Defective drywall imported from Chinese manufacturers installed in homes between 2004 and 2006 in areas with high heat and humidity has caused copper and silver electrical and air conditioning materials to corrode. The drywall emitted a higher level of sulfur than acceptable drywall causing the corrosion. Several class action lawsuits have been filed against the drywall manufacturers, installers, builders and insurers with settlements reached on several of the cases. Congress passed and the President has signed the Drywall Safety Act which would strengthen regulation of drywall and support ensuring that compensation is paid by Chinese companies under the terms of the lawsuit settlements and verdicts.
On January 14, President Obama signed into law the Drywall Safety Act of 2012 (H.R. 4212). H.R. 4212 is in direct reaction to defective drywall imported from Chinese manufacturers used in certain homes built or remodeled from 2004 to 2006. Passage of the Drywall Safety Act occurred in the last few days of the 112th Congress. The Senate passed H.R. 4212 on December 21, 2012 under unanimous consent. The House had first passed H.R. 4212 on September 19, 2012 under unanimous consent. The Senate amended the legislation on December 21 and the House then agreed to the Senate amendment on January 1, 2013, by a vote of 378 to 37.
H.R. 4212 strengthens sulfur labeling standards for drywall by requiring certain standards by the American Society for Testing and Materials to be treated as rules by the Consumer Product Safety Commission (CPSC). It would further require the CPSC to develop a rule that limits sulfur content in drywall to a level acceptable in homes which would not cause corrosion. In addition, the new law would direct the CPSC to revise its "Remediation Guidance for Homes with Corrosion from Problem Drywall" to specify that defective drywall should not be used in the production of new drywall.
Finally, the Drywall Safety Act expresses the sense of Congress that: “(1) the Secretary of Commerce should insist that the Government of the People's Republic of China, which has ownership interests in the companies that manufactured and exported problematic drywall to the United States, facilitate a meeting between the companies and representatives of the United States Government on remedying homeowners that have problematic drywall in their homes; and (2) the Secretary of Commerce should insist that the Government of the People's Republic of China direct the companies that manufactured and exported problematic drywall to submit to jurisdiction in United States Federal Courts and comply with any decisions issued by the Courts for homeowners with problematic drywall.
The sense of Congress contained in the bill addresses several class action and individual lawsuits which were filed on behalf of homeowners against the various parties involved with the defective drywall. The lawsuits were consolidated into the federal district court in New Orleans (In Re: Chinese Manufactured Drywall Products Liability Litigation). The primary defendants in the lawsuits are the two companies which manufactured the drywall, Taishan Gypsum and the Chinese subsidiary of the German company, Knauf, as well as builders and installers of the drywall and their insurers. For more information on the lawsuits, please go to http://www.laed.uscourts.gov/Drywall/Drywall.htm
As the case is winding its way through the judicial process, several companies have reached settlement agreements with the plaintiffs. For the most part, these companies were reimbursed by their insurance companies under commercial insurance contracts. In May 2011, a New Orleans building products supplier, Interior/Exterior (Inex) settled for $8M, its policy limit on one policy, and assigned its claim for an additional $72M under another policy. A second company, Banner Supply shortly thereafter reached a settlement agreement for $55M. Then in December, 2011, a major settlement with Knauf was reached in which the drywall manufacturer agreed to pay $800 million to settle the class action lawsuit.
Following the Knauf agreement, a global class action agreement, which consolidated 11 cases against suppliers, builders, installers and certain insurers, was reached in May 2012. The defendants agreed to settle the cases for a total of $80 million. The last remaining large lawsuit is against Taishan Gypsum.
Prior to settlements being reached, the federal government had published its views on remediation. In March of 2011, the CPSC and the Department of Housing and Urban Development (HUD) issued their updated remediation protocol for houses with defective drywall. The updated report recommended the removal and remediation of all problem drywall as well as fire safety alarm devices, electrical distribution components, including receptacles, switches and circuit breakers, and gas service piping and fire suppression sprinkler systems. The guidance can be found at http://www.cpsc.gov/info/drywall/Remediation031811.pdf
. Pursuant to H.R. 4212, the CPSC and HUD will need to update the guide to specify that defective drywall should not be used in the production of new drywall.
While settlements have been reached with several of the plaintiffs, it could still be some time before defendants involved with those lawsuits receive compensation and can replace, or be reimbursed for replacing, the drywall and address other issues resulting from the defect. It is unlikely though that the compensation will cover the full costs of remediation. The plaintiffs do now, however, have the backing of Congress and the involvement of the Secretary of Commerce to help increase the likelihood that they will eventually receive at least partial compensation.
Posted by Tristan North
Properly organized and operated home purchase programs result in no taxable income to the transferee without regard to whether the move meets the moving expense requirements, or whether the home is the transferee’s principal residence, or whether the employee is the actual owner of the home. So long as the employer has a non-compensatory business reason for the purchase, its expenses are its own and not treated as compensation to the employee. The body of this blog post explains why.
The Full Story:
Today’s tax quote: “All the Congress, all the accountants and lawyers, all the judges, and a convention of wizards, all cannot tell for sure what the income tax law says.” Walter B. Wriston.
As Mr. Wriston’s wry comment suggests, the tax code is a virtually inexhaustible source of questions and confusion.
One of the most enduring sets of questions raised by Mobility industry professionals about relocation home purchase programs involves the relationship of those programs to other familiar tax rules, such as the moving expense provisions of section 217 and the home sale capital gain exclusion provisions of section 121. For home sale expenses to be excludable from the income of the employee in an otherwise qualifying home purchase program, does the move have to meet moving expense rules such as the “50-mile” rule, or the “one year rule”? Does it make any difference if the home is the transferee’s principal residence? Does it matter who owns the home?
The answers to all of these questions is “no.”
Since Rev. Rul. 72-339, issued in 1972, IRS repeatedly has accepted the principle that if the employer buys the employee's home in a bona fide purchase for value, and sells that home to an unrelated buyer in a separate, independent sale, the costs incurred on that second sale are not income to the employee, but are costs incurred by the employer on its own behalf in order to dispose of a property it owns. Most recently, IRS reiterated that position in Rev. Rul. 2005-74. The underlying rationale is that the employee theoretically could have sold the home himself without incurring costs, and has simply done so to the employer. The employer's costs of disposal do not benefit the employee, but are costs incurred by the employer for its own benefit.
This rationale does not depend on whether the employee's move meets the requirements to deduct moving expenses, including either the 50-mile rule (which says that to deduct moving expenses the distance between old residence and new job must be at least 50 miles farther than the distance between old residence and old job) or the one-year rule (which says that in general moving expenses must be incurred within one year of initiating the move), nor indeed, that the employee is relocated at all. Rather, it proceeds from an assumption that the employer has purchased property from the employee for non-compensatory company business reasons, and then incurred its own costs to dispose of it. Consequently, for example, a home purchase program still results in no taxable income to the employee even if the home is purchased two years after the move.
For the same reason, the tax treatment of the employer's costs does not depend on whether the home is the employee's principal residence (which would be required for the employee to exclude capital gain under section 121), or even whether it is a house (as opposed to vacant land, for example). The tax treatment depends on the employer demonstrating a corporate business purpose for the purchase other than providing a benefit to the employee. Consequently, for example, the employer’s costs in purchasing and selling a second home (even if it also purchases and sells the principal residence) are still excludable from the employee’s income provided the home purchase program follows proper procedures.
This is not to say that relocation of the employee is irrelevant to the issue, however. As noted, the company must show that the home purchase was in support of an employer business purpose other than compensation. Whether or not the move qualifies for moving expense deductions, and whether or not the property is the principal residence, the relocation is helpful because it supports the purchase of the property from the employee as having been undertaken by the employer as a necessary part of facilitating the deployment of the employee to a new job location. That is a non-compensatory business purpose related to the proper organization of the employer's workforce.
If the employee is not changing job locations, it becomes more difficult for the employer to demonstrate a legitimate business reason for buying the employee's home, other than to confer a benefit on the employee. This is not to say such a showing is impossible. For example, it could be that the employer needs the employee to move to a bigger house in order to facilitate business entertainment, even though there is no job change, or the employer needs the employee to be closer to the workplace. Nevertheless, relocation for job reasons provides the most easily demonstrable and sustainable business reason for a home purchase.
As noted, this does not mean that the move must meet the Section 217 time or distance requirements, or that the property purchased must be the employee's principal residence. It is enough that the purchase is a necessary part of moving the employee to a new job location.
For the same reasons, it is irrelevant who actually owns the home. If the employer purchases the home in a bona fide, arm's length purchase, and that purchase is in order to facilitate moving the employee to another job location, the costs will not be taxable to the employee or subject to employment taxes, nor will they be taxable to the individual from whom the employer actually purchased the home. For example, the fact that the employee’s home is actually owned by the employee’s parents is irrelevant to the favorable tax treatment afforded a qualifying home purchase program.
It also does not matter whether the transferee is married to his or her co-owner. Rev. Ruls. 72-339 and 2005-74, on which the tax treatment of the employee’s home purchase is based, do not depend upon the marital status of the transferee (nor, indeed, on whether the seller is a transferee at all, provided there is a bona fide, non-compensatory corporate business reason for the home purchase). Rather, the rulings conclude that if the employer buys an employee’s residence in a bona fide purchase for fair market value, and no expenses are incurred by the employee on that sale, the employee is not taxed on the avoided expenses that are later incurred by the employer on the second sale. Neither the marital status of the employee and co-owner, nor the employee’s status as an owner at all, is relevant to this determination.
Some companies have policies that prohibit purchases from a person who is not the employee, but the policies are not tax-driven. Rather, they are driven by legal and practical concerns such as whether the employer will be able to obtain clear title, and whether the employer will have adequate remedies if difficulties arise. An employer has a considerably greater ability to recover from an employee than from an unrelated person.
Companies occasionally have tried to solve this problem by getting the actual owner to deed the property to the employee (usually with a quit claim deed) prior to the purchase by the company. However, this is a highly inadvisable practice that is fraught with tax and legal difficulties for the employee involved, and generally should not be done. For example, if the person giving title to the employee is not the employee's spouse, it is likely that gain on the employee’s sale to the employer will be taxed rather than qualifying for the home sale gain exclusion under Section 121, because the seller (the employee) has not owned the home for two of the prior five years. There also may be gift tax consequences, and issues as to mortgage interest deductibility. In addition, legal issues may arise that create problems for the employee. According to Worldwide ERC® General Counsel Dick Mansfield, these include the following: The transfer may change the character of the property in a divorce proceeding, or the type of joint ownership; the transfer may put the house at risk of someone else’s creditors; the transfer may trigger "due on sale" clauses in mortgages, or may violate provisions of the Deed of Trust or mortgage documents; or the transfer may affect local real estate tax status (such as homestead classification).
Suffice to say that the employer should strongly advise the employee to get independent tax and legal advice before moving the title in order to qualify for the home purchase program.
Worldwide ERC’s on-line tax and legal materials address these questions in several places, including “Frequently Asked Questions” and articles in the Tax & Legal MasterSource. So members who encounter these questions do not need a “convention of wizards” to address them, but can always find the answers there.
Posted by Peter K. Scott
Last week the Congress and the Administration reached a budget compromise that kept the Treasury liquid, and the country escaped a government shutdown and a default on debt payments. The compromise involved the adoption of a complicated mechanism to generate “cuts” in the budget in years to come, as well as authority to increase the federal borrowing limit to the largest amount in the nation’s history. Many economists – and many ordinary citizens—have looked at the political compromise and declared that it was not likely to achieve its stated purpose of reigning in federal spending and drastically reducing federal debt. One of those skeptics is the rating agency of Standard and Poor’s (S&P).
Friday after the markets closed, S&P announced a one-step downgrade to its rating of U.S. federal bonds from AAA to AA+. Although this is the smallest downgrade it can give, it is nevertheless the first time that U.S. bonds have been downgraded.
Today, S&P downgraded the debt of government-sponsored enterprises Fannie Mae and Freddie Mac also to AA+ from AAA, citing their reliance on U.S. government. Ten of the country's 12 Federal Home Loan Banks were also cut to AA+; the banks of Chicago and Seattle had been downgraded earlier.
Fannie and Freddie own or guarantee about half of all current U.S. mortgages, or nearly 31 million home loans worth more than $5 trillion; they account for nearly all new mortgage loans.
There has been an enormous amount of press – and hyperbole—in the media about this politically charged event. In this blog, I will give a first attempt at divining what, if any, effect it will have on the short term outlook of the employee mobility industry.
First, some background.
Regarding ratings, there are four major ratings agencies two of which have figured in the news, S&P and Moody’s are the largest and most respected. The former downgraded US debt and continued it on “watch” status; the latter only kept it on “watch” status with no downgrade. No other rating agency changed its rating.
Rating agencies are private companies that assess the financial strength of companies and governmental entities, particularly their ability to meet the interest and principal payments on their bonds and other debt. The rating for a given debt issue reflects the agency’s degree of confidence that the borrower will be able to meet its promised payments of interest and principal as scheduled. The rating for a given debt issue may differ somewhat from the overall credit rating for the issuer, depending on the terms of the issue. Thus, while the general obligations of the United States (Treasury bonds) have been downgraded, S&P will also review the status of other U.S. debt obligations, such as the bonds issued by the GSEs, Freddy Mac and Fannie Mae.
Currently, the countries with AAA debt rating from S&P includes: Australia, Austria, Canada, Denmark, France, Finland, Germany, Guernsey, Hong Kong, Isle of Man, Lichtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland, and the U.K. All other countries’ ratings fall below the vaunted AAA, ranging down to Greece’s CC rating, the current lowest. The S&P rating scale is a bit obscure, but easily understood; it is based on an A, B, or C grade, with subcategories to define the letter rating; thus AAA is better than A+, while AA+ is higher than AA-. All are “better” than A. The fewer the subcategory letters, the lower the score. S&P also gives a prognosis with its ratings: stable, positive or negative, and as a warning “watch negative” or “watch positive”. It rates the current U.S. outlook as negative.
For S&P, a bond is considered investment grade if its credit rating is BBB- or higher. Bonds rated BB+ and below are considered to be speculative grade, sometimes also referred to as "junk" bonds. China at AA- and the U.S. at AA+ are both therefore investment grade bonds, albeit without the highest AAA rating.
Moody’s, the other much-mentioned rating agency, still has United States debt rated as Aaa (its version of S&P’s AAA), but with a “negative outlook” which is a warning of downgrade.
Higher ratings theoretically allow countries to issue debt at lower cost by removing the risk component from the interest calculation.
There are no laws regarding the effect of the ratings of these agencies, and, in fact, during the 2008 meltdown of the financial industry triggered by the discovery of the inherent difficulties of asset backed securities (ABS), they were roundly castigated by the press and the Congress. Several suits were filed against bond ratings of private offerings.
The real effect of ratings is based upon the presumed accuracy and impartiality of the rating. Many financial institutions, for example, are required by policy or contract to invest some funds in “low risk” investments. AAA rated government bonds have been the preference of these investors, and of other investors seeking liquidity and no significant risk. The same applies to the reserves held by governments (now popularly called “sovereign” debt or holdings even where there is no monarchy involved). Most foreign countries that hold significant reserves have traditionally held U.S. Treasury bonds as a measure of safety and liquidity. As of May, the largest holders of U.S. treasuries were China, Japan, the U.K., the oil exporting countries (as a group), Brazil and Taiwan. While policies or contracts may require some institutions or companies to reducing their holdings in U.S. bonds, there is no law requiring them to do so, and further, U.S. regulated banks will not be required to dump treasuries to meet safety and liquidity standards, according to the FDIC.
Thus, in the end result, a downgrade is as much a measure of economic psychology and a reflection of the current recession as the nation’s ability to honor its debts. In fact, a country with the economic strength of the U.S. could always simply print money to pay its debts. While creating inflationary pressure would produce other unhappy economic consequences (remember the Carter stagflation?), nevertheless, bills would be paid.
Even though the downgrade will theoretically increase the cost to the Treasury of future debt issues, in my opinion the downgrade is best analyzed as what it says about the rest of the economy and the pace of recovery. The current reality is that even with a downgrade, the return on short term treasury bonds is actually falling; just the opposite of what the financial theory would seem to predict. In the current economic environment with little growth (except of regulation) and high unemployment, the added “risk” in U.S. treasuries is not currently enough to dissuade investors who are fleeing the equity markets to look to other financial vehicles for safety and stability. There are very few alternatives; the traditional commodities and precious metals have been bid up to record heights in the past months, and are therefore subject to a significant risk. Treasuries, regardless of the downgrade, look much safer to investors, as shown by the continuing demand and consequently low interest rates.
What are the short term effects on the employee mobility industry?
Since there never before has been a downgrade of U.S. securities, there is no history to guide in formulating an answer to this question. That being said, some prognostication seems justified by an analysis of current economic conditions.
First, the general economy will not likely feel any more pain than it already has; the legislative fix just agreed to has overshadowed any downgrade effects, and neither address the real problem facing the country, the lack of confidence and trust in the economic environment. Consumer confidence continues to fall, businesses refrain from investing domestically and hoard cash, and the federal government has shot all of the arrows in its economic quiver. The threat and reality of even heavier regulation and increased taxation are not going to spur domestic investment, just as a private rating agency’s downgrade of U.S. treasuries is not going to keep the government from issuing debt, or penalizing those who already hold it. What will likely occur, though, is a continued flight from equities, unrelated to, but triggered by, the downgrade.
Second, the just announced downgrade of Fannie and Freddy paper will likewise not have much of an effect on their interest rates, for several reasons including the fact that the risk is already factored into federally guaranteed securities. In addition, much improved underwriting and scrutiny of the underlying mortgages (some would say over scrutiny) make this paper again some of the safest available. Finally, the real threat to rising rates lies not in a minor downgrade, but in the threat contained in the current QRM (qualified residential mortgage) proposed rules, as I have discussed in previous blogs.
Third, one issue to watch is what might be termed collateral damage to toe government debt downgrade, and that is the possibility of a long term effect on corporate bonds, even if there is not actual agency downgrade on the paper or borrower itself. As I write this, it appears that the corporate credit default swaps (CDS) spreads have increased dramatically today, as they have been over the past week. This is as likely to have been caused by the weak economy as the federal downgrade, but certainly the latter did not help. Continued pressure will affect corporate borrowing rates, not a good thing when the economy starts to turn around.
(A CDS is similar in function to credit insurance that protects the buyer – for example, the buyer of a corporate security-- in the case of a default. If the loan or bond defaults, the buyer of the CDS can exchange or "swap" the defaulted loan for the face value of the loan which is paid by investors in the derivatives. In Wall Street parlance, the buyer of the CDS makes a series of payments ("fee" or "spread") to the seller of the swap and receives a payoff if the loan or bond defaults. When spreads increase, that means investors see more risk in the loans, similar in a way to a downgrade by a rating agency except that the parties to the CDS have their money on the line.)
Finally, there are no legal precautions that appear to be warranted by the downgrade. The only caveat applies to contracts, such as escrow and guarantees that might require investment of funds into “AAA paper”. For the most part, contracts containing these clauses were modified in 2008 and 2009 based upon the defects in the credit market (remember auction rate securities?). In the event that there are still contracts with the vague “AAA” language, the issue revolves around the actual wording, since Moody’s, Fitch, and the other agencies maintain their AAA equivalent rating for U.S. treasuries and debt.
Bottom line, then, for the employee mobility industry will likely be business as usual in today’s sluggish economy. Bad publicity for the U.S., but little dirct impact based on this one downgrade.
Roughly 44 cents of every dollar spent by the Federal government is borrowed, a sad fact but unfortunately true. Given the fact there was no fiscal 2011 budget passed by Congress (the government is running by virtue of a continuing resolution, essentially permission to spend at last year’s levels) the current debate over the debt limit becomes important to the general economy, as well as to members of the mobility industry that sell services to Uncle Sam.
The last time that there was a threatened shutdown, I blogged about the effects on government contracts, and gave advice about how industry members should handle the event. Fortunately, a last minute compromise – raising the debt limit—forestalled that crisis. And now the same threat has surfaced, but the mood of both Congress and the country suggests that another open ended debt increase will not occur without limits on government spending.
First, some background. Surprisingly, even though there have been 17 shutdowns in the past few decades (the last actual shutdown was in 1996), there is little law directing how the government must act. After the February compromise that raised the debt ceiling it was projected that the government would run out of money in ninety days. But May came and went without much fanfare because the Treasury issued $72B in securities that exceeded the federal debt ceiling. The justification was a sleight of hand accounting trick that suspended some federal retirement fund payments and used that money to finance the nation's general obligations. Sometime within the next two weeks, perhaps as early as August 6, the Treasury will not have enough money to run the government and pay our country’s huge interest and principal payments, because it must pay back those suspended payments from May.
So what will happen? Basically the Treasury will act like any business or homeowner that finds itself short of money: it will prioritize its bills and pay those that it thinks are the most important, deferring the others until it figures out how to pay them. Agency heads are faced with the quandary that Congress has mandated the laws and regulations they need to enforce, yet there will not be enough money to pay for that enforcement. Thus Cabinet members and other agency heads need to make the same decisions with the money allotted to them during a shutdown.
The only legal authority covering this behavior is derived from a 1980's opinion of GAO that essentially asserts the administration has the discretion on how to treat the incoming bills to the U.S. government. This presumably applies to federal debt payments (interest and principal), too. Yesterday, however, several members led by Sen. Pat Toomey (R., Pa.) announced that they will soon introduce a bill to direct the administration on the priority of spending during a budget crisis. It is not clear if this law will pass either house, or if it will be signed into law by the President. It is, however, an attempt to put a legal framework around an otherwise uncharted issue.
The term “government shutdown” is therefore a bit of a misnomer. In reality, the government decides which activities, programs, and employees will continue to be funded given the amount of money available from the Treasury. Every government agency currently has a series of contingency plans that rank their activities in order of importance, and can suspend those for which it cannot pay. Essential services, such as the military, will of course continue to be paid for, and most likely social security and Medicare will not be delayed. What other activities will continue to operate is a function of the money available and politics.
If the administration decides to “default” on federal debt payments, it will have significantly more money to keep the government itself running. The actual results of a default are the subject of a spirited debate, since there is no current history upon which to build an understanding. Though the Federal government technically defaulted on its bonds in 1790 and again in 1933, these were at most technical defaults that were instituted to cure then-current problems. In the former, investors in the war effort were paid in full later, in the latter investors were also repaid, though in currency that had been inflated by the removal of the gold standard from the terms of government bonds. Neither of these instances is comparable to today’s environment in which the government is simply running out of money and is faced with choosing the bills it can pay.
Perhaps the closest historical precedent is the 1995-1996 budget impasse which led to the longest government shutdown of 17 days – essentially over Christmas and New year. During that period, however, debt service payments were a significantly smaller part of the budget.
In any case, the results were not a major financial or social crisis. Large-cap equities kept their value, while Treasuries were extremely volatile as investors worried about whether they would be paid in a timely manner. For a short period, US dollar plunged in value, but returned to previous levels. Meanwhile, the price of gold spiked dramatically until the impasse finally broke in early January 1996. Although U.S. debt was put on negative watch by the major ratings agencies in 1995, these agencies never downgraded U.S. credit.
What makes a potential default more serious today is the U.S. debt is now on negative watch and the ratings agencies have warned of a downgrade from the current AAA-rating if the U.S. government fails to resolve its insolvency this time. According Moody’s, a federal downgrade would also trigger an automatic downgrade of about $130B in municipal bonds, and almost every other municipal bond would come under review. In addition, the ratings would be slashed on government bonds and mortgage-backed bonds secured by the GSEs (Fannie Mae and Freddie Mac). Since the majority of current mortgages are written or insured by the GSEs, this would certainly raise interest rates on residential mortgages, and likely keep the housing market in the doldrums for an even longer period.
But perhaps the greatest risk to the economy as a whole would be the uncertainty generated by the default. Consumer confidence is now near an all-time low now, which is one of the factors contributing to the sluggish economy; adding another layer of uncertainty will not help boost that critical number.
Bottom line: as I noted in February, a short shutdown of the government is not likely to have a devastating effect on the economy, or on current government contractors, but the longer the shutdown – or a shutdown accompanied with a temporary default on debt payments – is uncharted waters, with unknowable effects. None will likely be good for our industry.
Government contractors in the employee mobility industry need to dust off those earlier plans, and prepare to implement them. As I related in my earlier Blog:
During a shutdown, only “essential” federal employees are not laid off, and everyone else is given unpaid leave. Current law allows each agency to determine who is essential in this regard. For example, the FHFA will shut down and no mortgage related work will be done; this includes no payments for contractors, too, for example, if there are foreclosures in process, the attorneys will likely not work on them because they cannot be paid for the time spent during the shutdown.
Relocation companies providing services to the federal government need to make the decision whether to stop working on open files, but my opinion is that since they are generally sourced on a per transferee basis via the GSA schedule, there should be no great effect except that payments will likely not be made until after the end of the shutdown because the contracting officers, as well as other federal employees, will not be at work.
The mechanics of government contracts during shutdowns are that the contracting officer (CO) should provide each contractor with a Notice of Scope of Work Affected, Timetable and Permissible Activities (Notice). Contractors that have been paid in advance will likely be allowed to continue work. Others should stop work if notified to do so (subject to my comments on open files above); in the 1995-1996 shutdown some contractors were legally prohibited from being reimbursed for work not specifically authorized.
Prime contractors such as RMCs should receive the notice from their CO prior to the shutdown, but subcontractors will not. In the former case, RMCs should talk to their CO regarding the performance of work in process to be certain that there is authority to continue.
Subcontractors should get with the prime contractor and determine the proper response. Ask for a copy of the Notice and keep it in your records.
All real estate closings involving federal or GSE mortgages will most probably be postponed for at least a one to one time period, maybe more in as much as closing down and starting up the agencies takes some time; a more reasonable estimate would be that unfunded closings will stop when the shutdown starts, and only resume a week or so after it ends.
We all hope that Congress will be able to come up with a solution for the 44 cent problem this week, but in the meantime it is important to have a solid business plan ready to be activated if it takes more time than the Treasury has money.
Posted by Dick Mansfield
Last November the US Federal Trade Commission (FTC) published its rule enforcing a key element of the then recently passed 2009 Omnibus Appropriations Act as clarified by the Credit Card Accountability Responsibility and Disclosure Act of 2009. The rule was an attempt to regulate the new mortgage assistance relief industry that had sprung up as a result of the housing recession. The ensuing regulations, known as the Mortgage Relief Services (MARS) Rule put in place sweeping changes designed to protect homeowners from some of the scams brought about by the mortgage crisis.
The Rule was aimed at preventing schemes perpetrated shady organizations that promised homeowners relief from foreclosure by offering to negotiate short sales or mortgage modifications. Unfortunately, while upright and professional companies and individuals were offering these services, the industry was a magnet for unscrupulous groups whose only qualifications were their ability to separate distressed homeowners from their cash, usually without providing any actual services.
A key provision of the rule is a ban on advance fees. Companies cannot collect a fee (or advance costs) until the customer has been given a written offer from their lender that the customer decides is acceptable and a document from the lender describing the key changes to the mortgage that would result if the customer accepts the offer. Thus, the process is only paid for on the success of the mortgage relief service company. Otherwise, the consume (the homeowner) pays nothing.
In addition, the Rule requires companies to disclose key facts designed to help homeowners get the information they need to make an informed decision. In their advertising and in communications directed at individual consumers companies must disclose:
that they are not associated with the government and their services have not been approved by the government or their lender,
that the lender might not agree to change a customer's loan, and
that customers could lose their home and damage their credit rating if they stop paying their mortgage.
Under the Rule, companies must also explain that customers can stop doing business with them at any time and that they can accept or reject any offer the company gets from the lender or servicer. In addition, companies must disclose their fee and tell customers they are not required to pay if they reject the offer from the lender. The Rule also bars mortgage relief companies from advising customers to stop communicating with their lenders and bans false or misleading claims about mortgage relief services.
Attorneys who met three qualifications are exempt:
engaged in the practice of law,
licensed in the state where the homeowner or the home is located,
complying with state laws and regulations governing attorney conduct, with the caveat that to be exempt from the advance fee ban, attorneys must place any fee collected in advance in a client trust account and abide by state laws and regulations covering those accounts.
The Rule can be found at http://www.ftc.gov/os/fedreg/2010/december/R911003mars.pdf
The careful reader might notice that one very essential real estate profession is not exempted: licensed real estate brokers, who are perhaps the most qualified service providers to advise sellers and buyers on short sales.
As noted in my June 7th blog, short sales are an increasingly important component of the current housing market, and will likely be so for some time. Allowing real estate brokers to be a part of, or advise on short sales is essential to the proper functioning and growth of theses complicated transactions.
Fortunately, the National Association of REALTORS ® has intervened, and last Friday the FTC announced that it will forbear from enforcing most provisions of its MARS Rule against licensed real estate brokers and agents who assist consumers in obtaining short sales. As a result of the stay on enforcement, these real estate professionals will not have to make several disclosures required by the Rule that, in the context of assisting with short sales, could be misleading or confuse consumers.
The stay applies only to real estate professionals who:
are licensed and in good standing under state licensing requirements;
comply with state laws governing the practices of real estate professionals; and
assist or attempt to assist consumers in obtaining short sales in the course of securing the sales of their homes.
The stay exempts real estate professionals who meet these requirements from the obligation to make disclosures and from the ban on collecting advance fees. These professionals, however, remain subject to the Rule’s ban on misrepresentations.
However, the Commission also emphasized that the stay does not apply to real estate professionals who provide other types of mortgage assistance relief, such as loan modifications, and that it will continue to enforce the Rule and Section 5 of the FTC Act, which prohibits unfair and deceptive practices, against all other providers of mortgage assistance relief services.
The NAR press release is here: http://www.realtor.org/topics/mars/politicaladvocacy?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+RealtororgLawAndPolicyHeadlines+%28REALTOR.org+Law+and+Policy+Headlines
While many brokers have been involved with short sales, this “forbearance” should allow more brokers to become involved without the necessity of the red tape and additional costs involved with complying with the MARS Rule. This is good news for home sale programs in the employee mobility industry because it should facilitate efficiencies in short sales for transferring employees.
Posted by Dick Mansfield
Some companies will allow transferees to enter a BVO program with a short sale, others will not. If, as I suspect, banks refine and speed up the process, it is likely that more employees will become eligible. This is a good thing in so far as it may reduce reluctance to move, and it may reduce the need for other financial incentives now paid by employers in order to incent the employee to move.
Here is a brief checklist of issues that must be dealt with in a short sale. It is not exhaustive, in that many state and local issues may also be involved. And each lender has its own requirements. However, these issues should touch on most of the items that distinguish a short sale from a regular sale.
A much more thorough and practical discussion written by Bruce Perlman, Senior Vice President and General Counsel at CARTUS will appear in the July edition of Mobility.
Where the transferee is the seller (departure side of the relocation):
- Open negotiations with lender (probably the servicer is the best place to start); use of a broker or licensed short sale negotiator is often advantageous. Here one finds out the lender’s policies, and hopefully receives the initial short sale letter listing the necessary paperwork. It is important to scrutinize any initial paperwork for the terms, and especially to be on the lookout for claw back or other terms which might make the sale conditional on post closing lender acceptance of documents. Few purchasers will accept these conditions, and they are absolutely a problem in a two sale relocation policy.
- One question that often arises is the effect of a short sale on the sellers’ credit. Unfortunately, it is not an easy one to answer precisely, but it is universally true that there is most often a very serious negative effect, perhaps as much as a 50 – 200 point deduction from the presale FICO score (the higher the original score, the more the deduction). And generally short sales, like bankruptcies, remain on the credit report for seven years. It may be possible to negotiate with the bank to have it provide “paid in full” credit reporting on the transaction, depending on the circumstances. Another important tip is that short sale negotiations need not be started with the mortgage in a delinquent status, which would also adversely affects one’s credit score.
- Assemble the documentation. If a hardship letter is required (some banks require it before any other documentation, and will not agree to a sale without first approving it), one should be drafted, and will likely include the fact that the house is seriously underwater, that the seller does not have assets sufficient to pay the deficiency in a sale at the current time, and that the employee has been offered a job by the employer in another location. Appraisals, BMAs, or BPOs will be required early in the process, so the facts underlying the value of the house need be proven early on. If the traditional hardship factors are present, such as unemployment (of a spouse), illness, divorce, death in the family and the like, these make a more powerful argument for the short sale, as does bankruptcy.
- Most often lenders will require full financial disclosure from the seller, in order to prove that there are no hidden assets that could go to pay off the loan.
- It is absolutely important to fully and honestly disclose whatever information the bank requires, including the existence and amount of relocation benefits, and the fact that the house will be entered into a relocation transaction. Relocations still are strange to many lenders, and a careful explanation of the two sale process is critical. Remember that the laws regarding mortgage fraud are applicable to all aspects of the short sale.
- If the house will be sold in a BVO program, the bank will likely want to see both contracts.
- A rule of thumb in short sales is that there may be profit in these transactions, but none goes to the sellers. That being said, writing down of some part of the principal of an underwater house is a pretty good deal.
- Know the tax consequences of a short sale. Pete Scott has addressed this here:
Where the transferee is the buyer (destination side of the relocation):
- Understand that the process will take much more time than a normal sale.
- Be certain that there is a clause in the contract of sale that provides a time contingency for bank approval; this is important so as to protect any earnest money or escrow that is involved. Legally, the contract is not valid until the bank agrees (signs), but the time contingency provides protection to the buyer if the bank is unduly slow in its decision making (which could be based upon the buyer’s disclosures). Of course, make sure the proper contract is used; a regular sale contract is unacceptable since the bank must agree. In some cases buyers may use a standard contract as a negotiating tool with the bank, but this is not a good idea from a buyer’s point of view, and should be avoided, in my opinion.
- Purchaser’s title insurance is an absolute requirement to protect the buyer from any possibility of claw back based upon fraud or misrepresentation by the seller in the short sale process.
It is no secret that many states are scrambling for income in the face of seriously declining tax revenues and increasing demands for services. The Great Recession has been the perfect storm blending slim resources, no reserves, and high demand for unemployment, retirement and Medicare benefits into a cash draining catastrophe that many formerly free spending state legislatures are now forced to confront. Raising taxes or imposing new taxes is clearly the wave of the future. And our industry is not going to be immune.
Service taxes are, not surprisingly, levied on services provided to consumers, and are common to some degree in almost all states; they are often considered as an adjunct or extension to sales taxes, and commonly have the same tax rate as sales taxes. However, in most states professional services are exempt, and the applicability of these taxes is restricted by statute. Many other states have similar taxes that have an effect on prices and consumer behavior like the service tax; these are often styled as “gross receipt taxes” which are charged on a service business’ total revenue from services, “excise taxes” which are applied to the gross receipts of specified services (such as phone service), or a “use tax” on services not otherwise taxed. A few states use different terms such as Transaction Privilege Tax (Arizona), or Business and Occupational Gross Receipts Tax (Delaware) for the same type of tax. All of these taxes are really a tax on the consumer of the services, and are almost universally passed on to the buyer, either directly as a stated charge (as sales taxes are shown on receipts) or indirectly through increases in prices for the services. Generally states do not specify how the tax is to be identified and collected, most are silent on this issue.
In the EU and parts of Asia, taxes on services are routine in many industries and professions, which are subject to VAT rules. I will not discuss those taxes in the blog, however.
Taxes on services are beginning to impact the domestic employee mobility industry in several ways, primarily in real estate sales. States have always taxed the transaction, either by means of recording fees or direct levies on the sales price. As to the latter, at least thirty-five states plus D.C. impose a tax on the transfer of real property located in the state. In California, Louisiana and Ohio, real estate transfer taxes are imposed only at the local level. In Delaware, Maryland, Michigan, New Jersey, Pennsylvania, Washington and West Virginia, at least some localities may impose a tax in addition to the state transfer tax. None of these statutes are new, and while some of the tax rates are quit high – New York and Washington, for example -- the industry routinely expects to pay these taxes on the sale of a transferring employee’s house.
What we are beginning to find now, however, is the application of a service tax on the real estate commission, which has traditionally been an excluded item even in those states which otherwise tax services rendered to consumers.
The three states currently imposing these taxes are New Mexico, Hawaii, and South Dakota.
The Hawaii tax is unique in that it is both a sales and excise tax applicable at all levels of production like a VAT; it is currently 4% (except in Oahu which has imposed a .5% surcharge). The regulations can be found at http://hawaii.gov/tax/har/har_237.pdf
. The legislature just defeated a proposal to increase the rate by .5%.
South Dakota imposes a tax of 4% on nearly all sales of personal property and on the gross receipts of any business which provides services. The definition of “service” includes any activity “engaged in for other persons for a fee, retainer, commission, or other monetary charge” including, of course, real estate commissions, which are not exempt. The regulations can be found at http://legis.state.sd.us/rules/DisplayRule.aspx?Rule=64:06:01:07
None of these statutes is a new one, and I bring them to the discussion in order to analyze how they affect the cost of real estate transactions in a typical home purchase program. If more states adopt similar taxation regimes, there will likely be a cost impact on these programs.
The touch point of theses taxes in home sale programs is the sale from the employer to the ultimate purchaser; to the extent that the tax is passed on or built into the commission, it is owed by the employer and thus increases the cost of the sale. The listing agreement should deal with the allocation of the cost, either directly by requiring the payment of visible (i.e. enumerated) taxes, or indirectly by including them in the fee charged. In many cases, however, it is local custom and practice which dictates the allocation between the broker and the seller, absent a provision in the listing agreement. It is a better practice to specify the amount and payer of the tax, in the listing agreement and to list it separately on the HUD-1 if it is collected at settlement as a separate charge.
Parenthetically, there are similar taxes on other settlement services in various states. For example New York has imposed a tax on some title products, which is routinely listed on the HUD-1 and most often included in the calculation of the Title Services amount shown on line 1101.
The Hawaii general excise tax (GET) makes a good place to start an analysis because it has been in place for decades, and because its impact is often greater than the others because of the high cost of housing in the Aloha State.
The GET is a gross receipts tax on businesses; the entity receiving the income from services is the entity that is required to pay the tax to the state government. Unlike a sales tax, which requires merchants to levy and collect a tax at the point of sale, the GET does not contain any specifics other than the obligation for payment. Thus, the tax can be passed on to the consumer -- which is almost universally the case -- either directly as an itemized charge, or indirectly by being included in the service fee charged. As far as the state is concerned, so long as the required taxes are paid, how they are collected is irrelevant.
In real estate transactions in Hawaii, the custom and practice appears to be that the GET is added as a visible charge in addition to the commission, and is paid at settlement; interestingly, the GET addition is itself subject to the tax because the tax is not being “collected” by the broker, and the broker is required to pay the GET on its total gross receipts which includes the GET surcharge paid by the seller. Absent a written agreement to the contrary, it also appears that it is the local custom and practice that the seller (the consumer of the services) pay the fee, similar to other sales and service taxes levied by the law. The same result is found in New Mexico and South Dakota.
Over the past couple of decades, several other states have flirted with imposing some sort of service tax on the real estate commission; they were successfully convinced not to do so by effective lobbying by real estate groups (including the National Association of REALTORS ®) which showed that such taxes are regressive and they act as a drag on real estate sales by adding additional costs to the transaction.
Hopefully these convincing economic arguments will keep other states from imposing additional taxes on the real estate transaction. But today’s economic reality will make the commission an attractive target for cash-strapped state legislatures.
I have written several times over the past months about the importance of FCPA (US Federal Corrupt Practices Act) compliance, and of the penalties associated with failure to implement and manage a successful risk management program in accordance with the Act’s strict requirements. In the past couple of weeks, the government has brought several new high visibility cases against companies for violations, again highlighting the significantly increased enforcement activities undertaken by the Department of Justice (DOJ) and Securities and Exchange Commission (SEC), the two agencies which enforce the Act.
For those who may be less than familiar with the Act, the U.S. Federal Corrupt Practices Act is a domestic anti bribery and anti corruption law broadly applying to US and US based companies, with strong extraterritorial reach. It applies to all US companies as well as their employees and suppliers, and contains a strong record keeping component which likewise applies to suppliers.
Because of the reach of the law, and the fact that suppliers (and agents, distributors, too) are covered, companies in the employee mobility industry must be certain to understand the requirements and have in place, active, monitored, compliance programs in order to forestall criminal and civil complaints.
Especially important are the record keeping requirements, which should be an integral part of internal auditing of every company making payments or buying or selling services overseas. More and more international companies are requiring employee mobility service companies to demonstrate the strength of their FCPA compliance programs as a part of the RFP and contract process.
Las Vegas Sands Corp
Last week, Las Vegas Sands Corp revealed in its annual report that it was facing probes by both the SEC and DOJ over potential violations of the Act in its Macau casino operations. One of the issues under investigation is how Sands came to hire its chief lawyer in Macau, which is now a part of China.
The company said in its filing that it believes the investigations stem from allegations raised by the former CEO of Sands China Ltd. -- the division that oversaw the company’s Macau casinos -- in a lawsuit filed in Nevada last October. In the complaint, the CEO claims he was wrongfully fired in part for resisting demands by Sands that the company "continue to use the legal services of a Macau attorney despite concerns that his retention posed serious risks under the criminal provisions of the [FCPA]." The complaint can be found at http://media.lasvegassun.com/media/pdfs/2010/10/22/jacobsvsands.pdf
; even though it makes dozens of other allegations arising from other areas of law, it lays out in detail enough to warrant an internal and government FCPA investigation, according to the company filing. The allegations revolve around alleged straight out business bribery; interestingly, the suit does not contain a Dodd-Frank whistleblower claim, but is based primarily on contract law. The case is a good example of how FCPA investigations can be triggered by employment issues.
In 2007, a senior vice president of Alcatel – Lucent began serving a three year sentence in US federal prison for violation of the Act. He was convicted of funneling over $14 million of his employer's money to government employees in Costa Rica, in order to guarantee purchases from the state owned electrical and telecom company. As the investigation of that offense was being conducted, it became clear that Alcatel – Lucent's subsidiaries in Honduras, Malaysia, and Taiwan were also violating the Act, and had paid at least $1 million in bribes to officials of those countries. The company just signed a deferred prosecution agreement with the Department of Justice admitting it had profited by about $50 million from the business acquired from the bribes, which occurred between 2001 and 2006. For these violations, the company has agreed to pay over $125 million in fines.
Also last week, IBM entered into a consent decree with the SEC, admitting violations of the Act, and agreeing to pay a $10 million fine in the civil case. According to the degree, from 1998 to 2003, employees of IBM Korea -- a joint venture in which IBM held a majority interest -- made payments to various government officials in South Korea, the purpose of which was to increase the sale of IBM products to the Korean government. During that time, several government officials were paid approximately $207,000 in bribes, including improper gifts and payments of travel and entertainment expenses.
Furthermore, the decree continues, from 2004 until 2009 employees of IBM (China) Investment Company Limited and another IBM subsidiary engaged in the widespread practice of providing overseas trips, entertainment, and gifts to Chinese government officials. At least 100 IBM (China) employees were involved. Apparently the IBM employees set up a slush fund at a travel agency which paid for improper trips taken by Chinese government officials, and the employees also gave laptops and other equipment to these and other officials.
In this filing, IBM agreed that despite its extensive international operations, it lacked sufficient internal controls designed to protect prevent or detect these violations of the Act. In addition, it failed to keep accurate books and records as required. The failure to keep these records is a separate violation of the Act, and can be prosecuted even in the absence of proof of actual corrupt behavior.
Although the fine seems surprisingly small for a company the size of IBM, the SEC can also refer individuals to the Department of Justice for criminal investigation, and the reputational damage to IBM as well as the ongoing injunction contribute to a significant penalty.
This case is particularly useful to analyze, because of the difficulty of doing business in China, which is a culture where the differences between “gifts” and “bribes” is often hard to distinguish. Any company doing business in China should be familiar with the excellent article “FCPA Compliance in China and the Gifts and Hospitality Challenge” by F. Joseph Warin, Michael S. Diamant, and Jill M. Pfenning published in the Virginia Law and Business Review (http://www.virginialawbusrev.org/VLBR5-1pdfs/FCPA.pdf
). While it does not provide definitive answers, it identifies and discusses the issues, which have become even more important after the IBM consent decree.
U.S. Chamber of Commerce
Finally, the U.S. Chamber of Commerce, which five months ago released a paper that called on Congress to amend the Act to reduce its “onerous" impact on US businesses, just a hired former Attorney General Michael Mukasey to lobby Congress to amend the Act. Two of the Chamber’s recommendations are to more carefully define who constitutes a "foreign official" especially distinguishing between government employees and employees of state – owned companies, and to add a provision which would allow companies with active compliance programs to escape criminal liability based upon the actions of rogue employees.
This flurry of activity should spur members of the employee mobility industry to continue to examine and fine tune their compliance programs for activities conducted outside of the US, and for activities conducted by service providers or contractors in the foreign countries.
In the employee mobility industry, as in most US industries, we live in a business environment of increasing regulatory scrutiny. The “new normal” demands a more fine tuned focus on legal and tax risk management and compliance; failure to adopt and manage these programs puts a company’s assets – financial, personnel and reputational – at risk. Last week I discussed the potential impact of federal FOIA requests on corporate privacy, the bottom line being that the recent Supreme Court decision in FCC v. ATT held decisively that investigative information is not protected under the individual privacy exception provided in exemption 7(c) of the FOIA (Freedom of Information Act), thereby potentially exposing sensitive information to competitors and the public.
This week I will look at another FOIA case just argued before the Supreme Court which involves an exemption to the False Claims Act (FCA), a law that applies to companies supplying goods or services to the federal government, and in many cases to state and municipal governments.
By the way, the federal FCA does not apply to tax whistleblowers, an issue which was well addressed by Pete Scott in a blog earlier this week.
First, let me describe the highlights of the FCA. The False Claims Act (31 U.S.C. §§ 3729-33) is one of the federal government's primary weapons to uncover fraud against government programs, and to recover the damages arising from those actions. The original act dates back to the Civil War, it was originally aimed at war profiteers, merchants that sold shoddy goods at inflated prices for the war effort. One important element of the original law that continues today is the “qui tam” provision which allows citizens to sue on behalf of the government, and to receive a part of any recovery as a bounty for bringing the suit. In a qui tam action, the citizen filing suit is called a "relator", and is colloquially known as a “whistleblower”. As an exception to the general legal rules regarding who can file suit, qui tam relators are considered "partially assigned" a portion of the government's legal injury, thereby allowing them to proceed with their suits against putative wrongdoers. The relator does not, however, need to show that it has been personally harmed by the alleged fraud.
The provisions of the Act were recently strengthened by the Fraud Enforcement and Recovery Act of 2009 (FERA), which closed several perceived loopholes opened by courts, including the Supreme Court. The current Act prohibits a company or individual from knowingly:
Submitting for payment or reimbursement a claim known to be false or fraudulent.
Making or using a false record or statement material to a false or fraudulent claim or to an ‘obligation’ to pay money to the government.
Engaging in a conspiracy to defraud by the improper submission of a false claim.
Concealing, improperly avoiding or decreasing an ‘obligation’ to pay money to the government.
The False Claims Act has a very detailed process for the filing and pursuit of these claims, the specifics of which are not relevant here. However, it is useful to know that after the relator files suit – which must remain under seal (withheld from the public) for at least 60 days – it must serve a disclosure notice to the Justice Department containing all of the evidence the relator has in its possession. Upon receipt, the department is obligated to investigate the claims and may also open a criminal investigation.
At the conclusion of its investigation, or earlier if directed by a court, the Department of Justice must choose one of three options named in the Act:
Intervene in one or more counts of the pending qui tam action. This intervention expresses the government’s intention to participate as a plaintiff in prosecuting that count of the complaint. Fewer than 25% of filed qui tam actions result in an intervention on any count by the Department of Justice.
Decline to intervene in one or all counts of the pending qui tam action. In this case the relator and his or her attorney may prosecute the action on behalf of the United States, but the government is not a party to the proceedings apart from its right to any recovery. This option is frequently used by relators.
Move to dismiss the relator’s complaint, either because there is no case, or the case conflicts with significant statutory or policy interests of the United States.
In practice, the department may also settle, or decline to intervene in the case at all.
If the Justice Department intervenes in the case, it carries the bulk of the trial forward, with the full power of the US government behind it, and if the plaintiffs succeed, the relator and its attorney receive a portion of the damages – up to 30%-- as a bounty.
Potential damages under the FCA can be quite large: a violator is subject to three times the amount of actual damages plus civil penalties of up to $11,000 per false claim. The FCA does not provide a framework for calculating actual damages or for calculating the number of claims. Under aggressive theories of liability and damages accepted by some courts, damages may equal up to three times the amount of all money the government paid out, regardless of the value of goods or services received in exchange.
Perhaps because of the large potential for damages, the Justice Department continues to use the Act as a “general purpose anti fraud statute” which has at least in part motivated relators to come up with more and more creative theories of fraud under which they have brought false claims cases. Many courts are sympathetic to even the most farfetched claims.
FCA suits have become a big business; for the fiscal year ending September 30, 2010, the federal government won more than $3 billion in civil settlements and judgments, a 25% increase over the previous year and the second-largest yearly recovery amount ever. Whistleblowers continue to drive the recoveries under the FCA, and the government continues to rely heavily upon private plaintiffs to detect and expose fraud. Of the 709 new FCA matters opened during the last fiscal year, 573--more than 80%--were matters initiated pursuant to the Act's qui tam provisions, and more than $380 million in recoveries were awarded to private plaintiffs.
Some provisions of the Dodd-Frank Act passed last summer strengthen and expand the tools of whistleblowers by, among other things, prohibiting employment discrimination based on whistle blowing activity, clarifying the statute of limitations, and extending the provisions of the Act to previously uncovered federal laws. This will likely spur even further FCA actions.
More than 30 states and the District of Columbia have false claims acts, many based upon the federal statute.
Thus, any company doing business with the federal government, or with one of the states which have similar legislation, must continually update its risk management programs to train employees in the requirements of the Act, and to monitor compliance. Recent research has shown that the vast majority of whistleblower cases come from disgruntled employees, many of whom were not motivated primarily by personal gain. Based on this information, perhaps the most important first step in renovating a compliance program is to develop an internal mechanism to seriously look into employee complaints.
One of the defenses available to a FCA claim is that the information which the relator is using to bring the suit is already public, known as the “public disclosure bar”. Since the purpose of the Act is to encourage the uncovering of fraud, allowing relators to profit from already known fraud is far from its original intent. Specifically, the bar prohibits a relator from bringing a suit that is based upon information already publicly disclosed in certain statutorily named sources, including a “government report or investigation”.
The case just argued before the Supreme Court (Schindler Elevator Corp. v. US ex rel. Kirk) deals with this defense. The issue is whether a federal agency’s response to a request under the Freedom of Information Act (FOIA) is a government report or investigation that triggers that bar. If a response to a FOIA request necessarily triggers the public disclosure bar, then a relator may not bring a claim based on the government’s response.
The facts in the case are instructive in that they show the breadth of the Act’s coverage. According to the briefs:
“Daniel Kirk served with the U.S. Army in Vietnam from 1969 to 1971. Beginning in 1978, he worked at Millar Elevator Industries, which was later absorbed by Schindler Elevator in 2002. Although he had been promoted within the company on past occasions, in 2003, he was demoted from a managerial position to a non-managerial slot. He then resigned. Kirk filed a complaint with the Department of Labor in 2004 claiming his demotion was in violation of the Vietnam Era Veterans Readjustment Assistance Act. After his claim was denied by the department, he filed suit in the Southern District of New York in 2005 under the False Claims Act. Kirk claimed the company was shirking its obligation to take affirmative steps to employ and promote veterans, invite eligible veterans to identify themselves to employers and file annual reports detailing the hiring and placement of veterans.
Using documentation supplied by FOIA requests submitted by his wife and his own knowledge of company operations, he claimed the company failed to file reports from 1998 until late 2004 and filed false reports in 2004, 2005 and 2006, alleging that each claim for payment on the hundreds of government contracts submitted by Schindler was a violation of the False Claims Act.
The U.S. District Court for the Southern District of New York dismissed the complaint in March 2009. In April 2010, the U.S. Court of Appeals for the Second Circuit vacated the lower court order and remanded the case for further proceedings.”
The Circuit Court found that the production of documents under FOIA was not a government investigation or report which would trigger the ban, thus allowing the Plaintiff’s case to go forward. The decision was appealed to the Supreme Court.
In the recent oral argument before the Supreme Court, Petitioner Schindler Elevator argued that in order to respond to the FOIA request, the government had to search its records for relevant documents, and this constituted an “investigation” .triggering the ban. The Respondent argued that, to the contrary, FOIA should be considered an adjunct to the FCA, as a sanctioned method for relators to “root out” records which could show fraud on the part of contractors (this was an argument which the Second Circuit opinion championed). Needless to say, there were several amicus briefs filed on both sides of the issue.
The Supreme Court will rule on whether documents uncovered by a FOIA request are the result of a government investigation or report, or whether they are allowed to be used as tools to uncover suspected fraud. Depending on the decision, Mr. Kirk will either go home, or back to the District Court. Schindler Elevator has expended an enormous amount to time, energy, money and reputation defending the case so far; if it goes back to trial, it will expend more of each.
Regardless of the Court’s ruling in this case, it is yet another warning to companies in the employee mobility industry of the potential dangers of not having robust policies in place to monitor the provision of services to governments, and to listen to employees regarding those services.
This week, the U.S. Federal Housing Finance Agency (FHFA) released a proposed regulation which will ban the GSEs (Fannie Mae and Freddie Mac) and Federal Home Loan Banks from issuing or purchasing home mortgages where the property deed contains a Private Transfer Fee (PTF) covenant. This follows advice given by the agency last summer which similarly restricted the purchase and issue of mortgages with deeds containing PTFs. The difference here is that a regulation is not advice, it is a requirement which must be followed, and the regulation is slightly different from the advice. The proposed regulation will remain open for comment for 120 days, and will likely be adopted substantially unchanged thereafter. The prohibition, however, will be prospective only, and thus will not affect the thousands of existing mortgages for deeds containing a PTF covenant; but state laws regarding this type of covenant will continue to apply. This regulation is both good and bad news for domestic home sale programs.
Here is some background. As I have discussed before, the laws of real property transfer in the U.S. are the product of concepts first appearing in England in the late middle ages. While parchment deeds festooned with seals and tax stamps are no longer used, the principles are startlingly similar in many ways. In fact, in my office I have several English deeds from the 1700s, all of which are easily understood by any real property lawyer today.
One aspect of conveyancing law which had its origins in those times is the concept of a covenant running with the land. Covenants are restrictions on the use or transfer of the land itself, and the common law’s only required was that the covenant be a restriction which “benefits the land”. Originally, covenants most commonly dealt with joint rights of way, common accesses, and pasturage rights. In more modern times, they are a common method of protecting land from development. They are different from easements in that they define the very rights that a purchaser receives from the seller.
Early in this century, the use of covenants began to spread into restrictions related to ownership, and then fees. In the early and mid 20th century, states began to legislatively nullify the then not uncommon racial, ethnic, and religious covenants which had previously been enforceable in many states.
Later, as condominium, cooperative, and PUD housing became more common, covenants requiring payments to a condo or PUD association – either as dues, a fee due on sale, or both – became the normal method of financing maintenance of common areas and capital improvements. This sort of covenant is usually memorialized in a document commonly called the CCRs (covenants, conditions and restrictions), that often consists of hundreds of pages. Nevertheless, this type of covenant has become a ubiquitous and efficient method of guaranteeing contributions to common expenses, and is not affected by the FHFA proposed regulation.
PTF covenants are the latest morph of the covenants running with the land doctrine. They first become common in the mid 2000s as a method whereby builders could help finance residential developments. Here’s how they work: the builder sells units with a PTF covenant in the deed; usually the covenant required that, on each subsequent sale, some percentage of the sales price –usually 1%-- must be paid to the PTF trustee. Often the duration of this requirement is 99 years from the original purchase.
The financial structuring is very interesting. Finance companies (the most famous of which is Freehold Capital Partners) purchase the rights to the PTF proceeds, bundle these rights together and pool them into securities, which are then sold to investors. This is a similar process to the securitization of mortgages, but with less perceived risk because a fee must be paid whenever the property is sold, for whatever reason.
Needless to say, PTF mortgages have become very unpopular for any number of reasons. For the borrower, they reduce any equity in the property. In the mobility industry, they represent a difficult and sometimes expensive risk management issue, for often the PTF covenant is buried in the fine print of a CCR and can escape attention, and whether previous payments have been made is often difficult to determine.
Unfortunately, just because the proper PTF is not paid at sale does not mean that it goes away after the conveyance is complete; rather, it remains an inchoate lien on the property each time it is not paid. Thus, a trustee 99 years from the issue date would have every right to record a lien on the 99th year for the cumulative unpaid fees for all previous transfers. The last seller, of course, would be obligated to pay it; basically the property would be unsalable until the issue was sorted out, and the lien paid.
Over the past couple of years, states have been attempting to deal with the problems caused by these covenants. To date 19 states have passed various laws restricting PTFs; but the results are not uniform, and cover the gamut from California, which allows them with recorded notification, to 11 others which make the covenant totally unenforceable, to two states which make them unenforceable in the future, but allowing currently recorded deeds to continue to be enforced.
The FHFA proposed regulation allows fee covenants for condos, coops, PUDs and related nonprofit entities, but forbids the purchase or issue of mortgages with any other type of PFT covenants by the federal mortgage entities. In addition, it forbids the federal purchase of any security backed by PTF income streams. It is prospective in nature, taking effect in 120 days.
Thus, a combination of federal and state laws appears to be on the way to tightly control, if not eliminate, PTF deeds and related mortgages. However, Freehold Capital reports that there is over $600 billion worth of PTF mortgages currently in commerce. Many are undoubtedly from states which make those covenants unenforceable, but the majority of them are likely enforceable since much of the state legislation is prospective (MN, UT, possibly TX and HI) or only requires notice (CA).
Because of this, risk management systems need to be kept in place, especially in as much as deeds with PTF covenants will likely continue to exist, yet since the GSEs will not be able to purchase them, future buyers will have a difficult time finding financing for the properties. In fact, they might become almost unsalable.
No employer wants to find one of these properties in its inventory. That’s the bad news. The good news is that the proposed regulations will likely bring about the end of the use of PTF covenants.
The proposed regulations can be found at: http://www.fhfa.gov/webfiles/16480/PrivTransFeeGuidance081210.pdf