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Posting for
Monday, September 28, 1998
by: Bert Rush
brush@firstam.com
CLOSING INSTRUCTIONS/ESROW AND CLOSING/LAND FLIPS/DOUBLE ESCROWS
Greg Lindwall (Edina/Minneapolis) has provided copies of new lender requirements being included in closing instructions from certain major lenders.
These new requirements apparently result from recent losses suffered by lenders in connection with land flips and/or "straw man" schemes. For example, Greg reports that Weyerhauser Mortgage has stopped making purchase-money mortgage loans in Minnesota, effective 8/1/98, estimating their recent losses from land flips to be in the range of $20 million.
Here's the new standard instruction being received from some lenders:
"You must deliver to us prior to closing a source of title showing the name, date and recording information of the document that transferred title to the current owner. This loan cannot be closed or funded without the prior written consent of our President at *****, (1) in conjunction with, or simultaneously with, any other sale or financing of the property securing this mortgage loan (i.e., double escrow, double closing, flip sale, pass through, equity skimming, etc.), or (2) if such source of title shows a transfer of the subject property during the 6 months preceding the closing date. If the subject transaction is represented to be a purchase transaction, the loan cannot be closed or funded by you if the borrower has acquired or will acquire any interest in the property securing this loan prior to the scheduled closing of this loan; If the borrower has acquired or will acquire an interest in the property securing this mortgage loan prior to the scheduled closing of this loan, you must call the lender immediately. If the subject transaction is represented to be a refinance transaction, the loan cannot be closed or funded by you if the borrower has not yet acquired record title to the property securing this loan prior to the scheduled closing of this loan; if the borrower has not yet acquired record title to the property securing this mortgage loan prior to the scheduled closing of this loan, you must call the lender immediately."
My first reaction was that these requirements are a bit onerous. Tho I would hope otherwise, I suspect we have more than a few escrow and closing officers out there who wouldn't know a land flip if it came up and bit em. And can somebody tell me what "equity skimming" means?
But on reflection this may be a requirement we will have to (and can) learn to live with. Escrow and closing people should be trained and knowledgeable enough to understand the problem--as these lenders see it--and they should by now be accustomed to watching for the "double escrow."
The classic double escrow occurs when the escrow or closing officer is aware that property is to be acquired and immediately re-sold--with the ultimate buyer unaware that his (or her) seller only recently acquired the property, usually for a price much less than that being paid by the ultimate buyer.
Double escrows suggest fraud--either against the initial seller, the ultimate buyer, or the lender to the ultimate buyer. Here are three scenarios:
First--seller is a little old lady who has owned her home for 30-plus years and now must sell due to ill health. She has no idea what the property is worth. She is approached by an unscrupulous realtor who, sensing her naivete, tells the little old lady that the property is worth about half its true value. Little old lady lists the property with the realtor. Realtor conspires with a third party--for third party to offer to buy the property at the artificially low price. Meantime, realtor agrees to sell the property to another party willing to pay full value. Two closings occur almost simultaneously--the first from little old lady to the realtor's shill, and the second from the shill to the buyer paying full value. Both closings might even be funded by the second closing. Little old lady has been cheated.
Second--The victim this time is the ultimate buyer. Unscrupulous party convinces ultimate buyer to purchase property for a price in excess of its true value (by use of false rent rolls, nondisclosure of adverse information, etc.). Meanwhile, unscrupulous party agrees to purchase property from present owner at reasonable price. Two closings occur--the first from owner to unscrupulous party, and the second from unscrupulous party to ultimate buyer. Ultimate buyer is unaware that his seller (the unscrupulous party) only recently came into title, and is likewise unaware of the price paid in the first closing. Ultimate buyer pays waaay too much. This scenario is sometimes seen working on foreign buyers, or investors in commercial properties.
Third--The victim this time is the lender to the ultimate buyer. Property in question has low value. Unscrupulous party conspires to purchase property--or to form a legal entity which will acquire property as a contribution by the present owner, whereupon the present owner becomes a shareholder in the legal entity. Meanwhile, unscrupulous party conspires to sell property to a straw man--perhaps using a stolen or borrowed identification and financial statement (straw man may agree to allow himself to be put in title for payment of $3,000--never intending to claim ownership)--at an artificially high price. Unscrupulous party obtains commitment for purchase money loan based on artificially high price. Two closings occur--the first from the original owner to a middleman (at low value or as contribution), and the second from middleman to straw buyer. No payments are made on purchase money mortgage. Purchase money lender forecloses--and learns the property is worth $30,000 less than the loan balance. This is a classic land flip--some of which seen in the 1980's involved losses in the millions on single parcels of land. Now these flips are being done--all over the country--with low-value residential properties.
When a double escrow is detected, First American's recommended practice for years has been to require full dis-closure of the terms of each escrow to all parties--including lenders--in writing. This disclosure may be made in final closing instructions signed by the parties.
When a land flip is detected, the escrow or closing officer should proceed only with the guidance of senior underwriters or management. This usually means we'll turn the transaction down. We should not rely on the advice of an unknown employee, loan officer or mortgage broker representing the lender. As directed by the new lender requirement above, we may want written approval from the President of the funding lender. Yah, that'll happen.
And what about this requirement that we search for and disclose property transfers within six months of a pending transaction? Our Orange County, CA branch office uses this standard write-up in its preliminary reports/commitments:
"Note____: According to the public records, there have been no deeds conveying the property in this report within a period of six months prior to the date of this report, except as follows: None/(Other)"
This seems like a good solution--although remember the lender whose instruction is quoted above requires that we take the further step of going to their President.
A final thought: Last May I attended escrow training meetings conducted by Dave Westcott and Deborah Morrison (both of Sacramento) throughout northern California. They discussed the problem of unreasonable lender requirements and closing instructions which our people just have to refuse to sign. Remember one lender was requiring that "if the security for this loan consists in part of a home entertainment system, escrow may not close until being satisfied that the entertainment system is a fixture, and part of the real property security." Something like that.
Anyhow, we can't be signing off on such instructions--yet some lenders continue to submit them with each new deal. To avoid the hassle of having to call the lender each time--and having to explain again and again why we can't sign their instructions, Deborah recommended the use of a brightly-colored self-adhesive label, reading:
"Note: The Management of First American Title will not permit the completion of this form. If you have any questions on this policy please feel free to contact First American."
As soon as offending closing instructions are received, it was recommended that the escrow officer affix one of these stickers to the signature line and mail the instructions back to the lender. Deborah said she hadn't had a single complaint from a lender.
This note can be printed numerous times on a single sheet of paper. You buy the blank brightly-colored label sheets from your stationery supplier. Run the label sheets through your copy machine and you have a inexhaustible supply of labels for that endless flow of disagreeable closing instructions.
When we have to say "no" this seems to be an efficient and polite way to do it.
**********
Following Monday's posting Keith Pearson (Glendale/L.A.)writes:
This would seem to be particularly troublesome in places like Southern California with independent escrows. It is possible that these lenders will attempt to hang their losses on us if a deal closes without compliance with these instructions even when a independent escrow company does the closing.
The Orange County branch notation about no transfers within 6 months may hurt us as well as help us since it could be used by an attorney as notice of the problem on a file where there is a transfer within 6 months and the escrow officer at a independent does not get the permission of the President of the lender even though the instructions require that they do. It may be argued that the Title Officers may have to make a phone call every time there appears a transfer within 6 months of the closing in case these instructions are in the closing instructions furnished to a independent escrow company.
Reply to Keith: Yes, you're right about the independent escrow dynamic. Our claims handlers have seen that problem before--an independent escrow or independent agent failing to comply with lenders' instructions, with the result that the lender comes back on the underwriter for resulting losses.
As for the Orange County office "Note," I don't think it makes anything worse--the real problem is the closing instruction. Without the "Note," or without knowing which deals involve another transfer within the past six months, we're still in the same boat when we accept the instruction quoted in Monday's posting.
It's occurring to me now that I shouldn't be so guarded about identifying these lenders involved--I'm sure LandSakes Savants want to know. The two involved in the materials provided by Greg Lindwall are Countrywide Home Loans of Minnesota, Inc. and America's Wholesale Lender (out of Plymouth, MN). Both closing instructions contain identical language--and both give as their President's address that of Countrywide's home office in Calabasas, CA--although the Countrywide of Minnesota instructions do not contain the clause:
"...(2) if such source of title shows a transfer of the subject property during the 6 months preceding the closing date."
Another thing: While I think this is a serious issue, I don't want to see us (or our agents) over-react to it. Some of you may feel your escrow/closing folk can't be trusted to spot double escrows and land flips--so you'll instruct your people not to accept these instructions.
Others of you will feel your people can and should spot these issues--or perhaps you can train them to--so you'll be more comfortable accepting these instructions.
Still others will believe (as I do) that a transfer within 6 months of a closing date is not inherently suspicious--so you'll counsel your people to "know your customer," and if the transaction is otherwise clean-cut you'll let it close without contacting the President in Calabasas (or whereever) and just take the risk.
The most serious risk here, in my view, is a series of fraudulent closings--with the same players engaging in a pattern employing double escrows, quick flips and/or straw buyers. And remember right now these deals are being done with low-value residential properties. I think our people should be able to sniff out the real bad players--and avoid trouble--without delaying or turning away many legitimate deals. They just need to hear--from us--what the new rules of the game are.
I'll bet if you broach the subject with your escrow/closing folk they'll have some strong opinions about how we should proceed...maybe that should be your first step.
**********
Following Monday's posting Roger Therien (Riverside, CA) writes:
Coincidentally, a few months ago I sent out a memo on double escrows. It sets forth some admittedly arbitrary guidelines, but I want to have some way to identify these files and have them reviewed by management. At the same time, I don't want to unnecessarily bog down the production line. The following is the body of my memo. Note that I was not dealing with the lender-instruction issue. Your thoughts?
"Double escrows are dangerous because of the possibility that someone has been misled into selling the property for too little or purchasing for too much. First American does not want to be in the middle of the subsequent lawsuit.
If the sales price on the second sale is more than about 125% of the amount of the first sale, we need acknowledgements from the parties that the intermediary is purchasing/ selling at a *profit*. Where the second sale is more than about 150% of the amount of the first sale,, we need the parties to acknowledge the specific prices. If the customers do not want to do this, we cannot handle either the title or escrow for either transaction.
The parties we need to sign the acknowledgments are the seller, buyer, lender and lender's assignee."
Reply to Roger: I like this. There are so many different ways to try to explain our concerns in this area--it's a challenge. Your approach is to simplify--give 'em a few short rules of thumb. And, I think, once they ponder the "rules of thumb" their appetites are whetted to know more. We could probably use a good PowerPoint presentation on this--if only someone had the time to put it together.
**********
Paul Hammann (Santa Ana) writes:
One of the issues with double escrows that I think we have to be wary of is the possible threat of "tortious interference with contract" claims when we start disclosing without first advising appropriate parties of our need to do so. This can also lead to a customer-relations fiasco - the word in the industry will be that First American isn't interested in the customers' business and the true reasons for our turning away the deal will never be told.
Given these concerns, my practice has always been to identify who in the transaction(s) is getting the real benefit of the double escrow - it will be the buyer in the first deal who is the seller in the second deal (for a higher price) and, of course, the real estate agent/brokers. Before running down the path of disclosure, I would let those parties know of our need (and Company policy) to make full disclosure as a condition to our handling the title and escrow for any of the transactions. If they have a problem with that, we'll find out right away and, needless to say, they can then take the transactions someplace else. If they don't have a problem with our making the disclosures - no doubt because there isn't really any fraud going on - they may even assist us in the disclosure process by agreeing to disclose themselves or, at least, by forewarning the seller (and lenders) of the fact that disclosure will be made.
In response to your question about "who knows what 'equity-skimming' means anyway" (or something like that), I offer the following (I know you know but others may not): When I was in Washington, we had a lot of escrow claims (and some title claims) based on this set of facts:
A "suede shoe" buyer finds a parcel of real estate - usually residences in the claims I was involved in - which is owned by an elderly couple and is owned free and clear or nearly so. Given their age, the couple is looking for monthly cashflow and is attacted by the offer of a substantial down payment if the seller will carry the balance on a note secured by a mortgage. The buyer represents his intention to "refurbish" the place, which will supposedly increase the value. Of course, the buyer needs a loan to make that investment and talks the seller into agreeing to subordinate to that new, supposedly "home improvement" loan. The seller agrees to this because (1) the seller feels comforted by the size of the downpayment (certainly the buyer wouldn't walk away from such a sizable investment), and (2) the funds from the new loan will increase the value such that the seller's security will not be impaired even though they are now second in priority. The real story, of course, is that the buyer never intends to use the proceeds of the new loan to improve the property. In fact, some or all of those proceeds are what fund the buyer's initial down payment so the buyer actually has ZERO of his own money invested in the deal. Additionally, the buyer has a tenant lined up ready to move into the place as soon as the sellers have moved out. More often than note, the buyer negotiates for some period when nothing is due on the seller carry-back note. Interest starts to accrue but the first payment, often being "interest-only" isn't due for six months or a year. As a result, the seller isn't expecting any payments for a while and isn't the wiser when no payments are made. The bottom line: The buyer "skims" all of the rent from the tenant, makes no payments to the "home improvement" lender and eventually also defaults on the note to the seller. By the time the seller realizes what's gone on, the buyer is no where to be found - by the way, the buyer usually forms a corporation to take title and sign the seller carry-back note and mortgage, so forget about a deficiency - the buyer has pocketed the rents for six months or longer, plus any deposits he required of the tenant, plus any additional funds from the "home-improvement" loan above the down payment and closing costs. The seller is out their entire equity, except for the down payment, usually a substantial portion of their life savings.
I am sure many of you have other "equity skimming" stories you can tell with some variation on the facts above. Like clothing styles, it seems these schemes tend to repeat themselves and there may be many of our personnel who were not around when these things were prevalent the last time.
Reply to Paul: You're probably right about the conventional definition of "equity skimming." Still, I'd like the lender to define it for me. Meanwhile, Mary Powell writes:
When I hear "PowerPoint" my ears perk up. (I refer to the double-escrow exchange.) It isn't very time consuming to put together a basic presentation if it doesn't have to be fancy. If the text is available, any presentation can be pirated to accomodate the new information and voila! You have a great, versitle tool. To make 35mm slides from the electronic version is about $5 a slide. I could help on a limited basis if anyone decides to go ahead with this idea.
Reply to Mary: I wondered what was up with your ears. Thanks for the suggestion and offer of help--hope someone can tackle this.
**********
Following up on our posting for 9/28/98, Dave Westcott (Sacramento) writes:
In reviewing a claim (on an unrelated issue) I just noticed the escrow instructions from Bank of the West in 1995 contained the following:
"This escrow shall not close without the written consent of Lender whenever there is knowledge by the escrow agent or its employees of a concurrent escrow or an escrow to be opened or closed immediately upon completion of the existing escrow which will transfer or further encumber the Property."
Fewer words than your example, but the same idea, and legitimate in my opinion because we take the position that we are only subject to the escrow instructions. If that helps us avoid liability where we do a double escrow without instructions forbidding it, then it seems to me we have to allow the lender or parties to give us instructions forbidding it.
Reply to Dave: No telling how many of these instructions lenders have slipped by us--which is the main reason I feel we should be training our employees and agents to watch for land flips and double escrows. We're probably better able to detect the flip itself than we are the lender's instruction attempting to make us liable for any loss.
