1 June 2011

Mortgage Fraud

Mortgage Fraud

Valuing the Proceeds of Crime in Mortgage Fraud

Of every 10,000 applications for a mortgage, as many as twenty seven are fraudulent. Such frauds are more likely to be discovered during a period of economic decline, such as now. And when they are, you can bet that the prosecution will seek a confiscation order. So, the problem of how to value benefit in a case of mortgage fraud is of obvious importance. In order to explore the relevant principles, this article will suggest a number of ways to approach the problem intuitively, without reference to the legislation. Next, it will look at the relevant law and the correct approach as found in R v Waya [2010] EWCA Crim 412. Finally, the article will suggest that R v Waya may cast doubt on the correctness of those cases concerned with the confiscation of wages earned from employment secured by a false representation (e.g. R v Carter and Others [2006] EWCA 416).

A Typical Mortgage Fraud

A typical mortgage fraud may be committed in the following way. The mortgage applicant (‘the defendant’) misrepresents his income on the application form. Acting on that misrepresentation the lender transfers mortgage monies of (say) £600,000 to the defendant’s solicitor. The solicitor then arranges the purchase of a house costing £800,000. The purchase is financed using the tainted mortgage funds (in this case 75% of the purchase price) and an untainted deposit of £200,000 provided by the defendant (25% of the purchase price). Thereafter, the defendant keeps to his mortgage payments (which include capital payments using untainted funds). The value of the house increases. The fraud is discovered, and the defendant is convicted. At the time of the confiscation hearing, the value of the property has increased to £1.6 million (an increase of 100%). The defendant’s equity in the property is now £1.2 million (reflecting the increase in the price of the house and capital payments made on the mortgage).

Valuing Benefit: Some Possibilities

Approaching the problem from first principles, given that the purpose of confiscation is to deprive criminals of their criminal benefit, what should be the value of the benefit? There are five possibilities:

The mortgage funds: £600,000. The rationale for this is that the offence was fraudulently obtaining £600,000. That is the defendant’s benefit. What he did with the funds thereafter is irrelevant.

The value of the house at the time of the purchase: £800,000. Although the defendant only obtained the mortgage funds, the reality is that the mortgage funds enabled the defendant to buy the house: ‘but for’ the mortgage funds he could not have bought the house. His benefit should therefore be the value of the house.

The value of the house at the time of the confiscation hearing: £1.6 million. The defendant obtained the house which then increased in value. It would be unjust to allow the defendant to profit from his investment. His benefit should include the increase in value of the house.

The defendant’s equity in the house at the time of the confiscation hearing: £1,200,000. The defendant obtained a house worth £1.6 million, but the outstanding mortgage should not count as the defendant’s ‘benefit’ because these funds are owed to the lender.

75% of the value of the house at the time of the confiscation hearing: £1.2 million. The property obtained was the mortgage loan, which was then invested into an appreciating asset, namely the house. The benefit should be the value of the mortgage loan which is now represented by 75% of the value of the house (the remaining 25% represents the deposit which, being untainted, should not count as benefit).

The Statutory Provisions

Under the Proceeds of Crime Act 2002 (‘the 2002 act’) a person who has committed a criminal offence benefits from his offending if he obtains property ‘as a result of or in connection with’ the commission of the offence (s.76(4)). The person’s benefit is the market value of the property obtained (s.76(7) and s.79(2)).

The 2002 Act caters for the situation (present in a typical mortgage fraud) whereby a person invests all the property he has unlawfully obtained. In such a situation the court calculating the benefit must compare two valuations (s.80(2)). The first valuation is the market value of the property at the time it was obtained (adjusted for inflation). The second valuation is the market value of ‘any property which directly or indirectly represents’ the property obtained (s.80(3)); in other words the Court must look at the market value of any investment which ‘represents’ the property obtained. The defendant’s benefit for the purposes of confiscation is the greater of these two valuations. This process operates so that if the value of the investment has increased, the benefit is the value of the investment at the time of the confiscation hearing. But if the value of the investment has decreased, the benefit is the value of the property when originally obtained (adjusted for inflation). This accords with common sense. A person who has invested stolen property and made a profit ought not to be allowed to reap the rewards of such an investment. Equally, a person who has obtained property ought not to escape confiscation merely because he made a bad investment. Before turning to the correct approach to calculating benefit in mortgage frauds it is interesting to note another approach which has been rejected by the Court of Appeal, namely the ‘but for’ approach.

The ‘But For’ Approach

Benefit is the value of property obtained ‘as a result of or in connection with the commission of the offence’. One approach to valuing benefit might be to equate ‘as a result of’ with ‘but for’. Applying this approach suggests that (in our scenario) the defendant obtained the house, because ‘but for’ the mortgage funds, he could not have bought it. He therefore obtained the house ‘as a result of or in connection with’ the offence and his benefit is the value of the house. This approach has a superficial attraction but it suffers from three difficulties.

The first difficulty of the ‘but for’ approach is that broadening the scope of ‘benefit’ in this way ignores the narrow ambit of the original offence. In a mortgage fraud, the essence of the defendant’s conduct is obtaining mortgage funds via dishonest means. The property obtained ‘as a result of the offence’ is limited to the mortgage funds. (The position would be different if a person obtained a house by deceiving the owner into transferring the title deeds.) As Lord Bingham in R v May[2008] AC 1028 said (at paragraph 28): ‘If (say) a defendant applies £10,000 of tainted money as a down-payment on a £250,000 house, legitimately borrowing the remainder, it cannot plausibly be said that he has obtained the house as a result of or in connection with the commission of his offence.

Secondly, applying the logic of ‘but for’ reasoning would suggest that the property obtained by the buyer was both the mortgage funds and the house: both were obtained ‘as a result of’ the offence. In the current example, this would mean that the defendant’s benefit was not only the value of the mortgage funds (£600,000) but also the value of the house (£800,000), even though the mortgage funds were used to buy the house. Moreover, the ‘but for’ approach permits benefit to accrue indefinitely. For example, if the defendant subsequently legitimately remortgaged the house, each legitimately obtained mortgage should be added to the value of the criminal property, because ‘but for’ the original fraudulent mortgage and the purchase of the house, he would not have been in a position to remortgage. Such double counting would offend common sense. Toulson L.J. made the point clearly when he said in R v Pattison [2007] EWCA Crim 1536 (at paragraph 21): ‘Every school child knows that you cannot have the penny and the sweet. If your mother gives you a penny and you buy a sweet with it, your benefit is a penny’s worth and not two penny’s worth.

Thirdly, if the ‘but for’ approach is correct, the valuation provisions of the 2002 would have no apparent purpose. The ‘but for’ approach suggests that where criminal property has been invested, the investment is property obtained ‘as a result of’ the commission of the offence. The value of the benefit would simply be the value of the investment, and there would be no need for the detailed valuation provisions contained in section 80 of the 2002 Act.

The Correct Approach

The Court of Appeal in R v Waya provided guidance on the correct method to calculate the value of benefit in a mortgage fraud. The Court rejected the finding of the Crown Court (unchallenged by the defence) that the mortgage fraudster had obtained the house and that his benefit was the value of the equity in the house at the time of the confiscation hearing. The Court of Appeal held that the property obtained was the mortgage funds. The value of the benefit should be found by treating the mortgage funds as invested in the property and applying the section 80 valuation provisions.

Applying R v Waya to our example, the defendant obtained the mortgage funds. If the defendant had been caught immediately after the mortgage funds were transferred (and before a house was purchased) the value of his benefit would be the market value of the mortgage funds: £600,000 (adjusted for inflation). However, if the defendant has invested the funds in a house, the mortgage funds represented 75% of the purchase price, with the balance being met by the deposit. Section 80(3) applies, because (the mortgage funds having been invested in the house) the house ‘directly or indirectly represents’ the property obtained. Section 80(3) provides that the relevant value is the value of the investment, which has increased because the house has increased in value. It follows that the value of the fraudster’s benefit is 75% of the value of the house (£1.6 million) which is £1.2 million. The effect of this approach is to allow the defendant to profit from that portion of the investment which represents the original (legitimate) deposit. But the defendant is not permitted to profit from criminal property which was successfully invested. This approach exhibits a degree of internal logic (whatever one thinks of the fairness of the 2002 Act) and, as noted by Blake J. in R v Waya, it also has the ‘virtue of simplicity’.

Looking Ahead

As discussed above, the Court of Appeal has rejected the ‘but for’ approach to assessing criminal benefit in mortgage fraud. As a result there may now be a tension with other areas of confiscation, in particular cases where an individual obtains employment by deception and is then paid wages for his work. In R v Carter and Others [2006] EWCA 416 the defendant Lyashkov was convicted of obtaining a pecuniary advantage by deception. He had falsely represented to a potential employer that he was entitled to work in this country. He had been given a job, in satisfaction of which he was paid wages. The prosecution sought a confiscation order and alleged that his wages counted as benefit because they were obtained ‘as a result of or inconnection with the offence’. The defence argument was that the wages did not count as ‘benefit’ for the purposes of confiscation. The commission of the offence had merely provided the defendant with an opportunity to earn wages; the wages had been earned not as a result of the offence, but as a result of the work that he had satisfactorily performed for his employer. The Crown Court found that ‘but for’ the misrepresentation, Lyashkov would not have obtained the wages and he therefore obtained the wages. The Court of Appeal upheld the confiscation order and found that because the deception was an ‘operative cause’ of obtaining the wages, Lyashkov had obtained the wages for the purposes of confiscation. To the extent that the Court of Appeal in R v Carter adopted an approach closely resembling a ‘but for’ test, that approach has now been put in doubt by R v Waya. The Supreme Court will hear the case of R v Waya in 2011. Whether that Court will consider it necessary to comment on the correctness of R v Carter remains to be seen.

Experian (figures relate to the 3rd quarter of 2009).

This case will be heard in the Supreme Court in 2011.