Appraisal fraud

I. APPRAISALS AND APPRAISER LIABILITY.

A. Area Summary:

There have been significant developments in appraiser liability since the mid-
1980s (discussed below). As brokers look to professional appraisers to value prospective security
for the broker and the broker’s investors, appraiser liability has become an important issue.

1. Appraisals for Lender Purchaser Disclosure Statements. Business and Professions Code
§10232.5 provides that the Lender- Purchaser Disclosure Statement (“LPDS”) to be given to the investor/purchaser must contain:

“(a)(2) Estimated fair market value of the securing property as determined by an appraisal, a copy
of which shall be provided to the lender. However, a lender may waive the requirement of an
independent appraisal in writing, on a case-by-case basis, in which case, the real estate broker
shall provide the broker’s written estimated fair market value of the securing property, which
shall include the objective data upon which the broker’s estimate is based.”

(Emphasis added; See, similar provision for sales of existing loans, Bus. & Prof. Code §
10232.5(b)(2).) The question of whether the broker’s written estimate of value and supporting data
must meet the standards of a certified appraiser’s appraisal remains unanswered.

2. Impact of New SB 223 (Machado) 2007 Stats. Ch. 291, Real Estate Appraisals.

SB 223 (Machado), which because effective on October 5, 2007, as urgency statute, added
Civil Code § 1090.5, which provides:

“(a) No person with an interest in a real estate transaction involving an appraisal shall
improperly influence or attempt to improperly influence, through coercion, extortion, or bribery,
the development, reporting, result, or review of a real estate appraisal sought in connection with
a mortgage loan.

(b) Subdivision (a) does not prohibit a person with an interest in a real estate transaction from
asking an appraiser to do any of the following:

(1) Consider additional, appropriate property information.

(2) Provide further detail, substantiation, or explanation for the appraiser’s value conclusion.
(3) Correct errors in the appraisal report.

(c) If a person who violates this section is licensed under any state licensing law and the
violation occurs within the course and scope of the person’s duties as a licensee, the violation
shall be deemed a violation of that state licensing law.

(d) Nothing in this section shall be construed to authorize communications that are
otherwise prohibited under existing law.”

Comment: This bill raises a number of questions. What does no person “with an interest in a real
estate transaction involving an appraisal”? Does it just refer to the parties to the real estate
transaction (e.g., lender-borrower)? Does it include the mortgage broker? Does it include the
sales/listing real estate licensees involved in the sales transaction for which the mortgage loan
is being obtained? What is “an interest in a real estate transaction involving an
appraisal? Does it mean a person with an ownership or lien interest in the real property?

Similarly, the word “coercion” is grouped with “extortion” and “bribery” as prohibited acts.
Everyone has a basic understanding of what “extortion” or “bribery” is, however, “coercion” is
vague. To be found to have “coerced” the appraiser may involve as little as the implication that
the broker/lender will not continue to use the appraiser if the “property does not appraise” (i.e.,
implying it must meet a certain minimum to make the sales or loan transaction close successfully).

By specifying conduct that is not prohibited, it raises the specter that unlisted conduct may be
prohibited. For example, giving the appraiser the purchase agreement or information on the loan
being sought may not be thought of as coercion but, on the other hand, it does not fall within the
express permitted categories. That is, the sales price or financing amount may not be “additional,
appropriate property information” for an appraiser to consider in reaching his/her opinion of value

It is unclear to what extent SB 223, will impact the ability of a broker to give an opinion of
value (e.g., Bus. & Prof. Code § 10232.5), if a broker in the transactions is viewed as
being a person with an “interest in a real estate transaction involving an appraisal”

Where the lender/broker uses one or a small group of independent appraisers on a regular or
repeated basis, it may be the better practice not to give sales or loan information to the
appraiser to eliminate any implication of coercion at least until some of the terms in SB 223 have
be clarified by the legislature or by the courts.

3. Safe Harbor For Appraisals by licensed or Certified Appraisers who are Not Employees of the
Broker.

The legislature passed Business and Professions Code §10232.6 which provides:

“(a) A real estate broker, acting within the course and scope of his or her license, who arranges
for or engages the services of an appraiser licensed or certified by the Office of Real Estate
Appraisers for the applicable transaction, and delivers the resulting appraisal to the prospective
lender and prospective purchaser as required by Section
10232.5, has met the broker’s obligation of full and complete disclosure solely pursuant
to paragraph (2) of subdivision (a) of Section 10232.5 and paragraph (2) of
subdivision (b) of Section
10232.5, and is not required to provide a separate estimate of fair market value under Section
10232.5.”

“(b) This section shall not apply in instances where the licensed or certified appraiser is an
employee of the broker. However, the duty of disclosure shall not be deemed met where the broker
knew or should have known that the referral was negligently made or that the fair market value
provided by the appraiser was inaccurate.”

These statutes create incentives to retain appraisers who are not employees of
the broker and for adopting hiring practices for independent contractor appraisers that would
dispel any assertion of negligent referral. Section 10232.6(b) is not clear as to what
knowledge would render the “value of the appraiser” to be inaccurate. At this point, the licensee
should always determine whether they have information that may render the appraiser’s valuation
inaccurate. Where there are multiple lenders on a loan, the multi- lender rule as reconstituted in
Business & Professions Code §10237, et seq. provides:

“(1) Except as provided in paragraph (2), the aggregate principal amount of the notes or
interests sold, together with the unpaid principal amount of any encumbrances upon the real
property senior thereto, shall not exceed the following percentages of the current market value of
the real property, as determined in writing by the broker or appraiser pursuant to Section 10232.6,
plus the amount for which the payment of principal and interest in excess of the
percentage of current market value is insured for the benefit of the holders of the notes or
interests by an insurer admitted to do business in this state by the Insurance Commissioner:

(A) Single family residence, owner-occupied 80%

(B) Single family residence, not owner-occupied 75% (C) Commercial and
income-producing properties 65%
(D) Single family residentially zoned lot or parcel which has installed off site improvements including drainage, curbs, gutters, sidewalks, paved roads, and
utilities as mandated by the political subdivision having jurisdiction over the lot or Parcel 65%

(E) Land that has been zoned for (and if required, approved for subdivision as) commercial
or residential development 50%

(F) Other real property 35%”

“(2) The percentage amounts specified in paragraph (1) may be exceeded when and to the extent that
the broker determines that the encumbrance of the property in excess of these percentages is
reasonable and prudent considering all relevant factors pertaining to the real property. However,
in no event shall the aggregate principal amount of the notes or interests sold, together
with the unpaid principal amount of any encumbrances upon the property senior thereto, exceed
80 percent of the current fair market value of improved real property or 50 percent of the
current fair market value of unimproved real property, except in the case of a single-family zoned
lot or parcel as defined in paragraph (1), which shall not exceed 65 percent of the current fair
market value of that lot or parcel, plus the amount insured as specified in paragraph (1). A
written statement shall be prepared by the broker that sets forth the material considerations and
facts that the broker relies upon for his or her determination, which shall be retained as a part
of the broker’s record of the transaction. Either a copy of the statement or the information
contained therein shall be included in the disclosures required pursuant to subdivision
(k).” [Emphasis added.]

In Christiansen v. Roddy (1986) 186 Cal.App.3d 780, an investor sued the mortgage broker and the
appraiser after losing money in a loan investment. The court of appeal upheld a judgment against
the loan broker for negligent misrepresentation, while reversing the judgment against the appraiser
for negligent misrepresentation on the grounds that the appraiser had prepared the appraisal for
the broker and could not have anticipated the identity of the individual investor at the time that
he prepared the appraisal. This case seemed to limit any recovery against the appraiser to that of
negligence in preparing the appraisal but it has been impliedly overruled by Soderberg v. McKinney,
discussed below.

In the case of Bily v. Arthur Young & Co. (“Bily”) (1992) 3 Cal.4th 370 the California Supreme
Court held that an accountant, acting as an auditor, was not liable under general negligence theory
to investors in a computer company. The Court limited the accountant’s general negligence
liability to the person or entity that had contracted for the audit services. However, the Supreme
Court did acknowledge that the auditor could be liable for negligent misrepresentation to that
class of persons whom the auditor knows or should know will be receiving the audit report and acting in reliance on it. The Bily court indicated that a supplier of information
is liable for negligence to a third party “only if he or she intends to supply the information for
the benefit of one or more third parties in a specific transaction or type of transaction
identified to the supplier.” (Bily, supra, 3 Cal.4th at 392; emphasis added.)

In Soderberg v. McKinney (1996) 44 Cal.App.4th 1760, the court of appeal extended the Supreme
Court’s reasoning in Bily to an action by an investor against a broker and the appraiser. The
court held that the investor was in fact part of the class of persons that the appraiser knew would
be relying on his appraisal report, despite the fact that he did not know the identities
of the potential investors. The court of appeal rejected the appraiser’s reliance on Christiansen
v. Roddy, supra, and also found that the appraiser could be held liable to the investor under third
party beneficiary contract analysis.

B. Copy of Appraisal to Borrower and Investor.

1. Where Borrower Charged for Appraisal.

Any time a fee is charged by a broker to a borrower for an appraisal, a copy of the appraisal must
be given by or on behalf of the broker to both the borrower and the lender at or before the closing
of the loan transaction. (Bus. & Prof. Code
§10241.3).

2. Lender Must Give Borrower Notice of Right to Receive Copy of
Appraisal.

a. 1-4 Residential loans notice and right to receive a copy of appraisal.

A lender on a loan secured by a 1-4 family residence in California must provide notice to a loan
applicant of the applicant’s right to receive a copy of the appraisal, provided he or
she has paid for the appraisal. (Bus. & Prof. Code §
11423(a)&(b).)

An applicant’s written request for a copy of an appraisal must be received by the lender no later
than 90 days after (1) the lender has provided notice of the action taken on the application,
including a notice of incompleteness, or (2) the application has been withdrawn.

The lender shall mail or deliver a copy of an appraisal within 15 days after receiving a written
request from the applicant, or within 15 days after receiving the appraisal, whichever occurs
later. (Bus. & Prof. Code § 11423(c).)

The notice of the applicant’s right to a copy of the appraisal as provided in subdivision (b) shall
be given in at least 10-point boldface type, as a separate document in a form that the applicant
may retain, and no later than 15 days after the lender receives the written application. The notice
shall specify that the applicant’s request for the appraisal must be in writing and must be
received by the lender no later than 90 days after the lender provides notice of the action taken on the
application or a notice of incompleteness, or in the case of a withdrawn application, 90 days after
the withdrawal. An address to which the request should be sent shall be specified in the notice.
Release of the appraisal to the applicant may be conditioned upon payment of the cost of the
appraisal.

b. Nonresidential real Property Notice and right to receive a copy of appraisal.

Where the loan is proposed to be secured by nonresidential real property, the notice of the
applicant’s right to a copy of the appraisal shall be given within 15 days of receiving the
appraisal. The notice shall specify that the applicant’s request for a copy of the appraisal must
be in writing and that the request must be made within 90-days. Release of the appraisal to the
applicant may be conditioned upon payment of the cost of the appraisal and the cost of duplicating
the appraisal. (Bus. & Prof. Code § 11423(e).)

Compliance with the ECOA Regulation is deemed to be compliance with
Business and Professions Code 10241.3. (Bus. & Prof. Code § 11423(h).)

(i) This section is in addition to any right of access to appraisals that exists under any other
provision of state or federal law.

c. ECOA Rules.

Where a loan is secured by a lien on a dwelling, under the Federal Equal Credit Opportunity Act (15
U.S.C. §§ 1691 et seq. and Reg. B), a lender or a broker must give a borrower a copy as part of the
lender or broker’s standard process, or when the borrower requests a copy. (See, 12 CFR §§
202.14.) The creditor must mail or deliver a copy of the appraisal report promptly (generally
within 30 days) after the creditor receives an applicant’s request, receives the report, or
receives reimbursement from the applicant for the report, whichever is last to occur. A creditor
need not provide a copy when the applicant’s request is received more than 90 days after
the creditor has provided notice of action taken on the application under 12 CFR § 202.9 or 90 days
after the application is withdrawn.

C. Appraiser, Lender and Broker’s Duty to Borrower regarding
Appraisal.

Occasionally, the borrower may sue the broker and the appraiser for some error contained in the
appraisal report. In most loan situations, the appraisal report is necessary for the
decision-making of the broker and the investor in determining whether or not to make the loan.
Generally, the actual fair market value of the property is not as critical to the borrower, except
as a limiting factor on how much he/she can borrow. Indeed, the borrower has necessarily already
made the decision to seek a loan prior to the time that he/she initially contacts the broker. In
Nymark v. Heart Federal Savings (1991) 231 Cal.App.3d 1089, the court ruled that a borrower could not rely on an appraisal prepared for a lender in connection with a loan
transaction, and could not sue the lender for negligence regarding the contents of the appraisal
report.

Comment: Nymark involved a direct lender e.g., bank, savings and loan, credit union or CFL, who
unlike a licensed real estate broker, does not have a fiduciary duty to the borrower. It may be
advisable to have the borrower execute a statement that they are not applying for the loan
in reliance on the appraisal.

Actions by investors against brokers start with the basic rule that the broker owes a fiduciary
duty of care to the investor. An investor may sue the broker for negligence, negligent
misrepresentation, and breach of contract in the event of a negligently prepared appraisal (Bily v.
Arthur Young, supra) or for fraud in the event of a fraudulently prepared appraisal (Barry
v. Raskov (1991) 232 Cal.App.3d 447). In Barry v. Raskov, the court of appeal determined that an investor lender could
sue its broker for fraud, negligent misrepresentation and breach of fiduciary duty. The court of
appeal held the broker responsible for the appraiser’s fraud in preparing the appraisal report
reasoning that the broker had far greater control over the appraisers that it chose to
recommend to its investors, and could verify their work product through audits, etc. An
important part of the court’s analysis was that the broker has a non-delegable duty of care with
respect to valuing the security (i.e., liability cannot be shifted to the appraiser). While part
of the Barry v. Raskov decision has been superseded by Business and Professions Code §10232.6, the
broker must still be concerned, as that exception does not prevent the broker from being sued where
he/she “knew or should have known that the referral was negligently made or that the fair market
value provided by the appraiser was inaccurate.” (Emphasis added.)

D. Impact of Full Credit Bids at Foreclosure on Liability.

In many cases, the investor’s suit against the broker and the appraiser follows a foreclosure of
the underlying loan. In such a circumstance, the full credit bid rule plays an important part in
determining whether the investor can state a claim. The effect of a full credit bid is to establish
the value of the property. Since it is a full credit bid, it by definition satisfies the
underlying loan obligation and extinguishes the lien. If the investor sues the broker for
negligence or breach of contract regarding an appraisal report following a full credit bid at a
trustee’s sale, the investor’s action is precluded by the full credit bid. (Pacific Inland Bank v.
Ainsworth (1995) 41 Cal.App.4th 277.)

1. Fraudulent Inducement to Credit Bid (Full Credit Bid Rule Does
Not Apply)

However, the analysis changes when the investor’s allegations relate to waste, fraud, conversion,
or misrepresentations regarding the condition of the property, i.e., matters that are not readily
discernible prior to the trustee’s sale. In the case of Alliance Mortgage v. Rothwell (1995) 10 Cal.4th 1266, the California Supreme Court carved out a
limited exception to the full credit bid rule. The Supreme Court held that a lender is not barred
by the full credit bid rule from stating a fraud action against an appraiser where the claim is for
fraudulent inducement to make the full credit bid. The appraiser was part of a deliberate scheme
to induce the lender into making what turned out to be fictitious loans on nine properties. The
appraiser prepared reports that deliberately inflated the fair market value of the properties.
Upon default on the loans, the lender entered a full credit bid at the trustee’s sales, relying on
the values set forth in the original appraisals. Following the trustee’s sales, the lender
discovered that the values of the properties were far less than the values set forth in the
appraisals. The Supreme Court’s exception to the full credit bid rule was related to the fact that
the lender’s action against the appraiser was for fraudulent inducement to make the full credit
bid, as opposed to fraudulent inducement to make the loan itself.

2. Fraudulent Inducement to Make a Loan (Full Credit Bid Rule
Applies except Where Lender Relied on the Appraisal ).

In the case of Michelson v. Camp (1999) 72 Cal.App.4th 955, the court of appeal found that the full
credit bid precluded an action by a lender against third parties, such as appraisers, for
negligence, negligent misrepresentation, and fraud. In this case, the appraiser had been retained
by the borrower, not by the lender. However, the appraiser had recertified the appraisal for the
lender, but did not mention the lender’s investors. The lender might have been able to state a
claim against the appraiser for negligent misrepresentation (Soderberg v. McKinney, supra), but was
precluded from doing so by the full credit bid rule (Pacific Inland Bank v. Ainsworth, supra). As
to the fraud cause of action, the allegation was that of fraudulent inducement into making the
loan, as opposed to fraudulent inducement to make the full credit bid. The lender could have
protected itself by underbidding at the trustee’s sale, or by obtaining a new appraisal of the
property prior to determining its bidding strategy at the trustee’s sale. Consequently, the full
credit bid rule precluded the lender’s fraud cause of action.

The exceptions to the full credit bid rule expanded further in First Commercial Mortgage Company v.
Reece (2001) 89 Cal.App.4th 731. In that case, the court allowed the lender to sue the appraiser
and loan broker for fraud, negligent misrepresentation and breach of contract. The fraud
action was allowed because the original lender was fraudulently induced to make the loan by the
bogus appraisal and suffered damages when it was forced under its contract with its assignee
beneficiary (which made a full credit bid at the foreclosure sale of the loan) to take the property
back. On resale of the property by the original lender, the original lender suffered damages
because the property was worth not what the appraisal showed but much less. Negligent
misrepresentation was allowed because the court found the original lender justifiably relied on the
false appraisal in making the loan and not because of its assignee’s full credit bid.

3. Full Credit Bid Rule Applies).

However, the full credit bid rule did not preclude a lender’s action following foreclosure for
negligence and negligent misrepresentation against the appraiser in Kolodge v. Boyd (2001) 88
Cal.App.4th 349. When the lender credit bids at the foreclosure sale, if it can show it relied on
the questionable appraisal in determining the amount of his bid, his action for negligence and
negligent misrepresentation is not barred.

In transactions where the broker hires the appraiser, the broker has potential claims against the
appraiser for breach of contract, negligence, negligent misrepresentation, and fraud. In
transactions where the appraiser has been retained by a third party (i.e., by the borrower or
referring broker), then the better practice would be for the broker to obtain a separate appraisal
or to have the appraisal recertified by the appraiser for use by the broker for loan purposes. Mere
recertification alone, however, may not assure the broker of not being challenged with respect
to the appraiser’s qualifications. If the appraiser performs appraisals on a regular basis
for the broker, and knows that the broker’s investors rely on the appraisal, the appraiser may also
be liable directly to the broker’s investors.

Special attention must be paid to establishing a bidding strategy at the trustee’s sale. As is
clear from the above summary, a full credit bid at a trustee’s sale generally precludes the
bidder from suing the appraiser for most causes of action, such as breach of contract,
negligence, negligent misrepresentation, and fraud. The only exception, as established in the
Alliance Mortgage v. Rothwell case, is in those cases where the claim is for fraudulent inducement
to make a full credit bid, as opposed to inducement to enter into the loan. This will be
difficult in most cases, for the lender or broker must establish such justifiable reliance on the
appraisal report as to justify the failure to underbid or the failure to obtain an appraisal prior
to the time of sale.