At the end of March 2016 the Law Commission (the Commission) opened its consultation (which runs until 30 June 2016) on the Land Registration Act 2002 (the Act).
Simultaneously the Department of Business Innovation and Skills opened their consultation on whether the Land Registry (LR) itself should be privatised.
In this briefing we are focusing on the suggestion within the Commission's consultation paper that the LR indemnity should be caveated and potentially withdrawn from lenders in some scenarios.
What is the indemnity?
You may have thought that the legal title to a particular piece of land was 100% correct once it had made its way to the LR. However, that is not the case. There are inevitably mistakes on the register some of which are fraudulent and some inadvertent. In order to off-set the potential for errors there is a statutory entitlement to an indemnity from the LR.
This indemnity is found in Schedule 8 of the Land Registration Act 2002. The Schedule provides that a person is entitled to be indemnified if they suffer loss by reason of:
- rectification of the register;
- a mistake whose correction would involve rectification of the register;
- a mistake in an official search;
- a mistake in an official copy;
- a mistake in a document kept by the registrar which is not an original and is referred to in the register;
- the loss or destruction of a document lodged at the Registry for inspection or safe custody;
- a mistake in the Cautions Register; or
- failure by the registrar to perform its duty under Section 50.
In addition, a proprietor of the registered estate or charge who is claiming in good faith under a forged disposition is in the event of rectification regarded as having suffered a loss because of the rectification.
In reality this means that where there has been fraudulent activity leading to an error in the register a bank could historically rely upon the LR indemnity to cover any losses it had suffered.
The Commission has highlighted two features of the indemnity scheme. One is that the indemnity is available as a first rather than a last resort. This means that where in particular a registered proprietor suffers loss they don’t need to go and seek to recover those losses from the party who was responsible for them, they can go straight to the LR and leave it up to the LR in turn to recover the losses from the fraudulent party. Secondly, payment under an indemnity is not always dependent on the LR being at fault.
In view of the fact that the Government is proposing to sell the LR to the private sector it is perhaps not surprising that they are seeking through this consultation to tighten up the circumstances under which an indemnity may be claimed.
How does the LR currently cover the cost of the indemnity?
The cost of recovering indemnity payments is currently dealt with through the fees for applications and on an annual basis the LR has reported a surplus. However, there is a concern that the LR's customers should not be the ones to bear the cost of the indemnity and also that in a rising property market the financial consequences of fraud (which is also on the increase) are likely to rise inexorably.
Since 2008-2009 fraud has largely accounted for at least 50% of indemnity payments made each year. In 2014-2015 a total of £5.9m was paid out through the indemnity as a result of fraud (out of a total of £8.4m paid for the indemnity for the year).
What is the proposal in the consultation?
The consultation paper on the Act is lengthy - running to almost 500 pages. Chapter 14 focusses on the Indemnity and offers four options for reform:
- placing a cap on the level of indemnity that can be claimed;
- reforms relating to duty of care owed to the LR;
- other reforms in respect of identity fraud; and
- reforms relating to mortgagees.
A cap on liability
The Commission does not suggest a particular figure for this cap but suggests it should be at a high level to ensure that most claims could be covered in full. It also suggests that parties may need to resort to private insurance in order to top up that indemnity on higher value transactions.
Duty of care between solicitors and the LR
Should conveyancers have to make a declaration in the forms they submit to the LR to the effect that they have taken sufficient steps to satisfy themselves that documents relating to an application are genuine?
Should there be a specific statutory duty of care in relation to identity?
Other reforms in respect of identity fraud
There is provision within the LR forms for identity check but it is subject to a reasonableness test – what constitutes reasonableness in one case will not necessarily be the same in the next. Of course all conveyancers are subject to money laundering regulations and those acting for banks will be subject to the Council of Mortgage Lenders Handbook as well. Should the LR develop their identification processes for example by using a third party software such as "Verify"? This would involve an initial verification at the beginning of a transaction and a subsequent check using a reference number.
Reforms relating to mortgagees
Other systems of land registration around the world draw a distinction between different categories of claimant. In Ontario a distinction is drawn between registered owners in good faith and purchasers of land. This means that an indemnity is provided as a first resort only in respect of residential owners and purchasers. The New Zealand Law Commission has recently recommended more stringent duties on mortgagees to confirm the identity of mortgagors with the rationale that they are best placed to prevent identity fraud.
The Commission is suggesting two options here:
- to limit the ability of the lenders to obtain the indemnity in cases where a transaction has been entered into on the basis of a mistake in the register; and
- to place a statutory duty on them to actually verify the identity of mortgagors.
Limit the way in which lenders can claim an indemnity
Assume A is the registered proprietor of a freehold title. Fraudster (C) impersonating A grants a mortgage over the land to bank B which registers the mortgage.
Assume D is the registered proprietor of a freehold title. Fraudster (E) procures a transfer of D's title into the fraudster's name and becomes registered proprietor. Having obtained registration E grants a mortgage over the land to bank F.
In Scenario 1 there is no mistake on the register at the time the mortgage is granted: the register correctly identifies A as the registered proprietor of the estate. However, bank B's charge shouldn’t be registered because the mortgage has not in fact been granted by A.
If the Commission's first option were implemented then bank B would not be entitled to rely on the indemnity. Conversely, in the second situation bank F would be entitled to an indemnity because the mistake was on the register at the time the mortgage was granted.
Place a statutory duty on lenders to verify the identity of mortgagors
How about a situation where mortgagees would have a duty of care to the LR to take reasonable steps to verify the identity of their mortgagors? This again raises the question of what constitutes reasonable steps? Would this be down to the Financial Conduct Authority or the Council of Mortgage Lenders perhaps? Where the bank failed to carry out sufficient checks and therefore breached the duty the registration of charge would be a mistake and that mistake would be rectified but without payment of an indemnity.
Of course this could end up being a dual pronged attack on both solicitors and mortgagees as both will be under a duty to carry out best practice KYC checks on the buying/borrowing entity. As fraudsters become more and more sophisticated the length to which these parties should reasonably be expected to go will inevitably increase.
Potential impact on solicitors and their professional indemnity insurers
The duties owed by solicitors to lenders in conveyancing transactions are already extensive and can lead to claims for breach of contract, negligence, breach of fiduciary duty, breach of warranty of authority and breach of trust. The latter claim can lead to solicitors having to reconstitute the trust fund (ie all the monies advanced by the lender), thereby effectively indemnifying lenders from fraudulent transactions.
Recent cases have considered solicitors' duties in conveyancing transactions where a fraud has been perpetrated:
In the case of Purrunsing v A'Court & Co and Another both the buying and the selling solicitors were held to be liable (in breach of trust for the fraudulent activity). This was a case where a fraudster purported to be the registered proprietor of a house in Wimbledon. He then "sold" that house for £470,000 to the buyer. When looking at the red flags which should have been sufficient warning to the solicitors the court highlighted the following:
Seller's Solicitor Red Flags:
- The house was unoccupied; and
- The address for service on the official copies was not the property address and neither was it the address that the client gave for correspondence.
Buyer's Solicitor Red Flag:
The Buyer's solicitor raised additional enquiries in relation to the identity checks that the Seller's solicitor had done on their client. However, they failed to follow up on the inadequate replies that were given to those enquiries. Somewhat ironically, in raising those additional enquiries they raised the duty of care they were expected to give to the LR. In not pursuing the inadequate replies they were therefore held jointly liable.
In one of our recent briefings: Do solicitors owe a duty to the LR?, we talked about the case of the LR v Caffrey & Co and the length to which solicitors are currently expected to go. That case involved fraud by the borrowers (the true owners of the property), who wanted to remove a mortgage over the property. They instructed their solicitors (Caffrey & Co) that the lender had its own solicitors and provided fraudulent documents allegedly from the lender so that the LR could remove the charge. By the time the lender found out that the charge had been removed, the borrowers had re-mortgaged. The lender succeeded in claiming an indemnity from the LR and the LR succeeded in its claim against the solicitors for negligent misrepresentation.
Although the Court decided that the solicitors had misrepresented the position to the LR by providing the documents allegedly signed by the lender, the case was decided on its particular facts, which were not challenged by the solicitors because they did not attend the hearing. If they had, the decision may have been different.
Even though the LR was ultimately successful, it lost its subrogated claim in negligence because of the Court's views on the scope of solicitors' duties to a lender. The Court decided that:
- the solicitors did not owe a duty of care to the lender to verify the documents provided by the borrowers (allegedly signed by the lender);
- it was not a solicitor's duty to verify information provided by a third party, especially when this may mean not acting for its own clients and putting them to costs;
- the risk of fraud in an inherently risk system should not be passed from the lender to the solicitors;
- the LR could be said to owe a duty to the lender to ensure that its charge was not removed from the register because of fraud;
- the action by the LR is what caused the lender to suffer loss.
Although the Court considered several factors when concluding that the solicitors had not been negligent, one factor was that the lender had a remedy against the LR. If this is removed then courts may hold solicitors to a higher standard simply because they are required to have insurance to meet claims. This would allow the LR to rely on documents provided by lenders or solicitors somewhat blindly in the knowledge that it would be unlikely to be held responsible for any mistakes.
If a statutory duty was imposed on lenders, then it is likely that this would be passed to their conveyancing solicitors. This could lead to lenders taking a more relaxed view of their own internal checks before instructing solicitors, which could see fraudulent applications for mortgages which would have been identified at that stage slip through the net.
Subject to the scope of such a duty, it could mean that solicitors would become contractually liable for failing to verify the identity of potential mortgagees. Solicitors are already subject to a duty of care to identify their client but it is not absolute. Where there is separate representation, the question is whether the lender's solicitors would become responsible for the failure of the borrower's solicitors to identify a fraudulent client, or whether undertakings would be appropriate to guard against such a risk. Solicitors can reasonably rely on certain other professionals to verify a borrower's identity but this may become obsolete. The existence of compulsory professional indemnity insurance means that the risk will likely fall to solicitors.
If lenders cannot seek an indemnity from the LR, then it is reasonable to assume that they will make more claims against solicitors and seek to pass the risk of fraud to solicitors and their insurers. Given the sums paid out by the LR as a result of fraud (as cited above), this could hit the solicitors PII market hard.
With more and more solicitors taking on conveyancing matters at a fixed fee under pressure to complete the transaction as soon as possible, any restrictions on an indemnity from the LR could lead to firms being priced out of the market if they and their insurers have to bear the costs of fraud alone. In our view, in light of the increasingly sophisticated nature of mortgage fraud, only increased awareness and vigilance form lenders, solicitors, and the LR together can reduce the risk of the fraudsters being successful.