Is it an ethics violation for a lawyer to amend a real estate contract to inflate the purchase price with a matching seller's concession in order to enlarge the buyer's mortgage loan?

Plain-English summary

Opinion 710 addresses a residential real estate practice in which, after a contract is signed for a set price with a mortgage contingency, the lawyers for seller and buyer are asked to amend the contract to raise the purchase price and the mortgage contingency by equal amounts, while adding a seller's credit to the buyer at closing in the same amount, labeled a seller's concession or payment of the buyer's closing costs. The inquirer describes the amendments as calculated to increase the size of the buyer's mortgage loan and as a fraud on the ultimate investor.

The Committee explains how residential mortgage lending works through the secondary market: originators make loans and earn fees, then sell the loans to entities like Ginnie Mae, Fannie Mae, and Freddie Mac, which issue mortgage-backed bonds to investors who receive the borrowers' payments. Because the loan is sold on, a deception about the true price can reach investors who lack the chance to detect it.

Applying RPC 1.2(d) (no counseling or assisting client conduct the lawyer knows is illegal, criminal, or fraudulent), RPC 4.1(a) (no knowing false statement of material fact to a third person, and no failure to disclose to avoid assisting a client fraud), and RPC 8.4(c) (no conduct involving dishonesty, fraud, deceit, or misrepresentation), the Committee finds the unjustified seller's credit is the deception, because it is not supported by any added property, rights, or actual costs. The Committee analogizes to In re Labendz, where a lawyer was suspended for a year for participating in a price misrepresentation to inflate a mortgage, and cites Davin, LLC v. Daham on a lawyer's duty of candor and good faith.

The Committee concludes that the lawyer's participation in the transaction described would constitute ethical misconduct, because the lawyers knowingly participate in making a false statement of material fact to a third party and expose lenders and loan purchasers to greater risk than they knowingly accept.

In practice

The opinion holds that, under RPC 1.2(d), RPC 4.1(a), and RPC 8.4(c) as they stood at the time, a lawyer who participates in amending a residential real estate contract to inflate the stated price with a matching seller's credit, for the purpose of enlarging the buyer's mortgage loan, engages in ethical misconduct. Per the opinion, the deception is the unjustified credit, which misleads the originating lender and secondary-market investors about the property's true price, and the lawyer's duty is to see that the true terms of the transaction are disclosed. Because this opinion predates the most recent five years, verify the current Rules of Professional Conduct before relying on the specific rule text it describes.

Common questions

Q: Can I increase the contract price and add a matching seller's concession at the parties' request?

A: Not for the purpose described in the opinion. The Committee concludes that inflating the price with an offsetting credit to enlarge the buyer's mortgage deceives the lender and violates RPC 1.2(d), 4.1(a), and 8.4(c).

Q: Whose reliance makes this deceptive?

A: Per the opinion, the originating lender and especially secondary-market investors who buy the resulting loan are deceived about the property's true market price by the unjustified seller's credit.

Q: What if the increased price and the credit are both stated in the contract?

A: The opinion notes that even when stated to the originating lender, there is no assurance that secondary-market assignees know of the device, so the conduct still violates the Rules; the lawyer must prevent false or misleading information from reaching those who later purchase the loan.

Q: What discipline case did the Committee rely on?

A: The opinion analogizes to In re Labendz, 95 N.J. 273 (1984), where a lawyer was suspended for a year for helping misrepresent a sales price to inflate a mortgage with an offsetting seller's credit.

Background and rules framework

The opinion interprets RPC 1.2(d) (a lawyer shall not counsel or assist a client in conduct the lawyer knows is illegal, criminal, or fraudulent), RPC 4.1(a) (truthfulness to a third person, including the duty not to fail to disclose a material fact when needed to avoid assisting a client fraud), and RPC 8.4(c) (dishonesty, fraud, deceit, or misrepresentation), the New Jersey analogs to Model Rules 1.2, 4.1, and 8.4. The Committee frames the analysis around the secondary mortgage market and the lawyer's duty of candor to non-clients.

Citations and references

Rules of Professional Conduct:

• MR 1.2 / NJ RPC 1.2(d) (no assisting client crime or fraud)
• MR 4.1 / NJ RPC 4.1(a) (truthfulness in statements to a third person)
• MR 8.4 / NJ RPC 8.4(c) (conduct involving dishonesty, fraud, deceit, or misrepresentation)

Cases:

• In re Labendz, 95 N.J. 273 (1984), suspension for participating in a sales-price misrepresentation to inflate a mortgage
• Davin, LLC v. Daham, 329 N.J. Super. 55 (App. Div. 2000), lawyer's duty to act fairly, in good faith, and disclose significant facts

See also

• NY State Bar Op. 817: Grossed-Up Home Sale Price
• NY State Bar Op. 892: Undisclosed Real Estate Gross-Up
• NY State Bar Op. 1033: Short Sale Disclosure to Bank

Source

• Full text (Justia mirror): https://law.justia.com/cases/new-jersey/advisory-committee-on-professional-ethics/2006/acp710-1.html
• Issuing authority: New Jersey Supreme Court Advisory Committee on Professional Ethics, via the NJ Courts Supreme Court Committees page

Original opinion text

Reproduced from a full-text mirror of the official opinion for research purposes. Quotation marks dropped by the mirror's text extraction have been restored and a trailing document-control artifact removed; the linked official source controls.

186 N.J.L.J. 1198

December 25, 2006

15 N.J.L. 2572

December 25, 2006

Advisory Committee on Professional Ethics

Appointed by the Supreme Court of New Jersey

OPINION 710

Advisory Committee on Professional Ethics

Misrepresenting Purchase Price or Other Material Fact Regarding a Real Estate Transaction

An inquirer asks if it is an ethical violation for an attorney to participate in a real estate practice described as follows. A contract for the sale of residential property has been prepared by a realtor and signed by both seller and buyer for a set purchase price with a mortgage contingency. Either during attorney review or thereafter, the lawyers for the seller and the buyer are requested to amend the contract by increasing the purchase price and the mortgage contingency amount in like amounts. In addition, the attorneys are asked to amend the contract to provide that the seller give a credit to the purchaser at closing in the same amount, calling it a seller's concession or seller's payment of purchaser's closing costs. The inquirer states that the amendments are calculated to increase the size of the purchaser's mortgage loan and is a fraudulent practice perpetrated on the ultimate investor.

The Committee notes that in recent years residential mortgage lending has, through the secondary market, become a major category of finance in this country. As a result of federal programs, those who originate loans may earn financing fees at the closing and then convey those loans to entities such as the Government National Mortgage Association (known as Ginnie Mae), the Federal National Mortgage Association (known as Fannie Mae) and the Federal Home Loan Mortgage Association (known as Freddie Mac). These programs, in turn, after buying the mortgages from the originators, then issue mortgage-backed bonds to investors, who receive the periodic payments of principal and interest from the borrowers.

This secondary market enables the originating lender to sell the loan, and to originate more loans and financing fees with the sales proceeds. In addition, the secondary market has created an investment market for low risk mortgage backed securities, and attracts investment dollars into the residential mortgage business.

On the facts set forth in the inquiry, it appears that the sales contract as amended is submitted to the original mortgage lender, or broker, with the sales price increase and corresponding credit expressly stated, but without any assurance that assignees in the secondary market would be aware of the device employed to increase the size of the mortgage loan. The inquirer believes this implicates the lawyers for the seller and the buyer in a deceitful practice in possible violation of the ethical rules.

RPC 1.2(d), RPC 4.1 and RPC 8.4(c) are each implicated by the practice described by the inquirer. RPC 1.2(d) provides: "A lawyer shall not counsel or assist a client in conduct that a lawyer knows is illegal, criminal or fraudulent . . . ." RPC 4.1(a) provides: "In representing a client a lawyer shall not knowingly: (1) make a false statement of material fact or law to a third person; or (2) fail to disclose a material fact to a third person when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client." RPC 8.4 provides: "It is professional misconduct for a lawyer to . . . (c) engage in conduct involving dishonesty, fraud, deceit or misrepresentation . . . ."

By manipulating the sales price in the manner described by the inquirer, either the originating lender or the secondary investors may be deceived as to the true market price of the house. The deception is the credit to the buyer given by the seller to offset the increase in purchase price. The credit is not justified by any additional property or rights to be sold to purchaser, or by a legitimate charge against the seller on account of any actual costs assumed by it and otherwise payable by the buyer.

The deception in the deliberate overstatement of the property's sales price with the offsetting credit is similar to the case In re Labendz, 95 N.J. 273 (1984). In that case a purchaser's attorney was suspended for a year for his participation in the preparation of a mortgage loan application to a savings and loan association that misrepresented that the sales price was $107,000 instead of the actual price of $100,000. The $7,000 increase was to be offset by a seller's credit to the buyer. The motive of the buyer was to increase the mortgage amount to avoid the lender's loan limitations. The buyer was successful in obtaining the higher loan, but the scheme came apart when the seller's attorney refused to cooperate. The attorney in Labendz attempted to justify the credit as a legitimate expense, but the Court pointed out that no actual expenses or additional terms of value accounted for the credit. Id. at 276. The Court found that the conduct was serious and involved misrepresentations and violations of law, inconsistent with an attorney's duty to act with total honesty and avoid participating in any fraud or misrepresentation. Although the conduct in Labendz was particularly egregious, since there was no actual amendment to the contract of sale containing the offsetting credit, the underlying deception is otherwise the same as presented here.

The Committee also notes that New Jersey case law imposes a duty upon an attorney to act fairly and in good faith, Davin, LLC v. Daham, 329 N.J. Super. 55 (App. Div. 2000), and that candor and honesty necessarily require disclosure of significant facts even though disclosure might not be in the best interests of the client. Id. at 76. In Davin the Appellate Division held that a lessee stated a claim against a lessor's attorney, where the lessee was induced to enter into a lease despite the lessor's attorney's knowledge that, due to a pending foreclosure proceeding, the lessee would be subject to ejectment. The lessor's attorney not only failed to mention the foreclosure, he also inserted a covenant of quiet enjoyment in the lease, knowing his client could not fulfill it.

In the present inquiry it would seem that the originating lender would have the opportunity to uncover the ruse upon a close reading of the contract and the loan application, and to protect itself before completing the transaction, but it is less clear that persons investing in the secondary market would have the same opportunity, or would have recourse against the assignor in the event a later default occurs and a loss is suffered as a result of the enhanced sales price. Nevertheless, the conduct of lawyers engaging in this practice violates RPC 1.2(d) and RPC 4.1(a) because the lawyers have advised their clients, and have knowingly participated, in the making of a false statement of a material fact to a third party. The conduct also violates RPC 8.4(c) because it involves a deceit, intending that the mortgage loan investor will rely on the misrepresentations in the contract in determining the size of the mortgage loan. This conduct compromises the integrity of the underwriting of the loans because it exposes the lender and those who purchase the resulting loan to a greater risk of loss than is knowingly accepted. It is the lawyers' duty to see that the true terms of a real estate transaction are disclosed by their clients to the lender and to prevent false and misleading information from becoming available by their acts or omissions to those who, in due course, may purchase the loan. It cannot be disputed that the practice involves a material fact for if it were not expected to cause the lender to increase the loan, it would not be requested.

In conclusion, it is the opinion of the Committee that the participation of an attorney in the transaction presented by the inquirer would constitute ethical misconduct.