The Risk Manager, Winter 2008

It appears that we are headed for an economic slowdown and many experts are predicting that the subprime mortgage disaster that is unfolding, with the worst to come, foreshadows a deluge of home foreclosures. In fact, home foreclosures are already increasing at an alarming rate with Kentucky experiencing as many as most states. This has both retrospective and prospective malpractice risks for lawyers engaged in real estate and bankruptcy practice.

Retrospectively, what this means for lawyers is to expect some of the real estate matters they handled to come under close scrutiny in foreclosure and bankruptcy actions. If an error was made in any aspect of a real estate transaction, it figures to be found and a claim made against the responsible lawyer. Now is the time to review any real estate matter that is at risk of foreclosure to assure that it was error-free, or correct, if possible, any problems discovered before a claim is made.

Prospectively, it appears there will be a significant increase in bankruptcy and foreclosure actions. A recent Wall Street Journal article, ‘Foreclosure Mills’ Encounter the Wrath of Judges (The Wall Street Journal, B6, 11/30/2007) gave the following examples of problems courts are encountering with sloppy and predatory legal work in foreclosure and bankruptcy actions. Not only does this lead to judge-imposed sanctions, but it can result in malpractice and wrongful use of civil proceedings claims:

  • Lawyers in the mortgage-banking industry routinely initiate foreclosure proceedings without proper documentation included with the complaint.
    • “Judges have become more aggressive in holding firms accountable for what is a common practice: filing suit without showing proof that the plaintiff actually holds the mortgage and has the right to foreclose.”
    • One bank filed a foreclosure action before it had acquired the mortgage. The judge, after dismissing the suit with prejudice, noted that the plaintiff and its counsel had filed the lawsuit with no basis whatsoever, and ordered that the firm must in all future foreclosure complaints include “proof that their client is, in fact, the real party in interest.”
  • Lawyers are being fined by judges for filing motions in court on behalf of creditors that contain inaccurate claims about what debtors owe.
    • A bankruptcy judge in Texas fined a firm $75,000 “for filing pleadings that were ‘grossly erroneous’ and ‘gibberish,’ the result of the firm’s computer-generated pleadings. The judge wrote the firm has ‘become over reliant’ on the computer system and its attorneys are ‘allowing their signatures to become affixed to pleadings that they have not adequately reviewed.’ ”
    • Another Texas judge is considering sanctioning the same firm for misstating what a debtor owed by thousands of dollars.
  • A bankruptcy judge in New Jersey fined a firm $125,000 for using pre-signed certificates hundreds of times vouching for the accuracy of filings. He discovered this practice after the firm filed a default notice for a client that wrongly certified that the debtor was over $15,000 in arrears. The judge was singularly unimpressed with the firm’s explanation that pre-signed certifications were necessary because of its high workload.

In view of the severity of this developing situation it is timely to recapitulate the risk management information that we have provided in this letter for preventing real estate malpractice. We urge careful review of your practice with these guidelines in mind.

Know Who Your Client Is
Since real estate transactions involve many individuals and entities, it is essential that the lawyer clearly identifies with the client represented and that all other parties are on notice that they are not the lawyer’s client. If this is not implicit from the circumstances, make it explicit. Client identification confusion often arises when:

  • Working through a broker.
  • Representing the mortgagee as the only lawyer at a closing.
  • Working through a representative of a business group client.
  • Real estate transactions involving family, elderly, and divorce.

Document the Scope of the Engagement
Always use a letter of engagement to document the work to be done. The majority of real estate malpractice claims concern title searches. Is the lawyer to prepare an abstract of title indicating only what land records contain or a title opinion on validity of ownership? Is the search for liens only? Is the lawyer responsible for accuracy through the date and time of the completion of the title search or required to bring the search current to the time of closing? Be precise, detailed, and exclusive in the scope description.

Use Real Property Transaction Checklists
A good checklist for sale of real estate should cover in detail at a minimum: 1) the parties; 2) description of property; 3) condition of title; 4) construction status; 5) purchase and loan terms; 6) warranties of seller; 7) conditions of buyer’s obligation; 8) escrow; and 9) closing.

Manage Title Search Abstracts and Opinions Carefully

  1. Specify in the abstract or opinion the scope of the search, its purpose, authorized uses, and restrictions.
  2. If others are preparing evaluations on some parts of the transaction, clearly exclude those parts. If there is reliance on an expert opinion as part of the analysis (e.g., an environmental assessment), show that in detail.
  3. Be complete. Advise of any doubts or potential title defects no matter how remote. Taking risks on defects is the client’s decision – not the lawyer’s.
  4. Establish office procedures for quality control of title search documents. Procedures should indicate who is authorized to sign and release them for the firm and provide for a formal and cold review before release.

Foreclosure Sale Representation is Not Easy Money

  • The Risk: A few law firms handle a large volume of foreclosure suits in Kentucky. Rather than appear at foreclosure sales, these firms employ local lawyers to appear and bid on their behalf -- often for a fee of $100. They make malpractice claims against local lawyers if the sale is missed, the bid is not in exact accordance with instructions, or the representation is in any way unsatisfactory. Damages claimed are the fair market value of the property determined by the amount the client was willing to bid.
  • Malpractice Avoidance: The fee of the local lawyer is small and the malpractice exposure large. Is a $100 fee worth the risk of suffering a malpractice claim and paying a deductible of several thousand dollars – or is this business better avoided?
  • Malpractice Prevention: Docket carefully -- have at least a dual calendaring system (manual or computer) with your secretary keeping a matched calendar. Establish a third party tickler system as an additional safeguard. Calendar all critical dates with adequate lead times for preparation. Conduct a personal, monthly review of all foreclosure sales matters.

Real Estate Malpractice Errors

  • Erroneous description in deed of property to be conveyed
  • Misstated date to which interest was to be computed
  • Failure to fill in blank on form
  • Failure to reserve mineral rights
  • Failure to advise on impending change in law
  • Unauthorized delay or failure to strictly enforce closing time limits
  • Failure to discover encumbrances on the property:
    • mortgage lien
    • vendor’s lien
    • tax lien
    • mechanic's lien
    • contract for deed
    • right-of-way
    • mineral lease
  • Failure to assure that clients received or conveyed title as represented:
    • remainder
    • dower
    • outstanding life estate
    • lease
  • Errors in the description of the property
  • Failure to perfect security interest:
    • failure to prepare mortgage document
    • failure to update title search at time of closing
    • failure to record or timely record a mortgage
    • filing in the wrong county
    • failure to obtain releases of other encumbrances
  • Failure to collect or protect security interest
  • Failure to attend commissioner’s sale
  • Failure to know other applicable law, e.g., probate, tax
  • Failure to disburse sale proceeds properly