Thieves among us

Anew form of fraud has emerged in Canada that involves a fraudster relying on a ‘straw buyer’ to purchase a property for the fraudster’s benefit. The fraudster may lure an individual to act as a straw buyer by offering cash compensation and by misrepresenting the liability associated with the transaction. We have also seen a rise in the use of phony names, identity theft and the misuse of power of attorney documents.

In addition to mortgage fraud, a fraudster purchases property on speculation that its market value will exceed the sale price prior to the date of closing, but exploits the straw buyer in order to hedge his personal liability for any loss beyond the deposit if the market value tanks.

Unlike a bona fide speculator, who will still be bound to his purchase agreement and be forced to close and suffer financial loss, a fraudster will walk away from the transaction unscathed, unidentified and thus untouchable. When a straw buyer is used and the transaction falls apart, the seller may have no one to prosecute for the default and no recompense of her damages.

Although real estate agents are required by law and their regulatory bodies to verify the identity of their clients, it is not uncommon for them to neglect this requirement, or to be duped by the fraudster or even be parties to the fraud. Rather than passively relying on others to protect your interests, here are three simple considerations you can use to safeguard against fraud.

1. Be wary of an assignment clause

When a buyer enters into a purchase agreement as a speculator, he will require the inclusion of an assignment clause. An assignment clause provides the buyer with the right to assign the purchase agreement to any third party without the seller’s consent. The speculating buyer may also insist on including a provision in the purchase agreement that entitles the buyer to register title of the property in the name of any person or corporation distinct from the name of the buyer. Although there is nothing inherently wrong with either of these provisions, they should warrant further inquiry as to why they’ve been requested.

2. Require a sufficiently large deposit

From a seller’s perspective, a significantly large deposit is a sign of good faith that the buyer will complete the transaction on the date specified in the contract. A large deposit also assures a seller that the buyer has the financial means to close the transaction or, in the worst case scenario, that her damages will be compensated if the buyer fails to close.

If a buyer is too cash-strapped to come up with 5% of the purchase price for the deposit at the time of signing the purchase agreement, what is the likelihood of him being able to come up with 20% at the time of closing? Alternatively, if a buyer has a lot of skin in the game, he will be more motivated to ensure the transaction closes, even if it requires him accepting a costly borrowing arrangement – or, if he can’t close, cooperating with the seller in order to mitigate her damages and his liability.

How much of a deposit the seller should require is a tough question and will depend in part on where the property is located. Deposits can range from as little as a few hundred dollars to 15% or 20% of the sale price. A cautious seller should require a deposit that is large enough to cover her potential loss if the buyer does not close. A seller’s estimation of damages should include the anticipated decrease in the relisted purchase price, the carrying cost of the property until the relisted sold date, and $10,000 to $15,000 to cover legal fees.

If the buyer breaches a purchase agreement by failing to close, the deposit is not automatically released to the seller. Rather, the buyer and seller must mutually agree how the deposit should be released, or else the seller will require an order from the court to determine distribution. When a seller has unwittingly sold a property to a straw buyer, the complexity, cost and delay associated with obtaining a release of the deposit through court proceedings is exacerbated.

For example, the commencement of a legal proceeding requires the defendant to be personally served with the originating court documents. If the fraudster has used a fake name, or the straw buyer is a nonresident, it may be impossible to serve a buyer if you have insufficient means to ascertain his real information.

3. Know the buyer

In order to ward against straw buyers, always obtain two pieces of photo ID from the buyer, as well as the buyer’s phone number and home address. Know whose bank account the deposit is coming from; if the buyer is not the account holder, make further inquiries. Lastly, require a handwritten signature and ensure that the purchase agreement is witnessed by the buyer’s agent.

There is an emergent trend (at least in Ontario) of relying on electronic signatures on purchase agreements and other real estate documents. It is up to the person relying on the contract to decide if they will accept an electronically signed contract. An electronic signature should only be accepted if:

  • The seller can verify and authenticate the signature and clearly identify the person who executed the document
  •  An audit trail exists, which would enable an auditor to reconstruct who sent what documents and when
  • The seller has easy access to information relevant to the transaction, which would  be required if fraud is suspected
  • The metadata or audit trail is preserved and not capable of being deleted

Selling your property is one of the largest transactions you will ever make, and it pays to proactively ensure that your interests are properly protected.

 

 Monica Peters is a Toronto-based lawyer who specializes in commercial litigation with a strong focus on property-related disputes. Reach her at 416-869-7647 or mpeters@garfinkle.com.

 

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