A fraud by any other name is still a fraud

“We are seeing equity stripping morph into a lot of different forms. It’s an ugly chapter in real estate law, but fraud is fraud,” said Daniel R. Tyson at the 2008 Equal Justice Conference in Minneapolis earlier this month.

Tyson, who led a panel discussion, “Representing Equity Stripping Clients,” is a member of the real estate and commercial real estate lending practice areas at Best & Flanagan LLP in Minneapolis. He noted that the facts in all equity stripping cases are similar.

Equity stripping is a form of fraud that involves the transfer of title to real estate although it can include elements of predatory lending.

According to panelist Larry Moloney, lawyer with Southern Minnesota Regional Legal Services, equity stripping generally begins with a person who is in foreclosure because medical bills, job loss or other outside circumstance have made it impossible to keep up with mortgage payments. In Minnesota, he said, the home owner can receive notice of a sheriff’s sale.

“Even with a sheriff’s sale, owners have six months to work out an arrangement to keep their homes, but owners usually don’t know that. They assume they will have to be out in less than a month,” he said. “They’re panicked.”

Then they receive a call from an equity stripper who tells them they have no options and that the stripper offers the best chance for the owner to save the home, Moloney continued. The equity stripper promises to pay off the arrears or redeem the home while giving the owner a chance to fix his or her credit. The owner just has to sign a few documents, one of which is a deed turning over the property to an investor.

The now previous owner either has a lease with an option to buy or a land contract with a balloon payment. In either event, the owner is responsible for taxes and upkeep as well as making the agreed-upon monthly payment.

“The reason these deals are frauds,” said Moloney, “is that they are set up to fail. There is never a plan to return the house to the original owner. Either the monthly payments are too high, or the balloon at the end is too big, or there’s no chance the owner would be able to qualify for new financing.”

“The house – and all its equity – stays with the stripper,” he said.

In Minnesota, the private bar, Legal Services Corporation and elected officials worked together to curtail the practice. According to panelist Jodie M. Boderman, who serves as pro bono coordinator at the Minneapolis firm of Faegre & Benson LLP, a large part of this effort comes from networking.

She noted that the lending community was a part of the network as it is in their best interest to weed out fraudulent practitioners. She acknowledged that large firms may see a potential conflict of interest because they represent large financial institutions. “We pointed out that by joining our effort, these firms could actually benefit their clients by separating them from lenders who commit fraud.”

Moloney pointed out additionally that sometimes the original lenders join in the suits against the equity strippers because the lenders are likely to lose their security interest in the home.

Another concern for lawyers in the private bar is whether clients meet the income and asset guidelines to qualify as pro bono clients. Panelist David P. Graham, a partner in the mass tort litigation area of Oppenheimer Wolff & Donnelly LLP, Minneapolis, who also does pro bono litigation, said, “If the client doesn’t get the asset back, they’re eligible. It’s often their only asset. If it’s gone, they’re poor. It’s our job to help.”

Graham pointed out that a large part of the work he and others do is educating judges. “Federal judges and judges in large counties immediately grasp how unconscionable these cases are. We have to work with the others.”

Tyson noted that financing is critical. “If people can borrow from a reputable lender, they will not turn to equity strippers.”

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