Managing mortgage risk

The three biggest risks in mortgage claims are:

1. not adequately advising borrowers or third party guarantors about the transaction but certifying the advice has been given

2. not recognising a mortgage fraud situation

3. not advising lender clients about the lack of or inadequacy of security.

Mortgage related claims often appear as the second or third most expensive area of claims in any given year.

New and varied solicitor’s certificates, especially relating to self-managed superannuation funds, are still being generated. Practitioners must be on their guard to ensure they comply with rule 11 of the Legal Profession Uniform Legal Practice (Solicitors) Rules 2015, which provides that practitioners are only permitted to use the Law Society of NSW or Law Institute of Victoria form of certificates when giving evidence about advice they gave borrowers or guarantors.

Given these developments and the number of mortgage claims, there is no room for complacency in this area. The adage ‘prevention is better than cure’ is never more true than in this area of the law.

Refresher

Commercial Bank of Australia -v- Amadio and Anor [1983] HCA 14; (1983) 151 CLR 447

In this landmark case impacting on the involvement of practitioners in lending transactions, the High Court held that a mortgage and guarantee provided by Mr and Mrs Amadio to support an overdraft facility to their son’s building company should be set aside.

This was in light of the bank’s unconscionable conduct in obtaining execution of the mortgage and guarantee when it should have been evident that the couple were under a special disability or disadvantage, namely:

• their age and limited understanding of English
• their reliance on their son in business matters without the benefit of independent advice
• the circumstances in which the documents were signed.

As a result of the Amadio case and others which followed, the need for security providers, including surety mortgagors, guarantors and direct borrowers, to receive independent legal advice in lending transactions has become a regular part of the lending procedure in Victoria.

Lenders now commonly stipulate that security providers must receive independent legal advice from a practitioner before signing the documents and the practitioner must sign a certificate confirming the advice has been given.

A large number of practitioners have been sued by both security providers and lenders regarding the advice given or the lack of it! Such claims are known as ‘Amadio claims’ and they commonly occur in the following two ways.

1. The practitioner provides a certificate that advice was given and it is later contested.
2. An unrepresented security provider alleges the practitioner either acted for them or owed them a duty and failed to protect their interests.

Solicitor’s certificate claim

In this type of claim the practitioner is asked to provide a solicitor’s certificate to the effect that the documentation relating to the transaction was explained to the security provider. This advice is then disputed, and it is often alleged that the practitioner did not adequately explain:

• the full extent of the amount secured by the documents or
• that action might be taken against the security provider to recoup the funds, such as forced sale of the security provider’s home and financial destitution.

Some firms have a policy that only one person in the office is authorised to provide solicitor certificates. This controls the types of clients for whom certificates are given and the quality of advice provided.

LPLC’s claims experience shows that there are two high risk categories when providing solicitor’s certificates; new clients and third party security providers.

New clients

The highest risk category of solicitor’s certificate claims are new clients, particularly clients who walk in off the street. It also includes referrals from relatives, a bank, finance broker, agent or other third party. A problem we typically encounter is that the practitioner treats the attendance as a request for mere witnessing of documents, rather than an occasion calling for the provision of professional advice.

The claim above highlights the importance of being vigilant when providing a solicitor’s certificate, especially when new clients are referred to practitioners on an ongoing basis from one source such as a finance broker.

Some practitioners and firms refuse to provide certificates other than to existing clients because they regard the risk as too high. They regard clients who ‘walk in off the street’ as a particular risk.

The claim above highlights how an Amadio-type claim can arise even where a client is known to the firm and how important it is to:

• keep good files notes for all attendances
• explain in strong terms the obvious practical implications of entering into a transaction, particularly in light of a client’s financial position. This is especially important where the client is elderly and/or of limited financial means.

For another example of this sort of claim, see the case of Provident Capital Ltd v Papa [2013] NSWCA 36. There is a summary of this case under the Improvident transactions section below.

Claims by spouse/de facto

Another common scenario involves one domestic partner guaranteeing the debts of the other domestic partner or their business. Most typically this is the wife or female de facto spouse.

Conflict

In some Amadio claims where practitioners gave advice to third party guarantors, it was later alleged the practitioners either acted for the borrower in the same transaction or had acted for the borrower in other transactions and therefore had a conflict of interest.

The courts subjectively weigh each case on its merits to determine if the advice given by the practitioner was adequate to alert the guarantor to any relevant risks. Conflict will be just one of the issues to be looked at. A practitioner acting in conflict is more likely to be sued for negligence or breach of their fiduciary duties.

Conflict can also occur when acting for co-guarantors where the co-guarantors have different interests. These include husband and wife directors, business partner directors, and husband and wife where one is director but the other is not and doesn’t have any knowledge of the business financial situation.

Unrepresented security providers

In these type of claims the practitioner believed they never acted for the security provider who was unrepresented, but only for the borrower (or in some cases, the lender). This is not the view of the security provider who argued that some kind of retainer existed, or duty was owed and the practitioner failed to protect their interests. In those cases the security provider also alleged the practitioner had a conflict of interest.

Transactions involving security providers always require caution, especially where the parties are unrepresented. Often it is these parties who are inclined to argue that they would not have signed the document had they been properly advised.

We still see cases where a practitioner, sued by a security provider claiming a retainer existed or duty was owed, steadfastly maintains they were only acting on behalf of the borrower. However, the manner in which the practitioner conducted the matter can sometimes be open to contrary interpretation. It is easy for an unrepresented security provider to interpret contact from any practitioner as being the practitioner acting for them.

The correct form of certificate

Forms:

Client expectations

Using the LIV or NSW Law Society’s form of certification does not solve all the problems associated with Amadio claims. One of the reasons is that lenders tell their customers that their security documents need to be signed in front of a practitioner, rather than they need to seek legal advice before signing the documents. The emphasis is often placed on obtaining the signature rather than obtaining the advice.

This incorrect approach primes clients to expect the process of obtaining a solicitor’s certificate is akin to having a passport application witnessed leading to them becoming dissatisfied by the procedures and costs involved.

In response to LPLC’s concerns, at the time the solicitor’s certificate package was launched the Australian Banking Association (ABA) encouraged a branch-level education program about the legal service value of the certification process. In particular, the program included instructions that bank officers should:

• not advise customers to come back ‘in five minutes’ with a signed solicitor’s certificate
• explain to customers that it is the bank’s requirement that a solicitor’s certificate be obtained
• explain to customers that legal advice is required, not merely the witnessing of documents
• advise customers that the practitioner will need to consider the documents before providing legal advice and be entitled to charge a reasonable fee for the service.

The ABA has created a Code of Banking Practice which covers a wide variety of issues. In particular it prescribes the information banks should give to guarantors before they accept guarantees from them. This includes telling the guarantor they should obtain independent legal advice as well as giving them information about the credit facility that is to be guaranteed and the creditworthiness of the debtor. A copy of the Banking Code of Practice as well as a list of the banks that have agreed to comply with it is available on the ABA website.

New and/or inappropriate forms of certification

Some banks, financial institutions and franchisors have deviated from the solicitor’s certificate package both in form and substance. Some forms purport to certify matters other than explanations of mortgages or guarantees.

Certificates with misleading headings

In some cases a certificate headed ‘Certificate of witness/identification’ not only asked for certification that the signatory was one and the same person as that named in the mortgage but also asked for certification that the signatory had signed the mortgage of their own free will and with full understanding of the documents. This document was, by stealth, a solicitor’s certificate. Always read the document before signing it and do not rely only on the heading.

Inappropriate warranties

We have seen certificates where the borrower’s practitioner was asked to certify that the loan documentation was enforceable against the borrower. Another form of certificate stated that ‘the practitioner will warrant the warranties provided by the guarantor’. Neither of these certificates or warranties are appropriate for a practitioner to give when acting for the borrower or guarantor.

Certificates that are too broad

A certificate titled ‘Certificate of independent legal advice’ was forwarded to LPLC. It looked similar to the LIV certificate but required the practitioner to certify broadly that the practitioner had ‘advised the borrower before any documents listed in the certificate were signed’. There was no further detail about what the advice covered.

The document also contained a statement that ‘This certificate cannot be relied upon unless it is in the exact form prescribed by the Law Society of NSW without alteration and … is given by the holder of a current practicing certificate…’. This gave the impression that the document had the imprimatur of the Law Society of NSW which it did not. Eventually the lender in question was persuaded to accept the LIV form of solicitor’s certificate instead.

Certificates about financial advice

A certificate referred to us required an independent financial adviser to advise the client about the financial impact and effect of the loan. The loan capitalised the interest. Much of the certificate referred to financial advice and there were also aspects that appeared to require legal advice. When asked whether a practitioner was required to sign the document, the bank indicated that ‘many practitioners’ had signed such certificates. For this style of loan, the bank did not require a separate solicitor’s certificate. While it was clear that clients seeking to enter into these types of transactions required legal advice, it was equally clear that the type of certificate provided by the bank went beyond the realm of legal advice, and was not one practitioners should sign.

Trust opinion certificate

Rule 11 only covers advice given to borrowers, guarantors and mortgagors. It does not cover the trust opinion certificates or letters that practitioners are asked to sign where the borrower is a trust. These opinion letters or certificates are not usually evidence of the advice that was given but rather the borrower’s practitioner’s opinion about various matters relating to the formation of the trust and its entitlement to borrow the money including that:

• the trust documents given to them contained all the terms of the trust
• there was no conflict of interest which would preclude the trustee entering into the loan and
• the loan was for the benefit of the trust.

These facts are often outside a practitioner’s knowledge and may take a substantial amount of time and money to verify. Practitioners should not sign these documents if they cannot verify the truth of the statements.

LPLC has included here a typical opinion certificate used by the major banks and LPLC’s comments to assist practitioners when asked to provide such a certificate.

SMSF certificates

Practitioners acting for self-managed superannuation funds (SMSF) borrowing money are usually asked to provide certificates to lenders that go beyond certification of advice given and become opinion letters like the trust opinion letters discussed above.

The certificate usually provides that the practitioner has reviewed certain documents including the loan documents, deed constituting the superannuation fund and bare trust deed. The practitioner is often required to certify that the superannuation fund has been validly constituted and complies with the Superannuation Industry (Supervision) Act 1993 (Cwlth) (SIS Act). This is not something many practitioners will know and it is more appropriate that these compliance matters be referred to the client’s auditor.

A practitioner is also unable to advise on matters beyond their control. For example, a certificate may require the practitioner to certify that on completion the bare trustee will be the registered proprietor of the real estate. The lender will have the control of the transfer of land following settlement and so should not require the practitioner to certify such a matter.

Other matters may be known only to the borrower, and the borrower should provide any necessary certification relating to these matters, such as the requirement to certify that the loan funds will be used to acquire the real estate.

There is some argument that the effect of the wording of this type of certificate is that a practitioner is advising the lender. This may give rise to a conflict with the duties owed to the borrower. Wherever possible the lender should be told this and that the opinion required should more properly be given by the financier's legal advisors.

Franchise certificates

We have seen many and varied solicitor’s certificates relating to the purchase of a franchise as there is no standard form. Practitioners should read these certificates carefully and not sign one that states the practitioner advised the franchisee and the guarantor unless they are the same person.

Use of statutory declarations

Rather than seeking a certificate, a lender may request the practitioner witness a statutory declaration given by the security provider attesting to certain matters about the loan transaction.

By witnessing the client’s statutory declaration that they have received legal advice the practitioner is effectively giving a solicitors certificate in stealth. Their signature on the statutory declaration is effectively a representation to the lender that the practitioner did give the advice, because it would be inappropriate for a practitioner to witness a statutory declaration they know to be false.

Practitioners who give the client advice about the documents and transaction, and then witness the client’s statutory declaration to that effect, need to treat this as if they are giving a solicitor’s certificate. Follow the guidance given above and the recommendations below. In particular, the advice that should be given, keeping a file note of what occurred at the meeting and confirming the advice in writing.

Many recent cases have considered whether practitioners should have advised their clients against proceeding with various loans because the intended investment was unwise or unsafe.

Dominic v Riz

In 2009, the New South Wales Court of Appeal decision of Dominic v Riz [2009] NSWCA 216 softened the obligations on practitioners to advise clients about self-evidently absurd or improvident transactions.

The case concerned Mr and Mrs Riz, who intended refinancing their home to invest in a high-risk scheme and expected to receive a return on the investment that was described at first instances as ‘absurd’. The trial judge held that although the retainer was to advise and act on the loan and mortgage transaction, the duty of care extended beyond the limits of the retainer where the subsequent transaction was so improvident and risky. The trial judge found the practitioner liable but the Court of Appeal reversed this decision.

The Court of Appeal in Riz said the trial judge had gone too far in finding that practitioners explaining loan and mortgage documents are obliged to address the fairness and reasonableness of the underlying transaction. The court noted that the circumstances in which practitioners have a responsibility to act outside the retainer are ‘less than clear’. It acknowledged that if a practitioner sees something outside the retainer that could adversely affect the client they may be obliged to inform the client about it.

The Court of Appeal found that the practitioner had given the clients clear advice that they needed to obtain independent legal and accounting advice about the investment. The practitioner knew nothing about the investment other than that the expected return was very high. The clients were found to be aware of the risks involved.

Prior to the appeal being decided, other decisions explored the scope of the duty of care and whether it may extend beyond the scope of the retainer to include advice on the commercial wisdom of entering a transaction[2]. The courts have not been inclined to impose a duty in circumstances where the practitioner did not assume responsibility to the client or there was no reliance by the client.

[2] David v David [2009] NSWSC 8, Kowalczuk v Accom Finance [2008] 343, Spiteri v Roccisano [2009] VSC 132; Permanent Custodians v king (2009) NSWCA 600

Provident Capital Ltd v Papa

Since Riz the Court of Appeal in NSW has further commented on the duty of practitioners in Provident Capital Ltd v Papa [2013] NSWCA 36. The practitioner was giving Mrs Papa advice relating to borrowing money which she was then giving to her son for his business. The court found the practitioner should have brought to the attention of Mrs Papa in strong terms the obvious practical implications of her entry into the transaction and he failed to do so.

Risk management

It is good risk management in mortgage and loan transactions to specify:

• the scope of your retainer
• that you are not giving financial advice
• that the client should obtain their own financial advice.

Commercial v financial advice

This may not provide complete protection in the event the client enters into a blatantly improvident transaction. The Victorian Supreme Court in Spiteri v Roccisano [2009] VSC 132-22 VR 596 acknowledged that ‘in some cases there may be no bright line of distinction between legal and commercial advice where a practitioner is acting for a client in a commercial transaction’. There is often a blurry line between what is financial and what is legal advice.

While it may be tempting not to ask about the client’s arrangements, there is a risk that a court may say you should have known, been suspicious or made further enquiries. To avoid that risk, be proactive − you need to know enough about what the client is doing to determine if the matter is clearly improvident, absurd or ‘too good to be true’.

Ask your client questions such as:

• why are they entering into this transaction?
• what are they planning to do with the money they are borrowing and what do they hope to gain?
• if they are investing the money, what sort of investment is it and is it a managed investment scheme?
• if it is not a managed investment scheme, does the client know what safeguards there are, what security is offered and what that security is worth?

If it is clear the client needs to get independent financial advice, forcefully recommend that to the client and give them the opportunity to obtain that advice before proceeding.

If your client elects not to obtain independent financial advice, consider having them sign an acknowledgement that:

• they were advised to do so
• they declined to do so for the following reasons – (set out what the client tells you about their reasons)
• they are acting contrary to your recommendations in that regard.

In claims involving mortgage fraud, sometimes the fraud is committed by a family member on elderly parents or a spouse. While the practitioner is not usually involved in the fraud, their failure to detect tell-tale signs and properly manage the advice and certification for the loans often facilitates the fraud.

Here is a shortlist of many signature features of mortgage fraud claims. If any of these are present, take extra measures to ensure the borrowing is bona fide.

Signature features of mortgage fraud

• It’s a family affair: adult child defrauds elderly parents, or one spouse against another.

• Lost or missing duplicate certificate of title.
• Urgency.
• Excuses concerning the unseen borrower.
• No photo identification produced by the borrower.
• One or more of the registered proprietors is overseas and only contacted through a family member or third party.
• A third party is actively involved such as: a non-borrower providing instructions, or a broker.

• Certification is being provided to a new client.
• High risk lender and unencumbered title.
• Settlement money is going to a third party.

• Errors and omissions in the details including: spelling mistakes in names or use of anglicised names different to the names on identity documents, omissions or incomplete details.
• Inconsistencies in forms of signature.

Incomplete certification

Incomplete or negligent certifications by practitioners can have the unfortunate effect of facilitating a fraud. There are good reasons for going through all the steps including verification of identity and these should not be skipped.

Missing certificate of title

Mortgage fraud is becoming more sophisticated. In one case the perpetrator even took the trouble to forge a practitioner’s signature on a certificate. Lenders’ practitioners need to be alert to this possibility, particularly where suspicions are already raised. A lender’s practitioner may be exposed to liability by relying on a flawed certificate or advising a client to proceed in the absence of a title.

Claims in this category occur when practitioners are acting for lenders of all sizes − lending institutions, private lenders and smaller and second or third tier financiers. They do, however, occur more frequently when acting for private lenders, particularly on short term or urgent loans.

Common mistakes

No or inadequate security mistakes occur because a firm:

• fails to register the mortgage where the practitioner:

- simply forgot to register the mortgage

- delayed in registering the mortgage allowing a third-party caveat to be lodged after settlement

- failed to obtain consent of any prior registered mortgagee

- lost the mortgage or it was stolen

- failed to detect that the property comprised more than one title and the mortgage was only registered over one of the titles

- was unwell and didn’t manage to register the mortgage and there was no-one there to pick up the mistakes.

• fails to realise that the borrower was a half owner or not the owner of the property they were purporting to mortgage
• fails to advise the lender about obtaining security, often because the practitioner didn’t clarify the limits of their retainer and thinks they are just documenting the deal and not advising the client on the deal
• fails to advise the lender about the unusual nature of the security property, such as:

- unusual terms in a lease

- planning schemes

- encumbrances on title

• fails to pick up a problem with the written valuation
• fails to lodge a caveat where a mortgage is unregistered, resulting in a loss of priority
• acts for both sides and doesn’t protect one client by checking what they otherwise would if only acting for one party.

See also LPLC article: Independent valuations essential for lenders.

Mortgage drafting mistakes

If the mortgage is not properly drafted the security it purports to protect will be illusory. In the case of Hunt & Hunt Lawyers v Mitchell Morgan Nominees Pty Ltd [2013] HCA 10 the registered mortgage was an all monies mortgage that referred to the loan documents rather than set out the indebtedness in the mortgage itself. Because the loan documents were found to be forged and unenforceable the mortgage was found to secure nothing.

Mortgagee identifying mortgagor

Section 87A of the Transfer of Land Act 1958 (Vic) requires a mortgagee to properly verify the authority and identity of a mortgagor by taking ‘reasonable steps’ before the execution or variation of a mortgage.

A mortgagee is able to satisfy the onus by either following the standards set by the Registrar or the Model Participation Rules. If a fraud is committed and reasonable steps were not taken to verify identity the lender will lose the benefit of indefeasibility and the mortgage will be void.

In C & F Nominees Mortgage Securities Ltd V Karbotli & Ors [2020] VCC 987 the court found that the lender had not taken reasonable steps to verify the identity of the mortgagor by relying on a solicitors certificate of a solicitor who was advising the mortgagor about the loan and mortgage documents. In this case the mortgage was witnessed by someone other than the solicitor providing the solicitors certificate.

The three major equity release products commercially available in Australia are reverse mortgages, home reversion schemes and equity release agreements. Although ASIC provides some advice about the risks of these products on their MoneySmart website these products pose a range of complex issues and risks for practitioners.

Some important variables to consider in assessing the effect of an equity release transaction are:

• the loan or equity release amount
• rate of interest which is usually variable and other fees
• value of the property which can fall as well as rise
• the borrower’s life expectancy.

Typically, these products involve no repayments and capitalise interest or reduce the homeowner’s equity in their property. Equity is often eroded very quickly and they are often more expensive than traditional forms of borrowing. There is an inevitable measure of uncertainty about the size of the ultimate debt.

As with other forms of mortgage, lenders and equity release providers require borrowers/homeowners to obtain independent legal advice about the transaction before proceeding. In turn, practitioners may be asked to certify that their client has received independent advice about the nature and effect of the transaction.

Before you advise and certify

The client should discuss product alternatives with an independent financial advisor and choose one on the strength of financial advice, including Centrelink and tax issues, before the practitioner provides legal advice. The client should also consider potential suitability of other options such as downsizing, assistance from family members and the Pension Loans Scheme. There are no ‘standard’ products or conditions, so before dispensing legal advice spend time reading the fine print. The practitioner needs to understand the mechanics of the transaction including when the title changes hands, what security the borrower has, and particularly, the range of default provisions.

Also consider whether the contract contains any potentially unfair terms and complies with the consumer protection requirements contained in the National Consumer Credit Protection Act 2009 (Cwlth) (NCCP) which includes the National Credit Code. It is also important to consider whether the client has capacity to enter into the transaction.

Why equity release?

Understand the context of the proposed borrowing or equity release transaction. Remember that equity release products are often a more expensive form of finance than conventional loans. They should be understood as a choice of last resort.

Explain the nature and effect of the transaction as well as its risks clearly to the client and document that advice. Record why the client wants to use this product and what they understand of the transaction and the risks. Some situations might require the practitioner to take extra precautions, for example where the borrowing is for the benefit of a third party or intended as a gift.

Act very cautiously where the client appears vulnerable to the influence of another party, the documents are being signed under a power of attorney, English is not the client’s first language, there is undue haste to complete the transaction, or the loan money is to be disbursed to a third-party account. If you consider the client is acting under duress decline to act.

The retainer

Charge an appropriate fee for the advice. Providing the certification for a borrower is more than simply witnessing a document. The process will take time and judgment. Be clear that the advice being provided is legal and not financial advice.

LPLC general comments

The certificate example below contains clauses which are commonly found in certificates or opinion letters requested by lenders where the borrower is acting in the capacity as trustee of a trust.

LPLC recommends that opinion letters or certificates of this kind should not be signed by the borrower’s practitioner. The information required in these documents is information the financial institutions should be satisfying themselves, and not requiring borrower’s practitioners to certify.

If practitioners decide to give the certificate or opinion they need to understand that there is considerable work required to satisfy themselves about the issues raised, and there are some matters that just should not and cannot be answered.

LPLC’s comments have been inserted in the certificate as a guide to the matters which need to be considered.

Before a practitioner can provide any certificate to a lender they need to:

• obtain sufficient information and instructions from the client including the original trust deed and any variations
• explain the certificate to the client and also explain any concerns relating to the certificate and seek the client’s instructions to request that the lender amend its certificate as required by the practitioner.

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