Short sale fraud continues; Agents must present all offers (OR: Nov. 2010)

by Peg Ritenour
Vice President
Legal Services

An increasing number of transactions handled by REALTORS involve short sales. OAR’s Legal Hotline has received numerous calls from listing brokers who have been approached by investors looking to purchase these properties and turn around and sell them at a quick profit. The practice is becoming so common that it has even garnered a nickname…“flopping.”

While some of these transactions are legitimate, many others may involve questionable practices. In an article posted on its website last summer, Freddie Mac voiced concern about some of these transactions, characterizing them as short sale fraud.

Freddie Mac’s Investigation Unit defined this as any misrepresentation that would induce a lender to agree to a short sale that it would not approve if it knew all of the facts. This would also include failing to disclose pertinent information to the lender.

Although there are many variations of short sale fraud in Ohio and around the country, many of them are similar.

The following is an example of what Freddie Mac considers short sale fraud:

• A seller owes $100,000 on his mortgage, however, the property is only worth $80-85,000.
• An investor approaches the seller/listing agent with an offer to purchase at $70,000. The seller authorizes the investor to begin short sale negotiations with his lender, sometimes even giving the investor a power of attorney.
• The investor places the property on the market, often listing the property with a broker
–in some instances the broker may be the same one who had it listed for the owner of the property.
• The investor finds a “purchaser” and enters into a contract to sell to this “end buyer” for $95,000.
• The investor negotiates a short sale with the lender, obtaining approval of his contract to purchase at $70,000 by convincing the lender that is the highest price the market can support.
• The investor does not disclose his contract to sell the property to the “end buyer” for $95,000.
• Both transactions close on the same day with the investor netting $25,000.

Certainly “flopping,” like flipping, is not always fraudulent. However, in this case, the conduct that constitutes short sale fraud is the failure to disclose that there is an end buyer willing to pay $25,000 more for the property. By withholding this information, the investor convinced the lender to approve the short sale on terms they otherwise would not have. Clearly this deceit resulted in the lender taking a much larger loss on the sale than necessary.

In addition to civil action for such fraud, this type of conduct can also potentially result in criminal sanctions. In Connecticut, two real estate agents who concealed the existence of a contract with an end buyer at a higher price from a lender were recently convicted of fraud. Following that case, some experts began to predict that lenders may begin scrutinizing transactions for cases of short sale fraud more closely.

For this reason, the FBI, Freddie Mac, and the Ohio Division of Real Estate, along with other state licensing agencies, have cautioned real estate licensees about involvement in short sale transactions where the existence of a higher offer is concealed by an investor.

Additionally, these types of transactions with investors can pose agency and license law concerns for the REALTOR who has the property listed for the owner who is upside on their mortgage. As their listing agent, the REALTOR owes that seller full fiduciary duties, including the duty to present all offers to the seller.

For this reason, it would constitute a conflict of interest for that same listing agent to begin marketing and presenting offers on the property for an investor who has only an option to purchase the property.

Certainly real estate licensees should be aware that they cannot list property on behalf of an investor who does not yet have title to the property without the consent of the owner. Moreover, even if such consent is given, disclosure of the fact that the investor does not yet have title to the property should be made to any potential purchaser.

Because of the complicated nature and potential legal pitfalls of short sales, it is crucial that agents discuss such situations with their broker or manager from the outset. The legal staff at OAR are available to assist brokers and managers sort through these issues to avoid unintentional liability through OAR’s Legal Assistance Hotline.

Multiple offers and Short sales

Several REALTORS have contacted the Legal Hotline about handling multiple offers when dealing with properties that are going to be sold as a short sale. These agents recognize that they have a duty to present all offers to their client (the seller), and that it is in the best interests of the seller for all contracts to be submitted to the lender to minimize the amount of any potential deficiency judgment the lender may obtain against them.

However, in some instances the lender’s own policies make it difficult for REALTORS to submit additional offers to the lender. For example, many agents are reporting that if a lender is in the process of reviewing one short sale contract, they will not allow the listing agent to submit subsequent offers, even if they are for a higher price. While that policy may be difficult to understand, it is important for REALTORS to understand that their fiduciary duties to their client require then to follow their client’s instructions and act in their best interests.

Thus, if a seller accepts an offer contingent on their lender’s approval, and instructs the listing agent to submit it to the lender, the agent must follow those instructions. If the lender/asset manager refuses to allow them to do so, the agent should document the lender’s policy and refusal to accept the subsequent short sale contract. This will establish the agent’s attempt to follow the seller’s instructions and will also protect the agent from an allegation that the existence of a higher contract was withheld from the lender. Absent such a policy, all short sale contracts should be submitted to a lender if so instructed by the seller.