UK: Mortgage Fraud Revisited

Many professionals will recall the boom property market of the mid-to-late 1980s and the consequent aggressive lending policies of banks and building societies.

They will also recall the lax lending policies and controls that were exploited by mortgage fraudsters, which became apparent when the property market crashed and which led to large numbers of claims against, in particular, solicitors and surveyors.

These frauds of the late 1980s and early 1990s primarily concerned residential properties. They were commonly perpetrated by way of sub-sales, back-to-back sales and/or direct payments - mechanisms intended to disguise the fraudulent nature of the underlying transactions. The swathe of litigation that followed in the early 1990s set a number of significant legal precedents and resulted in the Law Society issuing guidance on warning signs that all solicitors should look out for when acting for both borrower and lender in a property transaction. As the property market began to improve and solicitors and lenders could recognise the warning signs, the amount of litigation in this area decreased considerably.

However, there are now signs that mortgage fraud is resurfacing - and possibly in a big way. This time the focus appears to be on lending on commercial property transactions as well as on residential transactions, leading to potentially much greater losses for the lenders and, as a result, larger claims against the professionals who act in the transactions. In recent months, a number of large-scale commercial property mortgage frauds have become apparent and are being investigated by the authorities. The Serious Fraud Office has conducted raids at various addresses, including those of law firms acting in the transactions. Indications are that a number of these frauds may be linked, pointing to a systematic attack on the mortgage system. As criminals attempt to launder the proceeds of their crimes through UK property there is a very real risk that this type of fraud will resurface on a large scale. There are, unfortunately, a small number of dishonest professionals who are willing to assist such people but this also has a knock on effect on the much greater number of honest professionals who become involved, but do not fully appreciate the warning signs.

Although some of the recent frauds concern commercial lending, the mechanisms by which these frauds are being perpetrated appear to echo those of the mortgage frauds of the 1980s and 1990s. Once more it seems that sub-sales and back-to-back sales and other such devices are being used to obfuscate transactions.

The property market, for the time being, continues to rise and it is well known that, in the residential market, lenders have been willing to lend large sums of money which can represent many times the income of their clients. They also continue to lend on self-certification loans. In a rising market lenders apparently consider this to be an acceptable risk. However, interest rates are now on the rise and it is quite possible that property prices will begin to decline in the relatively short term. At that point, with an increasing level of repossessions, we could well once more see a large number of mortgage frauds on residential properties, which have thus far gone undetected. The result could well be another swathe of litigation against conveyancers.

Warning Signs

So what are the warning signs to look out for and how can professionals best protect themselves? The starting point is the Law Society's "Green Card" warning on mortgage fraud, first issued by the Law Society in 1991 and which is updated periodically. Although originally prepared for use in relation to residential conveyancing, its terms are equally relevant in a commercial context and anyone involved in acting for lenders should be well aware of its contents. A solicitor who has to admit in court that he is not aware of the terms of the Green Card, or indeed has never heard of it, is likely to be looked upon unfavourably by a judge.

The warning signs follow common sense, and include that solicitors should be wary of clients they do not meet and of solicitors not known to them. They should be cautious of incomplete contract documentation, unusual instructions - for example regarding remittance of the proceeds of sale to a person other than the vendor - and of unusual transactions, including sub-sales and back-to-back sales for which no explanation has been given. Solicitors should also beware of circumstances where a deposit or part of the purchase price is said to have been paid directly by a purchaser to a vendor (so-called "direct payments") or where a purchase price is misrepresented in a purchase contract. Solicitors should also be aware that other parties, including other solicitors and valuers, may be complicit in fraud.

In today's rising property market there may well be legitimate explanations for the way in which particular transactions are structured and the lender may still be prepared to proceed with the loan. However, the solicitor must take care that the lender is given the opportunity to decide for itself, by ensuring that information that might have a bearing on the decision to lend is passed on.

The duty to report has become known as the 'Bowerman duty' following the decision of Sir Thomas Bingham M.R in Mortgage Express v Bowerman & Partners (1996) that "...if in the course of doing the work he is instructed to do the solicitor comes into possession of information which is not confidential and which is clearly of potential significance to the client, I think that the client could reasonably expect the solicitor to pass it on, and feel understandably aggrieved if he did not".

In Nationwide Building Society v Balmer Radmore (1999), one of the leading mortgage fraud decisions, the Bowerman duty was confined to matters within the scope of the lender's interest, which are determined by the terms of the retainer. The effect of this is that, unless inconsistent with the retainer, a solicitor will generally have a duty to report matters relevant to the value of the security (for example, an unexplained difference in price between a sub sale and the principal sale) but not those matters going to the creditworthiness of the borrower which the solicitor could normally expect that the lender would find out for themselves.

In the event that litigation follows from the claims that are beginning to emerge, the courts will consider the level of damages that should be awarded against solicitors and, in particular, whether they can be held solely to blame for the damage suffered.

The leading authorities on mortgage fraud, including Bowerman and Balmer Radmore (see above) but also Bristol and West Building Society v Fancy & Jackson (1997), provide guidance on the approach taken by the courts in determining apportionment between professionals in a claim. Claims against solicitors in this area very often also involve a claim against a valuer in either negligence or fraud for over-valuing the property concerned.

The lenders may also be criticised. It is clear that, where lenders operate inappropriate or risky lending policies, or do not follow their own internal lending policies and procedures, the courts will give very serious consideration to contributory negligence that can be said to have occurred. Precedent may be of limited assistance when evaluating likely contributory negligence awards because each instance will be fact specific. In the previous round of litigation, findings of contributory negligence ranged from 30 per cent to 90 per cent. One note of warning, however, is that if a solicitor's conduct is so defective that it amounts to a breach of fiduciary duty - requiring something close to dishonesty - the solicitor will not be able to use arguments of contributory negligence.

BLG recently held a seminar on mortgage fraud; to read more, please follow this link.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.