There are currently a number of good reasons why secured lenders ought now to be reviewing their books to unearth any mortgage fraud lurking. Limitation is the eternal enemy of claimants and although the Nykredit case of 1997 set out with apparent certainty how it operates for lenders, there have been developments in other arenas that may give rise to concerns about how time bar might operate in practice. Also the advantageous funding regime for claimants is under very serious threat, so acting fast is essential if you want to use it.
Why ought secured lenders now be reviewing their books?
First, the unprecedented run of low interest rates may mean that loans are generally performing, but if interest rates rise in the future and loans default so seriously that repossession becomes inevitable, lenders could face difficulties recovering from third parties if they have not protected their position now in relation to time bar defences.
Second, the regime of conditional fee agreements, allowing those with good cases to run them on a no-win, no-fee basis may be withdrawn in the next few months to a year. Those who can claim in a relatively risk free environment now appear likely to lose that significant advantage as a result of Lord Justice Jackson’s costs reforms.
It is also worth noting that the FSA believes lenders should not sit still in the hope that their books turn out to be (relatively) fraud-free. Findings from the FSA’s June 2011 Thematic Review found that, in relation to lenders’ systems and controls to detect and prevent mortgage fraud, whilst some progress has been made, lenders can do a lot better.
They say lenders should:
- Define systems and controls to detect and prevent mortgage fraud.
- Collect and share MI on mortgage fraud both within their own organisation but also more widely.
- Train underwriters to spot mortgage fraud more effectively.
- Introduce procedures to identify when undue pressure is being placed on underwriters by brokers.
- Carry out a fraud assessment which reviews their back book and clarifies their exposure to mortgage fraud.
Turning to other reasons why it is essential for lenders to seek out mortgage fraud, in addition to the time bar issue:
- Other claims may have eroded the defendant’s insurance policy limit so that the ‘last in the queue’ gets nothing.
- For valuers, they may have gone out of business. Solicitors maintain run off insurance cover even once they have ceased to trade, but once a valuation company ceases to trade their insurance cover may well end, so that any future claimant is left with no asset against which to claim. Many have already gone – Network, Lexicon, Allied but more may follow if the property market stays flat and claims increase meaning PI cover is difficult to renew.
- How robust are the insurance companies? Quinn Insurance went into administration, but they insured a significant number of solicitor firms.
Limitation and time bar – when did a loss arise – when the loan defaulted or at completion?
Six years after breach of contract or actual damage resulting from a negligent act occurs, a claim becomes time barred. The “actual damage” may not be the financial shortfall, easily quantified once a property is repossessed and sold, but could be the ‘paper’ loss where a lender has parted with money and obtained security and repayment obligations worth less than expected. The claim may then be time barred six years following completion, even if a loan is not then actually in arrears, nor the property repossessed and the consequent financial loss quantified.
These rules are fraught with difficulty when interpreted in a lending context. Three recent Court of Appeal cases in other areas have shown an increasing trend towards pinning the start date for time to run to the earliest point. It is a vital issue because either you have a right to claim or you are too late: there are no half measures.
Shore v Sedgwick (2008)
In April 1997 the claimant took pension advice and switched to a personal pension. His new pension fell in value and he issued a claim in 2005 for negligent advice, based on his understanding that he had lost out financially since around 2000. It was held that loss was suffered on the date of transfer of the pension in 1997 because he then held a more risky pension product. It was the possibility of actual financial loss by holding a more risky pension that constituted the legal loss to start the six year period running.
Axa v Akhter & Darby (2009)
In this case solicitors vetted claims being underwritten for after the event insurance by Axa. Axa alleged that the solicitors failed to assess the claims correctly, exposing Axa to higher losses on the ATE product because the claims underwritten had lower prospects of success than intended. The court found that limitation started to run on the professional negligence claim when the solicitor vetted the claim, not when the policy underwritten incurred a heavier loss than intended.
Pegasus v Ernst & Young (2010)
In Pegasus the Claimant sold a business and was advised by the Defendant as to how to minimise his capital gains tax liability. They advised setting up a company in March 1998 to take advantage of reinvestment relief. The scheme failed and the Claimant was exposed to an increased CGT liability. In November 2005 the Claimant issued proceedings for negligent advice but the court found that he was barred from bringing a claim because over six years had passed from the date the scheme was set up, 26 March 1998. At that date he suffered a loss because his tax position was irretrievably altered and despite no financially quantifiable loss then, there was a loss in legal terms because his position had been altered against his interests.
The leading case in relation to lenders is Nykredit (1997). This House of Lords case dealt with the position where negligent advice had been given, causing a loan to be made, yet the loan defaulted and a financially measurable shortfall was only revealed some time later. The Lords decided that the assessment of when the lender incurs damage, to start the six year period, is made by looking at the value of rights that the lender acquires in return for its loan. It receives security in the form of the mortgage over property, but also the borrower’s promise to repay the loan with interest. Only if the value of those, together, is less than the loan balance will actual damage to start time running have occurred. This is an assessment of fact depending on the circumstances of each case, which can be difficult to assess with certainty. It sounds deceptively simple but the leading legal text book on limitation periods says “they are matters of evidence which are in danger of making the determination of the date of accrual almost impossible in some cases”.
Even if a lender thinks it has a package of rights that exceed the loan balance at any given time, a review with hindsight once the loan has been called in, may give rise to arguments that loss occurred at a much earlier stage and that the claim is thereby time barred. Defendants will certainly be seeking out arguments of this nature in light of the recent trend in the Court of Appeal in case they can revisit the Nykredit decision on any particular set of facts.
The difficulty is applying the test when loans are being paid, when there is no apparent urgent reason to worry. Or when the loan is looking unsteady but the lender may wish to support the borrower and treat them fairly. By bending over to help a borrower when they can no longer maintain the originally agreed payments, perhaps by offering interest rate concessions, might time pass and make a claim impossible at a later date when the borrower can no longer sustain a loan even with assistance?
What if a property is overvalued and so at the time of release of the loan the security is not sufficient. If the borrower starts to pay the loan installments in full, then it could be said that no loss has at that point been suffered. But there may be underlying difficulties with the borrower’s ability to repay that only become apparent later when the loan goes into arrears. It may be that the rental assessment relied on by the lender was far too high so that the borrower never realistically stood a chance of maintaining repayments on a buy to let loan. There may be arguments that the package of rights was never equal to the loan sum released by the lender and so legal damage was suffered on loan completion. Or the overvaluation was so extreme that the borrower was never going to be able to repay the loan balance from sale of the property. This is particularly a problem with interest only loans where the capital still needs to be repaid at some point, but the security is unlikely to be sufficient to do that given the serious fall in property prices and continued stagnant values.
If there is any doubt over the borrower’s ability to repay, or the value of the security, then the safest course to eliminate any argument over time bar is to claim within six years of completion.
If you only discover you have a loss later, then there is a further 3 years to claim from the date of knowledge of loss, but this allows arguments over when the claimant first knew or ought to have known of their loss. The courts have not always been sympathetic to lenders who have information about fraud somewhere within their organisation, or ought to have been aware from publicly known frauds, but failed to react properly, for example, Finance for Mortgages v Farley (1996).
Leaving third party claims until after a repossession and sale crystallises a loss is legally risky since the claim may be out of time depending on the facts of each case.
Funding regime – no more no-win, no-fee?
As to the potential withdrawal of the advantageous claimant costs regime, the “Legal Aid, Sentencing and Punishment of Offenders Bill” has been presented to Parliament. If passed, it will implement many of the reforms proposed by Jackson LJ in the Final Report on his Review of Civil Litigation Costs, published in January 2010.
This will mean a radical change to the current system of ‘no win, no fee’ (also known as Conditional Fee Agreements, or CFAs) in civil litigation claims, such that:
- “No win, no fee” success fees will no longer be recoverable from an opponent;
- ‘After the event’ insurance premiums will only be recoverable from an opponent in certain clinical negligence actions;
- Damages Based Agreements, also known as contingency fees will be permissible where ‘no win, no fee’ agreements are currently permitted;
- Contingency fees will be subject to a % maximum.
The CFA regime has offered a very attractive, virtually risk-free, environment for claimants over the past ten years. CFAs have allowed claimants to pass significant costs on to a losing defendant, who pays the claimant’s costs if the case is won. The basic costs are payable, plus a success fee designed to compensate the claimant’s solicitors for those cases lost (where the claimant’s solicitor goes unpaid).
To protect the claimant against the risk of losing the case, and having to pay the defendant’s costs, insurance is obtained, the premium then to be borne by the losing defendant. This shifting of significant additional costs, the success fee and insurance premium, to the losing defendant was considered by the costs review to be objectionable, hence the regime may be coming to an end. The counter argument is that defendants did not settle good cases early enough and thus left themselves exposed to inflated costs, but that fierce debate will shortly be resolved as the legislation is considered by parliament.
The current indications are that the recommendation to revoke full CFAs will be passed, although precisely what replaces them remains to be seen.
Conclusion
Lenders aware of claims can still take advantage of CFAs to address deficiencies in their books. Waiting until loans suffer the consequences of higher interest rates may in some circumstances lead to time bar defences being raised, but also without the possibility of a no-win no-fee agreement there may be reluctance to pursue claims, however good they may be. Acting now to uncover potential problems and deal with them is therefore doubly advantageous.
