Daily Development for Friday, January 26, 2001

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

ESCROWS; DISCLOSURE: Escrow agent has duty to disclose "known fraud" to parties to escrow.

Mark Properties v. National Title , 14 P.3d 507 (Nevada 2000)

This case arises out of fraud practiced in a series of "flip" transactions.

Two out of state individuals arranged to do some land investing with a Nevada real estate investors. The out of staters form Mark Properties, a corporation which would provide 60% of the purchase price of target properties. The Nevada partners formed Terra Vegas Corporation, which would provide the other 40% of the purchase price. The properties would be held by a separate LLC. In exchange for the efforts by Terra Vegas in locating and managing the properties, Terra Vegas would obtain a 50% interest in the ownership LLC.

In the course of the first transaction, closed at escrowee National Title, an escrow agent became aware that Bash, one of the principles of Terra Vegas, and by extension a fiduciary of Mark Properties, its co-owner in the LLC, in fact had a separate escrow at another title company in which a company controlled by Bash was acquiring the property at a lower price.

The owners of Mark Properties knew of the double escrow, but were assured by Bash that Bash had acquired the property in that escrow at the same price that the LLC was paying. They later denied that the National Title agent had informed them that there was in fact a price differential.

After this first deal, the parties acquired another property, in which acquisition Bash again allegedly "flipped" the property for a higher price than what he paid for it in a simultaneous escrow. Finally, in the course of closing a third acquisition, the out of staters wised up. When it became clear that Bash's separate escrow was having trouble closing, and that a refund of a deposit made by Bash was in the offing, they demanded that the escrow agent hold the deposit to help them satisfy their claims against Bash for the earlier fraud. The escrow agent refused, and distributed the deposit as instructed by the parties to the escrow (note that since this was a separate escrow, the Mark Properties interest was not a party to it).

Mark Properties sued that title company for failure to disclose the fact of the flip plans and for refusal to hold the deposit. It also sued the earlier title company that had closed the two deals in which the Mark/Terra LLC had acquired properties "flipped" into an escrow from another escrow managed by Bash. It claimed that the title company escrowees in those transactions had a duty to investigate suspicious facts indicating possible fraud and to disclose such fraud.

The court here held that Mark Properties did allege a cause of action for failure to disclose *known* fraud, but concluded that there was no duty to investigate and discover fraud and that the escrow agent owes such duty only to the parties to the escrow. Consequently, since Mark Properties was not a party to the third escrow, involving the contested deposit, that escrow agent had no liability. Further, the escrow agent was not only permitted to follow the instructions of the principles to the escrow in distributing the deposit, it likely was required to do so.

The court remanded the case to the trial court for an analysis of whether, in the two prior transactions, the escrow agents were aware that a fiduciary of the acquiring LLC was in fact "flipping" the properties into the escrow from a separate escrow at which it was acquiring the properties for a lower price. Note that, in the first transaction, the escrow agent had testified at deposition that she was aware of these facts, but that she had disclosed them to Mark Properties, which the principles of Mark denied.

Comment 1: This case does not go as far as Butko v. Stewart Title, a recent Washington decision which was later withdrawn by the Washington Court of Appeals, but is reported as the DD for 10/27/00 on the DIRT Website ( GOTOBUTTON BM_1_ http://cctr.umkc.edu/dept/dirt/), in that it importantly limits the duty of the escrow agent to known facts indicating fraud and the disclosure responsibility to parties to the escrow only.

Comment 2: The case departs from California precedent finding no such duty. Lee v. Title Ins. Co., 70 Cal. Rptr. 378 (Cal. App. 1968), but follows Arizona authority, Berry v. McLeod, 604 P.2d 610 (1979).

Comment 3: The fundamental problem with requiring a disclosure duty of escrow agents is the problem of "false positives." Of course, it is desirable that known fraud be intercepted before it does damage. But not every "flip" is fraud, not even when the property is flipped into a separate escrow for a higher price. The fraud here arose because Bash was a principle in a corporation that was a partner in the LLC that was acquiring at the back end of the flip and was profiting from the front end. Is an escrow officer supposed to understand the complexities of fiduciary duties among principles of corporate partners? If so, then these folks aren't being paid enough. We talking a very complex set of principles here.

If a flip is not fraudulent, then to disclose information concerning the front end escrow conceivable might be a breach of confidential information that the escrow agent has received through its representation of the seller in the back end escrow. Should an escrow agent have the duty to maintain confidentiality as between parties to its escrow? Candidly, the editor always assumed that there was such a duty, although this doesn't mean that the editor would sit down with the escrow agent and tell the agent all his secrets. The danger of accidental disclosure is always there.

Does this new decision mean that as a practical matter escrow agents are best protected by telling everyone in the transaction everything they discover, regardless of apparent relevance? If I were an escrow company, I'd put this in my escrow agreement, thereby obliterating any expectation of confidentiality in the future. And if I were a party dealing with these knew "transparent escrows" I'd take pains to build walls of confidentiality around the escrow agent that undoubtedly will make carrying out these transactions all the more difficult, fraud or not.

Comment 4: Even more problematic is the fact that escrow agents often lack the sophistication or knowledge of the particular transaction to appreciate where fraud is and where it isn't. The instant case is an excellent example.

The editor remembers an incident early in his career in which he sold a property with a "sellers' wrap" mortgage and the escrow agent informed the buyers that this was a fraudulent deal because the mortgages amounts on the property exceeded the purchase price. It took days of explaining to cure the suspicions of the buyers. With other buyers, the deal might have been lost entirely. The escrow agent just didn't understand wraps, but this didn't prevent him from expressing his opinions.

Comment 5: More often, an escrow agent might have knowledge of specific representations that evidence in the escrow demonstrates is fraudulent. Although, again, what is and is not a fraudulent representation often is a close call, particularly when the escrow agent sees only a part of the communication that might take place among parties to the deal. Again, there is a significant danger of "false positives."

In the end, the editor concludes that the danger of false positives and the negative impact on the ability to work with the escrow agent in confidence outweigh any benefits that might accrue from sticking the escrow agent with a disclosure duty here.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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