The Final Word: FHFA Issues Final Rule on Private Transfer Fee Covenants. By: Kelly Shubic Weiner i

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1 The Final Word: FHFA Issues Final Rule on Private Transfer Fee Covenants By: Kelly Shubic Weiner i The wait is over. After cacophonous comment periods and much speculation, on March 16, 2012, the Federal Housing Finance Agency ( FHFA ) ii issued to the Federal Register its final rules regarding private transfer fees (the Final Rule ). The Final Rule restricts Fannie Mae, Freddie Mac and the Federal Home Loan Banks (collectively, the Regulated Entities ) from buying mortgage loans on properties encumbered by certain private transfer fee covenants iii and from otherwise dealing in securities backed by such mortgages or the income stream generated from such covenants. The Final Rule arrives almost two (2) years after FHFA published initial guidance on Regulating Entities dealing in mortgages subject to certain private transfer fees. The Proposed Guidance, and the Proposed Rule that followed in 2011, spurned divergent and dissenting discussions regarding the impact of the Proposed Guidance in an uncertain and unsteady residential real estate market. Although doubts may remain about the economic climate in 2012, FHFA s Final Order removed any doubt that unless a private transfer fee covenant falls squarely within the narrow exemptions set forth in the Final Order, builders and developers risk creating projects that are unable to be financed by homeowners that would otherwise rely on the Regulated Entities for acquisition and refinancing opportunities. This bulletin provides a brief overview of the history of the Guidance and the comments it generated, highlighting the leading legal thought groups that submitted comments. Additionally, it provides a summary of the Final Rule to which the Regulated Entities will be subject as of July 12, Initial Guidance and Feedback: On August 16, 2010, FHFA proposed the Guidance on Private Transfer Fee Covenants (75 FR 49932). iv The Guidance advised that the Regulated Entities should not buy or accept as collateral any mortgages on property that is subject to any private transfer fee covenant based on the fact that FHFA deemed such private transfer fee covenants as adverse to liquidity, affordability, and stability in the housing finance market and to financially safe and sound investments. In short order, the Guidance generated over 4,200 comments from the all sectors of the real estate community including Community Associations Institute ( CAI ), American Land Title Association ( ALTA ), National Association of Realtors, American College of Real Estate Lawyers ( ACREL ), American Bar Association ( ABA ), Joint Editorial Board for Uniform Real Property Acts ( JEBURPA ), Sierra Club, developers, builders and numerous other

2 representatives or individuals concerned about the potentially overreaching scope and breadth of the Guidelines. In general, the commentators reactions encompassed three distinct categories: (i) advocates of complete ban on private transfer fees; (ii) advocates of the exclusion from the Guidance s restrictions those private transfer fees payable to organizations that use the fees to provide a direct benefit to the encumbered property or general welfare purposes; and (iii) advocates of private transfer fees that support the payment of fees to for-profit entities regardless of whether such fees provide any direct benefit to the encumbered property or community. Additionally, several commentators objected to the uncertain implementation of the Guidance noting that if the Guidance were to be applied retroactively, it would create additional economic hardship to homeowners in an already unstable marketplace since mortgages on encumbered properties would be rendered unmarketable. Leading the commentators that supported a complete ban on private transfer fee covenants were those that found the private transfer fees overly burdensome with respect to both the financial consequence and restraint on alienation created by such covenants. These commentators argued that most homeowners are unaware of the existence of such covenants in the chain of title to their homes, and accordingly such covenants are frequently seen as a scam that divert equity of homeowners to other parties. Additionally, since such fees could be construed as having a negative impact on valuation of homes, the covenants unreasonably restrain the sale and marketability of property. Commentators supporting private transfer fee covenants in the context of fees paid to certain organizations that use the fees to provide a direct benefit to the encumbered property or general welfare purposes pointed to a few distinct yet pervasive examples of such fees in residential communities across the United States. Transfer fees collected by homeowner associations, condominium associations and the like for the future costs of capital improvements and needed repairs defray future costs that would otherwise be assessed as a special assessment against then-current owners. Without the additional income generated by sales, ownership costs would be driven up based on the need for the associations to mandate special assessments when repairs or replacements were needed. Additionally, those fees payable to charitable organizations that achieve a direct social benefit through the use of such fees for social welfare purposes are an important part of the fabric that support community enhancements such as green space, preservation efforts, affordable housing, and transit improvements. Accordingly, they should not be included among those types of transfer fees encompassed in FHFA s restrictions. At the forefront of commentators voicing opposition to any effective ban on private transfer fee covenants were those developers and builders that advocated the use of private transfer fees or capital recovery fees to create future revenue streams for themselves. This group argued that such fees create financing solutions designed to more efficiently structure the economics of

3 residential development communities and these fees create the ability for development costs to be equitably shared among current and future residents of the community. Ultimately, the transfer fees are an important development tool and in tough times they provide another source of revenue for developers that are strapped for cash and not finding many banks willing to jump into development projects. Among the front runners of thought leadership among legal organizations submitting comments were those submitted by JEBURPA. v At the time JEBURPA had been studying transfer fee covenants for more than three (3) years and had been instrumental in promulgating the Model Rule that it recommended all state legislatures enact. The Model Rule declared private transfer fee covenants that create a revenue stream for a third party without any direct benefit being available to the property should be unenforceable. In its comment letter, JEBURPA drew the distinction between non-beneficial or purely private transfer fees those at which the Model Rule is targeted to deem unenforceable and those beneficial transfer fees that derive some benefit for the subject property. JEBURPA grounded its objection to the Guidance in the fact that the Guidance is overbroad in the context of current law on transfer fees payable to home owner associations and similar organizations. In addition to being concerned about the possible retroactive application of the Guidance, JEBURPA noted that enforcement of such Guidance, without further distinction between the types of private transfer fee covenant in the marketplace, would hinder recovery of depressed residential real estate markets while driving up the transaction costs for homeowners seeking to refinance. Similar concerns were submitted by the American College of Real Estate Lawyers ( ACREL ). vi In an October 12, 2010 letter from then president, Kevin L. Shepherd, ACREL expressed concern that if the Guidance were to be adopted as proposed, it would create a cloud on the title of hundreds of thousands of homes in the United States thereby rendering title virtually unmarketable by restricting access to financing, resulting in significant devaluation of such homes in the midst of perhaps the worst housing crisis since the Great Depression. This unintended consequence is in stark contrast to the expressed purpose of the Guidance, i.e., to increase liquidity and stability in the housing finance market. If implemented, the Guidance may have the opposite effect with respect to the home owners ability to refinance and sell in the future. ACREL noted that transfer fee covenants have been in use in the United States for several years, impact hundreds of communities and hundreds of thousands of homes. In light of this, ACREL requested that FHFA withdraw the Guidance to avoid consequences in contravention of FHFA s stated mission to support housing finance and affordable housing. Echoing concerns expressed by ACREL, members (in their individual capacity) of the Hospitality, Timesharing and Common Interests Development Group and the Commercial Real Estate Transactions Group of the Real Property,

4 Trust and Estate Law Section of the American Bar Association submitted comments calling for a further refinement of the private transfer fees impacted ( RPTE Member s Comments ). vii Specifically, RPTE Member s Comments highlighted the Guidance s lack of distinction between non-beneficial and beneficial private transfer fee covenants. The unintended consequence of the Guidance is to effectively render unmarketable title to those homes encumbered by beneficial transfer fee covenants and non-beneficial transfer fee covenants, since owners will not be able to refinance their mortgages and any potential purchaser will not be able to obtain acquisition financing. This consequence, the letter points out, is contrary to the public mission of Fannie Mae and Freddie Mac and at the heart of what FHFA intended to protect. Proposed Rule: In reaction to the overwhelming number of comments, on February 8, 2011, FHFA published a Notice of Proposed Rulemaking (76 FR 6702) in which it indicated that it would make certain key clarification or distinguishing changes to the Guidance. viii First and foremost and drawing upon the distinction noted by many legal commentators, FHFA would except from the impacted covenants those private transfer fees that are used for the direct benefit of the encumbered properties. With a heightened focus on definitions, FHFA indicated that covered associations would include homeowner s associations and similar associations, as well as tax-exempt non-profit organizations. In reliance on traditional real estate law that requires a covenant to benefit the land that it burdens in order for it to be deemed binding and to run with the land, FHFA opined that without creating a direct benefit for the burdened land, this type of private transfer fee created a safety and soundness risk for the Regulated Entities. The Proposed Rule also clarified that it would be prospectively applied and indicated that it would only apply to private transfer fee covenants created after the publication date of the proposed rule. In order to provide the regulated entities with sufficient time to institute needed protocols, the rule would provide for an implementation period 120 days after the Final Rule was issued. FHFA s Proposed Rule appeased several of the 4,200-plus commentators that previously submitted objections, but despite the significant support of the Proposed Rule, elements of the rule remained at issue for some commentators. Specifically remaining at issue was the scope of the definitions of direct benefit, excepted transfer fee and adjacent or contiguous. Subsequent commentators recommended that that direct benefit should encompass all responsibilities that homeowners would expect community associations to undertake and complete. With respect to exclusions from private transfer fees, commentators indicated that certain exclusions should be added to the already short list to clarify the exemption of certain loan assumption fees, loan prepayment fees and deferred purchase price payments from the restricted covenant. Some other commentators noted that FHFA s inclusion of a 1,000 yard limitation in the definition of adjacent or contiguous was unreasonably restrictive.

5 Final Rule: On March 16, 2012, FHFA issued its Final Rule. ix As forecasted in the Proposed Rule, the Final Rule applies prospectively from the date FHFA issued the Proposed Rule. Accordingly, the limitation would not affect transfer fee covenants created prior to February 8, 2011 nor would it affect transfer fee covenants that were created by an agreement entered into prior to February 8, In a narrow construction of the private transfer fee covenants that would be exempt from FHFA s restriction, FHFA exempted certain classes of fee covenants that are associated with a direct benefit. Direct benefit is defined as when transfer fees are used for the acquisition, improvement, administration and maintenance of property owned by the covered association. Additionally, direct benefit includes cultural, educational, charitable, recreational, environmental, conservation, or other similar activities that are conducted in or protect the burdened community or adjacent or contiguous property or are conducted on other property that is used primarily by residents of the burdened community. This narrow definition results in FHFA s restriction in dealing being applicable to those private transfer fees that generate income for third parties that are no longer involved in the project or community. Moreover, such restriction will likely include those transfer fees to be used for a benefit that may be more tenuous than the direct benefit otherwise required. Conclusion: Although FHFA s Final Rule stops short of effectively prohibiting all types of private transfer fee covenants, the narrow definition proscribed for those transfer fee covenants that are excluded requires that such fees be used for a specific, direct benefit for the burdened community. For these purposes, with respect to any new project that contemplates use of a private transfer fee, careful attention should be given to ensuring that the covenant and use of fee meet the specific requirements of fees that are excluded from FHFA s Final Rule. Otherwise, sales and refinancings of homes in such communities may be adversely impacted by FHFA s limitation on the Regulated Entities from dealing in mortgages on properties encumbered by such transfer fee covenants. i Kelly Shubic Weiner is a partner in the Baltimore, Maryland office of Venable LLP. She serves as the Chair of the Common Interests Development Committee. ii FHFA is a Federal government agency created by the Housing and Economic Recovery act of 2008, Public Law , 122 Stat Its primary purpose is to regulate and oversee the Federal National Mortgage Association ( Fannie Mae ), the Federal Home Loan Mortgage Corporation ( Freddie Mac ) the Federal Home Loan Banks. iii A private transfer fee covenant is a covenant that requires the payment of a fee to another party upon each sale of the subject property. Typically, the fee is stated as a fixed amount or percentage of the property s sales price. A transfer fee covenant is intended to run with the land and be binding upon successor owners of the subject property. Private transfer fee covenants have been in use for several years. One of the earlier uses for private transfer fees originated in residential development communities wherein the local authority required the developer as part of the entitlement process to provide for the future funding of environmental mitigation costs.

6 Fees collected in connection with future transfers for the encumbered properties were paid to 501(c) (3) organizations tasked with an environmental or conservation cause. These fee structures allowed developers to move forward with large projects while addressing environmental sensitivities of the local governments. iv v vi vii df viii ix