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Speak to Your Supervisor Protecting Lenders and Lawyers under the Attorney Supervision Requirements for South Carolina Real Estate Closings By Lanneau Wm. Lambert Jr. and T. Hudson Williams PHOTO BY GEORGE FULTON Transactional lawyers are beginning to let themselves believe the real estate market is recovering. Please knock on your nearest piece of wood. Indeed, as money is beginning to trickle back into the market, commercial loans are being refinanced, land is being cleared for new construction and skeletons of developments halted in the midst of the crash, with walls half-bricked and roofs half-shingled, are being fleshed out as new ownership with fresh money takes over. Despite these modest signs of recovery, the sense remains that institutional lenders are fairly nervous about lending money due to both the continued instability of the market and the onslaught of new regulations. In South Carolina, recent decisions from both our Supreme Court and Court of Appeals give lenders another reason to be nervous that their system for closing real estate-backed loans may leave them unable to enforce their mortgages. In May of last year, the Court of Appeals held that a bank which closed a home equity line of credit without attorney supervision thereby committing the unauthorized practice of law was barred from all equitable and legal remedies leaving it unable to pursue foreclosure or sue on its note. Wachovia Bank v. Coffey, 389 S.C. 68, 698 S.E.2d 244 (2010). In August, the Supreme Court recognized the same equitable defense in holding that equitable remedies were unavailable to lenders who commit the unauthorized practice of law in the course of a real estate transaction and come to the court with unclean hands. Matrix Fin. Services Corp. v. Frazer, Op. No. 26859, 2010 WL 3219472 (S.C. Sup. Ct., Aug. 16, 2010). Matrix even went so far as to imply that once a lender has unclean hands with respect to a transaction, it forfeits all equitable claims concerning that transaction, including those against strangers to the transaction. Lenders have been aware of the rules for closing real estate transactions in South Carolina for some time, with the seminal case of State v. Buyers Serv. Co., 292 S.C. 426, 357 S.E.2d 15 (1987) articulating the requirements more than 20 years ago. But Coffey and Matrix now show that the consequences to lenders for failing to follow the rules are extremely harsh. The consequences to lawyers for aiding and abetting or merely acquiescing to the unauthorized practice of law in real estate closings have been made known through a series of attorney disciplinary cases which have been widely discussed among real estate practitioners for years. Unfortunately, very little has been developed in response to the attorney disciplinary cases to protect attorneys in a practical sense from assisting the unauthorized practice of law in the course of real estate closings, which the disciplinary cases indicate can happen unwittingly. Now that lenders are aware of the January 2011 15
severe risk they face for improperly closing real estate transactions, tools are being implemented in connection with closings which are aimed at protecting the lender, but which have the propitious byproduct of assisting attorneys in closing the transaction so as not to run afoul of the attorney supervision requirements. Of course, the ultimate beneficiary is the borrower/purchaser who is provided with the level of expertise the unauthorized practice of law rules are intended to provide. This article discusses the problems lenders face in adapting their systems for closing real estate transactions in other states to the requirements in South Carolina and gives examples from practice of how lenders are protecting themselves in light of the newly discovered risks they face as revealed by the Coffey and Matrix cases. It also discusses how lawyers benefit from these new implementations and both the positive and negative reactions from various parties to the transaction to the new direction closings are taking. Square peg in a round hole Naturally, the first types of lenders willing to ease into the slowly stabilizing market are large national companies with significant cash reserves, such as life insurance companies. These companies are making fairly substantial loans across the country and some of that money is finding its way to South Carolina. The difficulty at this time is that the borrowers for these loans tend to be larger, often more nationallyminded developers and investors accustomed to having the title insurance companies handle nearly every aspect of the real estate side of the transaction. The national offices of the title insurance companies generally have a well-established system for handling closings within their offices from start to finish. Everything from the title search to the disbursement of funds is coordinated by the title insurance company and an attorney is rarely involved in the actual settlement and closing process. These national company systems do not fit the model in South Carolina where an attorney must, at the very least, supervise all aspects of the closing which our Supreme Court has determined to be the practice of law. Those aspects include the title search, drafting title and loan documents, recording documents and disbursing funds. See State v. Buyers Serv. Co., 292 S.C. 426, 357 S.E.2d 15 (1987) (holding that a title company s preparation of mortgage loan closing documents constituted the unauthorized practice of law despite the company s employment of attorneys to review those documents, and that the closings should be conducted only under an attorney s supervision), modified by Doe v. McMaster, 355 S.C. 306, 585 S.E.2d 773 (2003) (holding that searching title and recording title documents must be supervised by an attorney in order to avoid being considered the unauthorized practice of law); see also Doe Law Firm v. Richardson, 371 S.C. 140, 636 S.E.2d 866 (2006) (citing Buyers Service and McMaster clarifying that a lender may prepare loan documents so long as they are reviewed by an independent attorney who makes the changes necessary to ensure their compliance with the law). When these national and regional developers come to South Carolina, the developer and its title insurance company often expect to be able to use the same closing system they use for deals in other states, and often some show resistance to incorporating a lawyer into the process. More often, national title insurance companies will attempt to pay lip service to South Carolina s requirements without fully adapting their systems to the extent necessary to comply. In a recent transaction, when the national office of a major title insurance company was asked whether it was using an attorney for the title search and recording the title documents, it maintained that it had a licensed South Carolina attorney which it used for all of its South Carolina transactions. In later discussions with that attorney regarding his role in the closing, it became apparent that he is only hired to certify the title and has never been asked to do anything beyond that task. Apparently this is a common mistake that many 16
national offices of title insurance companies make they assume that because they have a South Carolina attorney certify the title, they have complied with South Carolina s attorney supervision requirements. What happens when lawyers assume The previous example highlights another issue on which our Supreme Court spoke last summer when a lawyer is retained to handle an individual aspect of a real estate closing, she should verify that the other aspects of the closing are being properly supervised by other attorneys. In June 2010, the Supreme Court decided In re Schoer, 387 S.C. 604, 693 S.E.2d 927 (2010). In that attorney disciplinary case, Schoer was hired by out-of-state companies to conduct real estate closings, although his engagement did not include handling the title abstract, recording documents or disbursing funds. The court noted that Schoer closed approximately one hundred transactions on behalf of these two entities without making a sufficient effort to insure that a South Carolina lawyer was performing or supervising the closingrelated activities. Id. Schoer agreed to a two-year suspension from the practice of law for, among other things, violating Rule 5.5(a) of the Rules of Professional Conduct ( A lawyer shall not practice law in a jurisdiction in violation of the regulation of the legal profession in that jurisdiction or assist another in doing so. ). Schoer is the most recent of several cases in which attorneys have been disciplined for participating in real estate closings in which they failed to verify that the attorney supervision requirement was being met. In the case of In re Pstrak, 357 S.C. 1, 591 S.E.2d 623 (2004), an attorney was publicly reprimanded for similarly failing to verify other attorneys involvement in the course of two real estate closings. The two other attorneys involved were disbarred in large part for their conduct in the closings. See In re Arsi, 357 S.C. 8, 591 S.E.2d 627 (2004) and In re McMillian, 359 S.C. 52, 596 S.E.2d 494 (2004). As in Schoer, Pstrak was hired to play a limited role in the closing, specifically, he was to attend the closings in place of the attorney he understood to be the actual closing attorney. He wrongly assumed that the other aspects of the closing were being handled by the other two attorneys involved. The court noted that it was his professional responsibility upon serving as closing attorney, to ensure that the other aspects of the closing required to be handled by an attorney were handled or properly supervised by a person licensed to practice law in South Carolina. Pstrak, 357 S.C. at 6, 591 S.E.2d at 626. It is not unusual for lawyers to enter into limited engagements with real estate clients particularly for large commercial transactions in which the attorney agrees to handle a limited portion of the transaction (e.g., issuing an enforceability opinion). Schoer and the Pstrak line of cases indicate that in the course of these limited engagements, it is a violation of the Rules of Professional Conduct for the lawyer to assume that the other aspects of the closing are being properly supervised by other South Carolina lawyers without taking steps to verify that such is the case. After Coffey and Matrix, lawyers should find it easier to comply with this requirement now that lenders share the incentive to ensure the closing is conducted properly. Lenders reaction to Coffey/Matrix Before the Coffey case was issued in May 2010, lenders generally acknowledged the closing requirements developed from the Buyers Service line of cases, but full compliance was marginal at best. Now, with the realization that an improper procedure could jeopardize the validity of their mortgage, lenders have become understandably more concerned that the closing is done correctly. In light of Coffey and Matrix, it is not beyond the realm of possibilities that a complacent lender who allows the title insurance company to handle the closing as it would in other states could be found to have committed or aided and abetted the unauthorized practice of law thereby giving it unclean hands such that it cannot look to the courts to enforce its remedies for default. In a pointed dissent in Matrix, Justice Pleicones proposed this very notion: One need only review this Court s attorney disciplinary cases to see that many closings are conducted unlawfully, often without the knowledge of the lender. To hold that equity will not aid the lender in such a situation, will deny it the right to foreclosure. Matrix, 2010 WL 3219472 at n. 3. Protective measures in commercial transactions Since the issuance of the Coffey and Matrix opinions, lenders have pushed for a belt-and-suspenders approach to ensuring that the loan is issued in accordance with South Carolina law. Particularly, some lenders have responded favorably to an additional closing requirement to verify that the attorney supervision rules are being addressed by the parties to the transaction. In some cases, this additional requirement has taken the form of what has come to be known as a Letter of Understanding. The Letter of Understanding sets forth which attorney(s) will be supervising each aspect of the closing and is signed by the attorneys, representatives of the title insurance company, the borrower and the lender. The letter accomplishes several goals. First, it shows that the lender is aware of and has taken steps to ensure compliance with the attorney supervision requirements. In this respect, the purpose of documenting the lender s intentional efforts to comply with the requirements is to defeat any potential claim against the lender for being an accessory to a transaction tainted by the unauthorized practice of law. Should the attorneys involved fail to follow through on their responsibilities, the letter should forestall any potential that such malfeasance could be attributed to the lender and give it unclean hands. A second objective of the letter January 2011 17
is to satisfy the attorneys professional responsibility of verifying that the various aspects of the closing are being properly handled or supervised by licensed South Carolina attorneys as required by the Schoer and the Pstrak line of cases. Along those lines, it provokes discussion among the parties on the various aspects of the closing and often brings to light issues that would have otherwise been overlooked. This is particularly important in a multi-party transaction in which several attorneys are involved. In those situations, some aspects of the closing risk falling through the cracks when each party assumes they are being handled by someone else. Implementing the Letter of Understanding Other attorneys and parties involved in the transaction have had varied reactions upon being presented with the Letter of Understanding. Most attorneys who are familiar with the requirements in South Carolina appreciate that verifying the closing is being properly supervised is essential to every real estate transaction and take little issue formalizing such in a letter. For the most part, borrowers and title insurance companies are likewise willing to sign, if for nothing more than to do whatever it takes to make the lender happy and to get the deal done. At worst, national title insurance companies may show some level of confusion as to why an attorney is required to assume roles that it plays in transactions in other states, but there has been little objection beyond this basic discomfort of not being able to conduct the closing as they normally would. The most adverse reaction has come from attorneys who are typically hired to handle isolated aspects of a closing such as certifying title and are rarely made aware of how the attorney supervision requirements are being met with regard to the other aspects of the closing. These attorneys tend to feel caught off guard when asked to sign a letter stating that they are expected to be more involved in the closing 18 than they have typically been in the past. The adversity may stem from the implication inherent in the letter that the attorney has been mishandling her responsibilities in the past by not taking steps to verify that the closing is being properly supervised. The letter has also been received with hesitation from lawyers who are worried that by signing their name they are somehow guaranteeing that the attorney supervision requirements have actually been satisfied. For this reason, the Letter of Understanding has been drafted in the form of an acknowledgement in which the parties merely state their mutual understanding of how the attorney supervision requirement is intended to be met between the roles of the various attorneys. It is intended to be used as a tool on the front end of the transaction and stops short of warranting that the attorneys have actually carried out their responsibilities such that the supervision requirements have been satisfied. There has been some discussion among real estate practitioners about implementing a closing requirement similar to the Letter of Understanding but in the form of a certification. While a certification would undoubtedly carry more weight, given the mixed reaction to the Letter of Understanding, asking for a more concrete assurance that the supervision requirements have actually been satisfied is likely to meet resistance from attorneys in the commercial setting, at least initially. Attorneys have flatly refused to give written legal opinions that the supervision requirements have been met, some even going so far as to add to their standard opinion letter the qualification that no opinion is being made in that regard. Given the current state of the law and the costly consequences lenders could face if the closing is handled improperly, there is an understandable reluctance to give anything resembling a lawyer s independent guarantee that all aspects of a commercial closing were handled without exception to unauthorized practice of law matters when multiple lawyers are involved. Impact on business transactions going forward As raised in the Pleicones dissent in Matrix, the impact of the Matrix decision potentially undermines a lender s confidence in a continuingly unstable market and throws the title insurance industry in this state in a quagmire. From a lender s perspective, a certification is clearly preferable to the less convincing acknowledgement contained in the Letter of Understanding. As awareness of the Coffey, Matrix and Schoer line of cases continues to grow and these types of closing requirements become more mainstream in South Carolina, lenders may be able to require more than a mere recognition of the parties collective understanding of the conduct of the closing; but at this stage in the development of these new closing requirements and with such expensive consequences on the line for lenders, to expect lawyers to give anything resembling a guarantee is ambitious. Regardless of the ultimate form these closing requirements take, the development thus far has been promising for providing protections envisioned by last summer s string of opinions. Perhaps the Coffey and Matrix decisions indeed do exactly what the courts intended: spark an active campaign led by lenders to better ensure that real estate loans are closed properly in accordance with the long standing case law of South Carolina. While the changes are being driven in large part by lenders solely to protect their interests, they are no doubt benefitting closing attorneys by providing a supportive tool for managing transactions in the way our professional responsibilities require. Most importantly, and not lost on the courts, is that the ultimate beneficiary of a properly conducted closing is the party leaving the table with the property the consumer. Lanneau Wm. Lambert Jr. and T. Hudson Williams practice law at Turner Padget Graham & Laney, PA in Columbia.