North Carolina, Referral Fees, and Ownership Structures: Part 2
By: Pat Finn – North Carolina Licensed Partner
with Brownlee Whitlow & Praet
This is Part 2 of a two-part series related to North Carolina rules and requirements related to referral fees and ownership structures. Part 1 can be located HERE.
In Part 1 we discussed the general prohibition on paying valuable consideration to anyone not licensed by the North Carolina Real Estate Commission. And in a prior blog entry related to determining the need for a broker-in-charge, we discussed statutory triggers that would mandate the need for a licensed individual for your management company. Here we’ll discuss an overview of different types of ownership/management structures and the initial considerations in making those decisions. Then we’ll discuss examples of referral programs and lease-up activities – both good and bad.
One of the main exemptions to the requirement for licensing is the owner operated property. This falls under North Carolina General Statute § 93A-2(C)(7). The general idea is that an owner of a property is allowed to manage their own property and advertise, lease, etc. without the need for a brokerage license. This is most often seen in small-scale operations where an individual only has a single rental (or maybe only a handful) and handles everything themselves. In this instance, the owner is also the operator, and they are not required to be licensed. That would also mean they are not bound by the restrictions contained in Chapter 93A of the North Carolina General Statutes. As a reminder from Part 1, aiding and abetting a criminal act is itself a crime, so there is still potential criminal liability should an exempt party pay someone to break the restrictions within Chapter 93A.
The reason that this scenario is rare at scale is that maintaining all of your employees and assets under the same singular corporate entity (or even privately owned) creates a liability nightmare as all assets would be held within the same place that all liabilities would be generated. If a resident sues, the owned assets of the singular entity could be at risk of seizure to pay any judgments. If an employee sues, those same owned assets of the singular entity would also be used to satisfy any judgments.
What we see most often is single-asset-entities created to purchase and hold real estate. Those would typically come in the form of Limited Liability Companies, General Partnerships, Limited Partnerships, or a more complicated investment vehicle capable of ownership. Each individual property would often be owned by such an entity, within the larger portfolio of the parent company, where each individual property would conduct their own self-sustaining business operations. Management companies would often be their own corporate entity, coming in a form similar to the asset holding entities with additional corporate structures such as Limited Liability Companies (LLCs) and corporations (C-Corp and S-Corp). In order for the ownership and management entities to properly exist as separate legal entities, each individual ownership entity would contract with management for services at each individual property, where they would maintain their own distinct budgets and payment for services. These details are most often included in documents titled “Property Management Agreements” or “PMAs.” At this point, the analysis goes back to the original determination as to whether a broker-in-charge is required, which then triggers the prohibition on referral fees.
If you believe that your ownership structure is such that you do not require a licensed broker-in-charge, it is a best practice to discuss the referral fees with your legal team before implementing, as there could still be criminal liability for aiding and abetting such an action, even if you are an exempt party yourself. For those prohibited from paying referral fees, we’ll discuss examples that we’ve encountered that are both good and bad once you factor in the potential liabilities tied to violating the statutory and North Carolina Real Estate Commission rules and regulations.
The most common questions we receive all relate to discussions about what the compensation might be for a referral program. The ideas range from straight cash, to gift cards, to rent concessions, to opportunities. The Carolina Panthers may have numerous years where they are not a great team (said by someone born and raised in Charlotte), but the North Carolina Real Estate Commission would still consider an offer of a ticket to a game as “valuable consideration.” Another clever, but equally as problematic example is the opportunity to join a raffle for a much larger prize. Not only would this still be considered “valuable consideration” but would then trigger additional scrutiny as North Carolina regulates raffles pursuant to North Carolina General Statute § 14‑309.15 making such a practice potentially criminal in nature.
An example of a plan that we consulted on along those lines, that is much closer to compliance with the applicable laws related to a lease-up party. The idea was that a fun event was going to be planned which would be free to attend for anyone. Physical entry into the event would generate an entry in a drawing. As the event was free to attend and the drawing did not have the ability to purchase tickets, the previously referenced statute on raffles was not applicable. At the event, a drawing would be held for residents and a separate drawing for everyone else. The prize of each was a rent concession which would only apply if the individual was a current resident or became a resident. There were no loopholes for ownership to not pay, no abilities to purchase tickets, no fees paid to anyone bringing guests, and no compensation changing hands in any way outside of the drawing. This created a fairly large financial gamble for ownership that enough people would be drawn in by the idea of the party and impressed enough with the facilities that they would choose to sign leases on their own, and that these new residents would outweigh the concession offerings in the drawings. It is fully possible that the event would flop and a single person would show up, earning a large rent concession. But, in that scenario, ownership felt comfortable with the business side of the risks as long as they were able to avoid running afoul of the North Carolina Real Estate Commission. I’m not sure how this worked out for the client, but can say that this is the only offering I’ve been consulted on that had zero fine print to work in ownership’s favor.
On the opposite end of that spectrum, we assisted with a client who went out of their way to engage the services of a properly licensed broker who existed for the purpose of providing real estate referrals. The issue arose when the client realized that this third-party entity was sending their lowest level staff to conduct tours on-site as part of the referral program, and those individuals were not licensed brokers. Given that they were a third-party, the exemption for salaried employees of the management entity hired by ownership to conduct leasing operations would not apply. Our client was interacting in good faith with licensed individuals, only to have unlicensed employees do the literal legwork to get the sale. While an argument can be raised that such an unlicensed individual might be able to stand still and hold a sign pointing perspective applicants in the right direction of a tour, the second they open their mouths to describe the amenities of the property or to answer questions about costs, they are engaging in brokerage activities pursuant to the statutory definitions enforced by the North Carolina Real Estate Commission. In this instance, the owner/operator client of ours was being placed in a risky position, as they were unknowingly paying for services being provided by unlicensed individuals. That potential referral is not worth the scrutiny of the North Carolina Real Estate Commission, and upon learning about the practices, the client was able to retain the services of a more reputable referral company who could ensure that anyone handling those perspective applicants would be properly licensed themselves.
In conclusion, if you are worried about occupancy at your properties, you are not alone. And every owner/operator in the rental world has at some point considered referrals as a source of filling vacancies. While there are opportunities for legitimate plans, as well as legitimate companies focused on providing referrals, there are infinitely more ways to go wrong and jeopardize your brokerage licensing. Even the existence of a complaint to the North Carolina Real Estate Commission can cause denials of applications for the same broker for new properties. Meaning that expansion plans would need to be put on hold while defending any complaints, and that is assuming you successfully defend the complaint and are allowed to continue operations thereafter. As always, it is a best practice to consult with your legal team before implementing any new plans or policies, especially as they relate to activities triggering brokerage licensing.
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