidding multiple discipline practices (“MDPs”) remains a part of the rules governing the practice of law in the State of Georgia . 

Insurance

Until 1996 attorneys were exempt from the general requirement to be licensed to sell, solicit, or negotiate in connection with title insurance.  Since then attorneys wishing to sell title insurance have been required to become licensed.  The current law is embodied in O.C.G.A. 33-23-1 et. seq.  Georgia insurance licensing law is defined in broad terms.  “’Agent’ means an individual appointed or employed by an insurer who sells, solicits, or negotiates insurance.  Agent also means an individual insurance producer.”  O.C.G.A. 33-23-1.   Georgia law provides, “[a] person shall not sell, solicit, or negotiate insurance in this state for any class or classes of insurance unless the person is licensed for that line of authority in accordance with this chapter and applicable regulations.”  O.C.G.A. 33-23-4.  Since the removal of the exemption from licensing for attorneys for the selling of title insurance, an insurance license has been required of all that seek to sell, solicit, or negotiate insurance. 

No pre-license education is required of attorneys seeking to become title agents.  No continuing education is required.  The licensing process is quite simple, fill out a form, pay a $75.00 fee and get a license to sell title insurance.  Despite the simplicity of the process, supervisors with the Insurance and Fire Safety Commissioner’s office report that many lawyers that issue, sell, and receive commissions on the sale of title insurance are still not licensed. 

Splitting of insurance commissions is illegal in Georgia .  O.C.G.A. 33-23-4 provides “No insurer or agent doing business in this state shall pay, directly or indirectly, any commissions or any other valuable consideration to any person for services as an agent, subagent, or adjuster within this state, unless such person is duly licensed in accordance with this article.”  This would appear to be a significant bar to splitting of title insurance commissions to non-licensees.  However, the law contains no provision forbidding non-licensees from being owners of title insurance agencies.  O.C.G.A. 33-23-4 forbids a person that has had an insurance license “refused, revoked or suspended” from owning 10% or more of an agency.  Ironically that is the only restriction on ownership of an agency contained within Georgia law.  In other words a real estate broker that has never possessed an insurance license may be a 50% or more owner of a title insurance agency but an agent that has had his license suspended may never own as much as 10% of an agency.  To further illustrate the law regarding insurance agency ownership, the Insurance and Fire Safety Commissioner’s Agency License Application even contains a supplement on which the agency is to identify all owners, officers, and directors that are not licensees. 

            Real Estate and Mortgage Brokerage

Real estate brokers and agents must be licensed and are generally prohibited from paying referral fees.  O.C.G.A. 43-40-30 and 43-40-1. 

Mortgage brokers are subject to a somewhat different regulatory framework.  O.C.G.A. 7-1-1000 et. seq.  The mortgage broker must be licensed, but his employees to whom the mortgage broker splits commissions need not be licensed.  However, they must be employees and not independent contractors.  The employees must meet certain minimum standards including being felony free.  In addition real estate brokers are prohibited from receiving kickbacks or referral fees if they are not licensed mortgage brokers.  O.C.G.A. 7-1-1001 . 

            Federal Regulation

For purposes of ABRs in real estate practice, the Real Estate Settlement Procedures Act (“RESPA”), 12 USC § 2601 et. seq. is the primary Federal legislation.  Much of meat of RESPA is contained in the regulations, 24 C.F.R. 3500.  RESPA and its accompanying regulations contain a robust ABR regulatory structure, complete with such details as the amount of office space rent that may be paid. 

Regarding ABRs the basic RESPA commands are 1) do not require a referred consumer to use an ABR and 2) make a detailed disclosure of all ABRs.  A significant exception to the prohibition against requiring a referred consumer to use a particular ABR is for a lender may require a borrower to pay for the services of an attorney, credit reporting agency, or real estate appraiser to represent the interests of the lender. 

While the complete scope of RESPA regulation of ABRs is beyond the scope of an article of this nature, suffice it to say that at the Federal level there is just as much concern about the consumer protection implications of ABRs as at the state level. 

Missing Regulation ?

At the heart of professional licensure regulation, fee/commission splitting/referral fee legislation, and ABR limitation is a governmental consumer protection concern and suspicion when a professional refers another professional driven by a profit motive as opposed to a real concern for ensuring the consumer receive the highest value services.  Splitting insurance commissions, real estate commission, or legal fees with a non-licensee is illegal.  The intriguing area comes at the nexus between practicing law and selling title insurance and how each discipline is regulated by the State.  As set forth above, the rendering of opinion on title is the practice of law.  Title companies typically only allow licensed attorneys carrying errors and omission insurance to become agents in Georgia .  A title company will not issue a policy unless their agent renders an opinion on the title.  However, pursuant to insurance law, the title insurance company is permitted to pay a commission to an insurance agency, which is sometimes an entity that is an ABR.  Individuals that possess neither an insurance license nor a license to practice law may own an interest in ABR entity.  This presents an opportunity for an attorney to form an ABR and split their commissions for the what is arguably the rendering of opinion on title, arguably the practice of law, as the agent for a title company.  The ABR firm splits this commission with the people who refer business to the law firm, the other owners of ABR.  The other owners will typically be licensed real estate brokers and licensed mortgage brokers. 

The average consumer is relatively unsophisticated in real estate transactions.  The typical consumer purchases two to three parcels of real property in a lifetime.  Frequently the purchase occurs in a community in which the consumer has no pre-established ties or professional contacts.  Despite disclosure requirements, the consumer is commonly unaware of why they are being guided by real estate agents or mortgage brokers to use the services of a particular attorney.  This turf is becoming more hotly contested, the latest revision of the Georgia Association of Realtors sales contract now provides for the selection of the closing attorney.  Buyers and sellers usually yield to their respective real estate agent’s or mortgage broker’s opinions without appreciating that the referring party has a financial interest for making the referral. 

The title insurance commission money being paid combined with the current regulatory environment has been sufficient to encourage the development many affiliated business relationships.  Today it is not uncommon to see a large real estate brokerage with an office that is co-located with a mortgage brokerage and a law firm.  The home buying and selling consumer is almost always oblivious to the fact that the title insurance he is paying for at closing typically carries a 70% or greater commission rate and that a significant portion of the commission is many times being paid to the real estate broker or mortgage broker that referred the title agent pursuant to an ABR. 

The status quo may not cry out for reform but some changes in the law may be called for over time.  From the mac ro perspective the dollars involved are significant but small amounts are at stake per transaction.  The very high commissions and correspondingly low loss ratios in the title insurance industry raise questions about whether the legal structure creates a market inclined toward abuse.  Professionals splitting fees or commissions or paying referral fees are condemned while ABRs, that appear to sidestep the intent of those provisions, have begun to thrive.  Required disclosure of title insurance commission amounts may be beneficial.  More radical reform could include changing the law to permit rebating of commissions on title insurance to the purchaser or lender.  With disclosure this would put the purchaser or lender in the position of being able to negotiate the best deal for title insurance, shopping from one attorney to the next for the highest rebate.  A less elegant modification to the law would be to prohibit the ownership of title insurance agencies by non-licensees.  Whether reform comes to the otherwise unregulated world of title insurance commissions, it is certainly an interesting crossroads in our legal patchwork quilt that has stimulated the creation of some rather intriguing affiliated business relationships. 

About the Author

David J. Reed, Esq. is a real estate litigator, a licensed real estate broker, an active real estate investor, and a pilot.  For inquiries see www.davidjreed.com.   

Send mail to davidjreed@davidjreed.com with questions or comments about this web site.
Last modified: December 05, 2006