How to avoid the dangers of acting for borrowers on mortgage transactions

The seemingly innocuous role of providing independent legal advice to borrowers is fraught with danger for solicitors unaware of the pitfalls. Recent developments in the mortgage market and recent decisions in relation to the Contracts Review Act together with a proliferation of sophisticated frauds in the last few years, makes acting for borrowers a dicey business. A solicitor conversant with the issues is well armed to avoid problems.

 

17 April 2008

The Contracts Review Act 1980

Although the traditional defence of Amadio or Garcia type unconscionability is still available in NSW to a large extent the law has been subsumed by relief granted under the Contracts Review Act. This is because cases where a loan is unconscionable it is also typically found to be unjust for the purposes of the Act while the scope of the Act is much wider.

The most important recent development was the Court of Appeal decision Perpetual Trustee Company Ltd v Khoshaba [2006] NSWCA 41. In that case the borrowers were fully aware of the nature of the mortgage they signed, were under no undue influence, were compus mentis, and were borrowing in order to invest for gain. Nonetheless they were able to have their mortgage completely set aside. The only failings of the lender was not enquiring as to the purpose of the funds (beyond being told they were for investment purposes), not verifying the capacity to pay details (which were false on the application form) and not requiring independent legal or financial advice. As a result of this case lenders are more and more requiring borrowers to obtain independent legal advice.

Low Docs Loans

Low Doc loans rely on the borrower to self-certify the affordability of the loan. Lenders do not investigate the ability of the borrower to afford the loan. Where the loan was improvident for the borrower (at the time it was made) these loans are vulnerable to being set aside pursuant to the Contract Review Act. In order to bolster the enforceability of their mortgages (particularly in the wake of Khoshaba). Low Doc lenders are increasingly requiring borrowers to obtain independent legal (and in some cases financial advice1).

Cross-Claims by borrowers

Borrowers seeking to have their loan set aside will often attempt to bolster their chances by cross-claiming against the solicitor who independently advised them alleging negligence. Where the advice has not been properly given, and in particular where the solicitor has not ensured the borrower is not subject to undue influence, the borrower will succeed.

In Davies v Camilleri [2000] NSWSC 904 the borrower was a widow raising two children on a social security pension. The borrower had been talked into taking the loan by a loan broker who promised to invest the loan proceeds (but instead absconded). The borrower failed against the lender (under the Contracts Review act) but succeeded against her solicitor on the grounds that the independent legal advice was hidden in the presence of the loan broker and the solicitor failed to ensure the borrower was acting free of undue influence (in breach of an implied term of the retainer). Other cases with similar facts, issues and outcomes include Gellert v Bellamy [1999] NSWCA 123, IMB Society Limited v White [2000] NSWSC 10852; GIO Finance Limited v Cockburn [2000] NSWSC 3623.

Cross-Claims by lenders

One tactic used by lenders to hedge their bets when confronted by Contracts Review Act claim is to cross-claim against the borrower’s solicitor. This is based on a misconception that independent legal advice is a panacea which can prevent a borrower successfully raising a Contracts Review Act defence. Lenders have generally been unsuccessful against borrower’s solicitors where their loan is set aside under the Contracts Review Act, see for example Permanent Trustee Australia Limited v Gusevski [2005] NSWSC 1281.

Identity Fraud

Identity fraud involves the fraudster impersonating a registered proprietor in order to borrow on their land. To give themselves access to a solicitor’s professional indemnity insurance many lender’s insist on borrower’s being represented by a solicitor. They then require and rely on the solicitor to identify the borrower. If there is a fraud, and the borrower’s solicitor has been negligent in not picking it up, the solicitor will be liable to:

  • The lender (if the lender is not protected by indefeasibility4)
  • The defrauded owner of the land.

Impostors frequently target owners who are overseas or who are in nursing homes. This allows them to arrange access to the property for valuation purposes. They also target lenders who only require kerbside valuations (this includes short term / caveat lenders, some credit unions and building societies).

Most identity frauds tend to focus on unencumbered properties but the fraudulent payout of a legitimate mortgage in order to refinance a much larger sum is also common. Short term lenders who loan on the strength of a caveat are particularly vulnerable because everything is done in a rush. They are also vulnerable because they do not acquire an indefeasible mortgage. This makes them more likely to attempt to recover the loss by suing the borrower’s solicitor. Solicitors acting for borrowers on short term caveat loans should be particularly diligent in ascertaining identity. If they have never met the borrower before they should insist on photographing their client. If this is announced ahead of the interview it usually scares fraudsters away.

On 19 March 2003 the Law Society issued Caveat 238 which warned:

A second type of major fraud involves fraudsters’ illegally obtaining replacement Certificates of Title by using false identities and Fraud Squad police have warned of an extraordinary and widespread increase in ‘identification fraud’, where whole, well-documented identities are acquired by fraudsters.

The most abundant care should be taken in establishing the identity of new clients and parties to a transaction. Forged passports, drivers licences, credit cards, letterheads etc are available to fraudsters, and they clearly have no inhibitions in falsely signing documents as a solicitor, justice of the peace or otherwise. If a client has not been known to you personally for some time, do not witness their signature.

Rule 45 of the Solicitors Rules requires a solicitor to identify the proposed signatory by reference to one of the following documents:

  • Passport
  • Driving Licence
  • Medicare Card
  • Credit Card
  • Rate Notice
  • Other

It is hard to see how this rule encourages good practice in identifying borrowers. Any solicitor who relied on a credit card or Medicare card or even a driver’s licence to identify a borrower in the age of identity theft would be negligent.

Because of the sophisticated capabilities of fraudsters these days solicitors should identify the borrower independently of material supplied by the purported borrower. This might include searching the LPI register to examine signatures on the original transfer, telephoning solicitors who witnessed the client’s signature on earlier mortgages, visiting or writing to borrower at the security property. Looking the borrower and his employer up in the white pages, telephoning clients at their alleged employers and then Googling5 them to see what size their “footprint is” etc.

The November 2004 edition of the Law Society Journal carried an article entitled “What can solicitors do to reduce mortgage fraud?” which contains valuable guidance on techniques for uncovering fraud. The article is available to members on the Law Societies’ web site.

Solicitors who are asked to provide independent legal advice on security documents by people they have never met and who may be difficult to conclusively identify should decline to act. For a mortgage fraud to be pulled off the fraudster requires that the various checks in place by the lender to prevent fraud are each defeated. It is not good enough to make “reasonable efforts” to identify borrowers, if the solicitor is being asked to certify their identity steps should be taken to ensure that the person is who they say they are. In setting fees this should be taken into account with the result that often a solicitor will charge more for verifying someone’s identity than for providing the independent legal advice.

Value Fraud

Value fraud involves a legitimate borrower (as opposed to an impostor) seeking to borrow an illegitimately high amount of money on a property. This is done by misrepresenting to the lender the value of the property. Solicitor’s acting for borrowers can be liable to lenders if they allow themselves to be used to assist the borrower in misrepresenting the value of the property.

A typical modus operandi is that the lender will be given a contract showing a much higher purchase price than the consideration actually negotiated between the vendor and the purchaser. Stamp duty to be paid on the false amount (and a transfer registered citing the false figure as consideration). The motive of these frauds during good times is to allow a penniless developer to buy a property without actually contributing any money. The motive during bad times (such as the current market) is to allow a developer or other registered proprietor with negative equity to extricate themselves from the property and the existing loan.

The borrower/purchaser’s solicitor will be alerted to the fraud when the purchaser’s solicitor sends a settlement sheet which either refers to the real price or refers to a large deposit (for example 30% of the sale price) which has purportedly already been released to the vendor. Another method is for the purchaser to make up the supposed shortfall with a personal cheque to the vendor on settlement. Often the incoming purchaser will be fictional or a man of straw.

The enraged incoming lender finding that the property is worth far less than the mortgage debt (and the borrower is either non-existent or a very poor man in a far away country) will want to blame someone with a large professional indemnity policy. Accordingly they will be looking for signs that the solicitor who acted for either the incoming or outgoing borrower allowed themselves to be used to give credibility to the scam.

Broker Fraud

A great deal of fraud involves brokers (or more precisely criminals who style themselves as finance brokers). It is very common for brokers to target sole practitioners and offer to refer business to them. They then refer a few legitimate clients to build up a rapport before they refer a vulnerable person who they have convinced to invest money with them. They interpose themselves between the solicitor and his client (the borrower) and rush the transaction through with smooth talk and feigned urgency. Where the solicitor advises the borrower in the presence of the fraudster then he is usually found liable. This happened in Gellert v Bellamy [1999] NSWCA 123, Davies v Camilleri [2000] NSWSC 904, IMB Society Limited v White [2000] NSWSC 1085.

A particular area of danger in such situations relates to cheque directions. There is no point ensuring you (as borrower’s solicitor) deal directly with your client at the time of signing the security documents, if you subsequently allow the broker to procure the cheque directions from the client. Cheque directions are an easy way to defraud the borrower and a solicitor should ensure he covers himself by having a draft of the cheque directions signed at the time of interviewing the client and the final version faxed and verified with a telephone call. Be particularly suspicious when the surplus proceeds are directed elsewhere than into the borrower’s account. You should always verify the client’s bank account details with the client before directing the deposit surplus proceeds in case a fraudster has opened an account with a similar name. It is common practice for security documents to direct the lender to advance the funds as directed by the borrower’s solicitor so this issue arises frequently.

Finance brokers in the numbers and various shades that they now occur are a new phenomenon. Solicitors would be forgiven for equating receiving referrals from brokers with the relatively harmless practice of receiving referrals from real estate agents. The case law suggests it is not so.

False attestation by solicitors

All solicitors at one time or another have experienced a client asking:

You know my signature, if I mail it to you can you witness it?

or more dangerously;

You know my wife’s signature if I mail it to you can you witness it.

The client should be told forcefully and in no uncertain terms that such conduct is fraud. They should be reminded that people go to jail and solicitors get struck off for committing fraud.

Disciplinary consequences of false attestation

There is a long and lamentable list of cases heard by the Administrative Decisions Tribunal, Legal Services Division (and its predecessors) relating to solicitors who have falsely attested to signatures on mortgage documents. Such behaviour is always professional misconduct. The consequences vary depending on whether it is done for dishonest gain or because of a “judgement lapse”. Generally speaking the former are struck off while the latter are fined so long as they realise they committed fraud and show appropriate contrition.

The leading case is the Court of Appeal decision in Fraser v The Council of the Law Society of New South Wales [1992] NSWLST 6. The solicitor was informed that the mortgagors were hard to contact and that there was urgency in completing the transaction so he agreed to sign a document which read: “I, [name] solicitor do hereby certify that I have explained the mortgage documents and memorandum to the mortgagors.” The solicitor compounded this fraud by being evasive when another solicitor questioned him about the certificate. He also refused (before the tribunal) to concede that what he did was fraud and was accordingly struck off the roll. He appealed to the Court of Appeal and following leading questioning in the witness box by the learned judges Handley JA, Kirby P and Cripps JA he finally conceded that what he did was fraudulent. Upon this concession the Court of Appeal saw fit to restore his name to the roll and fine him $7,000.

Liability consequences of false attestation

In State Bank of NSW Ltd v Yee (1994) 33 NSWLR 618 a solicitor who witnessed forged signatures on loan documents was found liable to the lender and ordered to pay $26,000,000 in damages.

In Graham v Hall [2006] NSWCA 208 the Court of Appeal heard the case of a wife whose signature was forged and falsely attested by a Justice of the Peace. In finding the Justice of the Peace liable, Ipp JA (Giles and McColl JJA agreeing) noted:

To refrain from imposing a duty of care on a witness who falsely attests a dealing (with the result that the Registrar-General might be misled into believing that the dealing has been duly executed) would significantly … impair the reliability of our system of registration of real property.

This case was followed in the recent case of Ginelle Finance Pty Limited v Diakakis [2007] NSWSC 60 in holding a solicitor liable for a false attestation.

Professional Indemnity issues of false attestation

As is clear from Fraser v The Council of the Law Society of New South Wales [1992] NSWLST 6 falsely attesting a signature is fraud. This applies regardless of the innocent motives of the solicitor. As such the conduct is excluded by solicitor’s professional indemnity policies6.

In Yaktine v Perpetual Trustees Victoria Ltd [2004] NSWSC 1078 a son forged a power of attorney for his parents in order to borrow on the family home. The solicitor purported to act for the parents falsely attesting to the parent’s signatures on statutory declarations. He also wrote a letter to St George Bank requesting the CT and left a space for the forged signatures of the parents to be placed. The lender sued the solicitor and the professional negligence insurer denied liability and so the solicitor’s cross-claimed. Young J found for the insurer.

This case was followed in Ginelle Finance P/L v Diakakis [2007] NSWSC 60. The solicitor falsely witnessed the loan documents. The solicitor was sued for negligence and cross-claimed against Lawcover seeking indemnity. Hoeben J found against the solicitor and for the insurer. The solicitor was found liable to the mortgagor in the sum of $347,909.24.

What advice needs to be given?

In Fraser v The Council of the Law Society of New South Wales [1992] NSWLST 6 President Kirby noted:

It therefore stands as a warning to mortgagees, mortgagors, their solicitors and the finance industry generally about the importance of the provision of proper and independence advice to mortgagors contemplating the execution of a mortgage. The provision of the certificate of explanation is not a charade or a formality. To it attach important legal and professional consequences.

In Davies v Camilleri [2000] NSWSC 904 Bell J adopted with approval the evidence of an expert witness to the effect that a competent solicitor should advise:

  • The term of the mortgage;
  • The interest rate applicable to the mortgage and whether this rate could be charged during the term of the loan;
  • The interest that would have to be paid under the mortgage if the borrower elected to discharge the mortgage prior to the due date;
  • The costs, registration fees and stamp duty to be incurred as a result of the transaction and who was to pay;
  • The mortgagor’s obligation in relation to insurance and rates and taxes under the provisions of the mortgage;
  • The powers conferred on the lenders should the borrower default in paying interest or in repayment of the principal sum.

Further in rendering independent advice a competent solicitor:

  • Should ask if there are any other issues relating to the transaction about which the mortgagor requires advice or information.
  • Should ideally be alone with the mortgagor and if the mortgagor insists on another person being present the solicitor should be satisfied that the mortgagor is not placed under any pressure from others present.

Rule 45 of the Solicitors’ Rules regulates Solicitors advising on loan or security documents but applies only where the solicitor has been asked to provide evidence of advice. Solicitors should familiarise themselves with its provisions. Aside from the danger of breaching the rule it also gives a very bad impression in the witness box if you are trying to maintain you were not negligent but at the same time are forced to concede ignorance of the rule.

Rule 45.6.2 sets out the mandatory requirements for advising borrowers being:

  1. by signing the documents the borrower will be liable for regular payments of interest and repayment of the amount of the loan at the due date;
  2. if the borrower fails to make any payment on time, the lender can charge a higher rate of interest, and the lender’s costs of rectifying that failure;
  3. if the borrower fails to comply with any of the terms and conditions of the loan including the obligations to pay principal or interest,
    • the lender can sue the borrower personally; and
    • the lender may take possession of the borrower’s property; and
    • after notice, sell it to recover the amount owing together with interest and other costs including solicitor’s costs, the costs of selling the property and the costs of maintaining the property; and
    • if the proceeds of sale of the borrower’s property are insufficient to satisfy the debt to the lender, the lender can sue the borrower for the deficit; and
    • if the Consumer Credit Code applies, additional obligations, rights and remedies may apply as set out in the loan documents.

Rule 45.6.3 sets out the mandatory requirements for advising guarantors being:

  1. if the borrower fails to make any payment on time, the guarantor will be liable to remedy that failure, and that could involve the guarantor in payment to the lender of all amounts owed by the borrower including principal, interest, default interest and the lender’s costs of rectifying the default;
  2. if the guarantor fails to remedy any failure by the borrower to comply with the terms and conditions of the loan in any way, including the obligation to pay principal, interest, default interest, or other charges,
    • the lender can sue the guarantor personally; and
    • can take possession of the guarantor’s property secured to the lender and sell it to recover the amount owing together with interest and other costs, including solicitor’s costs, the costs of selling the property and the costs of maintaining the property; and
    • if the proceeds of sale of the guarantor’s property are insufficient to satisfy the debt to the lender, the lender can sue the guarantor for the deficit;
  1. if the guarantor is a proposed signatory to documents under which the guarantor’s liability can be increased, that fact, and the extent of the possible increase, and of any restriction or limitation of the guarantor’s rights or obligations in relation to the security and any other party to the documents;
  2. the lender can exercise its rights against the guarantor even if it has not pursued the borrower;
  3. the liability of the guarantor is limited to a specified sum, or is unlimited (whichever is the case) and may be affected by cross guarantees; and
  4. if the Consumer Credit Code applies, additional obligations, rights and remedies may apply as set out in the loan documents.

Financial advice

Rule 45

Rule 45.6.4 of the solicitor’s rules requires the borrower to be advised that:

  1. the solicitor does not profess any qualification to give financial (as distinct from legal) advice; and
  2. if the proposed signatory has any questions about any financial aspect of the transaction or the documents, the proposed signatory should consult an accountant or other financial counsellor of the proposed signatory’s choice before signing the documents.

    Extent of the retainer

    A solicitor’s retainer does not by implication require him to render financial advice to a mortgagor or advise him or her to seek the same Citicorp Australia Ltd v O’Brien (1996) 40 NSWLR 398 per Sheller JA at 413/4. It is important to note that the extent of the retainer is not the extent of liability. In Waimond Pty Ltd v Byrne (1989) 18 NSWLR 642 Kirby P said (at 652):

    Although the contract of retainer will be an important indicium of the nature of the relationship which gives rise to the common law duty of care (as the minority held in Hawkins) it will not chart exclusively the perimeters of that duty. Deane J pointed out (at 579) that, depending upon the circumstances of the particular case, the duty may require the taking of positive steps “beyond the specifically agreed professional task or function”, where these are necessary “to avoid a real and foreseeable risk of economic loss being sustained by the client”.

    Wheres the mortgagor is unsophisticated and the purpose of the loan is an investment, there is a duty to advise the mortgagor to obtain financial advice concerning the wisdom of the proposed investment scheme Gellert v Bellamy [1999] NSWCA 123 per Meagher JA7.

    It is, of course, true he was Mrs Bellamy’s solicitor not her financial adviser; but, that did not absolve him from telling her that she should not proceed without arming herself with full knowledge.

    Giles JA in agreement noting:

    .. it was submitted that it was not found that Mr Gellert was retained to give advice of a financial or commercial nature to Mrs Bellamy, or to advise her whether the transaction was a sensible one for her to enter into…The submission misses the point of his Honour’s reasons. There was stark potential for Mr Barton taking advantage of Mrs Bellamy, given their relationship; and Mr Barton’s interest in having the borrowed money, Mr Barton’s prime role in the transaction, and Mrs Bellamy’s apparent willingness to provide the mortgage of her home, were all the more reason for Mr Gellert to question, in Mrs Bellamy’s interests, whether she was acting free of any improper influence.

    In Riz v Perpetual Trustee Australia Ltd [2007] NSWSC 1153 Brereton J found that the solicitors’ retainer was to advise and act on the loan and mortgage transaction, and that the solicitors were not retained to advise on the proposed investment of the loan proceeds. Nevertheless he held

    In my respectful view, the position was correctly stated by Danckwerts LJ (with whom Sachs LJ concurred) in the Court of Appeal in Neuschul v Mellish & Harkavy (1967) 111 SJ 399, that although the duty normally owed by a solicitor to a client only extends to legal advice, it is often difficult in a given situation to disentangle legal and business or practical advice, and a solicitor who is carrying out a transaction for a client is not justified in expressing no opinion when it is plain that the client is rushing into an unwise, not to say disastrous, adventure. The cases that state that it is not the function of a lawyer to give financial advice mean that a lawyer is not expected to bring to his or her task the knowledge and expertise of a stockbroker, an accountant or a financial planner. But a lawyer giving independent advice is required to address the fairness or reasonableness of a proposed transaction, so that the client can appreciate its disadvantages; if this involves matters beyond the lawyer’s expertise, then the lawyer should seek specialist assistance. That is not to say that the solicitor is to be expected to give financial advice – of the type that a stockbroker might – about the proposed investment. But where it is evident that the borrower is relying on the investment to generate the income to service the loan which is secured over the family home, and where at first sight the expectation appears utterly unrealistic, a solicitor acting reasonably would … take steps for the protection of the client’s interest.

    In Riz the solicitor advised the borrower to seek independent financial advice but this was not enough. The solicitor knew that the borrower was intending to reinvest the proceeds in a scheme that promised returns of in excess of 100% per annum. Under those circumstances the solicitor could not be satisfied the borrower understood the nature of the transaction, particularly where the borrower was putting up their home and only asset.

    Borrowers under undue influence

    A common theme in reported decisions is the loan broker who escorts the mortgagor (who is a vulnerable middle aged divorcee or widow) to the solicitor’s office and is present during the giving of advice (this is after becoming chummy with the solicitor by offering to refer work to him). The purpose of the funds is to invest with the broker in some allegedly lucrative investment (caveat lending, gold mines in Indonesia etc) and the money is subsequently lost or embezzled.

    In Davies v Camilleri [2000] NSWSC 904 the borrower was a widow being manipulated by a finance broker who absconded with the money. The solicitor purported to advise her with the broker in the room and was found liable for the amount of the loan.

    In IMB Society Limited v White [2000] NSWSC 1085 Bell J held:

    …it was apparent that Mrs White, a middle aged woman of limited commercial experience, was seeking to jointly borrow as much money as might be raised on the security of her family home. Her income (as disclosed in the material available to the solicitors) was insufficient to service the loan repayments without the support of Mr Maggio… In these circumstances I am persuaded that the solicitors should have sought to confer with Mrs White in the absence of Mr Maggio in order to ensure that she was acting free of any improper influence. I consider their failure to make any attempt so to do to have been negligent.

    In GIO Finance Limited v Cockburn [2000] NSWSC 362 the mortgagor was a juvenile quadriplegic, the security property was a specially equipped house bought with the proceeds of a damages award from motor vehicle accident in which he became an invalid. The boy’s father borrowed against the property for his business which failed and the money was lost. The solicitor acting for the mortgagor signed a certificate stating he had explained the nature and effect of the documents before they were signed and had formed the view that the borrower had the requisite capacity to enter into the transaction. The mortgagor succeeded against the solicitor and GIO who had to contribute 50:50 to the loss sustained by GIO.

    In Gellert v Bellamy [1999] NSWCA 123 Giles JA noted:

    .. it was submitted that it was not found that Mr Gellert was retained to give advice of a financial or commercial nature to Mrs Bellamy, or to advise her whether the transaction was a sensible one for her to enter into…The submission misses the point …. There was stark potential for Mr Barton taking advantage of Mrs Bellamy, given their relationship; and Mr Barton’s interest in having the borrowed money, Mr Barton’s prime role in the transaction, and Mrs Bellamy’s apparent willingness to provide the mortgage of her home, were all the more reason for Mr Gellert to question, in Mrs Bellamy’s interests, whether she was acting free of any improper influence.

    A common trick of fraudsters is to join their victim as a co-borrower under the loan. This provides an excuse for them to be advised together. The indicator there is something rotten going on is that the victim is putting up all the security (owns the property) while the smooth talker who is going to “manage the investment” is putting up no security and has no assets.

    Conflicts of interest

    There are a multiple of cases where solicitors acting for the borrower and the lender have been held negligent to one or both. The Court of Appeal in Gellert v Bellamy [1999] NSWCA 123 conceded that acting for both is not by and of itself culpable (per Giles JA) however it is difficult to see how an unmanageable conflict in a practical sense can be avoided. The following are conflicts that can arise:

    1. A solicitor has a duty to ensure he asks probing questions to ensure the mortgagor is not being unduly influenced (see Davies v Camilleri [2000] NSWSC 904) yet answers given might automatically put the lender on notice (through the agency of the solicitor) of circumstances which would give rise to a defence based on unconscionability.
    2. Any good mortgage worth it salt has clauses in it which are onerous in the extreme. For example one lender has a Call Protection Fee equal to three month interest payable if the borrower refinances with another lender (as opposed to selling or redeeming cash) which is additional to a hefty early repayment fee. If the solicitor tells the borrower about it they are likely to refuse to proceed (effectively killing every loan). If the solicitor tries to assist the lender by not mentioning it then he betrays the borrower.
    3. Section 9(2)(b) of the Contracts Review Act prescribes that the court in deciding whether a contract is unjust shall have regard to whether or not prior to or at the time the contract was made its provisions were the subject of negotiation. A good borrower’s solicitor will try to negotiate the deletion of onerous covenants, a good lender’s solicitor will resist. A solicitor cannot very well negotiate with himself and so in acting for both parties he is at the one time denying the borrower the ability to negotiate a better deal while at the same time exposing the lender to having the mortgage set aside under the Contracts Review Act.

      Sub paragraph 4 of Rule 45 of the Solicitors Rules provides that the solicitor:

      1. must not act for the lender.

      However the rule applies only to loans where the lender has required evidence of independent legal advice.

      1. must not act where he or she has a conflict.

      This adds little to the mix. With or without the rule a solicitor should not act with a major conflict and very minor theoretical conflicts are always manageable with full disclosure.

      1. The solicitor must not advise a proposed signatory in the presence of any other signatory except in accordance with the principles laid down by the Privy Council in Clark Boyce v Mouat [1994] 1 AC. 428 at 437 being:
        • where the interests of the parties may conflict the solicitor may only act for more than one if he/she has obtained the informed consent in writing of those parties,
        • such consent should be given in the knowledge that there is or may be a conflict between the parties, and as a result
        • that the solicitor may be disabled from disclosing the full knowledge which he/she possesses of the transaction, or
        • that the solicitor may be disabled from giving advice to one party which conflicts with the interests of the other or others.

      The problem with the rule in Clark Boyce is that it fails to take into account a person who is being unduly influenced by a co-borrower or other person present at the time the independent legal advice is given. The principles are sound but solicitors should be aware of their inadequacy for dealing with situations where there is undue influence being exercised over one borrower/surety over another.

      Record keeping

      When a solicitor is sued by their borrower client the first indication that things will go badly for said solicitor is a scant file. In particular the absence of:

      1. Copies of the Declarations required by Rule 45.
      2. Originals of the Acknowledgements required by Rule 45.
      3. Copies of the security documents which were executed,
      4. Contemporaneous file notes of the interview when the advice was given,
      5. Signed cheque directions.

      File notes should include the recording of answers to probing questions. The questions should not be confined to the pertinent. As a good practice you should ask the client questions such as what they do, what their children’s names are, how old their children are, where they went on holidays last year, what car they drive and other personal questions. The recording of this information will make it virtually impossible for your erstwhile client to later claim the interview was rushed that you simply witnessed their signatures and did not have time to advise them. Solicitors should consider having the client sign their file notes and initial any particularly pertinent paragraphs.

      The client should always be given a photocopy of every document they signed. The copy should be taken after they have signed it (so they have a record of what they signed). Thus best practice at the end of an interview is to make two copies of the security documents (one for the client and one for your file). It is good practice to ask the client to sign a letter to the following effect:

      I acknowledge you have told me you will hold the security documents in your office and not send them to the lender for the next 24 hours. I have been given a full copy of the signed documents so I can go away and read them and think about the advice you have given me today. If I decide not to proceed with the loan or I want you to try to negotiate an alteration to the terms I should telephone you within the next 24 hours.

      Some solicitors who specialise in providing advice on mortgage documents record the interviews (with the permission of the borrower/client) and save the recording to a CD which is placed with the file. It may sound extreme but it is a sure fire way of avoiding trouble. Many unpleasant hours in the witness box can be avoided by this method. The author, who has used this method, has noted that it also tends to convince the client of the seriousness of the interview and enhance their gravity accordingly.

      Alarm bells

      There is typically no one particular aspect of transaction which leads to a finding of negligence against a borrower’s solicitor. Instead it is usually a series of aspects which, taken together, should have raise alarm bells. In Ginelle Finance Pty Limited v Diakakis [2007] NSWSC 60 one of the solicitors acting for the borrower was found negligent when he allowed the mortgagor’s daughter-in-law to take the mortgage documents to have them signed in front of another solicitor (they were in fact forged). Hoeben J held:

      The legal basis for the claim against [the solicitor] is that he had accepted a general retainer … to act on behalf of Mr Diakakis as mortgagor in the refinancing transaction. Because of that relationship Mr Grogan owed a duty to take reasonable care to protect the interests of Mr Diakakis. Included in that duty was an obligation to satisfy himself that Mr Diakakis understood and consented to the refinancing transaction.

      His Honour then went on to enumerate the various indicia that should have alerted the solicitor to foul play:

      • The solicitor at no time in the transaction had any personal contact with the mortgagor.
      • The unusual circumstance of daughter-in-law requesting that another solicitor advise the mortgagor as to the nature of the transaction.
      • That the previous loans were in default and had been for in excess of four months.
      • That the new loan was for a significantly greater amount in circumstances where payments in respect of the existing mortgages had not been maintained.
      • That the mortgagor was a pensioner and had to rely upon others to make payments in respect of the refinancing transaction in circumstances where those persons had demonstrated in relation to the existing mortgages that they could not maintain payments.
      • That the mortgagor was getting no direct benefit from the refinancing transaction.
      • That the person who appeared to be directly benefiting from the transaction, the daughter-in-law, was the intermediary who was providing all instructions to the solicitor.
      • The urgency with which the daughter-in-law was pressing for the refinancing transaction-to be finalised and her anxiety to receive additional’ monies from the transaction
      • The unattractiveness of the refinancing transaction in that the costs were onerous and the interest rates, particularly default rates, were high.

      The following are some of the things the authors suggests solicitors look out for.

      Unsavoury characters

      Benjamin Franklin’s Poor Richard counselled that he that lies down with dogs shall rise with fleas. Aggressive, disreputable clients with lucrative work are often a recipe for trouble. One solicitor, who recently had his practicing certificate suspended, claimed he was first browbeat then later physically threatened into falsely witnessing signatures on mortgages.

      In another case Picone [1992] NSWLST 17 the tribunal noted:

      Unfortunately the Solicitor was caught up in the classic trap which exists in many conveyancing transactions and which can be illustrated by the following elements:

      • A lucrative conveyancing transaction which is subject to time constraints; and
      • A domineering and aggressive client who is intent upon cutting corners and cares not whether professional standards are lowered in the process.

      Likewise finance brokers who offer to refer clients to a solicitor will often ask that the deal not be killed or are told don’t frighten the client just get the documents signed. Solicitors should choose their clients and business referrers wisely.

      It is no co-incidence that two of the leading cases (IMB Society Limited v White 2000] NSWSC 1085 and Lowy v Alexander [2000] NSWSC 661) involve a one John Maggio who Windeyer J (in Lowy) noted was “apparently a worthless rogue”. In both instances Mr Maggio convinced the hapless owners of almost unencumbered properties to invest in purportedly highly lucrative investment schemes which turned out to be shams. The simple fact is that fraudsters of all sorts tend to repeat their antics (ie: get up to their old tricks) and a simple search of Google or Austlii will often expose them.

      Money going to a third party

      Cheque directions that indicate the loan proceeds are going to a third party should raise concern. Unless the borrower is purchasing property it is unusual for a large slab of the principal advanced not to go through their own account first. It is often the indicator of a scam of some sort. When the dust settles the borrower will want a refund – from Lawcover! An ounce of prevention is worth a pound of increased premiums so solicitors should investigate what the purpose is and satisfy themselves it is not some pie in the sky investment scheme being foisted on a feeble minded victim or a fraud that involves deflecting the money advanced into the wrong account.

      Presence of the third party borrower in the room

      In Gellert v Bellamy [1999] NSWCA 123 Meagher JA stated:

      At no stage did he warn Mrs Bellamy of the danger she was in: any new change in Mr Barton’s affairs for the worse (and they never changed for the better) and her house would go; it would have been prudent for him to have made this clear to her privately, not when there were present any of the other parties for whom he acted; on the evidence, he never saw her apart from Mr Barton. If he were unable to do this, he could have insisted on her taking independent advice from another solicitor, but the thought never seems to have crossed his mind; and this failure is ironically magnified by his having considered that both Mrs Bellamy and Mr Barton should jointly have received independent advice.


      Third party loans to relatives

      In Gellert v Bellamy [1999] NSWCA 123 Giles JA citied with approval the remarks of Hulme J when he said:

      However it seems to me that the proper execution of the instructions in this case required the First Defendant to address the possibility of a conflict of interest between each and every of the parties on whose behalf he acted. Circumstances of oppression or misleading of elderly people by others, particularly those they trust, are notorious – see e.g. The Commercial Bank of Australia Limited v Amadio (1982) 151 CLR 447, of which the First Defendant said he had heard – and given the interest of Mr Barton in the transaction, the First Defendant was under an obligation to take steps to ensure that the Plaintiff was protected against him.

      Relatives may seem very close when they come to see you with a hail-fellow-well-met and laughs all round. Yet two years later the weaker party (against whom undue influence is alleged to have been used) will pour out a tail of woe from the witness box. Insisting on seeing relatives separately may take a little more time but compared to defending negligence proceedings it is actually a very efficient approach.

      Husband and wife scenarios

      Simon Konstantinidis [1992] NSWLST 11

      “at least at some point of time in the transaction, the Solicitor must obtain direct instructions from both parties. It is clearly not sufficient, and this case again illustrates this principle, to simply obtain instructions from one party to a marriage and assume that those instructions come from both parties”

      This decision makes clear that where a husband and wife are involved great care should be taken. Solicitors should take care to verify instructions with both clients.

      Co-borrowers generally

      Practitioners are reminded of Rule 45.9:

      If the solicitor is aware of a possible conflict of interest between the parties to the transaction, the solicitor must, before advising more than one of such parties, obtain the informed consent of each such party in writing in the form of Schedule 5 before such advice is given.

      A schedule 5 form should be used whenever there is one mortgagor or borrower to one transaction being advised. Where one of the parties are putting up all the security consideration should be given to requiring parties to be separately advised.

      1 Resimac, the lender in Koshaba’s case, now requires borrower’s over 60 to obtain independent financial advice (reported in the Australian Financial Review on 20 December 2006)

      2 In IMB although the solicitor was found negligent no loss was caused because the trial judge found the borrower’s confidence in the fraudster at that time was unshakable (and independent legal advise would not have prevented the transaction from proceeding). This decision undisturbed on appeal – White v Illawarra Mutual Building Society Ltd [2002] NSWCA 164

      3 In this case although the solicitor was found liable because the loan was set aside the lender was obliged to bring separate proceedings for contribution. The solicitor lost at first instance but succeed on appeal because equity did not regard the loan that was set aside as being a loss which the solicitor had to contribute too. It was simply a document evidencing a undue influence – Cockburn v GIO Finance Ltd (No 2) [2001] NSWCA 177.

      4 In the case of unregistered mortgages (caveat loans) the lender will not be protected by indefeasibility. Likewise if the fraud is detected before registration the lender will not be protected by indefeasibility. Also see Perpetual Trustees Victoria Ltd v Tsai [2004] NSWSC 745 and cases which followed it which hold all money mortgages do not benefit from indefeasibility.

      5 Often when a fraudulent employment reference is given it will be with a bogus company. A bogus company will have little or no internet footprint.

      6 In earlier cases when the wording of the policies used “brought about” by the solicitor’s fraud the insurer had to pay. See Comino v Manettas (1993) 7 ANZ Insurance Cases 61-162 and Underwriters at Lloyds v Ellis BC 9800334. However this line of reasoning was rejected by the High Court in McCann v Switzerland Insurance Ltd (2000) 203 CLR 579.

      7 See also Davies & Ors v Camilleri & Anor [2000] NSWSC 904

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