The downturn in the global economy caused, as many believe by a property asset bubble, ended as all do by showing who was swimming naked when the tide went out.

On this occasion it was the banks that for years had been fuelling the bubble with little effective regulatory control; the government appeared to turn a blind eye as there was prosperity, albeit illusory, for all to share in. The banks themselves followed an aggressive policy of lending in order to obtain a greater market share where they naively assumed that property prices would only move in one direction: up.

Such was their scramble to secure larger and larger slices of this seemingly endless cake that, according to some solicitors, at best the banks chose to ignore solicitors’ advice and duties to them as clients enshrined in the Solicitors Code of Conduct 2007 (SCC), and the Council of Money Lenders Handbook (CML); at worst, according to others, they told their solicitors that they need not report such matters to them.

There can be little argument that the banks must shoulder much of the responsibility. However it now seems that some banks may seek redress from the solicitors, whose advice in the heady time they appeared to overlook, in order to recoup some of their losses. The banks now wish to argue that their solicitors should have complied with their contractual obligations, most of which would appear in CML.

At the time, the market was saturated with adverts and enticements from banks offering super low interest rates, no deposit purchases, or high loan to value ratio (LTVR). The latter is a way in which mortgage offers can be calculated so that if a buyer is providing a 10% deposit on a property worth £200,000 then the bank will need to provide the remaining 90% or £180,000 making this an LTVR of 90%. In some cases lenders were offering 100% LTVR and more, meaning that the purchaser might only have to fund his legal fees and stamp duty – or nothing at all.

The government recently announced that it will be pursuing negligence claims against solicitors who had acted on behalf of Bradford & Bingley (now nationalised) in relation to hundreds of buy-to-let mortgages where the bank now faces losses. Claims have been made following a review of same-day remortgage applications which had been ‘unknowingly accepted’ when they might otherwise have been rejected. The banks highlighted failures by solicitors to comply with their obligations under the CML Handbook. The argument for the banks, put simply, is this: had the solicitor told us, we would not have lent the money.

What should the solicitor have told the bank as his client? There are many things, but principally there are rules covering price change, control of deposits, back-to-back and geography. The banks argue that the duties owed by the solicitor to them as clients help reduce the risk of mortgage fraud. As the solicitor didn’t report to the bank, mortgage fraud increased, thereby further inflating the asset bubble.

There are various forms of mortgage fraud. At its most basic, it involves a client misrepresenting his financial position, making him appear less of a risk to a lending bank, thus increasing the LTVR which the banks were willing to lend. At its most complicated, it can involve identity theft, forged documents, and offshore shell companies.

Whilst back-to-back transactions are lawful, they have the characteristics and propensity to become a fraudulent transaction on the lender. A common back-to-back transaction is as follows:

A (an innocent seller) sells his property to B for £250,000 where its true value is some £275,000 but A needs a quick sale. B then sets up another buyer, C, and agrees to sell the property to him for £300,000 on the same day that B buys it for £250,000. C obtains a mortgage for £285,000 being 95% of LTVR, but does not have the remaining £15,000 to complete the transaction. The lender bank relies upon its own valuation which is also £300,000. C informs his solicitor that he has paid a £15,000 deposit directly to B, and B confirms that. In fact, no monies have changed hands.

The solicitor fails to declare to the lender the existence of the direct deposit, and the fact that B was purchasing the property on the same day for £35,000 less than the mortgage being offered to C. On completion, B makes a profit of £35,000, which he may split with C, while C gets a property which he would not otherwise have been able to afford. The lender loses out, being left with a charge on a property which is probably greater than the property’s actual value.

The SCC, bolstered by the green card on mortgage fraud, sets out the circumstances which should put the solicitor on notice as to the legitimacy of transactions. Solicitors should, for example, consider the location of their clients: why is a client from Newcastle instructing a solicitor in Cardiff in relation to a property in Dover?

Misrepresentations or changes to purchase price, length of ownership, incentives, allowances, discounts, the direct payment of funds, gifted deposits, funds being received by or sent to third parties are others. The warning card concludes ‘if you are not satisfied of the propriety of the transaction you should refuse to act’. The CML Handbook states ‘if you need to report a matter to us, you must do so as soon as you become aware of it so as to avoid delay. If you do not believe that the matter is adequately provided for in the Handbook, you should identify the relevant Handbook provision and the extent to which the issue is not covered by it. You should provide a concise summary of the legal risks and your recommendation on how we should protect our interests’. This places a broad obligation on the solicitor to inform his lender client of any fact which may well affect its decision to lend.

Between 2005 and 2008, the housing market had a bull run. Buy-to-let schemes had become a large part of the market, and banks created mortgage packages specifically for it. It certainly appeared arguable that banks were more concerned with their market share than ensuring that the investments that they were making were sound. At the time of rising house prices, the odd loan which might go bad was not a cause for concern. However, once the market collapsed, banks were left with portfolios of property which they discovered were massively over-valued.

The approach by the banks changed overnight. Where lending policy seemed to have been driven by sales departments with little attention to risk, suddenly the banks no longer lent; risk was at the forefront of their agenda. All the products which the banks were keen to ensure enhanced their market share vanished overnight. Entrepreneurs who had been offered packages of money to go and create a property empire saw their dreams collapse. The banks were back on the attack, and the consequence is numerous claims for breach of contract and negligence against solicitors for failing to comply with SCC and the CML Handbook. If the legal actions succeed, it will have the effect of transferring a burden shouldered by the taxpayer in part to insurance companies.

Although each case will depend upon its own facts, oral evidence by a solicitor that the lender client told him not to report the matters he should to said client may be found to be a poor substitute for a well-documented file. There will be a substantial evidential burden for the solicitor. In appropriate cases, the solicitor may be called to account by the SRA.

While it was evident at an early stage that some lending banks were swimming naked, it may yet take some time to discover whether some solicitors were also swimming in the buff.

George Marriott is head of the professional discipline and regulation department at Russell Jones & Walker. Robert Drury is a solicitor in the professional discipline and regulation department at Russell Jones & Walker.