Claims Against Residential Appraisers in 2009

In 2009, the volume of claims against appraisers remained at the same record levels experienced in 2007 and 2008. Beyond this continued high level, we've observed several new claim trends affecting residential appraisers in 2009.

I'll start with the good news. Most of the claims we see are defensible. With experienced and knowledgeable defense counsel, we find that the claims can often be defended without any liability. Second, though the volume of claims is high, the volume does not appear to be increasing to even higher levels. We are slowly winding our way through the problems created by irresponsible lending practices at the peak of the bubble. As we get further away from that time, we are hopeful that we’ll start seeing a decline in the number of new claims.

Here are some of the major trends and issues we've seen in 2009:

1. Overvaluation Claims by Borrowers

Borrowers – regardless of the fact that they are not the intended users of most appraisal reports – are filing a majority of the claims we see against appraisers. These claimants are mainly homeowners or property speculators who purchased or refinanced properties at the peak of the real estate bubble in 2005 through 2007. Most of their claims fit a common pattern: borrowers typically allege that they borrowed or paid too much because the appraisal overstated a property’s value and often accuse the appraiser of conspiring with the lender to make sure the loan would close. There is always more to the story with these claims, however. It is typical for us to discover that the lender overlooked its underwriting guidelines or the borrower’s inability to pay or that the borrower lied to get the loan. Or, the borrower never looked at or considered the appraisal until his lawyer started coming up with parties to sue (and therefore did not legally “rely” on the appraisal). We will continue to see these kinds of claims at historically high levels until enough time passes that the claims are no longer viable.

2. Undervaluation Claims by Borrowers and Sellers

A noticeable new trend involves demands and complaints that appraisers have undervalued properties. These claims are usually made soon after the delivery of a report and are often intended either to intimidate appraisers to change valuations or simply to strike back at appraisers who have reported lower than desired opinions. In recent months, claims that appraisals are too low have made up about a third of the claims we see from borrowers.

A typical scenario for this type of claim involves a homeowner seeking to refinance debt on a property purchased in 2005 or 2006. The homeowner will usually provide an inflated notion of his home’s value to the lender. The appraiser, however, will accurately report a value that in many cases is 20% to 30% less than what the homeowner paid. When the loan officer informs the homeowner that the loan cannot be made and provides the appraisal to the homeowner (as required by the HVCC), the next thing we see is a demand letter from the homeowner or a lawyer threatening to sue the appraiser and/or report the appraiser to the state unless the appraiser raises the value or somehow “retracts” the report. Often, we will also see a threat that if the homeowner does not obtain the loan he wants, he will sue the appraiser for the interest that the homeowner theoretically would have saved if the appraisal had come in higher and the homeowner had received his or her desired loan.

A closely related trend involves an increased number of undervaluation claims filed by property sellers (and sometimes their real estate agents). Here, these parties claim that an appraiser’s lower than expected appraisal either caused them to lose a sale when a buyer backed out or caused them to concede to a lower sales price. They typically demand that the appraiser make up the “lost profit.”

We see almost all of these claims about undervaluation for what they are: frivolous. We also take them as an indicator that appraisers are doing their job and providing accurate information to their lender clients. If residential appraisals are a bit more conservative than a few years ago, appraisers cannot be blamed for that. This is the result of a deflated bubble, new appraisal rules, and thousands of lawsuits and administrative complaints filed against appraisers by lenders and borrowers blaming appraisers for loan losses.

3. FDIC Claims

A more disturbing trend that emerged in 2009 involves the FDIC. We are seeing more and more demand letters and lawsuits being pursued by law firms working on behalf of the FDIC in connection with its takeover of failed banks. The FDIC has so far seized about 120 banks in 2009. In most cases, when the FDIC takes over a bank, the banking assets and deposits are quickly sold to another bank. In its standard sale agreement, however, the FDIC retains the right to pursue claims and lawsuits in the name of the failed bank. Accordingly, the FDIC has hired panels of private law firms to review bank records looking for possible lawsuits to file against officers, directors, accountants, appraisers, etc. in an effort to blame them for causing the failed bank’s losses and to recover funds to replenish the FDIC’s coffers. Thus, we’ve begun to see the FDIC’s private legal teams sending demand letters and filing lawsuits against individual appraisers blaming them for loan losses following foreclosure. One thing that stands out about these claims is that the FDIC’s various private counsel often pursue cases with over-the-top zeal – as if wearing the shiny badge of a newly appointed sheriff. We are hopeful that the FDIC will ultimately realize that over-lawyered lawsuits against appraisers blaming them for irresponsible lending decisions by the likes of WaMu, Indymac and Downey Savings are a net waste of its funding.

The scariest thing about FDIC claims for a few appraisers, however, is that some E&O insurance policies (but not any issued by LIA) contain an endorsement excluding coverage for claims by the FDIC and other government financial institutions. Thus, we would advise appraisers to contact their insurance providers to confirm that no such exclusion exists in their policy.

4. Claims Involving Trainees and Independent Contractors

About 25% of the claims we see against appraisers have some tie to work or assistance provided by trainees. A large number of additional claims relate in some way to work performed by independent contractors. It’s not always that the trainee or independent contractor was at fault or caused the problem – it’s just that many claims have this tie. We urge appraisers to be diligent and hands-on in their supervision of work by trainees and contractors and to make sure that the quality of their own work product is not compromised by such assistance. Also, it’s very important that if an appraiser has ever used or now uses trainees or independent contractors, the appraiser should review his or her E&O coverage with his provider to make sure there is coverage for any claims that may arise from the supervision of that work – many current insurance policies sold to appraisers contain an exclusion of such claims (policies issued by LIA do not contain such an exclusion).