In August 2010, the Federal Housing Finance Agency (FHFA) announced that it was considering issuing "guidance" that would restrict Fannie Mae, Freddie Mac, and the Federal Home Loan Banks from dealing in mortgages on properties encumbered by certain types of transfer fee covenants. Following a 60-day comment period during which comments were submitted by over 4,000 individuals and organizations, including the American College of Real Estate Lawyers (ACREL), the Community Associations Institute (CAI) and the American Land Title Association, the National Association of Realtors, and numerous community associations, FHFA announced on February 8, 2011 that it was moving beyond "guidance" to formal rulemaking, publishing a proposed rule to prohibit private transfer fee covenants, with an exception for certain transfer fees paid to homeowners associations, condominiums, cooperatives, and 501(c)(3) and 501(c)(4) organizations.
While we are generally pleased with FHFA's response to public comments as expressed in the Part IV.C. of the proposed rule, we believe the actual language proposed to be codified at 12 C.F.R. Part 1228 requires some modification in order to appropriately reflect FHFA's expressed intent and avoid unintended consequences. Of particular concern are the following:
1. Encumbered Property or Properties. Section 1228.1 of the proposed rule uses a variety of terms and phrases to refer to the real property encumbered by a private transfer fee covenant, The terms "encumbered property" and "encumbered properties" appear to be used interchangeably, creating ambiguity as to whether the proposed rule is referring to (i) a particular lot or parcel encumbered by a transfer fee covenant; and (ii) all of the properties in a community encumbered by the same transfer fee covenant.
2. Excepted Transfer Fee Covenants. Section 1228.1 of the proposed rule defines an "excepted transfer fee covenant" as "a covenant to pay a private transfer fee to a covered association that is used exclusively for the direct benefit of the real property encumbered by the private transfer fee covenants." [Emphasis added]. There are several issues with the wording of this definition:
(a) It fails to incorporate the essential elements of a "private transfer fee covenant," as defined later in Section 1228.1;
(b) The phrase "that is used" requires a factual determination as to how the covered association is actually using the transfer fees. The Banks and Enterprises (as defined in the Proposed Rule) should not be required to look beyond the specific wording of the covenant to determine whether a particular covenant is an "excepted private transfer fee covenant." If required to investigate and make a factual determination, the Banks, Enterprises, and title insurers are likely to simply decline to deal with properties encumbered by any transfer fee covenant, whether or not it might fall within the definition of an "excepted transfer fee covenant," defeating the purpose and intent of this exception; and
(c) The requirement that the transfer fees be used exclusively for the direct benefit of "the real property encumbered by" the private transfer fee covenants could be construed to restrict use of the transfer fees to maintenance and improvement of the individual homes, lots or parcels encumbered by the covenant when, in practice, transfer fees are rarely if ever used for such purpose. Rather, they are typically used for things such as (i) the maintenance or improvement of common facilities, such as parks, trails, and recreational facilities owned, operated, or maintained by the association for the use of the owners and occupants of the encumbered property; and (ii) educational, cultural, recreational and social programs and activities which are sponsored by the association for the benefit of the owners and occupants of the burdened community.
By requiring that any "direct benefit" run exclusively to the encumbered property, the definition of an "excepted transfer fee covenant" is more restrictive than the term "direct benefit" itself, which specifically contemplates, in the second sentence thereof, that the direct benefit might flow to the encumbered property, the burdened community and its common areas, and to adjacent or contiguous properties. It also overlooks the fact that covered associations often use transfer fees to provide programs and activities for the benefit of the owners and occupants of the burdened properties, rather than providing a direct benefit to the properties themselves.
We believe a more appropriate definition of "excepted transfer fee covenant" would incorporate the required elements of the defined term "private transfer fee covenant," would limit the inquiry to matters that can be determined from a reading of the covenant itself, and would allow the "direct benefit" to flow to the owners and occupants of the encumbered properties, to the burdened community (as defined earlier in this letter), or to any property adjacent or contiguous to the burdened community.
3. Direct Benefit. The first sentence of the definition of "Direct benefit" in Section 1228.1 states, "Direct benefit means that the proceeds of a private transfer fee are used exclusively to support maintenance and improvements to encumbered properties as well as cultural, educational, charitable, recreational, environmental, conservation or other similar activities that benefit exclusively the real property encumbered by the private transfer fee covenants […]." There are several problems with this language:
(a) As stated earlier, transfer fees are rarely if ever used to maintain and improve the individual properties encumbered by the transfer fee covenant, yet this appears to be mandated by the first clause of this definition. The list of permitted uses needs to be expanded to include (i) the acquisition, improvement, maintenance, repair, or replacement of property owned, operated, or maintained by the covered association, other property within the burdened community, or property adjacent or contiguous to the burdened community, and (ii) programs and activities for the benefit of the owners and occupants of the burdened community;
(b) The use of the conjunctive phrase "as well as" can be read to mandate that the transfer fees be used not only for one or more of the listed purposes preceding such phrase but also for one or more of the listed purposes following such phrase. It should be sufficient that the fees are used for any one of the authorized purposes. The use of the fees for multiple purposes should not be required;
(c) By law, the activities of an organization described in I.R.C. Sections 501(c)(3) and 501(c)(4) must provide a public benefit, so they cannot "benefit exclusively the real property encumbered by the private transfer fee covenants," although they often provide a greater benefit to the encumbered properties than to the general public; and
(d) The owners of the encumbered properties, acting through a board or committee they select, should be permitted to direct the transfer fees to enhancement of local schools, libraries, or other public services (e.g., volunteer fire department) which benefit the burdened community, even if those schools, libraries or public services are not physically located within the burdened community or within 1000 feet of the burdened community.
In the second sentence of the definition of "direct benefit," the phrase "community comprising the encumbered properties" should be corrected to read, "community comprised of the encumbered properties."
The last sentence of the definition of "direct benefit" indicates that any public use of facilities funded by transfer fees must be subject to payment of use fees, except for de minimis usage by charitable or not-for-profit groups. This requirement overlooks the fact that, in many cases, the nature of the property or facilities being maintained by covered associations using transfer fees is such that charging a use fee is either impractical or inconsistent with the nature of the facility. For example, a covered association may use transfer fees to maintain parks or trails within the burdened community which are part of a larger network of parks and trails owned and maintained by other entities, with reciprocal use rights for their respective members or open to use by the general public. The owners of the encumbered properties would be entitled to use that part of the park or trail network lying outside of the burdened community in exchange for the covered association permitting others to use the parks and trails within the burdened community. Even where the parks or trails are not part of a larger network, it is often impractical to prevent public use of the association's parks and trails, as policing to prevent public use would be cost-prohibitive and there may be no single point of access at which public use fees could be collected. The fact that there may be incidental benefit to the general public does not detract from the benefits enjoys by the owners and occupants of the burdened community and should not be a factor in determining whether the direct benefit requirement is met.
4. Adjacent or contiguous property. The second clause in the definition of "adjacent or contiguous property" reads, "provided that in no event shall a property greater than one thousand (1000) yards from the encumbered property be considered adjacent or contiguous […]". This is problematic in that (a) it eliminates the ability of a covered association to maintain its office in a commercial area outside of the burdened community or use transfer fees to enhance local schools, libraries, fire departments, and similar public services which in turn benefit the burdened community; (b) it creates a standard which is difficult to apply to programs and activities; and (c) uses the term "encumbered property" rather than "encumbered properties" or "burdened community," which can be literally interpreted to prohibit the use of transfer fees collected on a particular lot to benefit property that is more than 1000 yards from that particular lot, even if the benefited property is within the overall burdened community.
5. Covered association. The phrase "organization comprising owners of" in the definition of "covered association" should be corrected to read, "organization comprised of owners of" (since the organization is comprised of owners, not the other way around).
6. Private transfer fee. The definition of "private transfer fee" should be revised to incorporate the concept that it is a fee that is payable on an ongoing basis each time the property transfers (except for any transfers specifically exempted by the terms of the covenant), and that the obligation arises pursuant to a covenant executed and recorded by someone other than the owner of the encumbered property before the owner of the encumbered property took title. It should not include any fee, charge or amount payable on a one-time basis that the owner of the property contractually agreed to pay and which is simply memorialized in a memorandum of agreement, mortgage, or similar document recorded in the land records which, once satisfied, ceases to be an encumbrance on the property. This would eliminate the need to itemize numerous items that should be excepted from that definition.
7. Effective Date. The effective date of the proposed rule should be the date that the final rule is announced, rather than the date that the proposed rule was announced, so that those who would be affected by the final rule have notice of the full extent of its applicability prior to it taking effect.