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False Security

Monday, September 12th, 2011

An unattested mortgage, even when recorded, fails its purpose.

ALPHARETTA, GA–On October 12, 2005, Bertha Hagler refinanced her home.

The property in question, center

She signed two security deeds (akin to a mortgage): A “first” securing repayment of $240,000, and a “second” for a lesser amount. But at closing somehow things got confused, and only the “second” got signed by the notary and witness who were there.

Weeks later when the security deeds were recorded no one noticed that the “first” was not properly attested to.

In April 2007 Bertha filed Chapter 7 bankruptcy, and a trustee in bankruptcy was appointed. The trustee noticed the defective security deed, and filed an adversary proceeding to avoid it as against Bertha’s home.

The trustee relied on Bankruptcy Code section 544(a)(3), the so-called “trustee avoiding power” or “strong arm” power. This code provision allows a trustee (or a debtor-in-possession) to avoid an interest in debtor real property that is not perfected as of the commencement of bankruptcy. (See our posting for 5/22/10, “Bankruptcy 101.”)

Fulton County Courthouse, where the questioned security deed was recorded and indexed in the land records

In this case, the trustee claimed the “first” was not entitled to be recorded in the land records, and thus “perfected,” because it did not comply with Georgia statutes requiring that a mortgage affecting real property be signed and acknowledged before a notary, attested to by the notary, and attested to by one additional witness, in order to be accepted for recording.

The bankruptcy court ruled in favor of the trustee, avoiding the mortgage and relegating the lender to status of an unsecured creditor for the $240,000 debt. The lender would stand in line for cents on the dollar.

The lender appealed, arguing that despite its flaws the mortgage was in fact recorded and correctly indexed in the land records. Anyone who searched the records should find the mortgage and readily understand it was intended to encumber the property. The lender relied on case law holding that a defective instrument once recorded may impart constructive notice of its contents.

The federal district court entertaining the appeal said the issue involved “an unclear question of Georgia law,” and asked the Georgia Supreme Court to decide whether, in Georgia, a recorded security deed with a “facially defective attestation” can provide constructive notice.

The Georgia Supreme Court building

The Supreme Court sided with the bankruptcy court. The Court allowed that a “duly recorded” albeit defective instrument can provide constructive notice, but said this security deed was not duly recorded because a lack of required attestations was apparent “on the face” of the instrument. Instead, the Court cited “longstanding law” that a mortgage recorded with “facial defects as to attestation” may not impart constructive notice.

The Court concluded saying the lender’s position would relieve it and other lenders “of any obligation to present properly attested security deeds.” It would “risk an increase in fraud,” and “shift to the subsequent bona fide purchaser and everyone else the burden of determining (possibly decades after the fact) the genuineness of the grantor’s signature.”

Moral: Another example of section 544(a)(3) at work, and a reminder (if we need one) that legal formalities matter.

The case is U.S. Bank National Association v. Gordon, ___ S.E.2d ___, 2011 WL 1102995 (Ga. 2011).

Mortgage Fraud / Gaming the System

Saturday, November 20th, 2010

Little lies with big consequences.

MIAMI, FL–Yvette Valdes was a mortgage broker, doing business as “Best Mortgage Choice” in Homestead, Florida.

Like other mortgage brokers Valdes relied on large financial institutions, so-called “warehouse lenders,” to finance her loans. Typically, a warehouse lender wires funds direct to an escrow or loan closer, acquires the loan through closing, and re-sells the loan in the secondary mortgage market where it is packaged, or “securitized,” for investment offerings (mainly bonds).

10802 SW 244th Terrace

This business model relies on guidelines and ratings to assure investment quality. Among the critical guidelines, for a prime quality loan, is a requirement that the borrower have equity in the real property security. Thus, a loan equal to 90% of property value is rated more secure than a 100% loan. Likewise, a buyer making a 10% down payment is deemed a better risk than one with no “earnest money.”

Which explains why faking this stuff is a big deal.

Two weeks ago, Yvette Valdes pleaded guilty to federal criminal charges related to mortgages she originated against two residential properties in Miami. Also pleading guilty were her daughter Jeannine Valdes-Perez, her brother Joseph Gonzalez, son-in-law Victor Perez, and a hapless escrow officer named Catherine Maiz. All five pled to one count of conspiracy to commit wire fraud, while Valdez-Perez also pled to an additional count of wire fraud.

According to court filings, Valdes conspired with the other defendants to acquire properties at 10802 SW 244th Terrace (the “10802 Property”) and 21012 SW 122nd Court (the “21012 Property”), under false pretenses.

Prosecutors dubbed this the "21012 Property"

For the 10802 Property, Valdes arranged for her son-in-law, Perez, to submit a loan application falsifying his employment, income, and cash on hand for a down payment. Valdes then enlisted the escrow officer, Maiz, to send a letter to the warehouse lender, Argent Mortgage, saying the title company was holding $17,000 received from Perez. The statement was false. Relying on false information Argent approved the loan and wired $337,808 to fund the closing. The loan defaulted, causing “substantial loss” to Argent.

For the 21012 Property, Valdes again arranged for Perez to submit a loan application with false information, including a statement he would occupy the property as his residence. This time, Valdes instructed Maiz to create a false settlement statement (HUD-1 form) misrepresenting the source and amount of funds handled through escrow. Mainly, the HUD-1 showed $26,321 as deposited by Perez toward closing. In fact, Maiz held only a “fake” check which, following instructions from Valdes, she did not attempt to deposit. Relying on phony documentation, JPMorgan Chase wired $246,646 to fund the closing. Unbeknownst to JPMorgan Chase, some $15,000 was diverted from loan proceeds to pay Perez for his cooperation as the “straw borrower.” This loan also defaulted, and JPMorgan Chase took a loss.

The Wilkie D. Ferguson, Jr., Federal Courthouse, Miami, Florida

Sentencing for all defendants is set for January 21, 2011. Each faces a maximum 30 years in federal prison.

Moral: As mortgage fraud goes, these are small cases. It appears the main motive was to create bad loans so Valdes, and others, could “earn” routine commissions and fees.

And this isn’t Valdes’s first brush with notoriety. In 2008, in a series titled “Borrowers Betrayed,” the Miami Herald named Yvette Valdes as a local mortgage broker who originated $22 million in loans approved by Orson Benn, a former executive with Argent Mortgage. According to the Herald, “nearly all of the (Valdes) mortgages contained false or misleading information.” Benn was charged with racketeering by Florida state prosecutors in 2008, and is serving an 18-year prison sentence.

Like counterfeit money, bad loans subvert the economy. Creating them is serious crime.

Postscript: In February 2011 each defendant was found guilty of one count of conspiracy to commit wire fraud. Valdes was sentenced to 33 months in prison, followed by three years’ supervised release, and ordered to pay restitution of $386,500; her daughter Valdes-Perez got 27 months, three years’ supervised release, and must pay restitution of $249,500; brother Gonzalez got 33 months, three years’ supervised release, and must pay restitution of $302,000; son-in-law Perez got 21 months, three years’ supervised release, and must pay restitution of $386,500; and, finally, escrow officer Maiz was credited for time served (nine months), plus five years’ supervised release, and must pay restitution of $337,000.

The Spider and the Fly

Saturday, October 2nd, 2010

How not to pay for that new home.

LEE’S SUMMIT, MO–Sanctum, LLC was developer of the “Siena at Longview” subdivision in this suburb of Kansas City.

In June 2002, Ivan and Marie Johnson entered into a construction contract with Sanctum for a new home to be built on Lot 7B in the Siena subdivision. The price would be $317,600, with the understanding the Johnsons would upgrade cabinetry, lighting and fixtures at their own expense, and receive credit for upgrades against the sale price at closing. Move-in was scheduled for November 2002. This would be their “retirement home.”

Lot 7B: A trap for the unwary

At the time the contract was made, Sanctum had construction loans from Gold Bank–secured by deeds of trust against the subdivision–for infrastructure and other improvements.

As provided by the contract, at signing the Johnsons paid Sanctum an earnest money deposit of $1,000, plus an additional $62,720 sixty days later.

Planning to move, the Johnsons sold their old home and moved into an apartment. They put most of their possessions in storage.

As work on the home proceeded the Johnsons advanced $57,517 for upgraded materials and labor.

November came, but the home was not ready. Each month thereafter Sanctum gave the Johnsons a new move-in date. Finally, in February 2004, the interior was ready and Sanctum scheduled a closing for March. The Johnsons were told they could move in on the first of April.

But as the closing date approached, Sanctum announced a new problem. It was, perhaps, “the problem” all along. Sanctum, it seemed, could not get its lender, Gold Bank, to release the property from construction deeds of trust without payment of an amount Sanctum didn’t have at hand. Sanctum hoped to have new investors, but wouldn’t be able to close until the investors were lined up and provided funding.

The Johnsons were allowed to move in, but there was no closing and they didn’t have a deed to the property. That, they hoped, would come.

Instead, by July 2004 Gold Bank put the subdivision into foreclosure. The foreclosure sale was held August 17. The Johnsons attended the sale, but couldn’t bid on Lot 7B because the subdivision was offered as a whole for $3 to 4 million.

By now the Johnsons had hired a lawyer, and they began heroic efforts to save their investment.

The Jackson County Courthouse at Kansas City, Missouri

First, they recorded a “Notice of Equitable Lien” against Lot 7B. Later, they filed a lawsuit and recorded a “Notice of Mechanic’s Lien.”

There were other mechanics’ lien claims against the subdivision, and other lawsuits, and the cases were consolidated for trial.

The trial court ruled against the Johnsons, and they appealed.

The Court of Appeals ruled the Johnsons were simply out of luck. Even though they had paid for substantial improvements, the court held they were not “eligible” to enforce a mechanic’s lien claim because the contract with Sanctum, coupled with their payments, made them “equitable owners” of the property. The court explained Missouri law provides mechanics’ lien rights for contractors and material suppliers, but not an “owner.”

As for their equitable lien claim, the court said the claim had merit and “the Johnsons did, in fact, have a legally recognizable vendee’s lien against the property in the total amount of $121,237.86.” But their lien was created after the Gold Bank deeds of trust were recorded and, the court said, it was wiped out by the foreclosure.

In closing, the court said: “This is not a result that sits well with the Court, but it is a result that is required by the law….”

Moral: The Johnsons should not have paid Sanctum or the upgraders before they had clear title to the property. That means a deed, of record, not subject to prior deeds of trust.

The earnest money should have been put in escrow, and not paid out until the buyers could get clear title.

“Unto an evil counsellor, close heart and ear and eye; And take a lesson from this tale, of the Spider and the Fly.” (Mary Howitt, The Spider and the Fly, 1829.)

The case is reported as First Banc Real Estate, Inc. v. Johnson, 321 S.W.3d 322 (Mo. App. W.D. 2010).

Escrow School

Sunday, July 4th, 2010

A seller’s trick brings a teachable moment.

VICTORVILLE, CA–Wesley was the owner of this house in Victorville, between Los Angeles and Las Vegas.

The property in question, sold by Wesley to Maria

When he contracted to sell the house to Maria, an escrow was opened to handle the transaction.

The escrow company asked Wesley to fill out an “Information Request” form, giving contact information for Wesley’s mortgage lender.  Wesley completed the form, reporting two deeds of trust against the property.  The first deed of trust was held by EMC Mortgage Corporation, for which Wesley provided an address, phone number, and loan number.

Escrow contacted EMC and, within a week, got a payoff demand for $176,317 good through the end of the month.

Escrow paid the demand and the transaction closed.

Ten months later Maria and her mortgage lender got notices of default, saying an unknown deed of trust was delinquent and had entered foreclosure.  Someone called the title insurer.

It turned out Wesley had pulled a fast one.  The information he provided about the EMC deed of trust pertained to different property, also owned by Wesley, across town.  So escrow’s payment to EMC made the ‘other’ property free and clear.  One month after close of escrow, Wesley and his wife refinanced the other property giving a new deed of trust for $150,000.

Wesley's other property, made free and clear

Having pocketed sale proceeds of $122,000, plus new loan proceeds of $150,000, Wesley netted about $270,000.

The deed of trust that Wesley left behind, the one that should have been paid off, had a principal amount of $264,000.

The title insurer demanded that Wesley straighten things out, but he wouldn’t, so the insurer paid $293,647 to clear Maria’s title.

And here’s the teachable moment:  The deed of trust that was “left behind” identified “MERS,” Mortgage Electronic Registration Systems, as “nominee” for the lender during the life of the loan.  MERS is a corporation formed by mortgage lenders to track ownership of promissory notes secured by mortgages and deeds of trust.  Once a mortgage has been recorded in county land records, and registered with MERS, anyone wanting payoff information need only contact MERS for referral to the current loan servicer.  The information is free, easy to get, and guaranteed accurate.

If escrow had asked MERS, rather than Wesley, they would have gotten true information instead of a nasty loss.

The deed of trust that was "left behind." Note MERS mortgage identification number (MIN), upper arrow, and MERS contact information, lower arrow. (Click to enlarge.)

Loose Ends

Sunday, June 27th, 2010

How not to close a credit line.

PARKER, CO–Most residential resales go smoothly, but some seem to follow one bad turn after another.

This newer home near Denver was owned by Paul and Robin.

The property in question: back on the market.

When the couple agreed to divorce, they applied for a home equity line of credit to finance the break-up.  Approved for a line of $100,000 by TCF National Bank, Paul and Robin gave TCF a deed of trust even as they contracted to sell the property to Jennifer.

Robin moved out and gave Paul a power of attorney to handle details of the sale.  The power of attorney was on a standard form, appointing Paul to act for Robin “to sell and convey” the property “for such price as to (him) may seem advisable.”

When it came time to close, the title agent got a payoff demand from TCF.  The demand, also on a standard form, called for a payoff of $80,462 within one week, by check to be mailed to TCF’s Consumer Payoffs department in St. Paul, Minnesota.  The demand specified, “(a) signed authorization from the customer requesting the account to be closed is also required.  The section below can be used to accomplish this.  Please return original signatures with the payoff funds.”

Paul signed the form, on the signature lines provided, for himself and Robin.  Underneath the line for Robin’s signature he wrote “/s/ Power of Attorney.”

The sale closed, and the title agent wired $80,462 to TCF.  Both Jennifer and her purchase money lender got title insurance.

One year later, Robin was dunned by TCF for overdue payments under the old credit line.  Her lawyer contacted TCF and was told, “(a) wire transfer of $80,462 was received…and applied as a payment on the account.  However, because TCF did not receive a signed authorization from the borrowers requesting that the account be closed, the account has not been closed.”


After the sale to Jennifer, Paul continued to get monthly statements from TCF showing a zero balance and “available credit” of $100,000.  It was too tempting.  Paul made new draws until he maxed out the credit line, then he stopped making payments.

Robin too failed to pay, and TCF began foreclosure proceedings.

While all of this was unfolding, Jennifer fell behind in her mortgage payments, and her lender commenced foreclosure.

Unbeknownst of each other, the two lenders held foreclosure sales and each “took back” the property.

The title insurance company for Jennifer’s lender entered the picture, and paid $160,543 to redeem the property from TCF’s foreclosure.  So now the title was clear, and Jennifer’s lender could deal with the property.

Having taken care of its insured, the title insurer then sued TCF to recover its money.

At the center of this dispute was the escrow officer employed by the title agent, who had handled the payoff.  Answering TCF’s claim that it did not receive authorization to close the loan account, the escrow officer produced copies of the authorization and the power of attorney.  She vowed she ‘must have’ mailed the forms to TCF, as ‘normal practice.’  But TCF denied receiving the forms and, even if they did, said they would not rely on Paul’s signature for Robin because the power of attorney did not expressly authorize him to close the loan account.

TCF won the argument, and the title insure took the loss.  Paul doesn’t answer, and Robin is forgiven.

Moral:  Our story ends with a mystery–who dropped the ball?

It seems likely that escrow mailed the authorization to TCF, but whoever received it there may not have matched it with the payoff received by wire.  Or, just as likely, the recipient may have found the power of attorney as unreliable, but didn’t contact escrow to say so.

Modern real estate transactions frequently close, and go to record, with loose ends and unfinished business.  Take, for example, the closing with a release of lien or mortgage “to come”–as happened here.

In real estate, loose ends represent risk.

Time and Chance

Saturday, May 8th, 2010

Departing sellers play “the Gap.”

Not so many years ago this house in Rockville, Maryland, was owned by Elizabeth and Charles.

Elizabeth and Charles offered the property for sale and accepted a buyers’ offer of $388,000.  In April, an escrow was opened with a local title company.

The house: You could say they sold it twice

But while it was in escrow, Elizabeth and Charles arranged to take out a new loan against the property.  On July 9, they gave a second deed of trust to secure a loan of $135,000 from First Guaranty Mortgage.  This second deed of trust was recorded in the Montgomery County Clerk’s office on July 20.

Meanwhile, the pending sale came together and, on August 25, it closed.  Escrow disbursed about $208,000 to pay off the first deed of trust, plus sale proceeds of $150,000 to Elizabeth and Charles.  The deed to new owners and their purchase money deed of trust was recorded on September 22.

But what about that second deed of trust, for $135,000?  It went unnoticed, and unpaid through closing, because it wasn’t posted on the county’s online database until August 27–two days after the closing.  It should come as no surprise that Elizabeth and Charles neglected to mention the recent loan when they got their check.

Montgomery County Judicial Center, where the County Clerk was backlogged

The gap between recording of the document and its appearance in the county database was due to a “backlog” at the Montgomery County Clerk’s office.  So the only way the title company could have known about the document would have been to visit the clerk’s office and rummage around.  And, of course, since it had not been paid the “second” became a first deed of trust against the property.

Title insurance paid more than $140,000 to release the missed deed of trust.

Moral:  There are roughly 3,400 county recording offices throughout the United States, and each is its own fiefdom.  Mostly they do a pretty good job, but it’s up to local government and, occasionally, time and chance.