Mortgage fraud has made many recent headlines. It, and other forms of real estate fraud, also appear to be on the rise. How is the fraud taking place and what are the red flags that appear beforehand? Let us take a look at a few actual cases that will illustrate some of the problems, and then point to potential solutions.

I will begin with an actual case in which we were representing one of the parties (a bank): The facts begin with a simple purchase and sale of a house. The transaction is on an existing property and there exists a mortgage already on the property, which has to be discharged.

So, as part of the transaction, the lawyer receives money from the new mortgage, which is to be used to purchase the house and discharge the old mortgage.

The person at the law firm doing most of the work is the senior law clerk of the lawyer who has been with him for 28 years. She opens and closes various transactions and signs key documents on behalf of the lawyer. She was the office manager responsible for managing the accounts payable and receivables and preparing deposits to the bank.

The deal "closes" and the lawyer (and his clients, and the banks involved) think the deal is done.

But… the law clerk comes in on the weekend and removes the documents relating to the financial transaction and all financial and other records from the lawyer's office. Soon after, the purchasers inform the lawyer that the old mortgage, that was supposed to have been discharged, has not been paid out.

So what has happened? The law clerk has taken off with the mortgage money. She fails to show up at work one day and after a day or two, the lawyer becomes suspicious and starts an investigation. He brings in a forensic accountant.

What they discover is that at least twenty four of the transactions administered by the legal clerk are suspicious. The physical files are gone and they have to be reconstructed with the aid of staff and other financial institutions. In fact, there is little to no evidence in support for many of the transactions at all.

They conclude that there were approximately thirteen disbursements made from the trust account, over a protracted period of time, in favour of people and companies believed to be controlled by the legal clerk and her relatives. These transactions totalled about $350,000. In total though, it is believed that she embezzled about $2.5 to $3 million from the lawyer's trust account.

The various law suits that have risen from the fraud, have exposed the complications involved: Who is responsible? Who are the victims? If one bank allowed the deposit of a cheque made payable to another bank, in a trust account, is the bank allowing that wrong transaction responsible? And how are innocent parties, who had no direct control or knowledge, made whole?

The situation also discloses that fraud as it relates to mortgages, can take many creative forms.

There are really two types of mortgage fraud: 1] Identity fraud in which somebody pretends they are someone they are not, whether it be a purchaser, a vendor, a lawyer or a bank (and yes, people have pretended to be all those); and 2] Value fraud in which the lender is misled about the value of the purchase price of the property being offered as security for the loan.

Allow me to provide examples of both.

In the first example, a purchase agreement is entered into between a purchaser and vendor providing for a purchase price of $400,000 and a deposit of $500 payable to the vendor's lawyer. This purchase agreement is entered into in December. The same real estate broker represents both the vendor and the purchaser.

A mortgage loan is arranged for $385,000 and the money is advanced. A title search by the purchaser's and lender's lawyer indicates that the vendor had originally purchased the property in November of the same year for only $300,000. The lawyer does not advise the lender of this fact.

Then, shortly before closing, the purchaser and vendor sign an amendment to the purchase agreement that is not prepared by either lawyer. It states that the purchaser will pay a further deposit of $20,000 directly to the vendor (as opposed through the real estate broker). At the closing that month, the purchaser's and lender's lawyer receives two receipts. The first one is for the deposit made at the beginning of the deal and the second receipt is for the further deposit of $20,000.

The lawyer again does not advise the lender that deposits are being made to the vendor directly, instead of the broker, or that additional deposits are being made.

On closing, the statement of adjustments indicates that the house is being bought for $400,000 and the purchaser is credited for both deposits. The mortgage amount remains the same, but now thanks to the credit of the new deposit, the amount advanced is greater than the amount due and owing. Nothing is paid by the purchaser. In fact, he gets some excess money from the mortgage.

In a situation like this, the fraudster will usually make some mortgage payments for a short time and then stop and go into default. The bank takes over through a power of sale, sells the house for less than the mortgage provided and there is a deficiency.

So what were some suspicious signs? The initial deposit was very low, the further deposit was not done through the broker or vendor's lawyer, the property was purchased for substantially less a month earlier, the purchaser did not have to pay any funds upon closing and the mortgage advance exceeded the balance due on closing. These are all red flags, but the lender really saw none of them as they were not disclosed by the lawyer. The lender really had little opportunity to protect itself.

As another example, let's say that on January 1^st, a purchase agreement is entered into between two parties (vendor A and purchaser A). The price is $400,000 with a deposit of $10,000. The closing date for this transaction is February 28^th.

In the middle of January, a second purchase agreement is entered into by purchaser A, who is now vendor B, and purchaser B.

The purchase price of the property in the second agreement is $500,000 and there is a deposit of $10,000 payable to Vendor B (who is the purchaser in the first agreement). The closing date is the same closing date of February 28^th.

A mortgage is arranged for $480,000.

The lawyer involved electronically signs the first transfer for $400,000 on February 28^th at 12 noon, indicating consideration for $400,000. Then later in the afternoon the second transfer is signed indicating consideration of $500,000.

The mortgage funds are provided and the mortgage is registered. The proceeds from the second transaction, on the direction of Vendor B (the first purchaser) are paid to various parties, who are not the parties to the transaction.

In essence, this property has been flipped with a fraudulent value. After closing, the fraudster may reside in the property for a short time or rent out the property but mortgage payments will probably stop being made very quickly. The bank will sell the property under power of sale but will be unable to realize the full amount owing on the mortgage because the real fair market value of the property is substantially less than the fraudulent amount of $500.000. Again, there will be a deficiency. And the fraudster walks off with the excess proceeds based on the false value.

With identity fraud, one is usually confronted with forged bank drafts and certified cheques. Such situations can transpire like this:

A new and previously unknown client shows up at a lawyer's office. At the same time, a lender contact, also unknown, from a major bank (allegedly) will ask the lawyer to act on the mortgage. The lawyer then receives mortgage instructions and a legitimate looking bank draft drawn on a major bank. The loan amounts are high. The client/fraudster is in a rush to complete the deal. The closing date may be a Friday before a long weekend (the bank may not be open and the lawyer's office is short staff).

The whole thing is a sham. The parties may look legitimate but they are not. The bank documents may look legitimate, but they are not. Before the counterfeit cheque is found out, the lawyer draws the funds from his trust account and the fraudster get the money. The lawyer is left with a huge negative balance in the trust account.

Fraudsters sometimes appropriate the identity of an owner of real property. With the fraudulent identity, the impostor can apply to the bank for financing (applying with false information, identification and references), obtain a mortgage on a property that is not his and obtain the funds. The real owner of the house is left with a mortgage and the bank has paid out funds to an impostor.

Even a lawyer's identity can be forged. This has lead to banks forwarding funds to imaginary lawyers, with imaginary letterhead. The forwarded funds are then placed into a ‘trust' account and the fraudster takes off with the money.

In other cases, borrowers are providing fraudulent documentation purporting to be the mortgage statements from the first lenders (the first mortgage) to satisfy second lenders of the equity in the property. Under such circumstances, the second lender is willing to lend more. In addition, one produces fraudulent appraisals.

The law society, lawyer's insurance and lenders have identified a number of red flags which often indicate fraudulent activity:

• The mortgage advance exceeds the balance due on closing or the lender is advancing more than 95% of the purchase price (and the purchaser provides no or minimal funds on closing).
• Credits are not referenced in the purchase agreement or disclosed to the lender (and the credits can be for things like gifts, renovations, rebates or additional deposits).
• The purchase price of the property has escalated substantially over a short period of time.
• Closing funds appear to come from a source that is not the purchaser.
• The purchase agreement (or any other document) indicates that a deposit is to be paid directly to the vendor, as opposed to the broker or lawyer.
• There is a third party involved, either giving directions or instructions, providing documentation and identification, or receiving documents and funds.
• The same vendors, purchasers, real estate and mortgage brokers are involved in multiple transactions.
• Last minute changes, rushed deals and/or higher legal fees are part of the transaction.
• Parties are offered money to lend their good credit rating to enable a purchase by someone else (and sometimes there is no prior relationship between the two parties).
• The person who has the good credit rating is not taking possession of the house, or is taking title "in trust" for someone else. That person may not even make any mortgage payments (and then, sadly, the person with the good credit rating is surprised when the person who is supposed to make the payments, defaults).
• The mortgage is for interest only or the interest for the entire term of the loan is deducted from the mortgage advance.
• The property is mortgage free.
• The interest rate on the mortgage is exorbitant.

This ‘red flag' list is by no means inclusive of every trick and means to fraud. The creativity level, unfortunately, can be quite high.

Lenders, lawyers, homeowners, insurers, all have exposure to fraud. And the ability to recover against the fraudster can be painful, expensive and fraught with difficulties. With mortgage fraud increasingly present in a booming real estate market, all parties have to take as many precautions as possible. And even then, we are all going to be challenged and confronted by those who hope that they can take money not earned and get away with it.

If you have any questions or comments, feel free to email me at kklayman@gcylaw.com.