Practice Tips: Fighting back against fraud — the risks in real estate.

David J. Bilinsky, Practice Management Advisor

Fraud against lawyers and involving lawyers is on the rise across Canada and the United States — and BC lawyers have unfortunately seen their share of the problem.

Fraudsters have exploited the weaknesses in our systems and shown why we must all put into place practice safeguards to limit our exposure. There are many factors that give rise to fraud. This article does not focus on those weaknesses, but on helping a lawyer avoid becoming the next victim or pawn of a fraudster.

As reported in this Bulletin, the Benchers have recently amended the Professional Conduct Handbook to strengthen Chapter 4, Rule 6:

Dishonesty, crime or fraud

6. A lawyer must not engage in any activity that the lawyer knows or ought to know assists in or encourages any dishonesty, crime or fraud, including a fraudulent conveyance, preference or settlement.3

Footnote

3. A lawyer has a duty to be on guard against becoming the tool or dupe of an unscrupulous client or of persons associated with such a client and, in some circumstances, may have a duty to make inquiries. For example, a lawyer should be wary of a client who:

(a) seeks the use of the lawyer’s trust account without requiring any substantial legal services from the lawyer in connection with the trust matters, or

(b) promises unrealistic returns on their investment to third parties who have placed money in trust with the lawyer or have been invited to do so.

Without limiting the endless ingenuity of fraudsters, here are examples of the main types of fraud that Canadian lawyers have encountered in real estate.

Use of false identity

In this circumstance, the fraudster impersonates the true owner of the property. The fraudster chooses the property, does a title search to confirm the identity details of the owner and then makes up false identity papers that match the identity of the true owner.

If the property is already mortgaged, the fraudster may forge a discharge to clear title. Then he or she applies to a new financial institution for mortgage financing equal to one-half the property value. The fraudster is counting on the financial institution doing only a basic background check since the mortgage is only 50% of the property value.

On receipt of the new mortgage funds, the fraudster may keep up the payments for a time before disappearing with the balance of the funds. The true owner is then left with the headache of trying to discharge the fraudulent mortgage. The lawyer who prepared and registered the mortgage later finds out that he or she witnessed the signature of a fraudster.

In a variation on the identity fraud, the fraudster presents to a lawyer a false agreement of purchase and sale to obtain title to a property. The fraudster then mortgages the property. Again, after a time, both the fraudster and the balance of the mortgage funds disappear. The true owner of the property finds that the property is in foreclosure and that he or she no longer holds title. The lawyer later discovers that he or she unwittingly helped a fraudster in obtaining title to the property.

A similar scenario involves the fraudster targeting property owned by a corporation. False minute books are prepared and the fraudster may impersonate one of the corporate principals. The fraudster applies to a financial institution for financing, and presents the false corporate documents in support of the mortgage application. Soon after receiving the funds, the fraudster disappears.

Another possibility is for the fraudster to impersonate both the purchaser of property and a legitimate lawyer. The fraudster enters into a real purchase and sale contract with a legitimate vendor. Using the false lawyer credentials, the fraudster opens a trust account and mocks up letterhead as if acting for the purchaser. The fraudster-as-lawyer draws up the purchase documents and applies for mortgage financing. When the mortgage funds are received, they are deposited to the false trust account. Then the fraudster and the mortgage funds disappear.

Value fraud

In this situation, back-to-back purchases of the same property are arranged from a legitimate vendor. The first purchase is for the arranged sale price — say $300,000. Then a subsequent (fraudulent) deal (from one fraudster to another) is arranged (i.e., a “flip”) for $400,000. Both purchases are set to close on the same day. The fraudster arranges for a high-ratio mortgage on the basis of the second deal. The high-ratio mortgage funds are used to close the real estate deals, since the amount of the mortgage (95% of $400,000 = $380,000) is enough to cover the deals.

The fraudsters are counting on the financial institutions not doing their full due diligence or having an on-site appraisal done of the property to verify the stated property value. Sooner or later, the balance of the mortgage funds and the fraudster disappear, leaving the bank holding a mortgage for far more than the property is worth.

A second value fraud occurs when a legitimate agreement of purchase and sale is entered into between a vendor and the fraudster, say for $350,000. The vendor and the fraudster then sign a one-page amendment that provides a credit of $50,000 against the purchase price (stated to be for repairs). The fraudster does not disclose this credit in obtaining high-ratio financing. The deal closes and the mortgage payments stop shortly thereafter. The fraudster disappears with the balance of the financing leaving the bank with a mortgage greater than the value of the property.

What to look for

There are usually indications that a fraud is in the works. Here are some of the signs to watch for:

Recent property purchase situations
  • The client has recently purchased the property on an all-cash basis and is now seeking to place a mortgage against the property.
  • The client has a transfer of the property but no other documents relating to the purchase of the property.
  • The client does not return to the lawyer who did the purchase to do the mortgage transaction and expresses a desire for the new lawyer not to contact the former one.
  • A historical title search reveals recent transfers at increasingly higher amounts, perhaps with the same lawyer on all the transactions.
Agreement of purchase and sale
  • The agreement contains no handwritten amendments.
  • The client is reluctant to produce identification or is uncomfortable with you making (front and back) photocopies of the identification produced by the client.
  • An amendment to the agreement provides for either a reduction in the purchase price or a payment to the vendor following closing.
  • The vendor acknowledges payment of a deposit that is not required by the agreement of purchase and sale.
  • The deposit is payable directly to the vendor, not to a real estate agent or a lawyer.
  • There is no real estate agent involved in the transaction.
  • There is an agent listed in the agreement, but the lawyer does not receive any communications from the agent or the agency (such as for payment of a commission).
The transaction(s)
  • The client does not have fire insurance on the home.
  • The utility companies are unaware of the vendor owning the home.
  • The client needs to close the transaction very quickly.
  • The client is a new client and promises to refer more transactions to the lawyer.
  • The client arranges the mortgage through a broker, and the brokerage fee is unusually high.
  • The client is prepared to pay higher legal fees than normal for the lawyer’s services.
  • The purchase price is much higher than the purchase price of recent transfers of the same property.
  • There are large and unusual adjustments in the Statement of Adjustments (e.g. a large credit for renovations or work to be done).
  • The statement of adjustments does not reflect the terms of the agreement of purchase and sale and any amendments thereto.
  • The title indicates a pattern of mortgages being registered and discharged shortly afterwards.
  • All of the funds required to close the transaction come from an institutional lender.
  • The name of the client in the identification produced by the client does not match the name of the client in other documents in the transaction.
Mortgage proceeds
  • There is a surplus of mortgage proceeds after the closing of the transaction to be paid to the borrower or to a third party.
  • The client directs part of the mortgage proceeds to third parties (e.g. off-shore recipients, currency exchange).
  • The client instructs the lawyer that it is unnecessary to prepare written directions authorizing the payment of funds to third parties.
  • The mortgage is a cash-back mortgage and the cash-back is the full amount of the equity in the property.
  • The client directs the lawyer to rebate a portion of the mortgage surplus to the vendor.
Client is a facilitator
  • A new client (facilitator) refers a number of real estate files to the lawyer, and the client, although not a party to the transaction, controls the transaction (e.g. gives instructions to the lawyer or arranges for the parties to the transaction to sign documents) and directs the parties in the transaction.
  • The client does not have a personal cheque for his or her pre-authorized debit plan but provides a blank “counter cheque.”
  • The lawyer is instructed to pay the excess mortgage proceeds to the facilitator even though the facilitator does not appear to have an interest in the transaction.
Flip transaction
  • The vendor acquires the property the same day that it is being sold for a higher purchase price (flip transaction).
  • The lawyer is asked to act for both the purchaser and the vendor in the flip transaction (see Professional Conduct Handbook, Appendix 3).
  • A bank loans money on the strength of the consideration contained in the flip agreement.
  • The client instructs the lawyer not to disclose to the lender that the transaction is a flip or that the lender is lending money on the higher consideration.
  • The transfer signed by the original vendor contains a lower consideration and is manually altered prior to closing to match the consideration set out in the agreement of purchase and sale.
Multiple transactions
  • A new client begins referring a number of real estate files to the lawyer, and the same parties (purchasers and vendors) are involved over and over in transactions.
  • The client indicates that he or she is in the business of renovating homes.
  • The same real estate agency appears regularly on the agreements of purchase and sale.
  • The mortgages arranged in these transactions are high-ratio mortgages with mortgage insurance.
  • The lawyer is instructed to use the excess mortgage proceeds for the purchase of another property.
Corporations
  • The original minute book for the company is not available or is incomplete.
Conclusion

Real estate fraud is but one type of fraud that can target lawyers. Upcoming Practice Tips columns will address fraud in other practice areas and fraud being perpetrated via the Internet. One thing is clear: every type of fraud involves someone motivated by the love of money who will seek to cheat by exploiting any weaknesses in our day-to-day systems.

Resources

www.lsuc.on.ca/news/pdf/convmar05_mortgage_fraud.pdf– Law Society of Upper Canada’s report to Convocation on mortgage fraud.

www.lsuc.on.ca/services/pdf/july2304_fraud_indicators.pdf– Law Society of Upper Canada’s practice tips on real estate transactions.

www.lsuc.on.ca/services/pdf/july2304_fraud_scenarios.pdf– Law Society of Upper Canada’s real estate fraud scenarios.

www.lsuc.on.ca/services/real_estate_fraud.jsp– Law Society of Upper Canada’s website on fighting real estate fraud.


I gratefully acknowledge materials prepared by LAWPRO and by the Law Society of Upper Canada that were adapted and summarized in this column, with permission, for the benefit of BC lawyers.