The outcome of lawsuits against two big appraisal management companies (AMCs) could change the nature of the legal relationship between appraisers and AMCs, observers say.

The cases involve the Federal Deposit Insurance Corp. and the AMC subsidiaries of two big names in the real estate data world, Lender Processing Services and CoreLogic. The FDIC is suing the two firms over appraisals its AMCs made under contract with failed banks IndyMac and Washington Mutual, each taken over by the FDIC during the financial crisis.

The suits allege that the AMCs were obligated to ensure submitted appraisals were of good quality and in line with professional standards. According to the suit, the AMC’s subsequent failure to comply with those stipulations amounted to gross negligence, costing the banks millions of dollars in defaulted loans and putbacks.

The suits were originally filed in May, but the key issue for the appraisal community was revealed in new filings made public in September, in which the FDIC explained that it intends to argue that appraisers were “legal agents” of the AMCs.

Held Liable

A legal agent is someone given legal authority to act on behalf of another – for example, a relative with power of attorney for an elder, or a manager entitled to negotiate contracts on behalf of a company. Unlike an independent contractor, a legal agent is able to enter his sponsor into obligations, and the sponsor is liable for their acts.

The question of whether an appraiser working for an AMC counts as a legal agent is “applicable to other AMCs in general and not just with respect to claims by the FDIC – the issues decided could strongly affect the future liability of AMCs to mortgage investors, lenders and even borrowers,” said Peter Christensen, general counsel for insurer LIA, and an author of the Appraisal Law Blog. “Bear in mind that many AMCs have been signing contracts to get lender work that are far less favorable to the AMCs than the contracts signed by [CoreLogic and LPS].”

If appraisers are independent contractors, any lender wishing to argue that flawed appraisals led to losses would have to litigate the matter case-by-case, appraisal by appraisal. But if the appraisers are ruled to be legal agents of the AMCs who gave them assignments, lenders may argue that an AMC’s standards and practices affected the performance of large pools of loans – potentially putting AMCs on the hook for millions in loan losses.

That big of a hit to the pocketbook could force AMCs to fundamentally alter their business models. Already, many AMCs are attempting to pre-empt such an outcome by re-writing contracts for appraisal services in order to firmly place liability on appraiser’s shoulders. With the housing market still struggling, few appraisers have the leverage to renegotiate.

The trend has raised eyebrows in many sectors of the housing market that fear more pressure on appraisers could impact appraisal quality. Ron Phipps, president of the National Association of Realtors, wrote a letter of protest to federal regulators in August, asking that they ban the use of such indemnification clauses.

“The mounting use of indemnification clauses by AMCs may be interfering with the appraiser’s independence and objectivity,” Phipps wrote, contributing to lowball appraisals.

Back To The Future?

But some say that if AMCs have to take more responsibility themselves for appraisal quality, it might not be such a bad thing, said Jonathan Asker, owner of North Atlantic Appraisal in West Bridgewater.

“There’s a transition going on right now in the appraisal profession across the country,” he said, “I think it’s reverting back to where it was, pre-mortgage broker time,” when more appraisers were full-time employees of a company.

“An appraisal company like mine, when somebody is unhappy, I fully expect to be sued, as well as the appraiser [because people consider my company responsible for the appraisal],” said Asker. “I share the liability there. Why can’t the AMCs? They don’t want to play by that rule?”

But as pressure heats up on AMCs it’s likely they’ll come to rely more on indemnification clauses. Recently, TCF National Bank filed a case against an AMC in Minnesota, following the FDIC’s line on AMC’s responsibility for appraisals.

So far, such indemnification clauses haven’t been tested in court, and it’s unclear whether they would hold up. What is obvious is that current errors and omissions policies weren’t written with the idea that big lender losses might come home to roost on individual appraisers or AMCs. The damage amount the FDIC is seeking against LPS alone is more than all appraisers and AMCs collectively pay for their E&O insurance each year, Christensen estimates.

Even ignoring the costs and risks of litigation arising from dubious boom-time sales, any insurance policy which guaranteed against third party losses would add an additional $100 to $150 in premiums on top of current appraisal fees, he calculated.

“No AMCs or lenders seem willing to pay appraisers for the price of liability risk that the literal application of these clauses seeks to shift,” he wrote.