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A Kentucky federal court has considered a constitutional challenge to a prohibition contained in the state’s real estate license laws prohibiting the splitting of a commission with out-of-state licensees.
River Oaks Management Company, LLC and 8177 Mall Road Investors, LLC (collectively, “Investors”) purchase and sell properties in Kentucky. The Investors are clients of Marcus & Millichap (“Brokerage”), a company which provides brokerage services across the country and has licensed agents in Kentucky.
Kentucky law prohibits a Kentucky broker from splitting fees with anyone, except that the Kentucky broker may pay a referral fee to “a broker licensed outside of Kentucky for referring a client to the Kentucky broker”. The Kentucky Real Estate Commission has issued a memo stating that “anyone who is brokering real estate in this state by representing a buyer or lessee or by representing a seller or lessor in a transaction involving real property located in Kentucky must possess a valid Kentucky real estate license.” The laws further make it illegal to “aid, abet, or otherwise assist any individual who is not actively licensed in Kentucky” in the practice of brokering, and this definition includes brokers at national firms who may not have a Kentucky license but who are licensed in other jurisdictions. Kentucky’s license laws make it a so-called “turf state”- click here to learn more about license portability.
The Investors and the Brokerage filed a lawsuit against the Kentucky Real Estate Commission (“Commission”), arguing that Kentucky’s prohibitions are unconstitutional because the restrictions made it illegal for brokers in other states to cooperate with Kentucky brokers on real estate transactions and so the state is protecting its market from out-of-state competition. The Investors and the Brokerage sought an injunction prohibiting the enforcement of the prohibitions in the state’s license law. Both sides filed motions with the trial court seeking rulings in their favor.
The United States District Court for the Western District of Kentucky found that the state’s policy of prohibiting the splitting of commission fees with out-of-state licensees (“OSLs”) was unconstitutional. The Commerce Clause in the United States Constitution gives Congress the power to regulate interstate commerce. Because Congress has this power, the “dormant Commerce Clause” doctrine works as a limitation on states that enact laws which interfere with or burden interstate commerce, making such laws unconstitutional.
A court examining whether a law burdens interstate commerce engages in a two-step inquiry: first, the court looks at whether the law directly burdens interstate commerce or discriminates against interstate commerce; and second, if the statute discriminates, the court must apply the strictest scrutiny, but if it does not directly discriminate, then the court applies a lower level of scrutiny and asks whether the burdens on interstate exceed the stated local benefit of the law.
The court first applied the consitutional test to Kentucky’s requirement of a license for real estate brokerage. Applying the test, the court found that the licensing requirement was a valid exercise of the state’s police power. The law regulates both in- and out-of-state brokers equally, and there is no evidence of an intent by the state to burden interstate commerce or was there an adverse effect on interstate commerce. Therefore, the state’s requirement of a real estate license for real estate brokerage was upheld.
Next, the court considered whether the prohibitions on fee splitting and “aiding and abetting” restrictions violated the Commerce Clause. These laws prohibit an OSL from earning fees from transactions involving Kentucky real estate and also forbid Kentucky licensees from assisting OSLs in the transactions involving Kentucky real estate. The court found that while the laws were facially neutral, the laws had a discriminatory effect on interstate commerce because they limit access to the Kentucky real estate market to Kentucky licensees. This burdens interstate commerce because it prevents clients of Kentucky real estate brokers from consulting with OSLs or inhibiting clients of OSLs from entering the Kentucky real estate market. Thus, the Kentucky law isolates Kentucky real estate from the national market, which is unconstitutional under the Commerce Clause.
Since the court found that the Kentucky laws burden interstate commerce, the court used the strict scrutiny standard to evaluate the state's laws. Under this standard, the state was required to demonstrate that there were no other methods for accomplishing its stated goal. The state claimed it was protecting the public from “unscrupulous and incompetent brokers”; however, the court found other alternatives existed, such as requiring the OSL to cooperate with a Kentucky broker, who would be responsible for the actions of the OSL in the Kentucky transaction. Thus, the court declared the Kentucky prohibitions on splitting a fee with an OSL for the brokerage of Kentucky real estate and the “aiding and abetting” restrictions unconstitutional, entering an injunction barring the Commission from enforcing these laws.
River Oaks Mgmt., LLC v. Brown, NO. CIV.A.3:06CV00451-S, 2007 WL 2571909 (W.D. Ky. Sept. 4, 2007). [This is a citation to a Westlaw document. Westlaw is a subscription, online legal research service. If an official reporter citation should become available for this case, the citation will be updated to reflect this information].