Separate representation for borrower and lender
A review of the difficulties with the current position and the options going forward, against the author's view that a rule change is needed
In my article in the January issue of the Journal, I posed the question as to whether it might now be time for the Law Society of Scotland to consider removing the exception to the general conflict of interest rule so that it would no longer be possible for the same solicitor to represent both borrower and lender in a residential property transaction.
Since that article was published, there has been considerable debate among members of the profession (see LinkedIn Discussion Forum, for example), and the matter has been discussed by appropriate Society committees. The Annual General Meeting in Perth also decided that a working party be established to examine the matter in detail with a view to it reporting back to a Special General Meeting of the Society in September 2012 if possible. Membership of that working party is drawn from the Society’s Professional Practice and Property Law Committees.
The purpose of this article is to examine some of the issues in the debate and whether we are defending a system that has outlived its usefulness.
The lender’s position
It is trite to say that in the vast majority of cases, clients will not be in a position to purchase a residential property without loan finance being available. Such loan finance is generally obtained from banks or building societies and is secured against the property in question by the grant of a standard security. The lender, quite reasonably, wants to ensure that it has a valid security in place and that the title to the property is valid and marketable. In short, the lender is entitled to require that its position is protected in case the borrower should default in making loan repayments or otherwise breaches the conditions of the standard security.
Over the years, practice has evolved whereby the borrower’s solicitor also acts for the lender – largely to keep costs down. A by-product has been that the transaction generally runs more quickly. In recent years however, there has been an increase in mortgage fraud and, unfortunately, professional negligence associated with secured lending. This has led to increased claims by lenders against the solicitors who were appointed to represent them. That appointment is almost universally done by reference to the CML Handbook thus forming a contract between the lender and the solicitor. A contractual duty of care is thereby created.
The CML Handbook is available only online and, unfortunately, there have been examples of the full import of the Handbook and individual lenders’ requirements not being fully acted upon by the appointed solicitors. This can be as a result of an individual lender’s terms being updated and this not being readily identifiable by the solicitor acting. This has led to PII claims and, in certain cases, professional sanctions. No blame can surely attach to the lender in cases where their interests have not been properly represented. That is not the only point at issue, however.
There is, in my opinion, an inherent conflict of interest. While it may appear to be convenient for a borrower’s solicitor to act also for a lender in a purchase, that convenience in itself is the very issue, in that a client may be perfectly prepared to accept, for example, that a completion certificate is missing, yet the lender may not take that risk. In such cases, the solicitor then ends up as the middleman attempting to broker a compromise between two positions… an instant conflict of interest. Why should the solicitor assume that risk?
It is also worthwhile stepping back for a moment to consider how we have got to where we are. As Ross Mackay, the convener of the Society’s Property Law Committee said recently, the view that separate representation will inevitably lead to increased cost for the borrower could have been avoided if, years ago, we had issued two invoices upon completion of a purchase transaction involving a grant of security in favour of a lender. This would have seen one invoice going to the purchasing client and the other invoice being addressed to the lender but stated to be payable by the purchaser. In practice, a single invoice was inevitably rendered to the purchaser to include all services provided by the solicitor. Clients and, indeed, lenders did not then appreciate or indeed value the work done by the purchaser’s solicitor with regard to the security element of the transaction.
Lenders have the funds that fuel the buying/selling process and, as such, they have a significant degree of control. In as much as the traditional system has suited clients (lower fees) and also solicitors, it is really a benefit to the lender. The true cost of securing the lender’s interest is, in the vast majority of cases, not passed on to the borrower, yet the borrower’s solicitor is potentially exposing the Master Policy to claims. This has led to considerable unrest and for calls for the present system to be overhauled. This has taken place at the same time as lenders have been “cleansing” their panels of solicitors – there being a number of high profile and in some cases quite ridiculous examples. That “perfect storm” has focused the debate as to whether the same solicitor should continue to be able to represent both borrower and lender.
The current stance of CML Scotland is that there is no reason to move to separate representation. See (www.journalonline.co.uk/News/1011444.aspx). There has been a meeting between representatives of CML Scotland and the Society’s working party, but it is fair to say that there is no agreement between them as to the way forward.
1. There are those in the legal profession who, along with most lenders, would prefer that the status quo should remain. For the reasons outlined above and in other articles, I believe that this is no longer either appropriate or desirable. A solicitor acting for a purchaser should be in a position to fully represent his/her client’s interests, without assuming unnecessary risk as a result of also acting for a third party who has or is likely to have a potentially conflicting interest.
2. Another option that has been suggested is where the present system continues but with the real cost of creating the standard security being passed on to the borrower, either at the time of the transaction or over the term of the mortgage. That sounds like a solution, but is it really? Simply increasing the fee does not remove the risk. Would there not also still be pressure on fees as a result of market forces? In that event, we are back to the same core problem of exposing the Master Policy to an unnecessary risk.
3. Lenders could and, indeed, are likely to create bespoke panels of solicitors to represent their interests. There is a precedent for this in the case of remortgage work. Although there are examples of different service levels with regard to such work, those solicitors who specialise in this area have invested considerably in processes and systems, and those processes could be adapted quite easily for wider use with regard to the grant of new securities.
There are still issues to be examined with such an approach, however, especially if the panel solicitor simply seeks to pass all responsibility onto the borrower’s solicitor. There are benefits of separate representation, however, in that the issues should be exposed for full consideration so that the lender can make an informed view. This could, of course, lead to delay, but if it is a delay caused by proper consideration of important issues, would such a delay not have been inevitable in any event if the interests of both parties were being properly represented?
It might also be possible for a new accredited specialism in secured lending to be created. That may be worthy of consideration, as it would provide those who specialise in that type of work and who wish to be represented on lenders’ panels to be seen to be specialists in that area. That, in turn, should make the process easier. We surely have to avoid a debacle of the type which has surrounded the introduction of new procedures in Scotland by certain lenders.
4. A further option is bespoke indemnity insurance in the form of a policy taken out by and for the lender. Such a policy would be used in separate representation cases and would seek to protect the lender against the carelessness or fraud of the solicitor acting on their behalf. First Title (www.firsttitle.eu) have created such a policy, called the Home Loan Protection Policy, and early feedback from lenders is positive.
By way of example, the average cost of a lender-only policy is envisaged as being in the region of £125 plus tax if the mortgage is less than £175,000. A pricing policy has not yet been developed for Scotland, however. One benefit of this approach is cost – it is a one-off payment which can be passed on to the borrower client and is probably more palatable to the borrower than he/she having to meet increased legal costs. Such a solution would appear to help all parties irrespective of what system the lender wishes to adopt.
Put bluntly, when all is stripped away from the system that operates at present, the essence is that it is the solicitor’s professional indemnity insurance that is the focus, as it is only the solicitor who has insurance in the process. The benefit of the First Title and other such policies available in the market place is that it introduces a “risk assuming” party. In other words, someone who comes to the transaction willing to assume the risk, rather than avoiding it or wishing to place it on another party in the transaction. This obviously requires a waiver of subrogation rights against the solicitor where they are negligent (but not criminally liable), and leads to a more co-operative attempt to help the client acquire their new home and the mortgage. Not all such policies offer waiver of subrogation rights and this should be investigated at the outset. There would still be a fee payable by the borrower to reimburse the lender having its solicitor carry out CML Handbook checks with regard to “back to back” transactions etc.
In the circumstances and given the challenging economic times at present, it is suggested that this option is worthy of further consideration.
In my opinion, the removal of the current exception, and a requirement that the borrower and lender be separately represented, will be in the overall best interests of borrower, lender, and the profession as a whole. Only by doing this will clarity and complete independence of advice be achieved.
The inherent conflict of interest between the interests of the borrower and the lender remain for as long as the same solicitor acts for both parties. In my opinion, the present system requires a complete overhaul, with the issues being looked at from first principles rather than us seeking to defend a system with which we have become accustomed. If we were starting today, would we adopt the present system of dual representation? I think not.
Professor Stewart Brymer WS, Brymer Legal Ltd, Dundee and Edinburgh, and the University of Dundee