Eyes Wide Shut: Rights, Remedies, Risks and Mortgage Fraud

MBABC 10th Annual Conference and Trade ShowPresented May 8, 2012

Grant Mayovsky, PartnerRobert Dawkins, Partner

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Defining the Problem

Mortgage fraud =

1. A deliberate use of misstatements, misrepresentations or omissions to fund, purchase or secure a loan.

2. A scheme designed to obtain mortgage financing under false pretences, such as using fraudulent or stolen identification or falsifying income statements.

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Overview

• The Changing Landscape• Identity Fraud• Legal Protections for Property Owners and

Allocation of Risk• Scenarios – Allocation of Liability• Passing the Hot Potato: An Overview of Mortgage

Broker Exposure

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The Lending Formula: 3C’s Cashflow + Collateral + Character = Loan

• In the last few years we have seen an increase in• the number of mortgage fraud cases

• “Impersonation” is the central theme in each of these

• Fuelled by:1. The Internet

2. Technology fake identification and document reproduction

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Cashflow Concerns: Make it up!

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The Mortgage Fraud Equation

Also fuelled by:3. The nature of the “hot” real estate market and the competitive lending

environment

4. Organized crime

5. Lack of Due Diligence know the people with whom you do business

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Overview: Identity Theft

• Identity theft refers to all types of crime in which someone wrongfully obtains and uses another person's personal data in some way that involves fraud or deception, typically for economic gain.

• It is estimated that identity theft and related fraud costs the Canadian economy about $2 billion annually.

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Identity Theft – Mortgage Fraud

• Mortgage fraud often requires that one of the parties to the transaction commits identity theft of the true owner.

• Perpetrators are invariably organized and usually require multiple participants.

• All lenders and brokers are susceptible to mortgage fraud and cooperation is required to prevent losses from these events – standard of reasonable due diligence expected.

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Solving the Loss Equation:Immediate vs. Deferred Indefeasibility

• Some provinces have adopted a system of “immediate indefeasibility”, whereas others have adopted a system of “deferred indefeasibility”. The approach adopted has a significant impact on imposing the risk of fraud onto one category of innocent victims over another.

Why mortgage brokers care?• Where loss falls could affect the validity of mortgage, the

potential liability of mortgage brokers as an avenue of recovery, the nature of claims which may be made and overall risk.

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Immediate Indefeasibility Favours Good Faith Purchaser

• The difference between immediate indefeasibility and deferred indefeasibility boils down to one simple fact scenario: Whether a good faith purchaser for value, without knowledge of fraud on the part of the vendor, can obtain an indefeasible title from the fraudster.

• Deferred indefeasibility favoured the true owner affected by the fraud.

• Immediate indefeasibility favours the good faith purchaser.

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Innocent Purchaser Receives Good Title

• For example, if the purported vendor of a property forged the signature of the true owner on a transfer document that was then registered in the land titles system, thereby depriving the true owner of their right in the land, then under a system of immediate indefeasibility the innocent purchaser would receive the title.

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Deferred Indefeasibility – Title Reverts to Original Owner

• Under this same scenario, with a system of deferred indefeasibility, the land would be returned to the true owner.

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BC – Land Title Act Amended on November 27, 2005 – Immediate Indefeasibility

• Void instruments – interest acquired or not acquired

25.1 (1) Subject to this section, a person who purports to acquire land or an estate or interest in land by registration of a void instrument does not acquire any estate or interest in the land on registration of the instrument.

(2) Even though an instrument purporting to transfer a fee simple estate is void, a transferee who

(a) is named in the instrument, and(b) in good faith and for valuable consideration, purports to acquire

the estate,

is deemed to have acquired that estate on registration of that instrument.

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Scenario 1

• An impostor obtains a mortgage against land that is not his.

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Scenario 1

• Application• Signed a void instrument• s. 25.1(1) applies – can’t acquire an interest in land by

registration of a void instrument• s. 25.1(2) does not apply because a mortgage is not a transfer of

“a fee simple estate” (title to the land)

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Original Owner Wins:F.I. Loses Mortgage

• Result• The mortgage must be removed from title• The lender has a claim against the impostor / others (mortgage

broker)?• No claim exists against the Land Title and Survey Authority

Assurance Fund (the “Assurance Fund”) because the lender did not rely on an inaccuracy in the register of land titles

• The title certificate is correct

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Scenario 2

• An impostor sells the land of the true owner to a good faith purchaser for value and the good faith purchaser obtains a mortgage

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True Owner Loses Title:

• Application• The transfer is a void instrument• But s. 25.1(2) exception applies to protect the good faith

purchaser because the transfer is a transfer of a fee simple estate• “Deemed to have acquired that estate on the registration of that

instrument”

=immediate indefeasibility

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Good Faith Purchaser Maintains Title: Subject to Mortgage(s)

• Result• The good faith purchaser gets the land • The new mortgage remains on title• The former owner deprived of the land has a claim against the

impostor and a claim against the Assurance Fund because he has been denied his interest in his land because of the “conclusiveness of the register”

• Validity of mortgage = no broker liability to lender as mortgage stays on title but risk remains at common law

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Scenario 3

• An impostor sells the land of the true owner to a fraudster. The fraudster obtains a contemporaneous mortgage against the land which gets registered on title.

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Scenario 3

• Application• s. 25.1(1) – the transfer itself is a void instrument.• The mortgage itself is likely a void instrument because the lender

purportedly took from the fraudster better title than the fraudster had. The fraudster had nothing because he obtained the title by fraud. The title is void and therefore the instrument is void.

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True Owner Wins:Mortgage Lenders Lose:

• Result• The title gets returned to the true owner.• The mortgage gets knocked off title.• The lender has a claim against the impostor and the fraudster

and others (mortgage broker).• The lender may have a claim against the Assurance Fund

depending on whether or not it relied on registered title certificate before advancing the funds.

• If the lender relied on solicitor’s undertakings then there is no claim to the Assurance Fund.

Vancouver City Savings Credit Union v. Hu, 2005 BCSC 712

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Mortgage Fraud Formula

Hindsight is 20 / 20 – Suspicious Circumstances1. Relevant Parties Distance Themselves

Want to avoid direct contact with lender – mortgage brokers may be used for this purpose

Prefer to deal with financial institutions that are not present in community where property is located

2. New unsolicited customers, without referral

3. No original asset or income documents presented – fax or copied and emailed

4. The property is usually clear title vacant land / abandoned equity take-out financing possibly involves transfer, but less common

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Mortgage Fraud Formula (cont’d)

Hindsight is 20 / 20 – Suspicious Circumstances (cont’d)5. Purpose of Loan ill-defined – story unusual

6. No negotiation of loan terms interest rate not priority in discussions – just wants mortgage

placed no apparent concern re: broker fees and commissions or other

terms (i.e. repayment, penalties, etc.)

7. Borrower picks the lawyer or notary also usually a long distance from the property to be mortgaged

8. Account opened and a portion of funds used for mortgage payments

9. Lawyer delivers the funds to someone other than vendor (or defined loan transaction purpose) or to an address that is different than the mortgaged property (Third Party Beneficiaries)

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Mortgage Fraud Formula (cont’d)

Hindsight is 20 / 20 – Suspicious Circumstances (cont’d)10. Recent credit bureau activity

a way to get personal information Numerous attempts to obtain loan

11. The F.I. employee or broker is a top producer

12. Limited personal contact between F.I. and borrower

13. Everything is a rush! almost no attempt to verify what is on paper double-check employment information – one call may be all it

takes / verify numbers through independent directory and call Google

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The Badges of Mortgage Fraud (cont’d)

Property Overvaluation Misrepresentation of character or use Intent to reside

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The Badges of Mortgage Fraud (cont’d)

Employment Forged or altered employment letters Forged or altered pay stubs Inflated income or tenure Other schemes

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The Badges of Mortgage Fraud (cont’d)

Identification Forged or altered ID Nominee borrower Alteration of personal info to avoid credit history

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The Badges of Mortgage Fraud (cont’d)

Equity Bogus gift Equity withdrawn prior to closing Down payment provided by undisclosed third party Full or partial down payment paid directly to vendor

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Passing the Hot Potato: Broker Liability

• Reputational and Business Risk• Possible Sources of Liability:

• Contract• Common Law:

•Negligence•Negligent Misrepresentation•Fraudulent Misrepresentation

• Equity: Trust, Tracing, Knowing Assistance, Knowing Receipt, Unjust Enrichment

• Professional Sanctions• Privacy and BPCPA

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Passing the Hot Potato: Broker Liability

FICOM Bulletin BULLETIN NUMBER: MB 04-005

• “Increasingly this office is being made aware of occasions where mortgage brokers are failing to verify client information that is being passed on to lenders. As a result, instances where lenders are receiving misleading or false information is becoming more frequent. Occurrences of this nature can tarnish the reputation and professional image mortgage brokers have within the lending community and amongst the general public.”

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Broker Liability

• “Mortgage brokers need to recognize that lenders rely on the information they receive regarding potential borrowers. Mortgage brokers cannot say that it is not their responsibility to verify the information being given to them during the application process. Lenders indicate they assume that mortgage brokers have verified the information before forwarding it on.”

• This office takes the position that a mortgage broker has a duty to ensure the information being sent to a lender has been verified.

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Broker Liability

• Regulator Expects “Reasonable Due Diligence”• Trust but Verify – Most People, Mostly Honest, Most of the Time• Some dishonest - some will “fudge” when in need of money• Consider red flags - Distance x Money = Risk• Obtain or verify information with third party sources (i.e.

employment)• Terms of Agreements, allocation of Risk Between FI and Broker –

apply most onerous and best practices to all

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Broker Liability: Contract

• Financial Institution Agreements

• Fulfill obligation honestly and in good faith, exercising reasonable skill, care and diligence, in accordance with recognized professional and industry standards, applicable laws and terms of agreement

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Broker Liability: Contract

• Verify identity with original ID• Ensure dealings with client face-to-face• Ensure source of all documentation provided by client is known,

verified, validated and trustworthy• Be vigilant to screen for possible fraudulent or misrepresented

information relating to identity, income, down payment, support documentation, credit history and other information

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Broker Liability: Contract

• Review and validate all supporting documentation and information provided to FI for accuracy, authenticity and integrity

• Inform FI if mortgage for benefit of someone other than the client applying for the mortgage

• Inform FI of any fact that may be useful or relevant to the Mortgage Application

• Promptly forward new information to FI – Duty may not end with presentation of application

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Broker Liability: Contract

• Liability and Indemnity

• Broker is “responsible and liable for all Mortgage Applications submitted by the Broker”

• Duty to indemnify “from and against all loss, liability, claim, damage or expense, whether direct, indirect or consequential, and including legal fees on a solicitor/client basis, which may be brought against [the FI] arising from or in connection with the servies provided by the Broker…”

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Broker Liability: Contract

• What does it all Mean?

• Substantial obligations under contracts to complete due diligence on information provided in applications

• Risk of substantial liability if not, including direct, indirect and consequential loss

• Loss of business lines – termination of agreements

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Liability: Common Law

• Potential for Claims by FI’s or Real Owners• Negligence (both)• Negligent Misrepresentation (FI)• Fraudulent Misrepresentation (FI) – includes recklessness and

wilful blindness

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Lessons Learned

• Mortgage Fraud is an issue and exposure for brokers• Trust but verify information from your clients• Develop and document standard best practices and

processes, ensure known by staff and followed• Ensure you enter into transactions eyes wide open, no

one deal is worth sacrificing your reputation and livelihood

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Thank You!

Grant Mayovsky

gmayovsky@blg.com

604-640-4165

Robert Dawkins

rdawkins@blg.com

604-640-4027

VAN01: 3049099