Is that Check from the Home Warranty Company Legal?

How many of us have sat at an escrow office with an elated buyer just minutes after the closing?  As they sit waiting for the title officer to return to the room with copies of the hundreds of pages they just signed, their real estate agent reminds them that they have a home warranty and that the agent will be providing the buyer with all necessary literature in case they need to use the warranty.  But if the agent is compensated by the home warranty company, that compensation may be a violation of RESPA.

On June 25, 2010 HUD published an Interpretative Rule, with a public comment period, in the Federal Register addressing the legality of payments by home warranty companies to real estate agents.  In December, HUD provided additional guidance regarding compensation from home warranty companies to real estate professionals.   In it, HUD reaffirms Section 8 of the Real Estate Settlement Procedures Act which prohibits payments to anyone involved in a real estate transaction for anything except services which are actual, necessary, and distinct from the primary services of a real estate agent or broker, which are not nominal and which are not duplicative.  In determining whether the payment by a home warranty company is legal or not, HUD will look at whether the duties performed by the real estate agent  meet the above criteria.  For example, marketing a specific home warranty company, doing sales pitches for the company, distributing promotional material about a home warranty company at the broker's or agent's offices or at an open house is considered a "referral" under Section 8 of RESPA, and as such it would be illegal to receive payment from the home warranty company.  HUD states in its explanation, "Nothing precludes a real estate broker or agent from performing services to aid the seller or buyer, or to increase the possibility that the real estate transaction will occur and thereby benefit the broker or agent.  However, the broker or agent may not be compensated by the HWC [home warranty company] for marketing services directly to particular homebuyers or sellers."

However, there are some services that HUD considers bona fide services for compensation by home warranty companies.  These include inspection of items to be covered under the warranty, recording serial numbers of the items to be covered, documenting condition of the items by taking pictures and reporting to the home warranty company regarding the inspections.  The test here is that the service must be actually performed by the agent receiving the compensation.  In other words, the agent must perform the inspections as the legal agent of the home warranty company, so the company must assume responsibility for any representations that the agent makes to the borrower, and the real estate agent must disclose to the borrower that he or she is being paid by the home warranty company and that the borrower is not obligated to purchase the services of any particular home warranty company.

Finally, in examining whether compensation by home warranty companies is legal, HUD will look at the actual amount of the payment to the real estate agent or broker to determine whether the amount paid is reasonable and customary for the work being compensated.  Even if HUD determines that the agent did actually perform the services required to deserve payment, if the compensation is too great, HUD can rule that the amount of payment that is greater than what would be considered reasonable and customary compensation for the actual service performed is an illegal referral fee.

Remember that the penalty for violating Section 8 of the Real Estate Settlement and Procedures Act is a $10,000 fine and 1 year in prison per violation.  If you have any doubts about whether the check from the home warranty company is legal or not, return it uncashed.  It's better to be safe today than really sorry tomorrow.