The Old Switch.
In this transaction, the buyer and seller agree to change the sales price in the contract and the seller kicks money back to the buyer at the closing (maybe without knowing it). For instance, the seller enters into a contract for sale for $400,000. The home appraises for $600,000, the buyer then returns to the seller and asks that they increase the sales price to $600,000 so he can get the higher loan and pocket the difference. The broker’s commission, oddly enough, is not increased, but the title policy premium is increased—it must reflect the sales price. The seller then kicks back the excess proceeds to the buyer. This occurs as a cash payment to a fictional company, a third party as a cover for the buyer. It could also show up as a “soft second lien” to the seller that will never be repaid, but shows up on the closing statement. Once again, we have a lender making a loan for more than the property is worth, putting money in the buyer’s pocket and destroying the loan-to-value ratio that the lender had anticipated. The problem with this scenario is the seller is happy to do it, because the seller ultimately gets his agreed sales price and doesn’t care that the buyer profits in the transaction. In addition to this, the seller and the broker make their sale! The buyer never makes one mortgage payment and moves on to his next transaction.
In Home Loan Corporation vs. Texas American Title Company, 191 S.W.3d 728 (Tex. App. Houston [14th Dist.] March 30, 2006, pet. den.), TATCO acted as a settlement agent for the closing of a residential mortgage loan funded by Home Loan. Home Loan sold the loan in a secondary market, no payments were made on it, and Home Loan was obligated to re-purchase it. Home Loan filed suit against TATCO alleging that TATCO breached fiduciary duties it owed Home Loan by failing to: (1) inform Home Loan that the seller had requested over half of the seller’s proceeds be paid to the mortgage loan broker; (2) inform Home Loan that the seller had requested that those proceeds be paid to the principal of the mortgage loan broker; and (3) accurately disclose the HUD-1 settlement statement how the seller’s proceeds would be or had been disbursed. The court noted that even though no formal escrow agreement had been entered into, a title company normally accepts funds for disbursement in a closing transaction for a fee and owes the party remitting those funds a duty of loyalty, a duty to make full disclosure, and a duty to exercise a high degree of care to conserve the money and pay it only to those who are entitled to receive it. The difference is what that fiduciary duty and full disclosure requires. The court noted that ordinarily a fiduciary duty of full disclosure requires disclosure of all material facts known to the fiduciary that might affect the rights of the person to whom the duty is owed. The court went on to note that there is a variation on how the disclosure duty was handled in the various states. TATCO argued that an escrow agent is required to remain neutral under Texas law, and while they owe a fiduciary duty to buyer and seller, these duties are strictly limited to its role as an escrow agent as defined by the escrow agreement, citing Equisource Realty Corp. vs. Crown Life Ins. Co., 854 S.W.2d 691, 697 (Tex. App. –Dallas 1993, no writ).
This court, however, held that despite the language of the Equisource case, they could find no Texas decision that has directly addressed any limitation on the scope of an escrow or other settlement agent’s fiduciary duties to disclose.
The court did note, however, that Home Loan suffered no loss from the disbursement because Home Loan had already funded the loan to TATCO. Their disbursement to TATCO was irrevocable and Home Loan would have had no recourse to prevent the disbursement. The real damage, the court noted, was because the underlying loan transaction was a sham and Home Loan would have suffered the resulting loss even if TATCO had disbursed the funds directly to the seller as set out in the HUD-1 statement.
This case was “Pet. Denied,” signifying that the Supreme Court is not satisfied with the opinion of the Court of Appeals. It has correctly declared the law in all respects, but the terms of the petition present no error that requires reversal, or that it is of such importance to the juror’s prudence of the state as to require correction, Tex. R. App. P. 56.1 (b) (1).
Note a different decision in Trahan v. Loan Star Title Company of El Paso, Inc., _____ S.W. 3rd _____ (Tex. App.-El Paso, July 26, 2007, where the El Paso Court of Appeals follows the Equisource line of cases defining the escrow agent’s duties as “strictly limited in the scope of the agent’s duties are defined by the escrow agreement.”
Query: Isn’t an escrow payment, at the seller’s request, to a third party for the benefit of the seller, the legal equivalent of a payment to the seller? Doesn’t the title company also have a duty of confidentiality? Full disclosure to all parties in a real estate transaction would have to breach these confidentialities.
In Chicago Title Insurance Company v. Home Loan Corporation ______S.W. 3rd ______, (Tex. App.-Houston [14th Dist.] 2007, opinion withdrawn), in facts very similar to the TATCO case, Chicago Title Company acted as a settlement agent in the closing of a loan which turned out to be a fraudulent transaction. The lender filed suit against Chicago Title alleging fraud and breach of fiduciary duties based on Chicago Title’s failure to disclose on the HUD-1 closing statement that seller’s proceeds would be paid, at seller’s request, to a third party (one Gerald Malone). This court gave an excellent discussion on the definition of fraud and focused on the fact that there was no intent to induce the lender in any manner, which is one of the factors required in the finding of fraud. The court further noted that the HUD-1 Statement states that it is furnished to provide a statement of actual settlement costs, but does not purport to reflect the disposition of the seller’s proceeds.
Experts for Chicago testified that it is common for sellers to request that their proceeds be disbursed to third parties. This is done to accommodate the seller’s request, not to commit fraud on a third party. The court further noted that there was no evidence that anyone in Chicago Title knew or suspected that the disbursement was in any way out of the ordinary, let alone indicative of wrongdoing.
With regard to the issue of fiduciary duty, the court noted the evidence was undisputed that Chicago Title followed the closing instructions the lender provided to Chicago, then reversed the trial court’s findings, holding that the lender take nothing from Chicago Title on their claims.
The Contractor’s Scheme. In this scenario, the buyer is supposedly going to do a substantial amount of improvements to the property, gets a bid from a contractor (a straw company) and then pays that contractor at closing… who turns out to be the buyer. Using the same example, it’s a $400,000 purchase, a $200,000 home improvement. The loan is based on the inflated $600,000. There is no construction loan like one would find in a traditional home improvement loan. The deal is closed and funded, the contractor turns out to be a front for the buyer, and no improvements were ever made. In Houston, there was a developer who converted apartments to condominiums. The subcontractors were paid directly out of the closing proceeds (pursuant to the developer’s instructions). The subcontractors (landscapers, appliance installers, painters, etc.) were all businesses owned by the lender’s senior vice president (who were also the project’s loan officer). He “approved” every loan and settlement. Believe it or not, the lender sued the title company for following their own loan officer’s instructions, and not discovering the fraud! The case settled, three executives of the title company lost their jobs, an escrow officer lost her license forever, and the title company paid a substantial sum to the lender. Remember, it was the lender’s own officer who set this system up. He was fired.
Query: Can you see how title companies get suspicious and cynical? Again, the buyer never makes one mortgage payment, puts the money in his pocket, and moves on to the next transaction.
Chuck Jacobus teaches Real Estate MCE at Champions School of Real Estate in Houston, Texas and is an attorney practicing in Bellaire, Texas as well as Executive Vice President of Charter Title Company in Houston, Texas. Chuck is a pre-eminent author of several books about Texas Real Estate and Texas Real Estate Law. He is currently a member of the Texas Real Estate Commission's Broker/Lawyer Committee and is Chairman of the State Bar of Texas Title Insurance Committee.