The Law Society has issued a new practice note on mortgage fraud. It came into force on 18 March 2008 and replaces its 1991 "Green Card" warning on property fraud. Solicitors acting for borrowers and lenders need to make sure they are fully on top of the contents of the practice note and will ignore it at their peril.
The issue of the practice note is timely. When property prices rise sharply, as they have for at least the last 10 years, it becomes easier for criminals to induce lenders to make loans exceeding the value of the mortgage security they obtain. They sometimes dishonestly inflate the apparent value of the property mortgaged, or secretly decrease the purchase price below that which the lender is told. They can then pocket the excess of the loan over the true, lower, purchase price of the property. If the price of a property then drops and the borrowers default, lenders then find themselves unable to recover the money that they have lent.
A property crash like that of the early 1990s may not of course recur, but many think it will. The last crash led to huge numbers of mortgage repossessions as borrowers fell into arrears with their payments to lenders.
In the last wave of claims, some professionals were in on the frauds which came to light but most were sued for negligence. Valuers were alleged negligently to have overvalued properties. Solicitors were often alleged to have failed to spot signs that fraud was going on - the Green Card drew their attention from early 1991 to some such signs - or that the borrower was not worth lending to. Many early claims succeeded, but the professions and their insurers fought back and levelled the legal playing field in a series of test cases. The lenders' own imprudent lending policies were also held to be responsible for many of their own losses, particularly in the cases involving the Nationwide.
Will there be a further wave of claims if the market falls? The answer to this is undoubtedly 'yes' and some claims have already begun to emerge. Some lenders, such as the Britannia, have already indicated that they have set up internal units to investigate frauds and launch claims where appropriate.
The Law Society has once more become worried enough about mortgage fraud to update the Green Card warning to solicitors that it first issued in the first wave of frauds.
New practice note
The new practice note is extensive. The Green Card ran to two pages but the new note is 16 pages long. It also covers both criminal and civil liability. It draws attention to the fact that solicitors can now be found criminally liable if their clients commit mortgage fraud because of the revised, wide definition of "fraud" in the Fraud Act 2006 and the anti-money laundering regime. Solicitors can now be found liable even if they were unaware of, or did not actively participate in, the fraud.
In terms of civil liability, the practice note makes extensive reference to the Council of Mortgage Lenders' (CML) Handbook, which these days will be the basis for the instructions given to solicitors acting for lenders. Solicitors should be aware of their duties as set out in the CML Handbook and consider those in conjunction with the points set out in the practice note.
Like the Green Card, the note lists a number of features to watch out for in identifying a potential fraud. However, it now goes into detail in relation to these features and provides specific examples of how frauds may be perpetrated. It identifies which markets are more vulnerable to fraud (e.g. the buy-to-let market), how fraudulently purchased properties can be used by organised crime, which entities are likely to be involved (e.g. related private companies selling to each other at inflated values), and how professionals are often involved (unwittingly) in the fraud (e.g. mortgage brokers or introducers being used to reassure the lender and provide apparent legitimacy to the transaction).
The note advises solicitors to undertake substantial due diligence in verifying the identify of their clients, to be wary of clients who do not want to meet them, to scrutinise mortgage and contractual documents and the signatures appearing on them and make enquiries if there are discrepancies. Solicitors must ensure that they comply with the Money Laundering Regulations 2007 as to their clients' reputation and bona fides, and to query any incongruities in the valuation. The note also advises solicitors to question whether the whole transaction "adds up".
The new note also makes it far clearer that solicitors cannot act for both the buyer and lender if a conflict of interest arises. It specifies that a conflict will arise if the practitioner has information about the conveyance that the lender would consider relevant to granting the loan but the purchaser client is reluctant to disclose to the lender. Additionally, if the solicitor discovers information which might be expected to be important to the decision to grant the mortgage, this must be disclosed to the lender client. Balanced against this, solicitors must also be aware of their duty of confidentiality to their purchaser client.
Practical consequences
Conveyancers who are properly conversant with the new practice note will undoubtedly benefit from it. Proper compliance with its guidance ought to reduce the risk of being involved in transactions involving fraud and therefore the risk of being sued for participating in the fraud or failing to spot it. A solicitor who can show that he or she has carefully followed the guidelines will also be able to point to having done so in the event of a claim from a lender.
Conversely, as happened with claims arising in the 1990s from transactions which occurred after the Green Card was issued, the court is likely to find that a solicitor ought to have the knowledge set out in the practice note and will be fixed with it. This will only be for transactions which take place after the note has come into effect, of course, so claims which arise from transactions which completed before 18 March 2008 will still have defendant solicitors and their insurers looking at the Green Card. We hope that for transactions after that the solicitors will have shown the fraudsters the red card instead!
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.
