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Mortgage fraud and illegality: The latest from the courts

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21/10/2021

Walker Morris Partner and Banking Litigation specialist Richard Sandford highlights Victus Estates v Munroe and Benjamin v Victus Estates [1], which demonstrates the courts’ up-to-date approach to mortgage fraud cases and the illegality defence, and offers practical advice for fraud prevention and cure.

Why is this case of interest?

Back in January of this year, we explained that, for a variety of reasons, 2021 was likely to see an increase in the commission of mortgage frauds.  Recent bank account fraud research from Experian confirms that loan fraud rates rose by 40% in Q2 2021, its highest reported level in the last three years and up 63% on the same period in 2020; and that identity fraud related to loans (where an individual gives false information or misrepresents their identity to access a product on more favourable terms) also rose by 18%.

One very common area of mortgage fraud risk, which often involves identify fraud and/or forgery, is co-ownership.  It can give rise to one co-owner borrowing against a property without the knowledge and consent of the other and it can facilitate schemes designed to defraud co-owners of their interest and banks of their security.  The Victus Estates case involved one such scheme, perpetrated across two co-owned properties.  (Details of the case are set out below.)

The case is of particular interest and use for mortgage lenders and their advisers, as well as all asset recovery professionals, because it confirms that, in many cases, a fraudster who has given false information or forged documents, will not then be able to rely on the illegality defence so as to void a transaction and leave co-owner victims and/or mortgage lenders with no legal recourse.

What practical advice arises?

The fraud in Victus Estates was perpetrated by one co-owner (the seller) in cahoots with the buyer, without the knowledge of the other co-owners of the properties.

The best fraud risk management strategies help to avoid that scenario via a combination of both proactive steps (for example, putting into place systems, processes, identity and document checks etc when customer data is collected and stored – often as part of the on-boarding/account-opening process); and reactive mitigation and recovery action (where fraud is suspected and/or detected).

In particular, to mitigate against the risk of mortgage fraud involving co-owners, the following practical pointers may assist:

  • Staff education is crucial. Lenders should ensure that their own colleagues are fully trained to be aware of fraud risks, to understand why risks are in fact risks, to spot indicators of fraud, and to follow mandatory processes and procedures to mitigate against and/or to react to incidences of potential fraud.
  • Due diligence on applications. Adopting rigorous Know Your Client (KYC) due diligence and really probing a loan application to get to know and understand the people involved (including all co-owners and, where possible, any other parties to the transaction), as well as the true purpose behind it, can be crucial.
  • Query applications and advice. Lenders should not be shy in raising issues or querying applications, transactions or advice they receive from solicitors, valuers or brokers.  Such individuals will be at the forefront of the transaction and, as such, may be better placed to spot mortgage frauds.
  • In-person valuer checks. Mortgage valuers should ideally visit properties in person – particularly any high value/high risk properties. When doing so, they should be asked to ensure that they meet [all of the] the genuine owner[s] (for example by comparing the ‘owner[s]’ that they meet with the ID[s]/photograph[s]/information on the lender’s file.
  • Obtain consent from all co-owners. When dealing with jointly owned properties, lenders/conveyancers should ensure that both/all proprietors are aware of and consent to the proposed transaction. If it is not possible to meet all owners to conduct such tests face-to-face, phone calls or (even better) audio-visual options such as Zoom, Teams, FaceTime and the like, should be utilised.
  • In today’s market, Fintech solutions also abound.  Proactive Fintech solutions, many of which can be deployed in real time, include multifactor authentication and identity verification tools, biometrics, tokens, enforcing complex password requirements, anti-malware, firewalls, and network analytics and dynamic scoring.  All such tools can all be invaluable in ascertaining the identity of, and relationships between, parties to a transaction.  Other, more reactive, Fintech solutions can perform millions of fraud checks within seconds, via data aggregation, pattern recognition and the use of Artificial Intelligence.

The best advice is for lenders and their professional advisers to combine a stringent human-led KYC approach with suitable digital safeguards.

What happened in the particular case?

The fraud in Victus Estates was perpetrated by one co-owner (the seller) in cahoots with the buyer, without the knowledge of the other co-owners of the properties.  The fraudulent scheme was designed to take the co-owners’ equity away from them and to leave the banks with no security.

In relation to the fraud against the co-owners, the judge in the County Court had held (and the matter was not in issue in the High Court appeal) that the fraud did not succeed by virtue of the fact that the seller had forged the co-owners’ signatures on the relevant transfer documents.  The innocent co-owners therefore retained their half shares in the respective properties.

The High Court appeal was concerned with the questions:

(1) were the fraudulent transactions a sham and of no effect, or were they nevertheless effective to transfer the fraudster-owner’s beneficial interests in the property to the buyer?  and

(2) in the latter scenario, in circumstances where the buyer then charges the properties to a lender, should the court hold that equitable interest remains with the seller so that the buyer does not acquire any interest and is incapable of charging any interest in favour of the lender?

In accordance with the Supreme Court’s decision in Patel v Mirza [2], the High Court exercised its discretion to ensure that the defendants could not rely on the illegality defence to render the fraudulent transactions void for all purposes.

The court found that, in accordance with the case of Grondona v Stoffel & Co [3], fraudulent transactions will not always amount to a sham and property rights (including equitable rights) can pass under an illegal contract.  Here, the transfers (TR1 forms) were in a form which satisfied the statutory definition of a conveyance [4] and so, despite the fraud, section 63 of the Law of Property Act 1925 applied with the effect that the fraudster-owner’s beneficial interests in the properties passed to the buyer.  It followed that the banks therefore had an equitable charge over those interests.

How we can help

Walker Morris’ cross-disciplinary Financial Services specialists are experienced and expert in dealing with all aspects of mortgage fraud prevention and cure, ranging from the provision of staff training and the preparation of policies and procedures to prevent, mitigate and respond to fraud; to litigation, tracing, recovery and enforcement action when the worst does happen.

If you would like to discuss any of the issues covered in this article, if you are interested in Walker Morris fraud prevention training, or if you would like any further advice or assistance in connection with mortgage or bank account fraud, please do not hesitate to contact Richard Sandford.

 

[1] [2021] EWHC 2411 (Ch)

[2] [2016] UKSC 42

[3] [2020] UKSC 42

[4] Law of Property Act 1925 s. 205

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