Property transaction advisers set for scrutiny

Matthew Howarth, commercial litigation partner

When the UK property market last slumped in the late 1980s it was defined by rising interest rates, repossessions and negative equity. It was also a time of reckoning for professional advisors involved in the property transactions that were integral to the mortgage lending process.

When borrowers were unable to repay their mortgages, lenders repossessed their properties and sought to sell these in order to recover the outstanding balance on the mortgage accounts. When a shortfall was incurred the lenders looked to their professional advisors to investigate why a shortfall had occurred.

In some case, lenders conducted large scale audits to investigate whether there had been any failures on behalf of the solicitors or the valuers when the property transaction was being completed. This allowed them to see if there had been any material failure in the duties of these professionals to their clients.

In a series of cases the courts established that in certain situations solicitors and valuers had failed in their duties to their lender clients and were liable to account to them for the damages that followed as a result of those failures.

These included examples where the solicitors failed to notify their lender clients of information that was material to the lending decision. These included non-payment of deposits by the borrowers, sub-sales or ‘back-to-back’ transactions where the same property was sold in a very short space of time with a substantial increase in the sale price.

Valuers were also in the spotlight during these audits when their valuations were subjected to scrutiny to assess whether they provided a true and accurate assessment of the value of the security supporting the mortgage loan. The results of these cases has laid down a series of legal principals which will no doubt become increasingly relied upon as we enter into what many believe is about to become another downturn in the economic cycle.

The signs are already here that indicate we are in an environment where solicitors and valuers retained by lenders in mortgage transactions will be challenged in the event that repossessions result in shortfalls in mortgage recoveries.

The FSA report published in January 2008 identified that more than a million homeowners could be at risk of serious financial difficulties and possibly losing their homes. The report cites three warning signs on mortgages that are indicative of potential problems;

• Where the loan taken out is for more than 25 years
• Where the loan to value ration (LTV) exceeds 90% of the value of the property
• Where the amount borrowed is 3.5 times greater than actual income of the borrower.

These indicators strike an alarming similarity to the lending criteria that was prevalent in the late 1980s and early 1990s that were the subject of recovery claims by lenders. Over one third of all mortgages sold between April 2005 and September 2007 falls into one or more of these categories.

Sometimes the actions – or failure to act – by solicitors and valuers amount to negligence and breaches of duties of care owed to their lender clients. Sometimes it can be more serious where the professional advisors were involved in a deliberate attempt to defraud the lenders.

In a rising market these acts often go unnoticed as the increasing value of the security will hide the potential breaches. However, in a declining market, these acts will now come under close investigation.

Tell tale signs include the same indicators as before but they now also take advantage of changes in technology where identity fraud may be involved. This includes the use of the internet for the creation of fraudulent applications, or the use of ‘mortgage mules’ who lend their identity to a fraudulent application, through to active involvement of professionals in the transactions.

The credit crunch has brought these matters to a head. We can expect an increase in the numbers of cases where lenders conduct reviews of their accounts where shortfalls have occurred to assess whether there is a claim against those retained to protect their interests in the mortgage transactions.

Lenders should be considering these files and looking for the tell tale signs to assess whether further investigation is warranted now. These investigations should take into account the substantive case law that has built up in the 1990s and the experience of the managed litigation cases conducted by lenders such as Nationwide Building Society and Paragon Finance plc. In these cases, these issues were tested in detail and the scope of duties of the professional advisors were carefully scrutinised.