A recent lawsuit brought by the liquidators of the Croatian (Toronto) Credit Union Ltd. seeking the recovery of $6.5 million in damages highlights a supposedly new form of mortgage fraud currently affecting lenders and, as is all too often the case, requiring vigilance from mortgage lending lawyers.
The particular fraud in the Croatian Credit Union case was allegedly the work of the former manager and his accomplices, although the lawsuit also sweeps in no less than five lawyers and a real estate broker in multiple separate matters involving millions of dollars in mortgage advances made against collateral that was, in the aggregate, worth only about half a million dollars.
None of the allegations have been proven in court.
Although the manager and his accomplices allegedly defrauded the Croatian Credit Union through a supposedly new scam, it’s only new because it hasn’t been around for a while.
Like most of these types of scenarios, the scam against the Croatian Credit Union is actually a very old form of value fraud that, as far as I’m aware, has always been referred to as an Oklahoma scheme.
An example of a typical Oklahoma scheme goes like this: A fraudster purchaser buys a piece of vacant land for, say, $10,000 from a real vendor in an otherwise legitimate transaction.
The fraudster immediately flips the land to an accomplice for an amount many times its original value like $500,000. The accomplice, armed with a recent transfer or deed and land transfer tax affidavit showing a purchase price of $500,000, then applies to a mortgage lender for a loan based on that value.
Even if the mortgage lender advances a conservative 70 per cent of the value, based on the ostensible $500,000 amount, the accomplice makes off with $350,000 in mortgage proceeds.
In some cases, the fraudsters make a few months of payments in advance. In more sophisticated matters, they make monthly mortgage payments to avoid any arrears and the added scrutiny that special loans attract.
They then run the same scam repeatedly against a single mortgage lender in rapid succession before absconding with the aggregate mortgage proceeds, leaving the lender with one or more valid and enforceable mortgages but on collateral worth a small fraction of the principal amount secured by them.
There are other variations of the Oklahoma scheme, but they all depend on somehow faking the value of the properties in order to dupe the lender into advancing far more than the underlying collateral is actually worth.
They generally don’t work unless there’s some defective link in the mortgage lender’s due diligence protocols, whether it’s reliance on a fraudulent participant or a faulty system that doesn’t require any evidence of value other than the last registered deed or an agreement of purchase and sale.
Typically, it’s a fraudulent appraiser, but in the Croatian Credit Union case, there was a manager who was allegedly in on the frauds and who facilitated the mortgage loans on knowingly exaggerated values. Of course, once someone like a manager is actively involved in the frauds, there’s really no stopping the Oklahoma scheme from running on.
It certainly seems to be the case in the Croatian Credit Union matter that the frauds went on for a long time.
In fact, the value frauds didn’t come to light until the owners of neighbouring properties started to complain to the local tax assessment authorities about their outrageous new property tax reassessments.
They, of course, stemmed from the artificially inflated deed values of the nearby fraudulently mortgaged properties.
The standard of care for mortgage lending lawyers caught up in Oklahoma files isn’t that clear, but it’s probably now incumbent upon lawyers to advise their lender clients of recent flips in the title to mortgaged property, especially in cases where the searches show sudden and vastly escalating values.
That said, it’s hard to believe that it’s now incumbent upon lawyers who find themselves in the middle of an Oklahoma scam to actually advise of a pending fraud or alert the lender to anything more than the fact that a recent flip transaction shows up in the title search.
I make a huge distinction between pointing out a peculiar circumstance, on the one hand, and alleging fraud every time a file has one.
It’s presumably still the lender’s role to assess whether the flip with escalating prices is a legitimate transaction or is part of a fraud. After all, there may be many legitimate explanations for why the price of a piece of collateral has gone up.
Those are appraisal issues that a lawyer shouldn’t be responsible for. It should be enough that the lawyer provided the client with the information in the title search.
Nor should it be the responsibility of lawyers to blow the whistle above the client contact they would ordinarily have reported to.
For instance, in the Croatian Credit Union case, there was a manager who was allegedly in on the frauds. It’s hard to believe, then, that it would have been incumbent upon the lawyer to go above the manager.
Of significant importance to the bar is the fact that Oklahoma schemes in most of their variations aren’t title or mortgage frauds in the classic sense. The mortgage is typically valid and enforceable in accordance with its terms.
The property used as collateral exists and is usually duly charged as security for the mortgage loan. The lender can always sell the property under power of sale or foreclose.
The only problem is that the mortgaged property is worth significantly less than it was supposed to be. As such, Oklahoma schemes are typically not covered by title insurance.
Lenders, not their title insurers, are fully exposed to the risks of these types of value frauds. Unfortunately, lawyers will face lawsuits by these lenders when an Oklahoma fraud leaves them with significant deficiency judgments against the absconded fraudsters.
Jeffrey W. Lem is a partner in the real estate group at Miller Thomson LLP. His e-mail address is [email protected].
