With more brokers wanting to boost their bottom lines with ancillary services such as mortgage lending and title insurance and closing services, large underwriters are stepping up with attractive contracts to add such services through joint ventures with the broker.

The problem is, the contracts may be a lot more favorable to the title company than to the broker.

Florida real estate attorney Hank Sorenson says he's noticed a rising number of agents turning into broker sole practitioners, who are being approached by large title companies to provide title services for them.

"The underwriters are approaching them directly," says Sorenson. "It's easy to find out who the top producers are. These companies have whole departments for business development, and they keep their finger on pulse of who the players are. That's not hard to find out. Anyone can get MLS numbers and find out who is selling and who is listing the high-priced listings. "

Many agents, whose production numbers have made their egos swell, like the idea of going into business for themselves. Having a large title company offer to underwrite their title services makes them particularly vulnerable to closing their eyes to the risks as the upside appears so dazzling.

The joint venture between the title company and broker can be set up as an LLC or an "S" Corporation. In an LLC, the agent buys a percentage interest; in an S corp, the agent buys stock.

However, the underwriters are always the majority holders, which means they can pencil in the most favorable terms to themselves or impose terms which aren't favorable for the broker for other reasons.

The underwriters define the rights in an operating agreement for the LLC, and it functions as a joint venture agreement between the underwriter and the broker. Sorenson has reviewed two such operating agreements recently and found problems with both.

"In addition to the operating agreement, the underwriter issues a pro forma with anticipated expenses and revenues which would give the broker a proposed bottom line of profits at the end of the year," explains Sorenson.

"In the first agreement," he says, "there were internal conflicts with the language on the ability to transfer an interest. Let's say you bought 50 shares of stock in an S corporation and the Realtor wants to bring on independent agents like buyer's agents and as an enticement, they might be offered shares. In a corporation, you would have a share transfer agreement in the joint venture agreement that would allow or restrict the Realtor's ability to transfer or sell that stock. I'm seeing restrictions in one paragraph but there is no restriction in ownership in other paragraphs, so the result of that confusion would be a confused Realtor - 'Can I transfer the interest or not?'

"Being able to transfer interest is a marketing piece for them, and as a corollary to that, in some operating agreements, the underwriter has attained the right of first refusal on the transfer of any ownership interest," explains Sorenson. "That is huge, because it says to the Realtor 'Yes, you can transfer your interest but whatever terms you offer, you have to offer those terms to us first, which in effect keeps them from transferring their interest."

Sorenson continues, "In one document, it said that a Realtor had to be exclusive and could not have any employment, management or ownership interest in any other similar title venture, but then later in the document it said that parties acknowledge that they may own or participate in business ventures of any kind. So, which one governs? If a Realtor is going to have a minority interest in a title venture, the underwriter is running things, the so the underwriter is the managing member of the LLC. If the Realtor perceives they are getting shoddy service, what is the only way you can punish someone in America? By taking your dollars somewhere else. Place the closing with another title agent where you have another interests. The Realtor needs to know if they can do that."

Another problem Sorenson has found is in operating agreements that permit the underwriter to invest operating capital that isn't immediately required in business operations in mutual funds, CDS and other types of investments. "The negative effect is that the Realtor is having someone else invest their funds," suggests Sorenson. "I don't want someone else investing for me. Forty percent of that money is mine."

Yet another problem is underwriters guaranteeing annual reports. "I would encourage quarterly reports," advises Sorenson. "You've got to have something on paper. If you have that ownership interest, and you are trying to get financing for something else, whoever that lender is will want to see quarterly reports for all your interests."

And what if you want out of the agreement? "Some of these operating agreements can't be canceled," warns Sorenson, "as there is no 60-day cancelation period, and the broker also has no way to get their capital contribution back. So make sure there is an adequate termination provision in the event that the relationship isn't working. I also recommend full membership consent (in LLC you have members) for large purchases or long-term obligations. Normally the managing member takes care of day-to-day operations, and the managing member enters into lease obligations. I would encourage that if there is an obligation taken on that is longer than two years that there is a full membership consent."

So, the moral of the story, is that if a broker is going to enter into a joint venture with a title company, to get a good corporate lawyer to consult. "Make sure that lawyer is also a licensed title agent who can assist in reviewing legal and business aspects of the documents, because most Realtors don't really know how title companies really generate revenue," says Sorenson.

Published: May 27, 2004

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