Real Estate: Mortgage Brokers

The Ontario government introduced Bill 65, the Mortgage Brokerages, Lenders and Administrators Act, in late February. If passed and proclaimed, the legislation will replace the Mortgage Brokers Act.

The good news for lawyers is that, in combination with modifications to LawPRO’s errors and omissions coverage, the new statute may encourage more lawyers to get back into the mortgage brokerage business. The bad news is that the timing might not be so good.

Ontario lawyers have been arranging mortgages for their own clients and those of other lawyers for some 200 years. The real estate boom of the mid-’80s, in particular, lined the pockets of the real estate bar, who generally carried on mortgage brokerage activities in conjunction with their conveyancing practices.

The 1989 crash in real estate values, however, put a serious crimp in the riches. It also marked the beginning of a five-year-long real estate recession of unprecedented proportions, exacerbated by the huge run-up in prices that preceded it.

“Simply put, no one would buy any real estate and many borrowers who owned non-income-producing properties defaulted on their mortgages,” says Graham Tobe, a Toronto lawyer and mortgage broker.
Lenders who suffered losses saw the bar’s deep-pocketed professional negligence coverage as a way to recoup some of their money. “The lenders sought advice from the litigators, who told them to sue the real estate lawyers,” Tobe says.

The claims were framed either in professional negligence, alleging some deficiency in the lawyer’s legal representation, or what amounted to bad business advice — “negligent underwriting” in mortgage broker parlance.

Many of the initial claims succeeded. “The primary culprit was the market, but there was plenty of unjustified optimism and sloppiness among lawyers,” Tobe says. “For example, while the more forward-thinking lawyers ensured their borrower clients got independent legal advice when it came time to execute the mortgage documentation in favour of their lender clients, the truth is that conflicts were prevalent and no one cared so long as everyone was making money.”

After a few hits from judges — “most of whom only knew about real estate from law school or the bar admission course and sided with the lenders,” according to Tobe — LawPRO (then known as LPIC) began settling cases en masse.

The debacle led to a five-fold increase in E&O premiums in 1995. Simultaneously, LPIC amended the mandatory insurance policy to exclude coverage for mortgage brokerage activities. “When LawPRO changed the rules to exclude the mortgage brokerage activities of lawyers from E&O coverage, many of us stopped doing it,” explains Robert Aaron of Aaron & Aaron, a prominent Toronto-based real estate practitioner.

Lawyers could still act as mortgage brokers — indeed, they remained exempt from registration under the Mortgage Brokers Act until 1997 — but found themselves on the hook personally for claims arising from brokering activities. “Lawyers who continued to mortgage broker either took that risk or paid $300 and obtained a mortgage brokerage licence and professional indemnity insurance as a mortgage broker,” Tobe says.
The province removed the exemption in 1997. “The only exemption remaining for lawyers was that they could obtain broker registration without meeting the education requirements of the Mortgage Brokers Act,” says Steven Pearlstein, a Toronto real estate lawyer with the firm of Blustein & Pearlstein LLP.

Meanwhile, title insurance in Ontario was coming into its own and the province was moving to a land titles system featuring electronic registration. The real estate market also picked up and, by 2006, prices had risen steadily for 12 years.

“All this made errors less likely and losses relatively rare,” Tobe says. But many of these factors contributed to a new crisis for real estate lawyers, especially those in more remote parts of the province. Banks and title insurers were taking away the residential real estate legal work that sole practitioners and small firms used to dominate and count on as their bread and butter.

“That started driving the profession, which had been abandoning mortgage brokering, back to this area of activity and fee generation,” Tobe says. Not surprisingly, brokers became unhappy at the legal profession’s renewed intrusion into what they regarded as their territory. The industry began pressing the government for change in the form of an all-inclusive licensing regime under amended mortgage brokers’ legislation.

In March 2005, the Financial Services Commission of Ontario (FSCO) released a consultation paper on the issue. To the despair of mortgage brokers, it recommended that lawyers “be exempt from the licensing requirement if their trading in mortgages constitutes providing legal services.” But the exemption would not apply to “lawyers buying, selling or trading mortgages on their own behalf.”

Six months later, LawPRO announced that if such legislation was passed, it would modify its insurance coverage “to insure lawyers for the specific legal services that fall within the exemption provision for lawyers in the proposed legislation.”

Proving that the 1990s real estate debacle had passed from its collective memory, LawPRO characterized the additional underwriting risk as “small.” Section 6(6) of Bill 65 exempts lawyers from registering as brokers “in such circumstances as may be prescribed.” At press time, regulations had not been promulgated, but Tobe says the intent of the legislation is to allow lawyers to arrange mortgages in the course of providing bona fide legal services to a borrower or lender.

Tobe believes, for example, that the exemption will apply to lawyers administering mortgages on behalf of an estate where the services can legitimately be seen as part of the legal services provided to the client. “The March 2005 paper from FSCO would have exempted lawyers where their brokerage activities ‘constitute providing legal services,’” Tobe says.

As he sees it, that goes beyond real estate practices to embrace corporate lawyers arranging a mortgage to finance the acquisition of shares, and family lawyers arranging mortgages to finance a matrimonial settlement. “Even though a family lawyer does not practise real estate, give advice on the mortgage transaction, prepare the document, attend on its execution or registration, or handle the advance of mortgage funds, he or she can arrange the mortgage without a licence and charge a fee for bringing borrower and lender together,” he says.
“The possibilities are endless because the need for money is pervasive and real estate is the most durable and concrete asset available to secure large loans.”

Clearly, lawyers will have to await the final wording of the regulations before acting on the new legislation. “The black and white of the issue is that on the one hand, nobody wants lawyers to be able to just hang out a shingle and call themselves mortgage brokers, but on the other hand, nobody wants to stop lawyers from giving incidental advice about obtaining a mortgage,” Pearlstein says. “But there are shades of grey in between and there could be problems in interpretation.

“The upside is that the Ministry is seeking input from both the law society and the Ontario Bar Association on the wording of the regulations.”

If the act passes and if LawPRO follows through on its announced amendments to the mandatory coverage it provides for lawyers, it will be the first time since 1997 that lawyers have both an exemption and LawPRO coverage for mortgage-brokering activities. Tobe believes the renewed integration of mortgage-brokering activities with the rest of lawyers’ practices may open up opportunities for the profession and facilitate financing arrangements for the public.

“The largest fees paid are not for advice or for conveyancing but for information such as bringing the parties together,” he says. “The new regime should also make it easier for lawyers who practise in remote areas — particularly sole practitioners and small firms — to provide more equitable access to legal services.”
Still, Tobe believes the failure of Bill 65 to require mandatory E&O insurance for mortgage brokers generally could be detrimental to the profession. “When lenders start losing money and the inevitable litigation ensures, the lawyers — who must have E&O insurance — will be the ones everyone looks to for compensation,” he says.

Inevitably, Tobe adds, that litigation will occur unless lawyers face up to what he calls the “fundamental problem” of conflicts.

“Lawyers should not ever represent both sides of a loan transaction,” he says. “They should make sure that both parties are represented separately and that the representatives are adequately compensated.”
Bill 65 may be new law soon, but Tobe’s advice is not new advice. It remains to be seen, however, whether lawyers will have learned their lesson this time around. After all, as Tobe notes with some irony, the law society has decided to reinstitute coverage for mortgage brokering just as the overheated market shows signs of slowing down.
“Wasn’t it [former Israeli foreign minister Abba Eban] who said that the parties in the Middle East ‘never missed an opportunity to miss an opportunity’?” Tobe asks. “I hope that doesn’t turn out to be the case here.”