The Traps and Tricks of “Borrower” Fraud, Forgery, and Identity Theft in Real Property Lending
Fraud and deception by “fraudsters” who pose as “borrowers” is rampant and very costly to lenders. While most lenders attempt to insulate themselves from the risks of fraud and deception by purported “borrowers” through the use of well-drafted escrow instructions and title insurance policies, the escrow agents and the title insurers frequently attempt to avoid liability to the lender. Therefore, the knowledgeable lender must be prepared to avoid the traps and tricks of the purported “borrower” and must also anticipate the efforts by the escrow agent, title insurer and others to avoid liability to the lender.
A common type of real estate loan fraud by a purported “borrower” is identify theft. This is where the purported “borrower” impersonates an individual or “hijacks” a business entity, by impersonating the management of the business entity, such as the manager of a limited liability company. The extensive use of the internet allows the “fraudsters” to hide in the shadows and avoid detection by even the most zealous lender. Similarly, the extensive use of loan brokers provides additional cover for “fraudsters” who like to hide and avoid direct interaction with the lenders they are seeking to defraud. Unfortunately, even the most zealous lender, from time to time, will be deceived by a “fraudster” and will discover what was believed to be a legitimate loan secured by a valid and enforceable first priority lien on real property is actually “a fraud” and the lender’s mortgage is not only a worthless “piece of paper,” it is also slandering the title of the true owner of the subject real property.
When a lender discovers that it has been the victim of fraud, prompt, focused action by the lender is required. The lender’s first step should be to identify all potential sources of recovery. Typically, these sources of recovery, at a minimum, will include the notary public, the escrow agent, the underwritten title company, the loan broker and the title insurer. Concurrently, the lender must be aware of its need to mitigate its potential liability to the true owner of the subject real property, without reducing or eliminating the liability of the notary public, the escrow agent, the underwritten title company, the loan broker1 and the title insurer.
POTENTIAL SOURCES OF RECOVERY FOR THE LENDER
Introduction
While there are a few instances in which the “fraudster” was not successful in escaping with all of the loan proceeds which were fraudulently obtained from the lender, those instances are quite limited and rare. Unfortunately, reporting the fraud to the police or other governmental authorities is rarely beneficial. In the authors’ experience, a fraud of less than $1,000,000.00 rarely attracts the interest of any governmental authorities. In addition, if the fraud does attract the interest of a governmental authority, that governmental interest may reduce or eliminate the ability of the lender to conduct discovery in civil litigation. This is because persons of interest may cite their Fifth Amendment rights against self-incrimination and decline to cooperate or respond to civil discovery until after the governmental investigation has been concluded.
The Notary Public Who Acknowledges the Trustor’s Signature on the Lender’s Deed of Trust
The signature of the purported “borrower” on the lender’s Deed of Trust must be acknowledged by a Notary Public before the Deed of Trust can be recorded. Unfortunately, this is one of the greatest areas of risk for the lender. Because of convenience, it has become all too common for the acknowledgement on the Lender’s Deed of Trust to be performed by a “mobile notary.” Unfortunately, far too frequently these “mobile notaries” have no assets and only a minimal bond.
Therefore, the authors recommend that the lender’s written escrow instructions to the underwritten title company (“escrow agent”) which will record the lender’s Deed of Trust, require that the signature of the purported “borrower” on the lender’s Deed of Trust be acknowledged by an employee of the title insurer or underwritten title company (“escrow agent”) which will record the lender’s Deed of Trust. An alternative, not one which is recommended by the authors of this article, is for the lender’s written escrow instructions to require that the signature of the purported “borrower” on the lender’s Deed of Trust be acknowledged by a notary public who is selected, retained and instructed by the underwritten title company (“escrow agent”). The Notary Public should not be selected by the lender or directly hired by the lender or the lender’s broker.
The “National Closing Office” of One of the “Big Four” Title Insurers
For a number of years title insurers, in large measure, directly dealt with their customers, except in areas where they had no “direct operations.” In some areas, the title insurers dealt with customers through local agents, which might be owned by or otherwise affiliated with the title insurer. In addition, there were independent agents. Depending upon the circumstances, a lender still might be able to deal directly with the insurer since the “big four” title insurers (i.e. First American Title Insurance Company, the Fidelity National Financial, Inc. “family” of title companies, Stewart Title Guaranty Company and Old Republic National Title Insurance Company) all maintain and operate national closing offices. Depending upon the size and the volume of loans done by the lender, the lender may be able to have its loan closings conducted by a “national closing office” of one of the “big four” title insurers.
The Underwritten Title Company/ Agent Which Will Record the Lender’s Deed of Trust
If the lender is not able to deal directly with a “national closing office” of one of the “big four” title insurers, the lender will probably be required to deal with an underwritten title company or agent (“Title Escrow Agent”), which will record the lender’s Deed of Trust. The party which acknowledges the signature of the purported “borrower” on the lender’s Deed of Trust and records the lender’s Deed of Trust is the most important person in a secured real estate loan transaction. Therefore, it is the authors’ recommendation that the lender take extreme care in selecting the Title Escrow Agent. In parts of the United States, the role of the Title Escrow Agent will be performed by a title agent who typically is a lawyer or a business entity which is affiliated with a lawyer.
There are hundreds of underwritten title companies and title agents in the United States. Unfortunately, not all of them have sufficient assets to respond to a claim by a defrauded lender. Therefore, it is the authors’ recommendation that the lender use an underwritten title company (“escrow agent”) which is a wholly owned affiliate of one of the “big four” title insurers (i.e. First American Title Insurance Company, the Fidelity National Financial, Inc. “family” of title companies, Stewart Title Guaranty Company or Old Republic National Title Insurance Company). As stated above, the lender’s written escrow instructions to the party who will record the lender’s Deed of Trust should require that the signature of the purported borrower be acknowledged by a person who is employed by the Title Escrow Agent.
“Independent” Escrow Agents
In some parts of the United States, especially Southern California, there are a large number of “independent” escrow agents (“Independent Escrow Agent”) which are able to handle certain aspects of the escrow for the real estate loan – excluding the recordation of the lender’s Deed of Trust, but including acknowledging the signature of the purported “borrower” on the lender’s Deed of Trust. The biggest challenge presented by a lender’s use of an Independent Escrow Agent is whether it has sufficient assets to satisfy claims by the lender, especially where there is a fraud which has been perpetrated on the lender which has rendered the lender’s Deed of Trust void because the purported “borrower’s signature on the lender’s Deed of Trust has been forged. Frequently the Independent Escrow Agent will inform the lender that it has errors and omissions insurance to cover any claims by the lender. Unfortunately, your authors have seen instances where the Independent Escrow Agent’s errors and omissions insurance policy was exhausted by the cost of litigation and there remained no money to pay the lender’s claims. In other instances, your authors have seen situations where the Independent Escrow Agent’s errors and omissions insurer denied the Independent Escrow Agent’s claims.
In addition to the ability to fully compensate the lender for any loss or damage caused by fraud, forgery and identity theft, title companies, which would otherwise have unquestioned liability as an escrow agent for the lenders, with all of the fiduciary duties attendant there to, will claim that they have no liability to the lender because they are a mere “sub-escrow agent” whose only responsibility is to follow the instructions of the Independent Escrow Agent.
The “Closing Protection Letter”
The American Land Title Association (“ALTA”) promulgates a “closing protection letter” (“CPL”) which is available to be used when a lender-or another customer-uses an underwritten title company or another agent of the title insurer, rather than dealing directly with the title insurer as the escrow agent and the title insurer. While the CPL arguably provides some benefits to a customer who is not dealing directly with the title insurer as both the escrow agent and the title insurer, a number of people criticize the CPL as not providing meaningful protection.
The “Authorized Agent Letter”
In addition to the CPL, some title insurers also provide an “authorized agent letter” for their customers. The “authorized agent letter” confirms that the agent is in fact the authorized agent of the title insurer and, in addition, purports to authorize the agent to “… conduct settlement closing services in connection with real estate transactions where …” the title insurer’s policies of title insurance are issued. However, the “authorized agent letter” goes on to state that the title insurer “… provides indemnification for the actions of an agent ‘in good standing’ in connection with those settlement services to the extent described in the closing protection letter issued to an insured for a specific transaction for which a title insurance policy is issued.” Since the “authorized agent letter” is issued in addition to the CPL, it is the authors’ opinion that it should be understood to provide additional assurances to those provided in the CPL (i.e. assuming liability for conducting the settlement closing services).
The Lenders Escrow Instructions to the Settlement Agent
The most important document in a loan transaction is the lender’s written escrow instructions to the settlement agent and, if possible, to the title insurer, which at a minimum, provide the following instructions: (1) The lender’s loan funds are not authorized to be disbursed, or otherwise used, until after the lender’s valid, enforceable and duly executed Deed of Trust has been duly recorded as a valid and enforceable first priority lien on the real property described in the lender’s Deed of Trust (subject only to the lien of current real property taxes on the real property which are not yet due or payable); and (2) The settlement agent is not authorized to use or rely on any indemnity agreement, bond or similar arrangement without the informed written consent of a specific person at the lender.
While there are a number of additional instructions which can be sent to the settlement agent, it is the authors’ opinion that the lender’s requirement of a valid and enforceable first priority lien is the single most important instruction. Unfortunately, from time to time, a lender may encounter resistance from a settlement agent to this instruction and the settlement agent will claim that it can only issue a loan policy of title insurance to the lender. If the lender encounters that resistance, it is the authors recommendation that the lender “shop around” to determine if it can identify a settlement agent which will agree to record the lender’s Deed of Trust as valid and enforceable first priority lien on the real property described in the lender’s Deed of Trust.
The 2021 ALTA Loan Policy of Title Insurance (Extended Coverage – No “Regional Exceptions”)
A lender rarely has a claim on a loan policy of title insurance if the settlement agent (i.e. underwritten title company, agent, escrow agent, etc.) has strictly complied with all of the lender’s express and implied escrow instructions. Therefore, the lender’s claims on the loan policy of title insurance are normally secondary to the lender’s primary claims for the settlement agent’s breach of the lender’s express and implied escrow instructions.
While the loan of the title insurance may ultimately provide some financial benefits to the insured lender, the policy’s Exclusions from Coverage, the Exceptions from Coverage and the Conditions are apparently drafted to materially reduce or eliminate the ability of the insured lender to receive financial benefits under its loan policy of title insurance. One of the more troublesome Exclusions from Coverage is Exclusion 3(a) for matters which were “… created, suffered, assumed or agreed to by the Insured Claimant.” This Exclusion is the most litigated provision in the loan policy of title insurance and provides the insurer with its “first line” of defense to claims by the lender on the loan policy of title insurance. The second most troublesome exclusion is Exclusion 3(b) for matters which were “… not Known to the Company, not recorded in the Public Records at the Date of Policy, but Known to the to the Insured Claimant and not disclosed in writing to the Company by the Insured Claimant prior to the date that the Insured Claimant became an Insured under this policy.”
Exclusions 3(a) and 3(b) are claimed by the title insurers to merely provide the title insurer with defenses to matters which were the insured’s “own darn fault.” However, a fact which may appear to the lender to be totally harmless before the close of escrow can become very challenging after the close of escrow. The authors are aware of a case where the insured’s lender’s claims were rejected by the title insurer where the unrecorded Deed of Trust had on it a forged notary stamp of the notary public which contained an inaccurate commission number for the notary public and the insurer unsuccessfully claimed that the lender knew that the notary stamp on the Deed of Trust was fraudulent.
For a lender to reduce or eliminate the risks presented by Exclusion 3(b), the lender, at a minimum, should attempt to provide to the title insurer or its agent, copies of all documents or information which the lender has in its possession on the proposed loan. This disclosure can be accomplished in a variety of ways, including, but not limited to, providing copies of the loan file to the insurer, providing a link to the loan file to the insurer or by providing access to the loan file to the insurer.
The challenges of Exclusion 3(a) are more difficult because it may be necessary for the lender to “unring the bell.” In one action, of which the authors are aware, the lender had a credit report which disclosed a recorded abstract of judgment against the proposed borrower. In addition, the lender had a commitment for title insurance which concealed and did not disclose the existence of the recorded abstract of judgment against the proposed borrower. The lender assumed that the commitment for title insurance was accurate and that the credit report was not. However, the credit report was accurate and the commitment for title insurance was false and misleading. After the loan closed, based on the false and misleading commitment, the judgment creditor executed on the real property which was encumbered by the lender’s insured deed of trust. The lender submitted its claim to its title insurer, and the title insurer denied the claim based on Exclusion From Coverage 3(a), on the ground that the lender knew of the recorded abstract of judgment. Accordingly, the borrower fraudulently obtained the loan by not admitting to the recorded judgment against him and the title insurer avoided liability based on Exclusion from Coverage 3(a).
The Purported “Borrower’s” Loan Broker
It is commonplace in real estate lending for a potential borrower to contact one or more loan brokers in an attempt to obtain the desired financing. While the vast majority of loan brokers are honest, like any other profession there are a few “bad apples” in the loan brokerage profession. Accordingly, as a lender you may receive a referral from another loan broker where that broker is less diligent or less honest than you. In the authors’ experience, many of these loan brokers have few assets and those assets which they do possess are hidden. Accordingly, while you may have a “bad apple” who refers a fraudulent loan to you, they may possess limited or hidden assets which may not furnish a good source of recovery.
DISBURSEMENT OF LOAN FUNDS
It is not uncommon for the lender to want to “hand the check” for the loan proceeds to the borrower. While that act might make for good customer relationships, it may also create issues for the lender, especially if the purported “borrower” is an imposter and the lender “hands the check” for the loan proceeds to the wrong/fake person. Therefore, it is the authors’ opinion that loan proceeds should be distributed to the borrower by the settlement agent after the recordation of the lender’s valid and enforceable first priority Deed of Trust.
PROMPT WRITTEN NOTICE OF CLAIM TO BE GIVEN BY THE INSURED CLAIMANT TO THE TITLE INSURER AND THE SETTLEMENT AGENT
Condition 3 of the 2021 ALTA Loan Policy imposes on the insured an obligation to provide prompt written notice to the insurer in the event that the insured has knowledge of any “… matter …” for which the insurer “… may …” be liable under the policy. This provision is read by the insurer as imposing a burden of eternal vigilance on the insured lender which is combined with a duty of providing prompt written notice to the insurer. In summary, it is the authors’ recommendation that the lender should always provide prompt written notice to the insurer where the lender has knowledge of a matter which “… may …” give rise to the insurer’s liability on the policy. Failure to provide the prompt written notice may result in a reduction of coverage to the extent that the insurer is prejudiced.
THE POLICY PROVIDES THAT THE INSURER IS NOT LIABLE FOR “LIABILITY VOLUNTARILY ASSUMED BY THE INSURED”
Condition 9(c) of the 2021 ALTA Loan Policy states that the insurer is not liable for “… loss or damage to the Insured for liability voluntarily assumed by the Insured … without the prior written consent of the Company.” While this Condition limits what the lender can do to modify the terms of a loan without the insurer’s prior written consent, it also presents a significant risk to the insured lender if the insured lender were to discover that it had received a false, forged or fraudulent Deed of Trust which had been recorded by the settlement agent on an innocent person’s real property, which is now slandering title to that person’s real property.
This is because, frequently, the title insurer will want to exercise Condition 9(b) in the loan policy of title insurance and attempt to prove that the insured Deed of Trust is in fact valid and enforceable. Unfortunately, that action by the insurer can create potential liability for the lender whose Deed of Trust is slandering the title to the real property where the false, forged or fraudulent Deed of Trust had been recorded. This is because the property owner, whose title is being slandered by the recorded false, forged or fraudulent Deed of Trust, will not realize that the settlement agent-not the lender-recorded the false, fraudulent or forged Deed of Trust and that the lender cannot reconvey it without the prior written consent of the title insurer.
Therefore, if you submit a claim based on a false, forged or fraudulent Deed of Trust, you should concurrently request the title insurer’s (and the settlement agent’s) written consent to reconvey the Deed of Trust without altering , changing or reducing your rights.
UNDERWRITING THE LOAN VERSUS UNDERWRITING THE LIEN
The lender makes the underwriting decision as to whether a potential loan should be funded or not. The title insurer, normally by and through its underwritten title company agent, makes the underwriting decision as to whether a lien has been created or not in favor of the lender. However, when a title insurance claim or an escrow claim arises, title insurers frequently claim that the lender’s alleged negligent loan underwriting results in Exclusion 3(a) barring the lender’s claim.
The “negligent loan underwriting” defense has routinely failed under scrutiny. However, when a title insurance claim arises, a lender should be prepared to have its underwriting of the subject loan scrutinized by its title insurer and potentially used as a ground proffered to deny the tendered claims.
PROMPT AND DILIGENT CLAIMS BY THE LENDER TO THE SETTLEMENT AGENT AND THE TITLE INSURER
If an apparent false, fraudulent or forged loan transaction is discovered, prompt written notice should be given by the insured lender to the settlement agent and the title insurer by email and Federal Express (or another overnight delivery service where a signed receipt is obtained). Most of the states have adopted, in one form or another, the Unfair Claims Settlement Practices Act, which was promulgated in June of 1990 by the National Association of Insurance Commissioners. In California, it is termed the Fair Claims Settlement Practices Regulations and is found at 10 Cal. Code of Regulations, Section 2695.7 and should be your “handbook” for your title insurance claims. Since escrow law and insurance law, especially title insurance law, is arcane and complex, you should retain a lawyer who is experienced with the issues in both of these fields when potential claims arise.
CONCLUSION
Real estate fraud, especially loan fraud is rampant. If you are engaged in real estate lending, your need to deal with loan fraud because it “comes with the territory.” While you cannot eliminate loan fraud, you can take measures to attempt to prevent or mitigate your becoming a victim of loan fraud. If you are victimized by loan fraud, by following the measures summarized in this article, you should be able to reduce or eliminate any loss, which you might otherwise suffer.
ENDNOTES
1 This article does not contend that there is a rule that loan brokers are always liable to lenders when a purported borrower defrauds a lender. This is because there is no such rule.
Loan brokers are included in this article because they are part of the “cast of characters” which are involved in the origination and servicing of most private money lending transactions.
John L. Hosack, Esq. is a shareholder with Buchalter, located in their Los Angeles office. Jason Goldstein, Esq. is a shareholder with Buchalter, located in their Irvine office.
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