Posting for

Tuesday, August 4, 1998

by: Bert Rush

brush@firstam.com

LAND FLIPS/FRAUD/DOUBLE ESCROWS

There were two interesting postings on the DIRT e-mail listserv yesterday, as follows:

From: "Kevin J. Dunlevy" <KevinD@stephenson-sanford.com

Subject: Land Flips

Land flips are hot right now in Minnesota. Florida, California and maybe Arkansas come to mind when thinking about real estate fraud. However, this one has made it to the frigid upper Midwest. State real estate licensing officials estimate there have been 250 land flips involving low-end properties, other estimates are higher.

A land flip involves a fair market sale from a usually honest seller to a speculator and then a sale by the speculator to a co-conspirator or an unsophisticated buyer. Here the ultimate buyer is often a single low-income mother who understandably wants to raise her children away from the gunfire and drug deals in rental properties.

To put numbers on it, the first purchase agreement is for $25,000, the true market value of the marginally habitable property as reflected by the property tax value. The speculator then makes a second purchase agreement for $75,000 with the unsophisticated buyer, supported by an appraisal that uses erroneous comparable sales to support the $75,000 price. Oftentimes the second purchase agreement includes overvalued repair and improvement allowances.

The speculator (often a real estate broker or mortgage broker) assists the unsophisticated buyer in qualifying for an asset based, sub-prime loan, because the buyer has a bad credit history. A title insurance agent issues a title commitment showing the speculator in title, when the first purchase agreement has not closed. The speculator needs to show good title so the loan to the buyer will close. There are often simultaneous closings of the first and second purchase agreement.

The speculator takes a "carry-back" mortgage for the spread between the $55,000 asset based loan and the second purchase agreement price. The speculator often funds the buyer's "cash needed to close" outside the closing by an alleged gift of the closing costs. The speculator usually gets that cash back at closing. The sub-prime, secondary market lender probably does not know it is taking a $55,000 mortgage on a $25,000 property, but I wonder if some secondary market lenders want to book the loans and sell them. Perhaps they plan to be in the Bahamas when the economy turns and these loans shake out.

The speculator usually does not try to collect monthly payments on the carry-back mortgage, hoping to make a second killing when the buyer refinances or sells.

Where do you draw the line between an aggressive business deal and a fraud? The US Attorney, the FBI, the Minnesota Attorney General and the Commerce Department are looking into these transactions, but what is their statutory or common law basis for nailing the speculators? Some appraisers are losing their licenses, and presumably, some real estate brokers and mortgage brokers will lose their licenses, but what are the standards?

Who should bear the risk of loss: the sub-prime lender, the unsophisticated buyer, the secondary market, the speculator, the real estate broker, the mortgage broker and/or the title company? Where is the line between a title company taking the business risk that the first deal will not close, and insuring the speculator in title, when the speculator has only equitable title under a purchase agreement and not actual fee title under a deed? When is the title company, buyer and/or sub-prime lender a dupe or duplicitous? Clearly, the speculator should bear the risk of loss, but people who have no honesty are difficult to collect from because they have no qualms against using false identities and they may not stick around for the fallout.

The local newspapers have published some features on this topic. See www.pioneerplanet.com <http://www.pioneerplanet.com and do a search for "land flips." Click on the July 29 article titled "More kids, women homeless in Minnesota."

X-Sender: akheel@pop.primenet.com

While it seems clear that the transaction described in the original post involved fraud and deceit, I think its important to note that the terms "speculator" and "land flip" should not necessary be viewed in the perjorative. There is nothing inherently illegal, unethical or immoral about entering into a contract to sell an asset before you have closed the transaction to acquire the asset, as long as all the necessary and proper contingencies are observed and disclosures made. If this were stock, I think they would call it selling short. In California we would probably call this a double escrow. As the poster correctly pointed out, we are a hot-bed of fraudulent activities out here [:-)] so there are abuses of course. But there are also many legitimate uses of such devices. I just want to make sure we don't paint all "speculators" with one brush.

Comment: In the 1980's land flips were found to be a primary factor in the failures of many S&L's. The worst of these often involved large parcels of vacant land--such as along Interstate 30 between Dallas and Fort Worth--achieving astronomic (false) values in "flips" done in rapid succession between parties acting in collusion. Many of these folks went to prison for bank fraud--so they got "painted" pretty good.

Lately we've seen a revival of the land flip--but now involving low-end residential properties. Within the past two years we've seen schemes involving the same players and dozens of properties in NJ, DC, TX, and elsewhere (not the same players in each state--but same players involved in multiple transactions evidencing a pattern of fraud based on artificial property values and bad appraisals). Con artists have figured out that some lenders are over-eager to make loans in this market segment--and they are taking advantage of lax controls. I don't see a lot of moral ambiguity here--an artificially set price and/or false appraisal are instrumentalities of fraud.

Our employees and agents should understand clearly that when they detect fraud or a pattern of suspicous transactions they should steer clear--consult with their managers and with state, regional or home office underwriters and/or counsel. People go to prison for these things--including title people, closing officers, and in-house counsel.

Some of you may remember the Keskey case (U.S. v. George R. Keskey, Jr. [7th Cir. 1988] 863 F.2d 474). Keskey was the Chief Title Officer and State Counsel for American Title in Milwaukee, WI. A local real estate investor ("good customer") named John Huber asked employees in Keskey's office to write-over unpaid mortgages. Keskey approved the practice, taking Huber's indemnity. Between late 1981 and March 1983 Huber closed more than 50 transactions in Keskey's office--while Keskey was aware of the on-going write-over practice and did nothing to stop it. There's no indication in the reported decision that Keskey received any kickback or bribe--just Huber's business. Apparently some lenders suffered losses due to these undisclosed mortgages (tho probably covered by title insurance). Keskey was charged with the federal crimes of conspiring to make false statements for the purpose of influencing federally insured financial institutions to grant loans (violation of 18 U.S.C. sec. 371) and aiding an abetting false statements in mortgage notes submitted to a federally insured savings and loan (violation of 18 U.S.C. sec.'s 2 and 1014). He was convicted and sentenced to six years in prison.

There are many other state and federal criminal statutes that can be used against "perps" of fraudulent real estate deals--including the venerable Racketeer-Influenced and Corrupt Organizations Act ("RICO").

So how's an employee or agent supposed to detect frauds? They aren't, really. Their job is to facilitate transactions--and make customers happy. But when fraud becomes apparent, it should be just as apparent someone is going to end up unhappy--and trouble is sure to follow.

Questions, comments, argument? Just press the "reply" button and send your thoughts to LandSakes.

**********

Following Tuesday's posting, Don Schenker (Madison, WI) writes:

Small world. John Huber recently made news reported in the Milwaukee Journal. He has been accused of this same exact low-income central city land flip scenario. Fortunately, no title policy on any of these properties was issued by First American.

He used LLCs and other real entities to hide the interconnection between

the buyers and sellers.

No word yet if the local D.A. will prosecute. He of course claims he is only benefitting the community by fixing up properties and helping people become homeowners.

And Oscar Beasley (Santa Ana) writes:

I find the land flip information very interesting in that there are two basic areas of concern. One is the transaction itself and the other is the handling of the transaction, that is the ESCROW. It is all well and good for a title company to issue a policy to the first buyer and then to the ultimate buyer if the agent has no interest of information about the flip. The bigger issue arises when the closing of both transactions are handled by the same title or escrow company, There is an agency relationship created between the buyer who then becomes seller and the escrow and also between the original seller and the ultimate buyer and the escrow. Under an agency relationship most courts have ruled that even if the agency is limited there is still an obligation to disclose that which effects the transaction to each of the parties. If there is any fact of fraud that is disclosed to the agent it must be disclosed to the principal. The courts generally I believe will require that the agent advise the principals that another escrow or closing exists, but not the facts involved.

I suppose that this begs the other issue. The Query is: Just because you can buy low and sell high is it a Fraud? It may depend on the status of the individuals and the knowledge possessed by each. If the first buyer already has a deal set for the ultimate sale and fails to disclose when first seller is totally without such knowledge is it fraud? Maybe not but only a court and/or jury may make that decision. Do you want to pay the cost and if wrong assume the damages. Is it not better just to disclose or not to handle one of the legs.

Finally, there was another reply to the posting on Pat Randolph's DIRT

listserv, which I've shamelessly copied and pasted below:

From: "Matthew J. Cholewa" <mcholewa@landam.com

Subject: Re: Land Flips

Since the co-conspirators (the "speculators," appraisers, perhaps the attorneys involved) were knowingly defrauding lending institutions through the use of an inflated appraisal, aren't the facts as you present them a fairly straightforward case of federal bank fraud? I don't see any line-drawing problem here. See 18 U.S.C. Sec. 1344:

Whoever knowingly executes, or attempts to execute, a scheme or artifice -

(1) to defraud a financial institution; or

(2) to obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses, representations, or promises; shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.

Matthew J. Cholewa

Lawyers Title Insurance Corporation

104 Sebethe Drive

Cromwell, CT 06416

mcholewa@landam.com

860-635-5566

Fax: 860-635-6606

Wonder how they'd feel about educating the competition? Nya-ha-ha.