A buy-to-let case in the High Court has sent shivers through the surveying profession and the insurance industry. And with claims from the housing boom set to run until 2013, this could be just the start of a wave of litigation

Two years on from the financial crisis and the fallout from the housing market crash continues to bite property professionals – and their insurers. Legal experts are warning the sector that it could be about to get a lot worse as lenders gear up to claw back cash from surveyors and estate agents. Meanwhile, a recent court ruling is likely to encourage buy-to-let investors to pursue claims against surveyors.

According to law firm Reynolds Porter Chamberlain, there were 25 High Court commercial and residential cases against surveyors and estate agents last year, compared with just one claim in the five years up to 2009. Meanwhile, insurers’ claims departments continue to be inundated with thousands of notifications of potential negligence claims by lenders, borrowers and investors hurt by the bursting of the housing bubble.

Commentators warn that if interest rates rise, this could lead to even more defaults on property loans, further whetting this appetite for legal proceedings. “There is a suspicion that lenders are waiting in the wings to see how the market pans out,” warns Weightmans partner Robert Crossingham.

Disgruntled investors

Law firms say that banks are likely to be the biggest driver behind such negligence claims as they try to recoup losses on the back of defaulting borrowers and the ongoing instability of the UK property market. Indeed, it has been suggested that banks could face losses of up to £70bn based on commercial property loans alone.

It is not just banks and financial institutions that are a cause for concern, however. Disgruntled individuals, such as buy-to-let investors, are queuing up to pursue claims after failing to generate sufficient rental income from their investments. According to leading law firms, the recent decision in the negligence case of Scullion v Bank of Scotland (t/a Colleys) could leave professional indemnity (PI) insurers facing a wave of claims as investors in the buy-to-let market try to recover lost income (see box, below).

Berrymans Lace Mawer professional negligence partner Caterina Yandell says the ruling has created a whole new class of claimant in the form of disgruntled investors. “These disappointed purchasers have a whole new angle on which to base their claims. At the very least, insurers of those valuers involved in the buy-to-let bubble of 2006 and 2007 can expect claims from these individuals.”

Unfortunately for insurers, there are a lot of potential claimants. According to the Council of Mortgage Lenders, the number of buy-to-let mortgages peaked at 346,000 in 2007. This compares with just 46,900 so far this year. Meanwhile, Ombudsman Services: Property, which records complaints against property professionals, reports a steady rise. Over the past year it has received 4,158 complaints compared with just 1,438 three years ago. Most complaints revolve around valuations and surveys.

Party to the scam

In addition, there has been a marked rise in fraudulent property transactions in recent years, which are set to generate future claims. Typically, this fraudulent activity occurs when the property purchaser contrives to procure a loan from a lender under false pretences.

PI broker Howden executive director Lance Rigby says: “For example, the valuation might not have taken into consideration a discount provided by the developer to the purchaser, so straight away the loan is worth more than the property was sold for.

“The loans are not repaid and it becomes apparent that the person who took the loan to buy the property was never intending to live there.” When the borrower begins to default, the lender can sue the surveyor for being party to the scam or failing to notice something was awry.

This problem is compounded by the fact that, in the current era of no-win, no-fee conditional fee agreements, disgruntled parties are much more likely to send letters to surveyors asking them to notify their insurer of a potential negligence claim. Rigby believes these “have a go” claimants end up overshadowing cases brought by people with genuine grievances against property professionals.

“The biggest challenge facing insurers and clients is dealing with the volume of notifications,” he says. “Without a shadow of a doubt, there are a number of notifications within the insurance industry that are spurious. They are being driven by this conditional-fee culture and clogging up the claims process.”

Reynolds Porter Chamberlain partner Alexandra Anderson adds that while such notifications may never reach court, they have a long-term effect on the business of property professionals and the efficiency of insurers’ claims handling. “There are an enormous number of initial notifications that have gone to insurers which may never be pursued. This, however, damages the claim records of surveyors and makes it that much harder for them to get renewal terms.”

This situation, she explains, leads to an increase in insurers’ administration costs as they are forced to open and maintain hundreds of files in response to these notifications.

Anticipating an avalanche

Anderson also warns that insurers could be seeing only the start of the problem. A lender can notify a negligence claim against a surveyor any time in the six years following receipt of a valuation or making a loan on the basis of that valuation. The floodgates could open as the deadline for the notification of claims based on

boom-years valuations draws closer. “We may see a further pick-up in claims because lenders will have to issue proceedings to protect their position on liability,” Anderson says.

“Next year will be the expiration date for 2005, and that was when the market was really heating up, and the banks were lending at three and a half times a person’s income. Next year we could see a bigger avalanche of claims.” Anderson predicts that, as a consequence of the six-year rule, a surge in notifications could last until 2013, six years after the housing market collapsed.

So what can be done? When it comes to fighting the banks, Weightmans’ Crossingham believes the best strategy is to highlight their often questionable lending practices. He says that the first port of call should be to ask banks for their lending files. “That will show what their lending criteria were. In the cases I have seen recently, the banks just didn’t bother to comply with them,” he says.“Not only did they lend to purchasers who could not afford to service the loan, but they also lent to borrowers with very poor credit histories who had defaulted on loans before and had a very high level of debt.”

Crossingham adds that in some cases banks ignored the surveyor’s valuation report or failed to understand it properly. He explains that this approach can help detect unscrupulous lending practices that may force the bank to either drop proceedings or help the insurer prove contributory negligence.

Act wisely

Anderson warns that insurers should not panic and waste time on spurious notifications. “Unless there is a credible case as to why there is some liability, they shouldn’t entertain a claim or rack up costs in trying to answer it. It is always for the claimant to establish that the valuer has done something wrong,” she says.

She explains that because there are thousands of notifications, claimant law firms have started to offer ‘bulk deals’, offering insurers the option of settling in one go a number of claims based on valuations made by a particular surveyor or for a particular lender.

Anderson says that while this may seem attractive, insurers should think carefully about going down this route. “While there may be some attractions for insurers in getting a large number of claims settled quickly and potentially on the cheap, that doesn’t allow them the opportunity to assess whether there is any merit to these claims. They should be standing firm.”

It seems the reverberations from the housing crash are far from over. The claims sector needs to be on its guard more than ever. IT

Scullion v Colleys: a case with 'serious implications'

In October 2002, Emmet Scullion invested in a buy-to-let residential flat, having obtained a valuation from Andrew Collins of Colleys, which is now part of the Bank of Scotland. Collins valued the property at £353,000, with rental income of £2,000 per month.
However, Scullion was only able to let the flat for around £1,000 per month. He sold the property in 2006 and received just £270,000 for it.
Scullion sued Colleys, alleging that Collins had overvalued the flat and provided an inaccurate rental figure. The judge dismissed the first part of the claim but agreed with the rental element, and in the quantum ruling on 8 October, Scullion was awarded compensation of £72,234.
Beachcroft professional risks partner Duncan Greenwood describes the case as an "unjust extension of third-party liabilities" and believes the implications of the ruling are huge. "The reasoning behind that successful award could have serious implications for surveyors and their insurers," he says.
Up until now, surveyors did not have responsibility to guarantee rental income and, more importantly, they were not hired to advise on the potential success of the commercial venture.
Greenwood explains that, traditionally, surveyors' rental estimates have been based solely on current market values. They have never been expected to take into account extenuating factors, such as the supply of and demand for rental properties in the local area, or additional expenses, such as service charges and the cost of managing the property.
While the judgment is set to go to appeal, leading PI insurer Zurich's professional and financial lines manager, Gail Cook, warns that insurers need to take note of the implications of the ruling. "This case does raise concern and presents questions as to the extent of the duty of care owed by a valuer to third party buy-to let-investors," she says, "whereas in the past this may have been viewed as a commercial trading risk."