Daily Development for Wednesday, April 30, 2003
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

ESCROWS; INTEREST; UNJUST ENRICHMENT: Although title
companies are not liable for breach of fiduciary duty for taking
"kickback" benefits when they deposit escrow monies in banks offering
such benefits, the banks themselves may be liable for unjust enrichment
when they charge excessive cash management services for management
of funds attracted by the kickback scheme.

Hirsch v. Bank of America, 132 Cal. Rptr. 220 (Cal. App. 3/29/03)

This class action was brought against four banks and numerous title
insurance companies relating to elaborate alleged schemes by which the
banks lured escrow deposit monies managed by the title companies into
their banks in exchange for a variety of lucrative incentives to the title
companies.

After the title companies were split off from this action, a trial court
sustained a demurrer to the complaint against them, finding that they
were not in breach of their fiduciary obligations in the escrow when they
took benefits for these deposits, since the deposits themselves did not
bear interest and the customers had signed document expressly so stating.
The editor has not seen the trial court opinion in that case, and apparently
the opinion on appeal has not yet been rendered.  In light of the facts
alleged in this case, the appellate court decision in the title insurer's case
will be quite interesting.

This case involves claims only against the lenders who engaged, it was
alleged, in an elaborate scheme not only to provide unlawful benefits to
the banks in exchange for deposits but in efforts to conceal those
benefits.

Here are the allegations:

     (1) Earnings Credits:  Earnings credits are credits, expressed in
     dollars, earned on deposited escrow funds.   Banks extended
     earnings credits to title companies based on the average daily
     escrow funds on deposit with them, and provided the title
     companies with monthly account analysis statements setting forth
     the exact amount of the credits.   Ostensibly, these earnings
     credits were used to pay for normal banking services provided to
     title companies by Banks or by third party vendors under contract
     with Banks.   In fact, Banks paid earnings credits for services that
     were not normal banking functions, e.g., invoices were paid for
     tax preparation;  voicemail systems; office supplies and furniture;
     and installation and upgrading of computer equipment in branch
     offices (even though the equipment was used primarily for
     nonescrow services).

     Additionally, Banks paid earnings credits for services that were
     never rendered, based on invoices they knew were not related to
     normal banking services.   Routinely the invoiced amounts were
     calculated to match and exhaust the available earnings credits.
     Further, earnings credits went to shell companies that had no
     independent existence, employees or payroll expenses, based on
     phony invoices.   The shell companies in turn funneled or rebated
     the payments to the title companies.   As well, earnings credits
     were paid to subsidiaries of the title companies for services
     invoiced at inflated, above- market rates.

     (2) MRCF's:  The MRCF process works this way:  On the last day
     of each month Banks calculate the amount of credit the title
     companies are eligible to borrow.   On the first day of the next
     month they inform the title companies of the net investable
     balance for the preceding month.   With that balance Banks
     purchase securities for the title companies, selecting the securities
     from a list in the MRCF contract which includes treasury bills,
     certificates of deposit, and highly rated commercial paper.
     Banks charge a nominal amount of interest on the credit extended
     to the title companies, but the securities generate a market rate of
     return, guaranteeing monthly profit to the companies.

     No later than the last day of each month Banks liquidate the
     securities.  They retain the principal from the sale along with
     sufficient funds to pay off the nominal interest charged.   The
     remaining "spread" is the interest earned on the securities, which
     Banks wire transfer to separate accounts controlled by the title
     companies.

     Appellants alleged that the MRCF's resulted in net payments
     based solely on the amount of funds held in non-interest-bearing
     escrow accounts and the market interest rates.   These payments
     amounted to rebates paid directly to the title companies, and as
     such they constituted interest in violation of federal law.
Plaintiffs further asserted that by agreeing to "covertly" pay interest on
escrow funds, Banks captured for themselves a larger pool of capital than
they could otherwise obtain from title companies, and reaped substantial
profits from excessive fees associated with offering and maintaining the
escrow accounts. The excessive fees were passed on, directly or
indirectly, to consumers.

Federal regulatory policy embodied in Regulation Q prohibits banks
from paying interest on a demand deposit, but there are exceptions that
permit the banks to absorb or reduce charges for banking services for
depositors with such deposits.  Further, the bank can also contract with a
third party to provide a "normal banking function" for the depositor if the
service is the equivalent of the provision of such services by the bank and
if there is no payment "to or for the account of" the bank's customers.

As can readily be seen, the above alleged schemes were designed to take
advantage of these loopholes in the federal regulatory scheme; but, if the
artifices alleged actually occurred, the banks went well beyond permitted
limits.

Plaintiffs alleged five causes of action:  (1) aiding and abetting
conversion of interest;  (2) aiding and abetting breach of fiduciary duty;
(3) aiding and abetting breach of agent's duties to principal;  (4) unjust
enrichment;  and (5) violation of the California's Unfair Practices Act.
They sought general and punitive damages, as well as an order "directing
restitution of all improperly assessed charges and interest obtained, and
the imposition of an equitable constructive trust over such amounts for
the benefit of Plaintiff[s], the Class members and the general public...."

The trial court found that, insofar as the banks were concerned, they
didn't deprive the depositors of any funds.  If the allegations were true,
the banks shouldn't have been providing these benefits to the title
companies, and therefore the title companies would not have been
providing them to the customers, who did not expect to receive any
interest.

Interestingly, the court does make a comment suggesting that indeed the
title companies ought to have liability based on the alleged facts.  Too
bad for the plaintiffs that this panel wasn't hearing the appeal of the title
company case:

     "Nevertheless, as between the title companies and its customers,
     Cal. Insurance Code section 12413.5 dictates that the customers
     have the superior right to any payments made by Banks that
     constituted interest in violation of Regulation Q.  Unless the
     funds were to be disgorged to Banks, the title companies would
     be obliged to pass those benefits on to its customers."

But the court then goes on to state that the banks might be liable for
unjust enrichment based upon the Banks charging excessive fees, without
justification, for escrow account services that were passed on to them.
These included fees involving account maintenance, account
reconciliation, monthly gener ledger and financial statements, checks
deposited, checks paid, check printing, check sequencing, photocopy and
clerical services, facsimile transmission, postage, express mail, incoming
and outgoing wire transfers, information and computer serves and scores
of additional charges for offering and maintaining escrow accounts."
Plaintiffs alleged that fees were charged at excessive rates, sometimes
generating profit margins of nearly 50 percent.  These fees were passed
on to consumers as higher fees for separate services or higher fees for
escrow services generally.

Although these fees were charged for services actually provided, and
although there normally is nothing wrong with charging a higher price if
the customer is willing to pay it, the plaintiffs alleged that the banks
reaped these fees as a consequence of the illegal activity described above,
and that they were liable to the plaintiffs to return their ill-gotten gains as
unjust enrichment.

As indicated, the court reversed the granting of the demurrer on this
count and remanded for trial.

Comment 1: Phoney invoices? Shadow corporations?  Hidden payments?
Pleeeease!!!  If these allegations are true, and there was a concerted and
planned effort to circumvent federal regulations, there has to be some
injury to consumers somewhere along the line, and there ought to be a lot
more fire than all the smoke blown up by plaintiff's counsel.  We haven't
gotten to the proof of facts yet, but let's hope that we do.  The banks may
be prepared to hand the plaintiff's counsel a check (that's all they're  in it
for, would be the editor's  guess) rather than to go any further public with
all of this.

But it's the lawyer's job to invoke the legal procedures appropriate to the
resolution of the dispute and to demurrer when the plaintiff's aim is off
target, even if the target is a fat and juicy one as (allegedly) it was here.
So the plaintiff's counsel, one of whom was DIRTer John Hosack, got a
nice victory here by using the "no harm, no foul" defense.

Comment 2: If this is happening in California, it's likely happening in
other states as well.  Lender's counsel would do well to ferret out and
eliminate parallel developments elsewhere.  Sooner or later there will be
liability for some of this conduct.  Don't let it be your client on your
watch!!

Comment 3:  It would seem that parallel reasoning to this case will result in the
escrow companies also being chargeable with unjust enrichment.  So one suspects
that more shoes will be dropping in this litigation.

Readers are encouraged to respond to or criticize this posting.

Items reported on DIRT and in the ABA publications related to it  are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters.  The same is true of all commentary provided by contributors to the DIRT list.  Accuracy of data provided and opinions expressed  by the DIRT editor the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.

Parties posting messages to DIRT are posting to a
source that is readily accessible by members of
the general public, and should take that fact
into account in evaluating confidentiality
issues.

ABOUT DIRT:

DIRT is an internet discussion group for serious
real estate professionals. Message volume varies,
but commonly runs 5 - 15 messages per work day.

Daily Developments are posted every work day.  To
subscribe, send the message

subscribe Dirt [your name]

to

listserv@listserv.umkc.edu

To cancel your subscription, send the message
signoff DIRT to the address:

listserv@listserv.umkc.edu

for information on other commands, send the message
Help to the listserv address.

DIRT has an alternate, more extensive coverage that includes not only
commercial and general real estate matters but also focuses upon residential real estate matters.  Because real estate brokers generally find this service more valuable, it is named "BrokerDIRT."  But residential specialist attorneys, title insurers, lenders and others interested in the residential market will want to subscribe to this alternative list.  If you subscribe to BrokerDIRT, it is not necessary also to subscribe to DIRT, as BrokerDIRT carries all DIRT traffic in addition to the residential discussions.

To subscribe to BrokerDIRT, send the message

subscribe BrokerDIRT [your name]

to

listserv@listserv.umkc.edu

To cancel your subscription to BrokerDIRT, send the message
signoff BrokerDIRT to the address:

listserv@listserv.umkc.edu

DIRT is a service of the American Bar Association
Section on Real Property, Probate & Trust Law and
the University of Missouri, Kansas City, School
of Law.  Daily Developments are copyrighted by
Patrick A. Randolph, Jr., Professor of Law, UMKC
School of Law, but Professor Randolph grants
permission for copying or distribution of Daily
Developments for educational purposes, including
professional continuing education, provided that
no charge is imposed for such distribution and
that appropriate credit is given to Professor
Randolph, DIRT, and its sponsors.

DIRT has a WebPage at:
http://www.umkc.edu/dirt/

Members of the ABA Section on Real Property, Probate
and Trust Law or of the National Association of Realtors can subscribe to a quarterly hardcopy report that includes all DIRT Daily Developments, many other cases, and periodic reviews of real estate oriented literature and state legislation by contacting Antonette Smith at (312) 988 5260 or asmith4@staff.abanet.org