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Allens Arthur Robinson

Focus: Banking & Finance – August 2008

Mortgage fraud in Queensland – a timely reminder

In brief: The United States sub-prime crisis and its global effects have focused financiers' minds on the importance of valid and effective security. One aspect of ensuring security is watertight, something which is not often given the attention it deserves, is the need, in Queensland, to verify the identity of the person purporting to sign a real property mortgage as mortgagor. Partner Adam Thatcher (view CV) and Lawyer Nicholas Ng look at a recent decision of the Supreme Court of Queensland that is a timely reminder of the importance of diligence by lenders and their professional advisers.

How does it affect you?

  • Lenders need to develop, implement and audit compliance with policies to detect and address mortgage fraud to ensure their security is valid and enforceable.
  • When taking security against real property in Queensland, stringent identity verification requirements are in place. Failure to comply with those requirements can potentially place lenders in an unsecured position.

The case

Hilton v Gray (2008) QConvR 54-686 involved what Justice Douglas referred to as a 'high interest, short term' loan 'granted by demanding lenders to desperate borrowers'. The lender advanced an initial $176,000 short-term loan to a borrower referred to as Mr Gray, secured over property owned by Mr Gray, followed by a further advance of $30,000. In fact, Mr Gray's signature on the loan agreement and mortgage over his property were falsified, and Mr Gray never knew of the loan.

A number of events transpired that may have indicated that the mortgage was fraudulently signed. These included that:

  • a solicitor's certificate provided with the signed mortgage documents was unsigned;
  • when a signed certificate was later provided, it was signed by a person who was not an admitted solicitor;
  • there were irregularities in the certificate provided that were not queried or otherwise followed up;
  • the lender's lawyers had no direct contact with the borrower (only his step-daughter who was purporting to act on his behalf); and
  • at no point did the lender or their advisers ask the borrower to provide photo identification.

In the absence of repayment, the lenders subsequently sued Mr Gray seeking to enforce the mortgage. The State of Queensland, which would have been responsible for compensating Mr Gray if the mortgage was enforceable, ran Mr Gray's defence.

The State argued that the conduct of the lender's lawyers, in omitting to follow up the matters above, amounted to fraud by the lender. This alleged fraud, the State argued, meant that the lender did not enjoy the benefits of their mortgage being registered. Practically, it would mean that the lender could not sue Mr Gray for the debt owed, nor sell his land.

Ultimately, the court found that there had been no fraud by the lender's solicitors, because for fraud to exist there needs to be actual dishonesty and the mortgage was enforceable. However, the court went on to suggest that this dishonesty could exist where there is a suspicion that a document is fraudulent, combined with wilful blindness to the issue.

Although this seems like a high standard of dishonesty to meet, the issue is one the courts can assess from a position of perfect hindsight, free from the commercial pressure to get the deal done, the tight timeframes and the vast geographic distances between parties that characterise many modern financing transactions.

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Section 11A of the Land Title Act

The mortgage in this case was entered into before section 11A, along with consequential provisions of the Queensland Land Title Act 1994 were introduced.

Under those provisions, the situation for lenders is even more tenuous. Fraud no longer needs to be proved – a lender can lose the benefits of registration of the mortgage if they do not take reasonable steps to verify that the person signing a mortgage as mortgagor is, in fact, the owner of the land being mortgaged, before the mortgage is registered.

The term 'reasonable steps' is a vague one, but under the Act, compliance with guidelines published by the Department of Natural Resources and Water is deemed to be taking 'reasonable steps'. Generally speaking, for individuals the guidelines recommend undertaking a 100 point identity check. The guidelines are not as prescriptive for companies, stating that the lender must comply with practices that a prudent lender would consider appropriate and reasonable.

However, the guidelines go on to say that taking these steps may not always be sufficient – it is incumbent on lenders to follow up issues which may seem unusual or suspicious. It is only after following up those issues that, under the guidelines, the lender will have taken 'reasonable' steps. This qualification is significant, as the knowledge of every employee of the lender, from the relationship manager for the borrower to the bank teller who processes a transaction, will be combined and attributed to the lender.

If the facts in Hilton v Gray had happened after these provisions came into force, the result would in all likelihood have been very different. No real identity checks were undertaken, and a number of matters which may have raised suspicion were not followed up. It is likely that the court would have found that the mortgage would not have the benefits of registration and, in the circumstances, be unenforceable.

If this occurred, the lender's usual right to claim compensation from the State for being defrauded would also be removed.

At a practical level, where the requirements are not complied with, lenders run the risk of ultimately being in an unsecured position.

Similar obligations are imposed on transferees of mortgages. A transferee is required to ensure that the identity verification steps were taken when the original mortgage was signed, which is arguably an even more onerous obligation.

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How can lenders' rights be protected?

Lenders need to develop an internal policy regarding identity verification that is consistent with the requirements of the Land Title Act. The policy will need to go beyond the mere mechanical carrying out of identity checks, and should extend to systems for detecting warning signs of fraud and establish lines of communication to ensure those warning signs are quickly communicated to all relevant parts of the organisation.

A culture of strict compliance with those policies will be essential, as will internal audit systems to ensure compliance.

A lender's professional advisers, brokers and other intermediaries need to be acutely aware of the Land Title Act requirements, and with each lender's identity verification policy. Again, a culture of compliance, and ongoing and thorough audits of compliance continue to be essential.

With these systems in place, lenders can take security with confidence that their interests are (to the greatest extent possible) protected if the unfortunate reality of mortgage fraud occurs.

For further information, please contact:

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