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LPLC: Security alert

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Cite as: March 2013 87 (3) LIJ, p.70

Claims based on inadequate security have increased with the soft property market.

Looking back at the 2011-12 policy year, we found that almost 25 per cent of LPLC’s total claims cost was attributable to practitioners advising on mortgage matters. Within the mortgage area, the most common and costly problem was inadequate security, accounting for 44 per cent of the cost of mortgage related claims.

Many recent claims involving allegations of inadequate security have related to practitioners in small firms acting for private lenders (often in connection with a second mortgage loan).

Claims relating to inadequate security

Practitioners would undoubtedly be aware that an inevitable consequence of a soft property market is mortgagees disappointed by sale prices when borrowers default.

Some of the allegations in claims by mortgagees have been that the relevant practitioner:

  • should have been aware that the property was not suitable security;
  • should have warned that the valuation was not reliable;
  • failed to investigate the borrower’s capacity to pay or otherwise advise the client on the financial risks; or
  • acted for both the lender and borrower and failed to protect the lender’s interests (especially in light of the borrower’s financial position).
Valuations

Practitioners who act for mortgagees should be aware of the decision of the NSW Supreme Court in Kayteal Pty Ltd v Dignan [2011] NSWSC 197. That case involved a relatively inexperienced lender who relied on a valuation of the security property to the effect it was worth $1.2 million when it was in fact worth only $52,000. The valuation had stated the property was not subject to flooding but searches indicated there was exposure to flooding.

After settling its claim against the valuer, the lender sued its solicitors, alleging that they (among other things) negligently failed to warn that the valuation was dubious or unreliable.

According to Brereton J, authorities have established that, without specific instructions, the responsibilities of a lender’s solicitor will normally be confined to ensuring the security is valid and enforceable, not advising on its value. However, a solicitor has a duty to report to the client matters that were or ought to have been discovered in the course of investigating title and preparing for completion which, in the view of a reasonably competent solicitor, might cause the client to doubt the correctness of the valuation or the borrower’s bona fides (though not merely their creditworthiness unless specifically instructed or assumed).

In Kayteal, the practitioner noticed discrepancies between the valuation and the survey. This caused him to ask the valuer to confirm the valuation, but he did not mention flooding. Brereton J concluded that the practitioner did not raise with the valuer all the discrepancies calling for the valuation to be reviewed (including exposure to flooding) that he ought to have. Further, his Honour found that the practitioner was negligent for failing to inform the client lender of the inconsistencies.

Borrower’s financial position

A common feature of many claims arising out of mortgage related work is borrowers whose creditworthiness is questionable. Such borrowers often go to considerable lengths to provide information or documentation that supposedly supports their purported financial position but in fact may not be accurate.

In Kayteal, Brereton J reiterated that whether a solicitor is required to investigate the creditworthiness of the borrower will depend on the terms of the retainer. Unfortunately, we have seen several instances where the practitioner’s role was not defined as clearly as it should have been. Practitioners who thought they were retained merely to document a loan have found themselves facing a claim that they did not warn the client that the transaction was high risk.

When acting for mortgagees, practitioners should refrain from giving financial advice unless they hold a financial services licence. However, the line between advice on legal issues and financial soundness can appear blurry on occasion. The duties owed by the practitioner will largely depend on the scope of the retainer and the type of client.

A key lesson is to ensure your retainer is properly scoped in writing at the outset, especially in circumstances where you understand your role is limited to documenting a loan. This may later prove critical in avoiding or defending allegations of breach of a duty to investigate and advise on risks such as the buyer’s capacity to pay or the value of the security.

It almost goes without saying that practitioners should avoid acting for both borrower and lender (especially where they have knowledge of the borrower’s financial position). Further, practitioners in the mortgage area need to be familiar with r8.8 of the Professional Conduct and Practice Rules 2005, which prohibits practitioners from acting for a borrower and a financier in connection with the loan of money where the financier is held out to the public as being in the business of lending and is not one of the five entity types listed in the rule.

Unsophisticated lenders

Non-institutional lenders vary widely in terms of commercial sophistication and practitioners should exercise particular care when advising inexperienced lenders. Always recommend that your client consult a specialist for financial advice and give the client time to obtain this advice. Keep a record of your advice and the client’s response.



This column is provided by the Legal Practitioners’ Liability Committee. For further information ph 9672 3800 or visit www.lplc.com.au.

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