MEMO ON THE LEGALITY OF DOUBLE ESCROW IN NEVADA

Dear Yonas,

We wholeheartedly thank you for assigning this project to us.

As per our understanding of the issue, you want to know the legal

compliances to be followed, steps to be taken and the issues to be

taken into consideration while having a double escrow in Nevada.

In this memo we are detailing you on the subject matter with the Land

Mark Nevada cases dealing with the issue of double escrow inclusive of

legal provisions and case laws whereby the legality of the double

escrow is mentioned in detail. We have also included additional

disclosure provisions and Fannie Mae’s publication of Mortgage Fraud

News pertaining to Pre-foreclosure Sales Abuse which can be helpful

for you in your real estate profession.

I. DOUBLE ESCROWS

Double escrow is a real estate transaction involving two contracts at

two different prices, with two different buyers, on the same property,

closing escrow on the same day. Whereas assigning a contract uses

one purchase contract whose closing name and "taking title as"

identification is identified by the closing attorney or escrow officer, a

double escrow often uses a straw buyer whose name goes onto the

chain of title where the assigned contract "bird dog" does not.

At close of escrow, all participants, lenders, sellers, buyers and brokers

are informed of all parties involved and all monies that change hands.

Double escrows are totally legal and all processes within them must be

disclosed by either the originator of the "deal" or by the closing escrow

officer.

A popular transaction these days is to have an investor "save" a

defaulting homeowner by purchasing a home in a non-MLS short sale

and then listing the property in MLS as a non-short sale resale, in the

hopes of having a simultaneous closing. Double escrows may be legal,

but should only be done with an abundance of caution and well-drafted

written disclosures to the lenders, the seller and the second buyer,

particularly when the short sale buyer's agent is the resale seller's

listing agent.

II. LANDMARK CASES:

1. (Holland Realty Investment Co. v. State, 84 Nev. 91, 436 P.2d

422 (1968)

In 1968, the Nevada Supreme Court decided a case involving a double

escrow where the Real Estate Commission had revoked the broker's

license. Although Nevada has several new statutes today with updated

wording, the basic lesson is the same i.e.; a licensee owes a duty to

fully disclose material facts of the transaction.

The facts of the Holland case were mostly undisputed. In a double

escrow transaction, the Broker purchased a residence from the Seller

for $ 3,500 and sold the same home to the Buyers for $ 4,500,

retaining for himself the $ 1,000 difference in price, less escrow costs

(about $ 120). The escrows were opened within a day of each other; it

appears that the Broker offered to purchase the residence after he had

contacted Buyers and discussed the $ 4,500 purchase price. Both

escrows closed simultaneously, with the Buyers' money being used to

fund Broker's purchase from Seller.

The Broker admitted that:

He did not tell the Buyers that he was the owner of the property, or

who the owner was.

He failed to tell the Buyers that he was making a simultaneous

purchase of the property from Seller for $ 3,500 or that he was using

Buyers' money to make the purchase.

He failed to tell the Buyers that he was making a profit on the

transaction.

He did not tell the Buyers that they could purchase the property for $

3,500 or tell Seller that the Buyers had offered to pay $ 4,500 for it.

On appeal, the Supreme Court agreed that the Commission acted

within its powers: "The very practice of double escrowing is fraught

with deception, and one who engages in it cannot do so with the

candor and honesty demanded of a duly licensed real estate broker

without violating and breaching the basic fiduciary trust which is

expected of him."

“The case specifically mentions to fulfill the fiduciary duty of disclosure

while double escrowing.”

2. Alley v. Nevada Real Estate Division, 575 P. 2d 1334 (1978)

This was an appeal from the district court order affirming the decision

of the Nevada Real Estate Division and its Advisory Commission to

permanently revoke the real estate broker's license held by Jerry L.

Alley.

In the case, the record of the administrative proceedings established,

inter alia, that Alley had received a secret profit of $ 2000 for himself,

and others, by utilizing a "double escrow" scheme.

Engaging in an undisclosed double escrow transaction is a breach of

the licensee’s absolute fidelity to the client. The Nevada Supreme

Court Justice McDaniel, in this case, defined Double Escrow and then

went on to explain the law's denunciation of such schemes and found it

illegal when the broker or salesman purchases a principal’s property in

the first escrow, and sells it to a third party at a profit in a second

escrow without a full disclosure to both the principal and the third

party. The escrows close at the same time and the broker or salesman

thereby uses the proceeds from the sale in the second escrow to

purchase his principal's property. The broker or salesman receives a

commission on the sale in the first escrow and a secret profit on the

closing in the second escrow.

The court stated that such schemes were denounced in Holland Rlty.

v. Nev. Real Est. Comm'n, 84 Nev. 91, 98, 436 P.2d 422, 426

(1968), where the court stated the following:

A broker when pursuing his own interest cannot ignore those of his

principal and will not "be permitted to enjoy the fruits of an advantage

taken of a fiduciary relationship, whose dominant characteristic is the

confidence reposed by one in another."

The law does not allow the agent who also has a right to purchase to

wait until someone makes an offer of an amount in excess of the

agreed purchase price and then elect to purchase the property at the

lesser price without informing the owner of the higher offer, and, after

the agent has obtained the consent from the owner to buy the

property, then immediately sell it for the higher price as his own

property.

The administrative determination to permanently revoke Alley's license

finds ample support in the record; thus, we perceive neither an abuse

of discretion nor conduct that could be considered arbitrary or

capricious. Accordingly the order of the district court was affirmed.

“The case notifies that any anticipated interest must be disclosed even

if it is only a pass-through interest. For example, a licensee must

disclose when the licensee takes title, however briefly, during a ‘double

escrow’.”

3. Goldstein v. Hanna, 97 Nev. 559, 635 P.2d 290 (1981)

In this case, Callahan was the listing agent for a condominium owned

by Hanna. Goldstein and Hanna signed a lease with option to purchase

to close by December 9, “unless exercised prior thereto.” During the

lease period, Goldstein exercised the option and signed a purchase

agreement with another buyer using a double escrow. Both closing

dates were set for August 29. Prior to the closing, the ultimate buyer

backed out. Goldstein contacted Callahan who advised him the option

was still good until December 9. This was both a misstatement of the

law and beyond Callahan’s authority. Goldstein, justifiably relying on

Callahan’s statement, did not close on August 29. The seller then

cancelled the escrow and attempted to get the property back.

Goldstein sued Hanna for specific performance citing his reliance on

Callahan’s statement. Though the court’s decision was split as Justices

Mowbray and Manoukian dissented. Hanna eventually lost the

property.

III. LEGAL PROVISIONS & CASELAWS

The following are the legal provisions to be complied with while double

escrowing, inclusive of other real estate transactions.

DISCLOSURE OF LICENSEE’S INTEREST

o A licensee must disclose in writing to the parties whenever the

licensee has a personal interest in either the transaction or the

property. Such disclosure ensures everyone is aware of the

licensee’s potential conflicting loyalties. (NRS 645.252 (1) (b)

& (c); NRS 645.633 (1) (g); NAC 645.605 (4); NAC 645.610

(1) (b) (1-2); NAC 645.637 and NAC 645.640).

o The licensee should be aware that some laws prohibit certain

acts even if the licensee’s interest is disclosed. As an example, a

salesperson may not receive compensation from anyone other

than his or her broker: taking such payment is illegal whether or

not it is disclosed. (NRS 645.280)

a. Interest in the transaction:

Any time the licensee has an interest in the transaction, that interest

must be disclosed in writing. An “interest in the transaction” occurs

when:

1. Compensation:

The licensee receives, or expects to receive, compensation from more

than one party; NAC 645.605 (4) (e)

The licensee is under an affirmative duty to disclose to each party to

the real estate transaction each “source” from which the licensee will

receive compensation. (NRS 645.252 (1) (b))

The statute does not require the licensee to disclose the amount of the

compensation, only its source - the identity of the person or company

giving the compensation. (NAC 645.605 (4))

Compensation includes referral fees and other payment such as fees

received from vendors to be on a broker’s list of service providers.

Even though the broker may give a service provider list to a client

without charge, the broker must disclose if a vendor paid to be on that

list. (Excerpts from Judy bendure, “Preferred Vendor Lists,” Real Estate

Division Open House, vol. 25, issue 1, winter 2000, at p. 4. The Open

House is the Real Estate Division’s information bulletin.)

Compensation includes money the broker may accept, give or charge

as a rebate or direct profit on expenditures made for the client. (NRS

645.633 (1) (g)) For example, a buyer asked the broker to have a

new air conditioning unit installed. The buyer paid for the unit in

escrow. The air conditioning manufacturer offered a $200 rebate. The

broker, when he purchased the unit, applied for and kept the rebate

without disclosing it to his buyer. This is a violation of the broker’s

absolute fidelity to the client.

2. Party in the transaction:

When a licensee is acting as a principal, it is a material fact and must

be disclosed. (NRS 645.252 (1) (c); NAC 645.637)

This ensures all parties to the transaction are fully aware of where the

licensee’s loyalties may lie. Moreover, the licensee may not acquire

(purchase), lease or dispose of (sell), any time-share or real property

without revealing the licensee’s licensed status. (NAC 645.640 (1)).

3. Personal relationship with one of the principals:

The licensee must disclose whenever he or she has a personal

relationship with a principal to the transaction.

A licensee (including permitted property managers) must disclose the

licensee’s affiliation with or financial interest in, any person or entity

that furnishes maintenance or other services related to the property.

(NAC 645.605 (4) (b))

b. Interest in the Property:

A licensee, whether acting as an agent or a principal, has an “interest

in the property” whenever the licensee has, or anticipates, an

ownership interest. (NRS 645.252 (1) (c) and NAC 645.640)

Failure to disclose the licensee’s interest is an element in the Real

Estate Commission’s determination of whether the licensee was

deceitful or dishonest. (NAC 645.605 (4))

In Alley v. NV Real Estate Div., 94 Nev. 123, 125, 575 P.2d 1334

(1978) , it was stated that any anticipated interest must be disclosed

even if it is only a pass-through interest. For example, a licensee must

disclose when the licensee takes title, however briefly, during a

“double escrow.”

In the case of Tahoe village realty v. DeSmit, 95 Nev. 131, 134,

590 P.2d 1158 (1979), it was quoted that engaging in an

undisclosed double escrow transaction is a breach of the licensee’s

absolute fidelity to the client. The Nevada Supreme Court has found it

illegal when, the broker or salesman purchases a principal’s property in

the first escrow, and sells it to a third party at a profit in a second

escrow without a full disclosure to both the principal and the third

party. The broker or salesman receives a commission on the sale in the

first escrow and a secret profit on the closing in the second escrow.

In lemon v. landers, 81 Nev. 329, 332, 462 P.2d 648 (1965), the

court mentioned that a licensee may not take an undisclosed profit at

the expense of another party, nor may the licensee purchase or sell

the property of a client through the use of a third person without full

disclosure and the client’s consent.

DISCLOSURE IN WRITING

Whether the licensee’s interest is in the transaction or in the property,

the disclosure must be in writing. An oral disclosure does not satisfy

the regulations. (NAC 645.637)

When disclosing the licensee’s interest in the property, the disclosure

must state the licensee is acquiring or selling the property for him or

herself and that the licensee is a broker, broker-salesperson, or

salesperson. The Real Estate Division will recognize the disclosure if

the licensee includes the term “agent,” “licensee,” or “broker, broker-

salesperson, salesperson,” whichever designation is appropriate. (NAC

645.640 (1))

It was stated in American fidelity fire ins. v. Adams, 97 Nev. 106,

108, 635 P.2d 88 (1981), that the disclosure must be made “as soon

as practicable,” but not later than the date and time on which any

written document is signed by the parties. The Nevada Supreme Court

has defined “as soon as practicable” to mean “promptly” or “within a

reasonable length of time” considering the facts and circumstances of

each particular case.

Advertising: If the licensee advertises a property, the advertisement

must identify the licensee’s licensed status. This disclosure must be

made whether the licensee is acting as an agent or as a principal.

(NAC 645.640 (2))

Accordingly, the licensee must state “for sale by owner-broker” (agent,

salesperson, etc.) (NAC 645.610 (1) (b) (1-2)) or substantially

similar words in any advertisement for the property in which the

licensee is a principal

Facts that concern the transaction must be disclosed to the licensee’s

client. (NRS 645.254 (3) (c)) This disclosure may require the licensee

to reasonably investigate certain aspects of the transaction. These

may include, but are not limited to, facts about the escrow, relevant

loan information, or the status of other transactions (for example,

contingency sale property).

A licensee must be aware of the boundary between authorized real

estate services and unauthorized services. Often a licensee is

requested by a client to advice or act on a matter for which the

licensee is not authorized. Sometimes however, the licensee, willingly

and without instruction, crosses this boundary.

The two areas in which a licensee is most likely to provide

unauthorized services are with legal and appraisal activities. Clients

will ask a licensee to tell them their rights under a contract, or ask

what their legal options are. Additionally, clients often ask the licensee

what a property is worth or the value of a business. Because these

activities are so intricately woven into the fabric of a real estate

transaction, the licensee can easily slip into providing unauthorized

answers and services. If he or she does so, it is a violation of not only

NRS 645, but of the statutes regulating those professions. Excerpts

from the Real Estate Commission Disciplinary Fine Report, 1/95

through 9/30/04

A licensee must disclose to each party to the real estate transaction

any material and relevant facts, data or information which the licensee

knows, or which by the exercise of reasonable care and diligence he

should have known, relating to the property which is the subject of the

transaction. (NRS 645.252(1) (a)).

A licensee may not attempt to sell, or offer to sell, any real property

with knowledge that the title is un-merchantable unless he notifies the

prospective purchaser of that fact before the payment of any part of

the purchase price. (NAC 645.635).

A licensee may not offer real estate for sale or lease without the

knowledge and consent of the owner or his authorized agent. (NRS

645.635(1)).

IV. ADDITIONAL INFO:

It is of significance importance to note that the FBI has added the

practice of "flopping” (flipping a short sale) to its list of recognized

real estate and mortgage fraud.

In addition, Fannie Mae has identified fraudulent short sale schemes

for its servicers to watch for when approving a short sale and/or

approving a purchase loan on a short sale.

Fannie Mae’s publication of Mortgage Fraud News as on July 2009

pertaining to Pre-foreclosure Sales Abuse

Fannie Mae has become aware of a new variant of property flipping

involving pre-foreclosure (short) sales.

The trend Fannie Mae have observed involves a perpetrator who

submits a short sale offer to purchase a pre-foreclosure property at a

price less than the current indebtedness. This perpetrator locates a

second buyer, who may not be arms length, to purchase the property

at a higher price simultaneous with the short sale or in rapid

succession, concealing the second (higher) transaction from the lender

approving the short sale.

The second transaction may involve a new loan based on an inflated

appraisal.

In some cases, the perpetrator convinces the homeowner to deed the

property into a land trust, with the perpetrator (or his accomplice) as

trustee.

Example:

Fannie Mae has been advised of instances where the perpetrator is the

listing agent, and the agent presents his/her short sale offer as the

“best” offer, even though the agent has received other, higher, arms

length offers.

As this trend has gained momentum, some title companies have begun

to refuse to close the simultaneous transactions. As a result, a second

version of this scheme has evolved in which the closing involves only

one transaction: from the homeowner to (the perpetrator’s) ultimate

purchaser. The perpetrator is paid out through or outside of closing.

Some of the tactics observed include a second mortgage filed by the

perpetrator against the property immediately before closing, and

inflated real estate commissions.

These flips can potentially be identified and thwarted by either the pre-

foreclosure lender or the lender financing the second (inflated)

transaction.

Fannie Mae recommends the following best practices in assessing pre-

foreclosure sale activity:

Confirm the ownership status of the property:

a) Is the title held in trust?

b) Was it an allowable transfer? (Servicing Guide, Section III,

Chapter 4)

Review marketing efforts such as the MLS listing.

Condition approval on disclosure of all contracts pending on the

property prior to mortgage payoff.

Validate the purchaser’s loan approval, deposit and funds to close.

Condition approvals for pre-foreclosure sales on review of the final

HUD-1 Settlement Statement :

a) Review the sales price and payouts against the purchase offer.

Fannie Mae recommends the following best practices to avoid financing

inappropriate property flips:

Validate the purchaser’s deposit and funds to close.

Use reliable appraisal valuation sources.

Review the final HUD-1 and do not allow excessive seller concessions

to be paid to the purchaser.

Question excessive sales commissions.

Validate that the seller holds clear marketable title to the property.

V. CONCLUSION

Hence, from the above revealed case laws and legal provisions, we

would advise you to provide proper disclosures to the clients as

acknowledged by law to be hassle free from all the legal impediments

brought on as a result of double escrow.