As is now clear, a new wave of mortgage fraud has been building steadily since last year and this is bound to keep professional indemnity (PI) insurers on the run throughout 2008 and beyond. However, 'straight' negligent over-valuation claims against surveyors, without any obvious fraud element, are breaking through too.
'Straight' valuation claims
The first sub-prime cases of this sort are now well into the early stages of protocol. In no small measure, these seem to be a product of the 27,000 home repossessions reported during the course of 2007. Some sub-prime lenders have already had to release their underwriting, arrears, possession and marketing files to opponents. That may well have been an anxious and difficult process for the lenders. PI lawyers will be tearing into the detail of those files as we speak.
Adapting to tackle recent lending practice
On the valuer side, there has been a clamour to resurrect those trusty old defences that last saw active service during the lender litigation era of the 1990s. But any established principles will need to be updated and adapted to fit the 'new' practice of sub-prime lending experienced in more recent times.
Generally speaking, findings of contributory negligence against lenders, during the 1990s period, were modest. A discount of 15% or 20% was then regarded as weighty (although there were some extreme cases – and obiter comments – where the relevant discount was put as high as 75%).
New degrees of imprudent lending
This time around, lenders might not be fighting contributory negligence cases with the same vigour. Indeed, they would do well to act tentatively. These are uncharted waters for all concerned. The sub-prime product suite has been seriously scaled down since the onset of the credit crunch. In itself, that retreat is possibly suggestive of lenders acknowledging that they had been too far 'out on a limb' for too long, in terms of risky approvals.
Adopting FSA principles
The other 'new' factor, today, is the presence of the Financial Services Authority (FSA). There was no regulatory dimension to speak of during the 1990s claims phase. In the absence of any decided authorities (currently) regarding sub-prime lending practice, defence lawyers are likely to hijack the FSA 'treating customers fairly' outcomes as a framework for advancing imprudent lending allegations. The FSA has been critical of borrower affordability, circumstantial and 'needs' assessments in this sector, so lenders are already on the back foot here.
PMV and repossessions
Another interesting aspect likely to feature in the defence of sub-prime cases concerns the use of the Projected Market Value ('PMV') basis for advising. The PMV model is close in its roots to the artist formerly known as 'forced sale valuation'.
The definition of PMV was hammered out between the RICS and the CML. Practice Statement 3.3 of the Red Book provides that PMV means:
"The estimated amount for which a property is expected to exchange at a date, after the date of valuation specified by the valuer, between a willing buyer and a willing seller, in an arms-length transaction, after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion."
Practice Statement 4.2 goes on to stipulate that valuations of residential property, for the purpose of possible possession proceedings, shall be on the PMV basis.
There is an argument, of course, that, by their very nature, sub-prime loans are more likely to end up in possession proceedings than loans made to mainstream borrowers. This brings any PMV advice, if asked for and given, into sharp focus.
The Finance Industry Standards Association (FISA) uses a standardised valuation reporting form for its lender members. Many of those members operate (or did operate) prominently within the sub-prime market. When valuers are reporting on the FISA form, they are required to give their opinion of Market Value ('MV') but, on every occasion, of PMV too.
In these cases (and others), where valuers have been required to advise on both the MV and PMV basis, some interesting lines of defence start to open up. First of all - if there is a significant discrepancy between the valuer's MV and PMV figures (say, of more than 15% to 20%) – and the lender has proceeded to make its advance regardless – that may strengthen contributory negligence allegations.
Similarly, it may well be that the valuer's advice on the PMV basis is defensible (but he or she is exposed on the MV assessment.) Such a situation could lead to novel defences on a reliance and/or causation footing, whereby valuers might contend that – given the risk quality of the loan proposed – the PMV basis was always the more important of the two figures for the lender to heed.
A blank canvas for dealing with these claims?
The latest over-valuation cases, now reaching the desks of PI insurers, appear to be in the 'classic' 1990s mould. In large part, the legal blueprint for resolving these claims is firmly established and the old, familiar principles are set to be well used once more.
However, the risks taken by lenders over the last five or six 'easy money' years amount to something unprecedented. As yet, there is no definitive standard for assessing what was sensible sub-prime practice and what might not have been. That gap will need to be filled before too long and doubtless, we shall see some novel ways to dust off those old defences and to develop a few new ones too.
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