What Every Lawyer Should Know about Litigating Real Estate Fraud Cases in California
1. Required licensing for brokers and salespeople. To lawfully engage in the activities most people associate with “real estate agents” a person must first be licensed by the California Department of Real Estate. Cal. Bus. & Prof. Code §10130. The DRE offers only two types of licenses: (1) a broker’s license or (2) a salesperson’s license. It is critical to know whether the actors involved are actually licensed because that impacts their potential liability as well as their employers’ potential liability. An individual’s license type, status, and history can be found on the DRE’s Web site at www.dre.ca.gov/.
2. Brokers’ vicarious liability. The DRE requires that every real estate broker “have a written agreement with each of his salesmen” whether that salesperson is licensed as a salesperson or a broker. 10 Cal. Code Regs. §2726. The agreement must “cover material aspects of the relationship between the parties, including supervision of licensed activities, duties and compensation.” Brokers typically use these agreements to characterize their relationships with their salespeople as that of independent contractors.
However, the real estate laws are specifically designed so that brokers are held vicariously liable for their salespeople regardless of their titles. Business and Professions Code Section 10032(a) explicitly states that all real estate-related regulations and statutory obligations of brokers and salespersons to members of the public “shall apply regardless of whether [they] have characterized their relationship as one of ‘independent contractor’ or of ‘employer and employee.’” Further, a salesperson is defined by statute as someone who is employed by a licensed broker. In other words, a salesperson can only act through and on behalf of a broker. Brokers are also required to supervise their salespeople and are subject to discipline by the Real Estate Commissioner for failing to do so. California and federal courts have consistently interpreted this statutory scheme in favor of brokers’ vicarious liability for the acts of their salespeople.
The consequences for brokers are severe. If brokers are found guilty of fraud, either their own or that of their salespeople, the DRE can revoke or suspend the brokers’ license. This eventuality can figure heavily in settlement discussions.
3. Real estate licensees and fiduciary duties to their clients. Real estate licensees owe at least two fiduciary duties to their clients: (1) the Duty to Use Reasonable Care and (2) the Duty of Undivided Loyalty.
The Duty to Use Reasonable Care means that a real estate licensee acting on a person’s behalf must act as a reasonably careful real estate licensee would under the same circumstances. The Duty of Undivided Loyalty requires real estate licensees to act only to further their clients’ interests. A licensee breaches the Duty of Undivided Loyalty when knowingly acting against the client’s interests or acting on behalf of another whose interests are adverse to the client’s.
4. Unaffordable new loan? Be creative. Often, the largest obstacle to resolving a real estate fraud case is the existence of a new loan that the fraudsters have taken out on the property. A number of creative solutions exist to overcome this problem: (1) the homeowner may be eligible for a reverse mortgage that would pay off the new encumbrance and allow the homeowner to live in the property without making mortgage payments; (2) the new bank may modify the new loan to reflect terms acceptable to both sides; (3) if title still rests with the straw buyer, do a “short sale” back to the victim; (4) move to cancel the new Deed of Trust under the theory that a grant deed, void ab initio due to fraud, cannot convey good title and therefore cannot form the basis of an encumbrance even for a bona fide encumbrancer (e.g., the new bank). Under this last scenario, the encumbrancer may still be entitled to an equitable lien on the property for the amounts it paid that benefited the victim.
5. Red flags for lenders. There are several common “red flags” that mortgage brokers and lenders should look out for when reviewing real estate loan applications. If a mortgage broker gave its seal of approval to a loan application containing one or more red flags without further investigation or if a lender loaned money based on an application containing red flags, their ability to claim that they were defrauded and their available remedies (e.g., an equitable lien) may be limited. Examples of red flags include (1) an incomplete purchase/sale agreement; (2) undated documents; (3) significant or contradictory changes in income, assets, and/or liabilities over a short period of time; (4) irregularities in the sources of the buyer’s down payment (i.e., if the application says that down payment is coming from one source, but then it comes from another); (5) multiple purchases of rental properties; (6) post-closing loan payments to be made by someone other than the borrower; (7) the seller pays all closing costs; (8) HUD-1 Closing Statement contains unusual disbursements or payoffs; and (9) the deal is structured as a “For Sale By Owner” when, in reality, the defrauders are acting as dual agents for the buyer and seller.
These and other tips for identifying fraud in real estate transactions are widely available. As with many other things, however, the best method for identifying and remedying fraud is to prevent it from occurring in the first instance. Additional methods to spot fraudulent transactions before they occur are available online at www.freddiemac.com/dgtq/pdf/fr.pdf.