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Alternative Resolution of Pennsylvania Real Estate Agreement of Sale Disputes: Part One- Residential Agreement Mediation

By: Bradley S. Dornish, Esq.

Sooner or later most real estate investors face a real estate agreement of sale dispute. It is less likely for consumers but always a possibility. There are required non-court processes in both the PA Association of Realtors’ residential agreement of sale form (ASR) and its commercial agreement of sale form (ASC). The procedures are different, in front of different types of authorities, but both types of mandatory alternative dispute resolution have a lot in common, too.

As I write this article, my last mediation representing an investor was just over a week ago and I am presently serving as an arbitrator in the resolution of a dispute under a commercial agreement. This article will examine mediation under the ASR and a second article will discuss arbitration under the ASC.

For residential agreements of sale used for single family homes and up to four unit residential apartment buildings, the process is mediation. Parties to an agreement of sale need to understand what mediation is and is not. Mediation is an opportunity for both parties to the agreement of sale to be heard by an impartial mediator, who hears both sides, typically together in the same room, then works with each, typically one at a time, to try to reach a compromise which both sides can accept, to avoid going to court against each other.

The parties required to participate in the mediation of their disputes over the agreement of sale are the seller and the buyer. Sometimes real estate agents and brokers, home inspectors or others involved in the real estate transaction may agree to participate in the mediation as parties with respect to claims against them but those parties are not bound to go through the mediation process.

The buyer and seller can each make the demand to submit their dispute to mediation and each pays an equal share of the mediator’s fees. If one party requests mediation the other is bound under the agreement of sale to participate. As a practical matter, however, if a party refuses to pay his or her share of the mediator’s fees, the mediation is reported as unsuccessful and the parties are able to proceed to court.

Each party is allowed to be represented by counsel but no party is required to have counsel to participate in the mediation.  Certain local associations of realtors, like the Realtors’ Association of Metropolitan Pittsburgh, have contracts in place to refer mediations which are presented to them to a particular mediator or service. Other associations send their mediation requests to the Pennsylvania Association of Realtors which identifies potential available mediators and provides a list of several to the parties.

One advantage of the mediation process is its relative speed. Once a request is made and a mediator is selected, it often takes only a few weeks to have the face to face, sit down mediation. This contrasts to time delays of many months or even a year to get to court. Despite the required payment of the mediators’ fees by the parties, mediation is often less expensive than filing a court action because even if the parties hire lawyers for the mediation it typically only consumes a couple of hours of attorney time, as opposed to time drafting complaints and answers, going to court for motions, asking and responding to discovery, preparing witnesses and attending trial. These types of activities typically consume ten hours or more, sometimes much more attorney time.

Of course, if either party is not prepared to compromise and reach a settlement through mediation, all the time and costs of mediation are spent already and the case still has to proceed to court. The type of court action which follows a failed mediation depends on the amount of money claimed as damages by the party bringing the action, typically the buyer. Sometimes the seller brings the action if the buyer fails to close, has not liquidated damages and the seller claims to have suffered a loss as a result of buyer’s failure to close.

For actions involving $12,000 or less, the parties can file in Magisterial District Court and get a quick hearing in front of a Magisterial District Judge. While many of these judges are lawyers, many are not and some do not have experience with real estate contracts.

For cases involving up to $50,000 in at least Philadelphia, Montgomery, Bucks and Lehigh Counties, up to $35,000 in Dauphin and Allegheny Counties (among others), and caps as low as $25,000 in some other counties, suits can be filed to be heard in front of three lawyers who practice in the county, who take turns serving as arbitrators and who may or may not have experience in real estate contract matters. When the dispute involves amounts above the arbitration limit for the particular county, such cases go directly to a judge of the county Court of Common Pleas where they are heard either with, or more often without a jury.

Like mediation, the hearings or trials in front of Magisterial District Judges or Arbitrators can be appealed to a trial de novo, or to a brand new trial in front of the Arbitrators from the Magisterial District Judge, or in front of a judge from arbitration. Each of those appeals requires more time and more preparation from attorneys, so the fast, easy result in a smaller case can turn into a long, expensive process in any event.

The potential costs and time consumed by litigation create an incentive for all parties to participate in mediation. Any party who does not understand the potential costs, and those who do not care about the costs and just want to exact punishment on their opponents, do not heed the economic incentive to mediate.

In my experience there are some parties who are by nature more or less likely to successfully mediate. First time homebuyers who confuse seller disclosure claims with a warranty or guarantee, are often made to understand the difference by a mediator. Lawyers and engineers as parties, who often approach mediation as only the first phase in a process, are less likely to reach a settlement by sitting with a mediator.

Consider the parties as well.  Claims against real estate sellers which also involve claims against brokers, agents, inspectors or others may not be able to be mediated effectively if those parties decline to participate.

For parties ready and willing to resolve their disputes quickly and efficiently, mediation remains an extremely effective tool and should not be overlooked.  If you have a dispute over a residential agreement of sale for which the Pennsylvania Association of Realtors ASR form was used, consider the factors above and determine whether you want to pursue mediation.  If you receive notice that mediation has been requested by the other party to such an agreement, be prepared to respond.  In either instance, you should consult with an attorney familiar with the mediation process before you go it alone.

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania.  He can be reached at bdornish@dornish.net.

June 2017

Recent Developments in PA Rental Registration and Inspection Cases

By: Bradley S. Dornish, Esquire

The last few months have seen several important developments in rental registration litigation in Pennsylvania. The most recent development was a series of Commonwealth Court decisions on May 17th, which will have a significant impact on the pending rental registration cases challenging Pittsburgh’s rental registration ordinance. Those cases, Building Owners and Managers Association of Pittsburgh v. City of Pittsburgh et. al., at No. 100 C.D. 2016 and No. 102 C.D. 2016, and Pennsylvania Restaurant and Lodging Association, et.al. v. City of Pittsburgh, at No. 79 C.D. 2016 and No. 101 C. D. 2016, were both appeals of decisions by Allegheny County Court of Common Pleas Judge Joseph James, in which Judge James had found city ordinances, one requiring City employers to give all employees sick time off under a specific set of rules, and the other ordinance requiring security guards and building service employees in Pittsburgh buildings to receive training on emergency response to exceed the City’s authority to regulate employers under its Home Rule Charter.

In both cases the Commonwealth Court en banc , meaning seven of the judges of that court together, rather than a panel of three, affirmed Judge James’ decision that the ordinances exceeded the City’s authority under its Home Rule Charter to regulate employers. These decisions are very positive signs for the rental registration cases against the City, which are now pending in front of the same Judge James in the Court of Common Pleas of Allegheny County.  That is because the landlords’ and real estate agents’ attorneys in the rental registration cases made the same argument that the rental registration ordinance exceeded the City’s authority under the Home Rule Charter.

Not only are those arguments made in briefs which we filed with the court many months ago, but Judge James had also stayed further proceedings in the rental registration cases while waiting for the Commonwealth Court rulings on the cases above. When he did that, he indicated that he preferred to wait to see what the Commonwealth Court decided in those cases, so he would not be reversed on three similar cases. This suggests that the Judge is inclined to rule that the Pittsburgh rental registration ordinance likewise exceeds the City’s authority under its Home Rule Charter.

On May 30th, Judge James advised that he is now ready to move forward on the rental registration case, with additional briefs and argument by the attorneys to take into account the recent decisions of the Commonwealth Court.  We expect to get dates for those briefs and argument in June, and could get the court’s decision on the Home Rule Charter issue this Summer.  Even if the decision is in our favor, and the ordinance is invalidated by Judge James, the City could still appeal, and the case could go until well into 2018.

Unfortunately, a decision invalidating the City of Pittsburgh’s rental registration ordinance on the basis of exceeding its authority under its Home Rule Charter will not invalidate all other such ordinances, even if the decision is appealed to Commonwealth Court and affirmed there. That is because most PA municipalities are not home rule municipalities, so the decision on that basis would have no bearing on their ordinances.

The other rental registration case we are following is now pending in Pennsylvania appellate courts. The case of Costa, et. al v. City of Allentown, was decided in the Commonwealth Court at No. 826 C.D. 2016, with an opinion filed January 12, 2017. That decision does affect all other rental registration ordinances in Pennsylvania, and the cases pending in the courts to challenge those ordinances, such as the cases against the Erie and Pittston ordinances.

In the Allentown case, there was a non-jury trial in the Court of Common Pleas of Lehigh County, and the primary issue in that trial was whether the $75.00 annual fee for rental registration in Allentown was an amount which covered the City’s costs of administering the registration program, and therefore a legal and proper fee, or whether that amount was substantially in excess of the costs of the registration program, and therefore an illegal tax on residential rental properties in violation of the Local Tax Enabling Act, 53 P.S. Section 6901 et. seq.

The Local Tax Enabling Act (LTEA) is the PA state law keeping control of the power to tax in the state legislature, except for certain specific types of taxes which the legislature has specifically authorized municipalities and school districts to charge.  For example, a few years ago when the City of Pittsburgh tried to fill a budget shortfall by raising its occupational privilege tax on those who work in the City from $10.00 per year to over $50.00 per year, the City had to go to the State Legislature and get the legislature to amend the LTEA to allow the City to impose that exact tax on those who worked there. The legislature amended the LTEA, and Pittsburgh has collected the extra tax ever since.

In Allentown, the City had imposed rental registration, with inspection every five years, beginning in 1999. The original license fee was $11.00 per year per residential rental unit, and climbed to $21.00 per unit by 2009. In 2010, the City more than tripled its annual license fee to $75.00 per unit per year, and landlords in the City thereafter filed suit seeking a declaration that the $75.00 annual fee was an unlawful special tax, an injunction against the collection of the fee, and a refund of the fee paid by all landlords in the City since 2010.

At trial, the landlords and the City each had accountants as expert witnesses. The landlords’ accountant, Robert Boland analyzed the amount of revenue collected by the City from the $75.00 fee, looked only at the direct costs to the City associated with the registration and licensure of rental units and inspections, and testified that the revenue generated by the $75.00 annual fee on 24,000 units, roughly $1,800,000.00 per year, grossly exceeded the costs of the program and therefore constituted an illegal tax. Boland looked at the city’s personnel costs related to the rental registration, licensing and inspections, and certain direct costs like vehicle maintenance, vehicle insurance and fuel, cell phones for inspectors, and increased computer costs of the City.

The City’s expert accountant, Trevor Knox did a different analysis of the costs of the rental registration and licensing, called a “full cost” approach. In his analysis, Knox considered the rental program as a comprehensive program regulating all activities of the City related to residential rental units. Knox more broadly allocated personnel costs to the program, including $223,000.00 per year for wages of City personnel who performed general services not specific to rental registration, and $165, 566.00 in general City overhead. He also allocated $482,285.00, a substantial amount of the City’s police budget, to the rental program based on a finding that there had been a disproportionate number of police calls to residential rental units, as opposed to commercial properties and owner occupied homes.

Even with these allocations of additional costs over $900,000.00,constituting over half of the total revenue collected by the City, and additional allocation by Knox of the cost of certain code enforcement functions like boarding up vacant properties, complaint inspections, emergency sewer issue responses and social services to tenants living in substandard conditions, Knox concluded that the total costs which he allocated to the rental program were about 15% below the revenue generated by the $75.00 fee per unit, resulting in general revenue to the City of over $250,000.00 per year.

The trial judge rejected Boland’s testimony, accepted Knox’s testimony, and concluded that for all practical purposes, the costs of the Rental Program equaled the revenues generated by the $75.00 annual fee.

On appeal to the Commonwealth Court, the landlords made the argument that only the direct costs associated with the registration of each unit, the inspection of each unit, and disruptive conduct reporting costs should have been considered by the trial court, since those were the only costs which were created by the ordinance, and which would disappear if the Rental Program created by the ordinance ended.  The Commonwealth Court rejected the landlords’ argument, and affirmed the trial court decision in favor of the City.

The Commonwealth Court explained its decision by finding that the landlords’ attempt to limit the calculation of the City’s costs to direct costs was too narrow.  Judge Brobson, writing an opinion in which Judges Wojcik and Pellegrini joined, explained the Court’s decision that the City was allowed to add some indirect costs related to the Rental Program to its calculation of cost of the program, including some pre-existing budget items which were redirected to the Rental Program.  Judge Brobson stated” In essence, the governmental unit is permitted to reallocate or redirect existing costs to a newly established program if additional burdens are placed on such governmental unit’s existing services.”

In applying the “additional burdens” standard to Allentown’s allocation of costs to the Rental Program, Judge Brobson explained that some costs like the time police took to track and report disruptive conduct of tenants, and some part of the salaries and benefits of City employees who worked in other departments but spent some of their time performing functions for the Rental Program, were reasonable to allocate as costs of the program. However, the judge also explained that certain other indirect costs included by the City’s expert would not be properly attributable to the Rental Program. Those costs included general administrative overhead supporting the City as a whole, and any code enforcement functions not related specifically to the Rental Program, such as costs to board up vacant properties, responding to emergency sewer issues, or assisting social services agencies with conditions at residential rental properties.

Judge Brobson’s opinion thus gave a good bit of guidance on how to analyze allocation of indirect costs in rental registration cases under his “additional burdens” standard. In the Allentown case, however, the Commonwealth Court did not go through each allocation of indirect costs made by the City. Instead, the court stopped its analysis once it found that the landlords had taken an all or nothing approach, arguing that only direct costs of the program could be allocated by the City. The court found that the landlords had the burden of proof of showing which indirect costs were not reasonable to allocate to the program, and by not getting into the details of those costs, did not meet their burden.

To be fair, the landlords not knowing the standard the Commonwealth Court, or even the trial court would apply at the time they engaged in discovery, it would have been extremely difficult to anticipate correctly. And since the Allentown decision has been appealed to the PA Supreme Court, and is awaiting its decision whether to allow the appeal, we can’t presume that the additional burdens standard will remain the law in Pennsylvania. Landlords would certainly prefer a direct costs analysis like that presented by the landlords in Allentown.

If the PA Supreme Court allows the appeal and reverses the Commonwealth Court, we could get a better standard against which to hold ordinances in future cases. For the time being, however, the standard explained by Judge Brobson in his Allentown decision is the current law in Pennsylvania. That means we have changed our approach to arguing the reasonableness of rental fees in other pending cases. In cases from Erie to Pittston, we are developing through additional discovery whether there are indirect costs which those cities can show they reasonably allocate as costs of their rental programs, as creating additional burdens on existing city services. We will also have our expert witnesses analyze the direct costs of such programs separately from the indirect costs, so that we can be prepared if the PA Supreme Court reverses the Commonwealth Court decision in the Allentown case on appeal while our other cases are still pending.  It is likely to be a very interesting year for rental registration cases in PA. Look for more updates to come!

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania.  He can be reached at bdornish@dornish.net.

June 2017

Crowdlending Mortgages for Pennsylvania Real Estate Investment

By Bradley S. Dornish, Esquire

Solicitation of mortgage backed loans for rest estate investment has long been regulated and greatly limited by both Federal and Pennsylvania Securities laws.

Federally, under the Securities Act of 1933, the offer and sale of securities is required to be registered. Under the Securities Exchange Act of 1934, once a registered offering is made, the offeror is subject to ongoing reporting obligations over the life of the investments.  Many exceptions to the requirements of these laws are limited to investors known as “accredited investors,” those with high net worth and investing experience.

Pennsylvania real estate investors seeking private money backed by mortgages to buy and/or renovate Pennsylvania investment properties with funds from Pennsylvania residents, may be able to avoid the imposition of Federal Securities Laws, but Pennsylvania has its own Securities Law, the Pennsylvania Securities Act of 1972.  Under that Act, the offering of securities in Pennsylvania is regulated, subject to very limited exemptions.  Offers to no more than 50 persons over the course of a year which result in sales to no more than 25 investors who meet the Pennsylvania standards for “accredited investors” avoid registration under the Pennsylvania Securities Act, but still must be documented as “limited offerings” with thick, detailed Private Placement Memoranda requiring detailed legal disclosures and accountant prepared financial forecasts.   These costs can be substantial.  The last private placement I was involved in ran over $10,000.00 in legal fees and more than that in accounting fees, taking a year to prepare before the first solicitation could be made.

For these reasons, we have long directed our clients away from raising capital by selling shares or interests in proposed real estate mortgages, unless they are ready to spend tens of thousands of dollars on securities compliance in an effort to raise millions of dollars of real estate financing.  Most investors with purchase and development plans which meet these threshold requirements also have the cash or equity and good credit to finance through bank loans at lower cost and with shorter turnaround times.

Since the emergence of the internet as a primary means of communication and connection between those with needs and those with skills or money, the ways of doing business have changed substantially.

First, crowdsourcing became a means by which those with problems were able to find those with skills and desire to solve those problems without hiring the problem solvers and creating an in-house research and development team.  Much innovation by small business relies, at least in part, on crowdsourcing and major companies have also turned to the crowd to augment their own research and development.

Crowdfunding has taken longer to develop in the United States due to the complex Federal and State Securities Laws described above.   The first crowdfunding activities here were on a non-equity donation basis, where someone with a business dream asked for, and sometimes received, small donations from the crowd, with no expectation of return of capital, interest or equity in the business.  Certainly, this avoided securities problems but meant that there was no investment benefit to those in the crowd who parted with their money.

The Jumpstart Our Business Startups Act, known as the JOBS Act, was enacted in April of 2012 and established a regulatory structure for startups and small businesses, including real estate investors, to raise capital through securities offering using crowdfunding on the internet.

At that time, Title II of the JOBS Act directed the Federal Securities Commission to amend its Rule 506 of Regulation D to permit general solicitation or general advertising in offerings under Rule 506 but still required that all purchasers of the securities had to be accredited investors.

Title III of the JOBS Act added a new Section 4(a)6 {15 U.S.C. 77d(a)(6)} to the Securities Act and that exemption created the greatest opportunity for crowdfunding business investment including mortgage loans on investment real estate.

The Section 4(a)6 crowdfunding exemption has specific requirements and limitations, which include:

  • The amount of capital raised must not exceed one million dollars in a twelve (12) month period.
  • Individual investments in all crowdfunding issuers in a twelve (12) month period are limited to:
  1. the greater of $2,000 or five (5%) percent of annual income or net worth, if the annual income or net worth of the investor is less than $100,000; and,
  2. ten (10%) percent of annual incomed or net worth (not to exceed an amount sold of $100,000), if annual income or net worth of the investor is $100,000 or more.
  • Transactions must be conducted through an intermediary that either is registered as a broker dealer or is registered as a new type of entity called a “funding portal.”

Section 4A of the Securities Act was also part of Title III of the JOBS Act.  That section, 77 U.S.C 77a, requires the issuers of crowdfunding securities and the intermediary broker-dealers or the funding portals who connect those securities to the investors, must provide certain specific information about the investment, the issuer and the intermediary, to the investors, take offer actions and provide notices and information regarding the transactions to the Securities Commission.

Or

Section 4A of the Securities Act was also part of Title III of the JOBS Act.  That section, 77 U.S.C 77a, requires that the issuers of crowdfunding securities and the intermediary broker-dealers or the funding portals who connect those securities to the investors, must provide to the investors certain specific information about the investment, the issuer and the intermediary and must take offer actions and provide notices and information regarding the transactions to the Securities Commission.

After the JOBS Act was enacted in 2012, the Securities and Exchange Commission (SEC) began to develop regulations to implement the new law.   Some provisions on crowdfunding were ambiguous in the law as written and required clarification through regulation before they could be implemented.

In October of 2013, the SEC published proposed new rules for crowdfunding, which generated almost 500 detailed comments from industry groups, state securities regulators, investor organizations, Members of Congress and others.  After consideration of all of those comments, final rules for “Regulation Crowdfunding” were published by the SEC in 2015, and became effective May 16, 2016.   With these rules in place, borrower/issuers, Crowdfunding Portals and lender/investors can now feel comfortable moving forward with compliant crowdlending transactions.

The first clarification offered in Rule 100(a)(1) of Regulation Crowdfunding is a clear limit of one million dollars in the aggregate amount a borrower/issuer can borrow from all crowdlending investor/lenders in a twelve (12) month period.  This limit is on the total amount loaned and does not allow for deduction of the amount of fees and costs the borrower/issuer pays to the funding portal to process and place the loan transaction.  The rule also makes clear that there is a control group test for the aggregation.  This means that you, as a borrower/issuer, cannot increase the amount of money you can borrow by forming one or more additional entities.

Under Regulation Crowdfunding Rule 100(c), an investor/lender is limited to investing the greater of $2,000 or five (5%) percent of the lesser of the investor’s annual income or net worth if either net worth or annual income is less than $100,000. An investor whose net worth and annual income both exceed $100,000 is limited to investing ten (10%) percent of the lesser of annual income or net worth, in any event not to exceed $100,000 across all crowdfunding investments, even if the crowdfunding investor/lender is an “accredited investor”.

The SEC provided the following chart to help explain the rules.

Investor

Annual                        Investor                                                                                               Investment

Income Net Worth Calculation Limit

$     30,000      $   105,000      Greater of $2,000 or 5% of $30,000 ($1,500)                        $    2,000

$   150,000      $     80,000      Greater of $2,000 or 5% of $80,000 ($4,000)                        $    4,000

$   150,000      $   100,000      10% of $100,000                                                        $  10,000

$   200,000      $   900,000      10% of $200,000                                                        $  20,000

$1,200 000      $2,000,000      10% of $1,200,000 (Capped at $100,000)                 $100,000

Next under Rules 100(a)(3) and 300(c), borrower/issuer is limited to using a single portal and its associated platform for each proposed loan.  This is to help assure transparency for the transaction, making it easier to confirm the maximum aggregate borrowing of the borrower/issuer and the maximum permitted investment of each lender/investor.

Regulation Crowdfunding Rule 100(b) excludes from using crowdfunding foreign issuers and investment companies, as well as Exchange Act reporting companies (companies issuing securities listed on securities exchanges like the New York Stock Exchange).  The Rule also prevents those borrower/issuers who are delinquent in providing their annual Regulation Crowdfunding reports to the SEC under Rules 202 and 203(b), from issuing additional offering of securities under this Section.  So, a borrower who wants to continue borrowing up to a million dollars each year under Regulation Crowdfunding has to keep up on all annual required reports or will be shut off from further use of the borrowing process.

The information required to be disclosed when money is sought through Crowdfunding is clear:  Rule 201(a) and (c) requires a borrower/issuer to disclose information about each person having a twenty (20%) percent or greater interest in the borrower/issuer and information about the business experience over the past three (3) years of its officers, directors or others with similar roles.

Rule 201(d) requires disclosure of the business and business plan of the borrower/issuer, but is flexible to allow the scope of those disclosures to match the amount of money sought.

Rule 201(i) requires a description of the use of proceeds sufficient to permit prospective lender/investors to evaluate the investment.  The level of detail is determined based upon particular facts and circumstances, and the rules contemplate that even a range of possible uses of proceeds without a single definitive plan can be the basis for a request for funding under this Regulation.

There are additional disclosure requirements on the identity and compensation of the intermediary or crowdfunding portal, risk factors of the investment, other debt of the borrower/issuer, as well as its other exempt offerings and related party transactions.  Rule 201(y) added a catchall provision for the borrower/issuer to disclose any material information to not make the rest of the information disclosed not misleading in light of the circumstances under which they were made.

Disclosures of the financials of the borrower/issuer are also scaled to the amount of the loan being requested.  For amounts up to $100,000, disclosure of total income, taxable income and total tax on tax returns and financial statements certified by the principal executive officer covering the past two fiscal years are sufficient for offerings more than $100,000 up to $500,000.  Rule 201(t)(2) adds a requirement for accountant reviewed financial statements and for offerings more than $500,000, a one-time use of reviewed financial statements, followed by a general requirement for audited financial statements.

All statements issued are to be prepared in accordance with Generally Accepted Accounting Principles (GAAP).

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania.  He can be reached at bdornish@dornish.net.

February 2017


Investors – HR-5201 is Our Chance to Bring Back the Seller Financing Business

By Bradley S. Dornish

Recently, I attended the National REIA Mid-Year Leadership Conference in Atlanta. While there, I had the opportunity to network with Charles Tassell, National REIA’s Chief Operating Officer and Director of Government Affairs, and with Jeff Watson, who leads the Distressed Property Coalition and is Nations REIA’s representative to the Seller Finance Coalition. (For those who don’t remember, ACRE is the Southwestern Pennsylvania Chapter of National REIA and we contribute over $5,000.00 per year from your ACRE dues to National REIA to support its operations).

The most exciting news to come out of this year’s Mid-Year Conference is that HR-5301 had gotten broad bi-partisan support from liberal and conservative members of Congress, and is not opposed by the National Association of Realtors. This means HR-5301 has a great chance of passing, even in an election year.

So, why should you as a real estate investor care about this? Because not too long ago, buying and renovating single family homes and selling them to consumers with seller financing was an important part of many investors’ businesses, as well as a great way to improve the housing stock in U.S. cities, provide more jobs in the rehab construction industry and provide clean, safe, affordable homes to consumers who wanted to own, not rent.

When the SAFE Act, Dodd-Frank Act became law, investors were limited first, to no more than five, and then to no more than three, seller financed loans to consumers per year. Even more restrictive, the Dodd-Frank regulations imposed the same burdens on investors to verify consumer credit and income from third party sources and properly calculate each consumer’s ability to repay which it imposed on big banks like Bank of America, Wells-Fargo and Chase. And if that weren’t enough, seller financed loans from mom and pop real estate investors were subject to the same voluminous and strict scrutiny of the Consumer Finance Protection Bureau in Washington, D.C.

Over the past few years this led me to advise my client investors to not finance to consumers – PERIOID. You could still buy, renovate and rent properties, and even give tenants the option to buy (with financing they could get from a bank or mortgage lender). But a seller financed mortgage or installment land contract was just too risky for most sellers under these laws. Because of this advice, some gurus even said I was unfriendly to investors, which is ironic since real estate investors are the bulk of my clientele.

In the wake of these onerous laws and regulations, National REIA became the largest member of the Seller Finance Coalition and helped to craft and supported what has now become HR-5301, The Seller Finance Enhancement Act. HR-5301 was introduced in the House in May and is now in review by the House Committee on Financial Services, a standing committee on which Pennsylvania representatives Keith Rothfus and Michael Fitzpatrick sit as members.

What does HR-5301 actually say or do for us if it passes and becomes law? You can read the whole text at Congress.gov, searching under bills, or see the link on our ACRE website. No need to fear, it is not a whole book like Dodd-Frank or Obama Care. It is only four short pages.

The short summary is that it EXEMPTS sellers of real estate who provide seller financing on up to 24 properties, in a 12 month period, to consumer borrowers by mortgage loans or equivalent (i.e. installment land contracts) from the Loan Originator Licensing and Registration requirements of the SAFE Act (12 U.S.C. §5103), and from the debt to income ratio restrictions of the Dodd-Frank Act (15 U.S.C. §1693c (b)(2)(A).

Twenty four seller financed loans per year, including first mortgages, second mortgages and installment land contracts is enough for almost any small real estate investor to get back to improving our cities’ housing stock, providing clean, safe housing for consumers to own, and making some long term interest on these transactions to help secure and stabilize our own financial futures.

Call or email Keith Rothfus today to express your support for HR-5301. (412) 837-1361; rothfus.house.gov.

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania. He can be reached at bdornish@dornish.net.

July 2016

Use of Criminal History to Deny Rental Applicants and Fair Housing

By Bradley S. Dornish, Esq.

For many years I have used criminal records histories to screen applicants for my own rental properties, and taught others how to search online for PA criminal records histories of their own rental applicants. I have done this without considering the race, national origin, religion, sex or familial status of the applicants. I have had and helped others develop policies to apply only convictions of significant crimes, such as felonies, crimes involving violence, drug dealing, domestic abuse, forgery, theft by deception and extortion as litmus tests to deny an applicant the opportunity to rent housing. I have always told my clients that one being convicted of a crime does not make one a member of a protected class, and that fair and uniform application of non-discriminatory criteria for tenant screening is appropriate and legal.

I have counselled against using mere arrest records without conviction, except if the arrest is recent and a case involving potential incarceration of the applicant. The exception is based on the risk they will not be able to continue employment and pay the rent, or occupy the property, if incarcerated during the lease term.

Growing up, I remember well when my parents rented to a nice, normal appearing family of four without running a criminal check, only to learn later that the husband was on probation following conviction and incarceration for burglary. They learned this after other apartments in the building were broken into several times, with no apparent forced entry to the building, and missing furniture, TV sets and small appliances were all found in the new tenants’ apartment.

My practices in tenant screening and those I advise clients to follow are changing, based on a developing line of cases and the guidance on fair housing recently issued by HUD’s Office of General Counsel.

The “Disparate Impact” cases find employers and housing providers liable for discrimination without the need for any intent, if the practices they follow which are not otherwise discriminatory cause a disparate impact on a protected class. The logic is that if reading the entrails of sacrificed animals is an important religious practice of Zoroastrians, and you restrict the practice without showing a legally sufficient justification for the restriction, you are liable for discriminating against Zoroastrians.

On April 4th, 2016, the office of General Counsel of the U.S. Department of Housing and Urban Development, HUD’s legal department, issued its “Guidance on Application of Fair Housing Act Standards to the Use of Criminal Records by Providers of Housing and Real Estate Related Transactions”. Basically, this guidance is a ten page explanation of how use of criminal conviction histories has discriminatory effects on African Americans and Hispanics because there are higher rates of convictions and incarceration among those populations then the average for the entire population.

The first step outlined by HUD in its guidance is determining whether the landlord’s criminal history practice has a discriminatory effect. HUD’s guidance quotes studies showing nearly one third of the population of the U.S. has a criminal record. For 2013, HUD cites statistics that African Americans were arrested at a rate more than double the population as a whole, and make up 36% of the prison population, but only 12% of the U.S. population.  HUD further cites data that Hispanics make up 22% of the prison population, but only 17% of the total U.S. population. By contrast, non-Hispanic Whites comprised 62% of the population, but only 34% of the prison population. Thus, the imprisonment rate for African American males is almost six times that for White males, and the rate for Hispanic males is over twice that for non-Hispanic White males.

HUD concludes that although these are national statistics and state and local statistics may be relevant to show differing conclusions, in the absence of different statistics, these statistics show reasonable cause to believe blanket use of conviction records would have a disparate impact on African American and Hispanic populations, and therefore have a discriminatory effect.

The second step of HUD’s analysis is evaluating whether the landlord’s criminal records policy is necessary to achieve a substantial, legitimate, nondiscriminatory interest.  If HUD has found the discriminatory effect in step one, the burden in step two shifts to the landlord to prove that the challenged policy or practice is justified. That means the landlord has to provide evidence that the landlord has a substantial, legitimate, nondiscriminatory interest in using the criminal records policy it has, AND evidence that the policy is successful in achieving that interest or result. Blanket statements that “we do this to protect other residents’ will not cut it. You have to show evidence that your policy works.

In this part of its analysis, HUD comments that exclusion because of prior arrests not resulting in conviction will certainly fail to meet the landlord’s burden. Further, exclusions based on prior conviction without considering the nature of the conviction, the length of time since the conviction, and what the person has done since will also most likely fail.  In order to successfully exclude persons from tenancy based on prior convictions, HUD directs that the landlord must show that the way it uses conviction records accurately distinguishes between criminal conduct that indicates a demonstrable risk to resident safety and/or criminal conduct that does not.

No more rejection of convicted embezzlers, forgers and tax evaders would appear to be available under this standard.  As I recall, the only significant thing Al Capone, the notorious Chicago gangster was convicted of was income tax evasion. He never had a conviction for his role in the St. Valentine’s Day massacre. A policy as directed by HUD would appear to mean Al Capone would qualify to rent your property.

The third step is evaluating whether there is a less discriminatory alternative to achieve the same result. Even if a landlord proves its policy of using conviction records actually works to provide a safer place for its tenants to live, HUD gives the prospective tenant an opportunity in its third step to show the landlord’s goal could be met by a different screening process which would not prevent the applicant convicted of the crime which would pose a risk to tenant safety from being approved as a tenant. HUD suggests the tenant can show the facts or circumstances surrounding the criminal conduct, such as age at the time of the crime, evidence of being a good tenant before and/or after the conviction, and evidence of rehabilitation.

HUD also suggests that a landlord delay consideration of criminal history until after financial (credit and employment) requirements are met, to minimize the costs to the landlord associated  with a more thorough and individualized review of the tenant’s criminal history. All this time, I thought I was doing tenants a favor by screening criminal records first, and refunding their fee for a credit report if I rejected on criminal history first.

One type of criminal conviction can absolutely still be a bar to tenancy, without violating the Fair Housing Act. Section 807(b)(4) of the Act provides that  refusing rental to one convicted of “illegal manufacture or distribution of a controlled substance” does not violate the Act. Note that conviction is required, and it must be for drug trafficking, not possession.

So, what is a landlord to do? Stop automatic litmus tests for conviction records as a bar to tenancy, except for drug trafficking convictions.  Consider the length of time since the conviction, the nature of the specific offense and its relation to the safety of other residents, and consider what the prospective tenant has done both before the conviction and rehabilitation since the conviction before rejecting the applicant. Maybe it is easier to run the credit report and verify employment first!

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania.  He can be reached at bdornish@dornish.net.


May 2016