When a lender suffers a loss due to fraud by a solicitor the claim might be against the compensation fund or against the professional indemnity policy depending on the circumstances. Most lenders believe they will never get paid from the compensation fund which is a discretionary fund aimed at covering hardship so they want to find ways to claim against the professional indeminty insurance policy for the firm. This leads to small firms being disadvantaged.
Mortgage Finance Gazette have recently published an article explaining some of the reasons behind this. With their kind permission we thought you might like to read the article on our site but you can also read it on their site here.
Building lenders’ defences
Where mortgage fraud has been detected lenders often turn to the valuer or solicitor to recover losses but the insurers of these firms look for get-out clauses. Alison Poole, solicitor in the financial institutions group at Eversheds, reports
On 4 January 2012, the British Bankers’ Association along with various other bodies, issued an updated version of its Good Practice Guidance Note on mortgage fraud.
The guidance aims to assist lenders in identifying and mitigating possible vulnerabilities to fraud in the lending process.
The timing comes as no surprise. In January 2011, the National Fraud Authority published its second annual fraud indicator which showed that fraud had cost the financial services sector £3.6 billion, and of that figure, it estimated that £1 billion could be attributed to mortgage fraud.
The BBA guidance recommends that individual lenders should know their business and the risk of fraud associated with the products they offer, and have sufficient defences in place.
So how have lenders responded to this? What additional defences have lenders put in place? What further defences might they put in place to further protect themselves?
It is clear that lenders, having been stung badly by the sheer scale of their fraud exposure, are tightening up their anti fraud controls.
Lenders now routinely limit their exposure on new build developments to a specific number of properties. This is a small but vital step in combating fraud — the past years have seen lenders suffering massive exposure over certain key developments (most of which will be well known to fraud and professional negligence lawyers). By reducing its exposure on any individual site, the lender benefits from a corresponding reduction in exposure where a fraud is later uncovered.
But what else could lenders be doing in the spirit of the BBA guidance to protect themselves? This is a potentially huge topic, so we will limit this commentary to a single recommendation.
The fight against fraud involves a battle on two fronts — one is around tightening up front end lending procedures to ensure that exposure is limited. The other, which we will focus on in this article, is around ensuring that, when fraud is detected, the lender has the best possible chance of making a recovery (often against the valuer or solicitor involved in the transaction).
Lenders will be familiar with the problem — a large loss is sustained following a fraud. The lender sues (for example) the solicitor who represented it on the transaction. The insurers for the solicitor are able to avoid the insurance policy, alleging that the solicitor was involved in the fraud. The net result — the lender recovers nothing.
Solicitor insurers are able to avoid cover where the partners of a law firm acted dishonestly. However, insurance is granted to any partner who is innocent of the fraud. So provided a lender can identify an innocent partner, the insurers should pay out.
This sounds simple enough but, needless to say, it is not. It would be possible to write an entire book on what constitutes “innocence” in the eyes of the civil courts. Suffice it to say that a partner who initially appears innocent may be tainted by the fraud if, for example, he or she turned a “Nelsonian” eye to the fraud. Insurers will be quick to avoid cover where this is the case.
Insurers have also been known to deny cover by arguing that an innocent partner is not in fact a partner at all but an employee. The past years have seen a number of very large loss cases where this argument has succeeded thus reducing insurers’ exposure by millions.
In short, a lender can only rely on the innocent partner exemption if:
1. the innocent partner is a “true” partner in the eyes of the law, or
2. the innocent partner is in fact an employee, but was held out as a partner and the lender relied upon such holding out.
Again, there is a great deal of law in this area. However, it is safe to say that lenders should never assume that someone is a partner simply because that person is described as such on the firm’s notepapers. Title is irrelevant — whether someone is a true partner is determined by the substance of their role. So the supposedly innocent “partner” may in fact be an employee and may not therefore rescue the lender’s claim.
That said, lenders can improve their position under the second limb above. If an employee is held out as a partner and the lender relies upon this, then the law firm (and its insurers) may be prevented from denying that the employee is a partner.
Key to this is the concept of reliance — the lender needs to be able to prove that it used the law firm in question because it had more than a single partner in the knowledge that this would afford extra protection in the event of fraud.
So, in the spirit of the BBA guidance, what steps could lenders take to bolster their defences? No doubt there are many, but we would recommend focusing first on the “innocent partner” issue and thus taking a close look at the panel of solicitors who are able to act for the lender in mortgage transactions.
The more partners the panel firm has the greater the chance that one of those partners will be an “innocent partner” in the event of a fraud. It may be prudent therefore for lenders to look only to firms with three or even four partners as a minimum.
Lenders should also ensure that they protect themselves under the “reliance” doctrine.
A clause in the Certificate of Title making it clear that the lender is placing reliance on there being at least two “true” partners in the firm should suffice.
These relatively minor steps might have saved the lending industry a vast amount in the past years.