Unauthorized Disbursements of Lender Loan Proceeds

Unauthorized Disbursements of Lender

One result of the “subprime fallout” is that lenders are taking more care to ensure that their loan proceeds are not diverted upon escrow close. What about those loans that have already closed in violation of the Lender’s instructions or where the Lender already foreclosed? The Court in the very recent case of Plaza Home Mortgage, Inc. v. North American Title Company, Inc. – filed April 27, 2010, Fourth District, Div. One (Cite as D054685) gives guidance on these issues and may provide an additional basis for lenders to recoup loan losses when escrow disburses loan funds in a manner unknown to the Lender and and not disclosed on the final HUD-1, or verbally to the lender by escrow.

The trial court in the Plaza Home Mortgage case found that loan documents were not signed by the borrower (but by his attorney) and that there was an unauthorized payment to the attorney out of escrow that was not disclosed on the final HUD-1, and was unknown to the Lender. The loan subsequently went into default and the lender (who could not sell the loan on the secondary market because of a payment default) eventually foreclosed and lost money due to the decline in the market. Still, the Lender sued the escrow/title for damages related to closing the loan in violation of the escrow instructions.

The trial court held that the escrow company was not liable because based on the closing instructions, funding of the loan had concluded before the unauthorized funds were paid and that the escrow instructions and obligations only applied prior to funding. The trial court also found that there was no connection between the damages claimed by the Lender and the actions of the escrow (i.e. the damages to the Lender really resulted from the decline in the market).

The appeals court overturned the trial court and found that the closing instructions bound the escrow company to ensure that the loan documents were signed by the borrower and to disclose fees and costs not disclosed in the HUD-1 or verbally to the lender by the escrow agent, and that these obligations did not cease just because the loan funded. The case was remanded to the trial court to determine whether the escrow breached its obligations and whether the breach caused the Lender’s damages.

Again, this case has significance for two reasons: First, it expands the scope of the escrow agent’s responsibility (assuming the escrow instructions provide for it) to ensure that funds are not diverted. Second it keeps open the theory that a lender suffering loss due to a declining market, can go back to loan origination and assert damage claims based on wrongful disbursement. Lenders should take note of this case and review their escrow close instructions.

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