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Posts Tagged ‘escrow’

Closings Gone Bad

Posted on: October 25th, 2018

By: Dana Maine

Nathan Hardwick IV was convicted by a Northern District of Georgia federal jury on October 12, 2018 of embezzling $26 million from the accounts of his former firm, Morris Hardwick Schneider.  $20 million of this amount was from the firm’s escrow accounts.  The good news for clients of the firm is that firm’s insurer, Fidelity National Finance, stepped in to cover most of the escrow shortfall.  All parties to real estate closings were watching this trial and trying to understand how this scheme could have gone on for as long as it did and involve this amount of money. There are lots of lessons to be learned, and policies to be implemented.  Doubtless, attorneys for escrow agents and their insurers are scurrying to draft these new policies and put them in place.  Hardwick’s sentencing is set for December 19.  He will remain in custody until sentencing.

If you have any questions or would like more information, please contact Dana Maine at [email protected].

Banks Attempt to Expand the Scope of Liability for Escrow Companies

Posted on: April 27th, 2018

By: Bryce M. Van De Moere

The collapse of the subprime mortgage market in 2008 created shock waves still felt today.  Over-extended lenders such as Washington Mutual and Countrywide failed; larger financial institutions absorbed their loans and were tasked with trying to administer, process and enforce hastily executed loans poorly documented.

As the surviving financial institutions complete clearing out the remaining bundled loans, a trend has emerged where large institutions attempt to shift responsibility for collection of outstanding loans to other professionals in the real estate sales market.  A target of big banks seeking to protect themselves from bad debt, uncollectible loans or defective security instruments has become the title insurers and the escrow holder.  Historically, escrow has held the position of the third party in a real estate sales transaction that holds money while ownership, money and title transfer. The escrow holder is the fiduciary to the buyer and seller, tasked with following the buyer and sellers’ instructions in the sale of real property that ordinarily includes extinguishing existing loans in favor of buyer’s new mortgage.  The title insurer protects the buyer and buyer’s lender to ensure the new mortgage is in priority to protect the lender’s security interest.

Where this issue has arisen is in the repayment of the mortgage after the sale of property, usually a home equity line of credit (HELOC) that was offered by the now-defunct lender.  Much of this commercial paper was acquired in pools as opposed to individual transactions with a matching promissory note and deed of trust.  New lenders change loan numbers from the old defunct lender’s account number to account numbers matching the system by the new owner of the paper.  Other instances, the loan is marked as a secured but the original deed of trust is missing or no assignment of the security interest is recorded.  A third situation occurs where there is an accounting issue when a seller claims to have made payments that are not credited on the account.  Finally, in the waning days of Countrywide and Washington Mutual, people refinanced their loans but the paid deed of trust was not re-conveyed and included in the pool of notes and trust deeds transferred.  Buyers and their lenders want free and clear title.  Escrow can only rely on what the principle tells them the loan number on any HELOC is or if the old loan number is printed on the deed of trust pulled from the assessor’s office.  If the loan number is the old number, a payoff demand may or may not pick up the correct loan account.  Big lenders use clearing houses to issue reconveyances that may or may not record within the statutory 75 days required under California Civil Code 2941.  A new buyer may receive a notice from its lender that has picked up an re-conveyed lien on the property that was to be free and clear.  A title insurer wants to protect its insured so it will issue a release to clear title.

All the while big bank is putting the pieces of the puzzle together on the old account and realizes they have been underpaid.  Civil Code 2943(d) offers a remedy, but it is often an empty remedy since the loan obligation is still enforceable, but only as an unsecured contract debt and their former borrower is long gone.  What to do?  Big Bank sues the escrow for preparing a faulty payoff statement and the title company for statutory violation of Civil Code 2941(b)(6), wrongful recording of the release.

Although existing case law holds the escrow holder’s duty is only to the depositors and not a third party outside of the escrow (Summit Financial v. Continental Lawyers Title, 27 Cal. 4th 705 (2007)); more and more trial courts are allowing bank’s claims against escrow companies to survive summary judgment forcing escrow companies to the exposure and risks of trial.  Second, on statutory violations against title insurers, banks are using the remedy of subsection (b)(6) as a statutory indemnity, threatening title insurers with exposure to the remaining balance plus all accrued interests, costs, penalties and attorney fees.

Big institutional lenders are well positioned to force changes, legislatively and judicially in what was once thought of as solid law limiting insurers and professional clients’ liability.  The next new horizon looks to be an assault on those limits of liability.

If you have any questions or would like more information, please contact Bryce Van De Moere at [email protected].

Wire Fraud. Who Bears the Risk?

Posted on: November 2nd, 2017

By: Allison S. Hyatt

Wire fraud is on the rise in recent years. Finding out that escrow funds were mistakenly wired into the wrong hands is every broker, banker, consumer or escrow agent’s worst nightmare. Article 4A of the Uniform Commercial Code governs wire transfers and the unique issues raised by this method of payment commonly used in commercial transactions. The purpose of Article 4A was to define precise and detailed rules to assign responsibility, allocate risks, and establish limits on liability with respect to the complex claims that may result when a wire transfer goes awry. Critical consideration was given with respect to each party’s need to predict risk with certainty, insure that risk, adjust operational and security procedures, and to price wire transfer services appropriately, especially given the substantial amounts of money commonly involved in these transactions.

One of the liabilities balanced by Article 4A is the risk that a third party will steal a customer’s identity and issue a fraudulent payment order to the bank. Usually the bank bears the risk for unauthorized wire transfers. However, in a real estate transaction, whether the bank, broker, or escrow agent employed commercially reasonable security procedures in the transaction may shift this liability. For instance, as the Eighth Circuit found in Choice Escrow & Land Title, LLC v. BancorpSouth Bank, if a bank’s security procedures are commercially reasonable and it complies with those procedures along with its customer’s wiring instructions, the loss of funds resulting from an unauthorized wire transfer will fall on the customer if the bank is found to have accepted the fraudulent payment order in good faith. 754 F.3d 611, 625 (8th Cir. 2014).

In Choice Escrow, an employee of the escrow company fell prey to a phishing scam causing the company to contract a computer virus that led to a series of fraudulent transactions. 754 F.3d at 615. Choice Escrow maintained a trust account with BankcorpSouth. The bank received a request for a wire transfer of $440,000.00 from Choice Escrow’s trust account via the bank’s internet wire transfer system. Because the request was made using Choice’s User ID and Password, the bank approved the fraudulent transfer request even though the account lacked sufficient funds to cover the transfer. Id. at 616.

In its analysis, the Eighth Circuit evaluated BankcorpSouth’s security procedures, which provided its customers with four different security measures. Choice Escrow had declined two of these measures. 754 F.3d at 617-622. Looking to a recommendation report published by the Federal Financial Institutions Examination Council (FFIEC), the court found that BankcorpSouth’s security procedures complied with the FFIEC’s guidance. In addition, the bank had also expanded its security procedures to address security threats that arose after the report was issued. Taking these factors into consideration, the court found that BankcorpSouth’s security procedures were commercially reasonable. Id.

Next, the court analyzed whether BankcorpSouth acted in good faith, finding that “[w]here, as here, a bank’s security procedures do not depend on the judgment or discretion of its employees, the scope of the good-faith inquiry under Article 4A is correspondingly narrow.” 754 F.3d at 623. The court reasoned that because the bank had promptly executed a payment order that had cleared the bank’s commercially reasonable security procedures and the bank had no independent reason to suspect the order was fraudulent, the bank met its burden of establishing it had acted in good faith. Id. at 624. Thus, Choice Escrow was left liable for its customer’s loss. The fact that the escrow company had declined two of the security procedures offered by the bank appears to have been a significant factor in the court’s reasoning.

The lesson to glean from the Choice Escrow opinion is that to protect against liability, escrow companies, brokers, and other parties involved in commercial transactions, should all continually assess the commercial reasonableness of their security measures, which may include: 1) the use of email accounts that require additional forms of authentication; 2) the use of digital signatures for messages; 3) the use of encryption to communicate with clients; and 4) the frequency of password changes, among others. In addition, if a breach occurs resulting in an unauthorized wire transfer, courts will likely evaluate the reasonableness of the company’s wiring procedures, including steps taken to review wiring instructions to verify their authenticity. Strict adherence to commercially reasonable security measures is key.

If you have any questions or would like additional information, please contact Allison S. Hyatt at [email protected] or (916) 472-3302.