By AAR General Counsel Michelle Lind, Esq.
AAR members have been receiving numerous solicitations from loan modification companies offering fees for referring homeowners in distress or offering to pay fees for assisting in modifying the homeowner’s loan. These programs raise numerous questions about the licensing required and the risks involved. Unfortunately, there are few clear answers.
Whether an individual must be licensed by the Arizona Department of Real Estate (ADRE), Arizona Department of Financial Institutions (DFI) or admitted to the Arizona State Bar to perform loan modifications depends on what activities will be involved in the service. Further, these programs may involve potential legal risks and liability.
Real Estate Licensing Requirements
“Any act, in consideration or expectation of compensation, which is included in the definition of a real estate . . .broker, whether the act is an incidental part of a transaction or the entire transaction, constitutes the person offering or attempting to perform the act of a real estate broker” within the meaning of the statute. Thus, a real estate license is required to:
• Sell, exchange, purchase, rent or lease real estate
• Negotiate or offer, attempt or agree to negotiate the sale, exchange, purchase, rental or leasing of real estate
• Advertise or hold out as being engaged in the business of buying, selling . . .or leasing real estate or counseling or advising regarding real estate
• Assist or direct in the procuring of prospects, calculated to result in the sale, exchange, leasing or rental of real estate
• Assist or direct in the negotiation of any transaction calculated or intended to result in the sale, exchange, leasing or rental of real estate
• Incident to the sale of real estate negotiate or offer, attempt or agree to negotiate a loan secured or to be secured by any mortgage or other encumbrance upon or transfer of real estate
See, A.R.S. §32-2101(47). Loan modification alone does not fall within the definition of a real estate broker and thus no real estate license is required. However, if the activities are incident to the transfer of real estate, a real estate license would be required.
Mortgage Broker Licensing Requirements
A mortgage broker must be licensed by the DFI. A “mortgage broker” is defined as a person . . . who for compensation or in the expectation of compensation either “directly or indirectly makes, negotiates or offers to make or negotiate” a mortgage loan. A.R.S. §6-901 (8). A.A.C. R20-4-102 defines “directly or indirectly makes, negotiates, or offers to make or negotiate” as:
• Providing consulting or advisory services in connection with a mortgage loan transaction…
• Providing assistance in preparing an application for a mortgage loan transaction… regardless of whether the person providing assistance directly contacts any potential investor or lender
• Processing a loan
However, “directly or indirectly makes, negotiates, or offers to make or negotiate” does not include modifying, renewing, or replacing a mortgage loan…already funded, if:
o the parties to and security for the loan are the same as the original loan immediately before the modification, renewal, or replacement, and
o if no additional funds are advanced and
o no increase is made in the credit limit on an open-ended loan.
Replacing a loan means making a new loan simultaneously with terminating an existing loan.
The DFI reports that some companies offering loan modification rapidly move into areas of activity that do require a license. Each case must be evaluated to determine if the activities of the modifier are really directly or indirectly negotiating a new mortgage loan. The DFI is contemplating revisions to R20-4-102 to increase the agency’s jurisdiction over loan modification companies, but all Rule change packages are currently on hold. Therefore, the DFI does not currently have jurisdiction over loan modification companies if the activity involves modifying, renewing, or replacing a loan if the parties to and security for the loan are the same as the original loan immediately before the modification, renewal, or replacement, and no additional funds are advanced and no increase is made in the credit limit on an open-ended loan. The DFI, however, is accepting complaints regarding loan modification companies in order to evaluate the conduct of these companies. Also, the DFI is working with the mortgage and real estate industries to draft legislation that would take precedence over the rule and require that loan modification companies be licensed.
Additionally, pursuant to A.R.S. §32-2155(C), a real estate licensee may not collect compensation for rendering services in negotiating mortgage loans unless the real estate licensee has a mortgage broker’s license or is an employee, officer or partner of a corporation or partnership that holds a mortgage broker license.
The “Practice of Law”
Arizona Supreme Court Rule 31 prohibits the unauthorized practice of law. The “practice of law” is defined in part as providing legal advice or services to or for another by:
• Preparing any document in any medium intended to affect or secure legal rights for a specific person or entity
• Preparing or expressing legal opinions
• Negotiating legal rights or responsibilities for a specific person or entity
• Providing legal services by “preparing any document in any medium intended to affect or secure legal rights for a specific person or entity”
• Negotiating legal rights or responsibilities for a specific person or entity
Thus, if the services provided in the loan modification program involve services affecting legal rights within the scope of Rule 31, the activity could constitute the practice of law. 1
Lawyers are also being solicited by non-lawyers with loan modification business opportunities. A recent article warns that a lawyer going into a loan modification business with a non-lawyer is ethically dangerous. 2
Civil Liability
A broker or salesperson risks potential civil liability arising from participation in loan modification programs. A homeowner who was directed to a loan modification company or represented in a loan modification by a broker or salesperson may thereafter bring a claim if the loan modification fails, resulting in foreclosure or other damages, or if the homeowner determines that a mortgage loan could have been obtained at a lower rate or at a lower cost.
Generally, the designated broker is vicariously liable for a salesperson acting within the scope of the salesperson’s employment. See e.g., A.A.C. R4-28-301(H). However, when a salesperson is acting solely on the salesperson’s own behalf, and not acting on behalf of the designated broker, the designated broker should have no liability for the salesperson’s actions. See e.g., Pruitt v. Pavelin, 141 Ariz. 195, 206, 685 P.2d 1347, 1356 (App. 1984). However, because of the potential liability and the possibility that loan modification activities on behalf of a homeowner could be construed as being within the scope of the salesperson’s employment, many employing brokers, as a matter of policy, limit or prohibit a salesperson’s involvement in these programs.
In addition, a broker’s errors and omissions (“E & O”) insurance will likely not cover any claims by a homeowner arising out of the acceptance of fees in connection with a loan modification program. E & O insurance coverage is generally limited to conduct as a real estate salesperson or broker. Thus, any real estate broker or salesperson becoming involved with a loan modification program should obtain additional E & O insurance to cover these activities.
Fraud and Deceptive Practices
Finally, brokers need to be aware that there are reports of an increasing number of complaints that some loan modification companies are engaged in fraudulent activities or other deceptive practices. The FBI has reportedly received hundreds of reports of suspicious activities and the Better Business Bureau is warning consumers to thoroughly research any loan modification company they are considering. Obviously, a broker or salesperson who becomes involved in a fraudulent enterprise risks criminal charges as well as civil liability.
1 Article 26 provides that: “Any person holding a valid license as a real estate broker or a real estate salesman regularly issued by the Arizona State Real Estate Department when acting in such capacity as broker or salesman for the parties, or agent for one of the parties to a sale, exchange, or trade, or the renting and leasing of property, shall have the right to draft or fill out and complete, without charge, any and all instruments incident thereto including, but not limited to, preliminary purchase agreements and earnest money receipts, deeds, mortgages, leases, assignments, releases, contracts for sale of realty, and bills of sale.”
2 “Loan Modification: The not-so-golden business opportunity for lawyers” by Patricia A. Sallen, Ethics Counsel for the State Bar of Arizona, and Lynda Shely, of The Shely Firm, P.C. http://www.myazbar.org/eLegal/archives/090317/LoanModBizEthicsAlertFinal.pdf
Conclusion
When considering solicitations to become involved with a loan modification program, a real estate broker or salesperson must first determine the scope of the program and whether the activities require a license. Investigate the company’s background and find out how long the company has been in business. The broker or salesperson should also inquire about the availability of appropriate E & O insurance to cover the risks involved. Finally, a salesperson should discuss the loan modification program with the designated broker to determine whether the brokerage company permits its salespersons to engage in these activities.
AAR General Counsel Michelle Lind is a State Bar of Arizona board certified real estate specialist and the author of Arizona Real Estate: A Professional’s Guide to Law and Practice.
This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.
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