No-Conflict Considerations in Short Sale Fees

As short sales and pre-foreclosure assistance servicers proliferate, the type, style and amount of fees that these individuals and companies charge has become ingenious and varied.  This article discusses the rights and wrongs regarding the most popular of the charging methods.

A short sale and pre-foreclosure servicer for our definitional purposes will be called the Short Sale Servicer.  The services offered usually include some mixture of collecting financial information from the "financially stricken borrower", getting current valuations on the mortgaged property, finding a realtor or working with a realtor to find a buyer, and finally negotiating for the financially stricken borrower (whom I also interchangeably call the "seller") with the borrower's lenders to get the buyer's contract approved for a short sale.  The services can be run by real estate agents, lawyers, title companies, or any other service company.  No license is needed to be a Short Sale Servicer.

The Short Sale Servicer typically charges a fee to the financially stricken borrower, although usually the fee is discussed as being paid by the borrower's lender.  The fee is sometimes a single payment paid up-front, or a contingency fee paid when the house is sold.  Sometimes the Realtor already handling the sale hires the Short Sale Servicer and promises to pay a portion of its commission for the work the Short Sale Servicer will do.  In all cases the Short Sale Servicer acts as the agent (ie: representative) of the financially stricken borrower in the negotiations with the borrower's lender.

The question must be asked - Whose best interests is the Short Sale Servicer representing?  The answer is not so obvious.

Where a fee agreement is based substantially on a contingency (the contingency being the realization of a short sale closing), the Short Sale Servicer has a financial goal of creating a situation where the sale occurs.  This requires the agreement of the buyer, the seller, and the lender (or lenders). (See Short Sale Trilogy).  The Short Sale Servicer makes little or no money if these three elements do not come into agreement.  Therefore, there is an inherent conflict of interest that such a Short Sale Servicer has with EACH of the parties - including the seller!! (See Who Controls the Short Sale?).  This conflict occurs because in contravention to looking out for the financially stricken borrower (the "principal / agency relationship" in legalese) the Short Sale Servicer needs to assert its arguments for acceptance of the contract to each of the buyer, lender(s) and its principal, the seller.  The essential reason for the conflict is that the push for the seller to accept what may not be a contract agreement that is in its best interest will still provide the Short Sale Servicer with payment of its contingent fee - without any more work.  If there is a fear that the lender will not budge, then it is the seller who must be convinced to relent or the contingent fee will not be paid. 

Most Short Sale Servicers also state that their client - the seller - is not paying their fee and the lender is paying it instead. This is partially true and partially untrue.  At best it is misleading.  The seller is always paying - the costs of the sale, including the cost of the Short Sale Servicer if characterized as being paid by the lender is just increasing the deficiency the seller will owe to the lender at the end of the short sale. This happens one of two ways: (1) If there is no financial relief by way of IRS income exclusions for the resulting 1099 report on written off debt, the financially stricken borrower will owe income tax on the deficiency. (2)  If the lender as part of the transaction requires the seller to repay the deficiency over an extended period of time after the sale, then the fee is being paid initially by the lender but later repaid by the seller.

An exception to the immediately preceding paragraph is where the seller's real estate agent contracts with a Short Sale Servicer and agrees to share a portion of its brokerage commission as the Short Sale Servicer's fee.  Aside from the illegality of sharing a contingent brokerage commission with an unlicensed person not a co-broker in the transaction, this also adds the element of to whom the allegiance of responsibility resides - to the real estate broker or to the seller?

Some Short Sale Servicers require payment "up front".  This type of payment contains no conflicts of interest as stated above and I believe it to be the most equitable to the seller.  This is because the Short Sale Servicer has a clear allegiance to the seller and only its reputation is at risk for failing to find the best solution for its client.  Failure has no financial penalty and success no bonus - the incentive is to have satisfied customers that recommend the servicer to their acquaintances - and to do the job contracted to be done.

Many Short Sale Servicers also require that the closing services including title insurance be run through their affiliated companies.  There is an inherent violation of RESPA in this requirement and the seller should have a choice to obtain their own closing agent and title insurance provider.  Although there is nothing wrong with using the Short Sale Servicer's affiliated company and it may be more economical to do so, do homework on this issue.

Short Sale Servicers do provide a much needed service to real estate brokers and to financially stricken borrowers.  The specialized knowledge of the Short Sale Servicer can make an important difference in guiding the real estate broker, seller and buyer through the negotiations with the lenders.  The reasonable fees paid for their services can be valuable in softening the inevitable unfortunate situation of the financially stricken borrower.

Copyright 2008 Richard P. Zaretsky, Esq.