Fraud can hurt more victims that the original mark. The Washington Supreme Court recently had to weigh the rights of two victims – a defrauded bank and a series of investors who were affected when another investor improperly put their property on the line.
A limited liability company with twelve investors bought land near Olympia, giving a $400,000 trust deed to a bank to raise the purchase money. Several years later, a 39 percent investor in the company decided that he needed to raise $1.5 million for his other businesses. He offered a different bank the property as collateral. Bank 2 required him to refinance the original loan with part of the proceeds, and thought that it would take over as the primary lender.
The investor didn’t ask his co-investors for permission to do this. Instead, he forged a document to assert that he owned all of the company and gave that to Bank 2 This fraud got him the loan. (And he probably was the person who paid Bank 1 on behalf of the company, so the other investors might not have realized the scam immediately.)
When he didn’t pay off, the deception was discovered, and Bank 2 and the company ended up fighting over their rights to the original land. The trial court ruled that Bank 2 could not enforce the $1.5 million trust deed because the investor didn’t have the power to sign a trust deed binding the company. That part of the ruling was not appealed.
The trial court also ruled that Bank 2 was able to take over the $400,000 trust deed that was refinanced, under a rule that, effectively, Bank 2 bought those rights from Bank 1 by refinancing. (The technical term is “subrogation,” and the basic reasoning is that the company would have been unfairly enriched if the $400,000 trust deed was cleared from the title when it hadn’t paid off.) That part of the ruling was appealed by the company, arguing that someone who steps in without being asked isn’t entitled to take over rights like the trust deed.
The Washington Supreme Court ruled that it was no longer going to recognize the “volunteer” rule that the company argued as part of Washington law. Instead, relying on recent trends in the law generally, it said that if someone paid something to protect its interests, it was entitled to claim the rights of the person it paid off:
Bank 2 → Pays Bank 1 to refinance Bank 1’s loan
Bank 1 → Allows Bank 2 to step into its shoes as lender to the extent of Bank 1’s loan
The reasoning of this rule, and similar rules, is based on fundamental fairness. There were two victims, Bank 2 and the company. Bank 2 clearly had to take the loss for the $1.1 million difference between the two loans, but as to the initial $400,000 loan, it simply wouldn’t be fair for the company to walk away suddenly free and clear. Bank 1, however, had been paid off, so only Bank 2 could continue to receive payment for the original loan, to recover at least what it paid out for the refinance.
Obviously, honesty would have saved everyone a lot of trouble. This situation, however, doesn’t just happen as a result of fraud. Insurance payments, honest refinances, and second loans also raise similar questions. In general, watch out for someone who pays to clear out someone else’s interests in property or a business to expect to step into the shoes of the person they pay off.