The credit crunch and the subsequent malaise in the housing market in the UK over the last few years has had mortgage lenders examining their non-performing mortgage cases for any evidence of fraud, or of “negligence” by the solicitor in failing to exercise their duty of care to the lender in relation to the creation of the mortgage security. Any failure by the solicitor to comply with the letter of their mortgage instructions – typically based on the lenders’ handbook of the Council of Mortgage Lenders (“CML”) – is being pounced on. At the same time lenders are coming under increasing pressure from the Financial Services Authority to (more) actively manage their panels in an attempt to counteract the risk of fraud.
The feeling from lenders, and backed by the CML, is that for too long solicitors have concentrated on their duty of care to their purchasing client, and have paid scant attention to the duty they owe to the lender, whom they conveniently forget is also their client. While a purchaser may be willing to “take a view” on, for example, the absence of documentation for historic alterations to the property, often the views of the lender are not sought.
From the solicitors’ point of view, they have been effectively subsidising the lender’s legal costs by subsuming the cost of dealing with the mortgage security within their own fees for handling the purchase. They are on the sharp end of the purchaser’s moans and groans about the level of legal fees, while the lender’s legal costs are being masked. Too often when they report matters to the lender they being are asked to “use their professional judgement” in deciding whether the matter might adversely affect the lender’s interest – in other words passing the buck straight back to the solicitor.
The crux of the matter is that there is an inherent conflict of interest in a solicitor acting for both the mortgage lender and the borrower in putting a mortgage security (legal charge) in place over the borrower’s home. For a long time both the Law Society of Scotland (“LSS”) and their equivalent in England and Wales have recognised the efficiency and cost savings involved in one solicitor acting for both lender and borrower in a residential conveyancing transaction – each affording an exception to their conflict of interest rules which otherwise prohibit the solicitor from acting for both parties. But things are now changing.
Signs of change
There are increasing calls for this lender/borrower exception to the conflict of interest rules to be revisited. A motion from the Scottish Law Agents Society (“SLAS”) to this end was put to the LSS AGM in 2011, and a subsequent LSS committee investigation of the issue is to be reported on at this year’s AGM on 31 May 2012, but more on this in a moment. An SLAS discussion paper prepared in support of their 2011 motion sets the broader context in relation conflict of interest rule exceptions, and is an interesting read. A more recent report by Peter Nicholson, Editor, in the February 2012 edition of the Journal of the LSS also looks at these issues in some detail – see at www.bit.ly/AmxfLr.
All the signs are pointing to the status quo no longer being sustainable beyond the immediate term. The main signs are:
- lenders decimating their conveyancing panels, with one major banking group slashing their UK panel to 40 or so firms (with reportedly only four firms covering Scotland), and charging their customers a fee if they choose to use a firm that is not on their panel;
- the removal of “dormant” firms from panels by some lenders, with firms being required to complete lengthy and intrusive application forms to apply to re-join those panels;
- threats (in Scotland) of firms being removed from panels if they do not use the Registers of Scotland’s Automated Registration of Title to Land (“ARTL”) system for relevant cases;
- solicitor firms being charged an annual administration fee to remain on a lender’s conveyancing panel; and
- the development by the CML of a new set of lenders’ handbook instructions for England and Wales to deal with the situation where the lender instructs a solicitor other than the one acting for the purchaser (“separate representation”), with a Scottish equivalent to follow.
Perhaps the most concerning development is a recent solicitor disciplinary case in Scotland where the LSS has prosecuted a solicitor for repeated failure to comply with the CML lenders’ handbook. While the solicitor’s failures cannot and should not be forgiven, the clear message from the LSS is that its auditors will examine the minutiae of a solicitor’s purchase file for compliance with the CML lenders’ handbook. They will report and potentially act on any non-compliance they discover, insignificant or otherwise, irrespective of whether there has been any fraudulent or otherwise criminal activity on the part of the solicitor, and irrespective of the presence or absence of a complaint by the lender. Solicitors are already asking themselves whether it is worth all the hassle, and whether they should decline to act for their client’s mortgage lender.
Collision course ahead
There are some meaty issues in all of this, and what might appear to some to have been a convenient compromise between competing interests looks to be heading for the rocks. Here are some of the issues, with some thoughts:
- Lenders are considered free to choose whom they instruct to act for them. Counsel’s opinion obtained by the LSS supports this. No one lender in the UK has a monopoly of market share such that their practices might be deemed anti-competitive.
- However, the action by some lenders in excluding one or two partner firms from their panels for no apparent reason other than their size has been met with vociferous objection from all sides. “Small” does not necessarily equate to a higher risk of fraud or negligence.
- Separate representation of the lender, where they appoint their own solicitor to put the mortgage security in place (that is, not the borrower’s solicitor), has its own issues:
- the consensus appears that this inevitably leads to delays – the lender’s solicitor, presumably dealing with volumes of cases, has no interest in an individual borrower’s completion deadline, and will beat time only to the service level agreement agreed with his lender client;
- the borrower’s solicitor will be unwilling to exchange contracts or, in Scotland, conclude missives until he has certain knowledge that the lender’s solicitor is happy with all title and property issues – again more potential delays;
- a purchasing borrower may have taken a “commercial” view on certain issues relating to the property, such as the earlier example of the absence of paperwork for historic alterations, whereas the lender’s solicitor may take a different view if hide bound to follow a detailed set of security instructions from his lender client;
- one version of separate representation sees the lender’s solicitor taking a certificate of title from the borrower’s solicitor – but that is seen by some as simply adding a layer of administration that the borrower ends up paying for, and for no apparent added value; and
- separate lender representation means two sets of solicitors and two sets of legal fees, with the borrower ending up paying more.
- However, why should borrowers meet their lender’s legal fees for putting the mortgage security in place in any event? Some would argue that this has been a convenient truth for too long. We’ve already seen lenders offer “fees free” or “fees assisted” remortgage schemes where the lender meets or contributes to the legal costs of the remortgage transaction. Why should this not be replicated by lenders for purchase mortgages? The reality is, of course, that borrowers will end up footing the bill in any event through higher application or “administration” fees for their mortgage, or through higher interest rates. Solicitors would argue: “better that, than having it wrapped up and hidden within the purchase legal fee”.
Change is coming
And so to return to the upcoming LSS AGM on 31 May 2012 when their investigating committee is due to report. The signs are that the majority of solicitors are resistant to a change in the lender/borrower exception to the conflict of interest rules, and instead favour the status quo. While the SLAS is trying to rally the troops in favour of change, there is a question mark as to whether their ultimate goal is to protect the vested interests of solicitors, rather than having the best interests of the house buying public at heart. A “convincing public interest case” would have to be made to convince the LSS to make a rule change, and this is considered unlikely to materialise at this stage.
In the meantime the growing signs are that some mortgage lenders are closer to making the change to separate representation across the board than others may think. The one thing clear is that change is coming.
John Lunn is a solicitor and partner in Morton Fraser LLP, and is head of their Retail Banking team. He would be interested in hearing your views on this piece, and can be contacted by email at: firstname.lastname@example.org.
This article was first published in the May 2012 edition of Financial Regulation International