New Jersey Real Estate Lawyer Liable in Client’s Mortgage Scam

(Plus: Update on Fee-Shifting in New Jersey Legal Malpractice Cases)

By:  Matthew S. Marrone

            In what is believed to be the first ruling of its kind in New Jersey, a bankruptcy court judge has held a real estate lawyer liable for nearly $700,000, plus punitive damages and legal fees, for his role in a client’s mortgage foreclosure rescue scam. 

            In O’Brien v. Cleveland, docketed in the United States Bankruptcy Court for the District of New Jersey at No.: 08-1676, plaintiffs Sean and Nicole O’Brien sued defendants Frederick Cleveland, Cleveland Development, LLC, and William E. Gahwyler, Jr., Esquire.  The case began as a Chapter 13 bankruptcy proceeding, through which the O’Briens attempted to save their home from foreclosure.  When they were unable to maintain their payments, the first mortgagee received relief from the automatic stay to complete the mortgage foreclosure.

            At the eleventh hour, their mortgage broker referred them to Frederick Cleveland as a financier who might be able to help them.  Cleveland offered to arrange financing in the amount of $540,000 to satisfy existing debt and save the property.  He explained to the O’Briens they would need to transfer title to him, but they could continue to occupy the house if they paid him $5,000 per month.  By faithfully paying $5,000 per month for two years, Cleveland told the O’Briens they would establish a track record for a new lender and could then buy back the house from Cleveland for $650,000.  What Cleveland did not explain, and what the O’Briens did not anticipate, is that he would actually mortgage the property for $646,000 and pocket over $100,000 for himself.

            As the sheriff’s gavel was poised to fall, the parties gathered at the law office of William A. Gahwyler, Jr., Cleveland’s lawyer.  Gahwyler prepared all the closing documents for the O’Briens to sign, including a HUD-1 which misrepresented the sale price as $808,000, and falsely showed Cleveland as investing $187,978.91 in cash.  In reality, Cleveland invested nothing, but instead withdrew over $100,000 from the closing proceeds.  The closing statement also showed the O’Briens were to receive $287,516.17 in cash, which was a misrepresentation.  After the closing Cleveland eventually defaulted on his payments to the new lender, in spite of the fact the O’Briens made their monthly payments of $5,000.  The payments to the new lender actually amounted to $6,800 per month, which Cleveland failed to tell the O’Briens.

            The judge found Cleveland’s conduct in violation of New Jersey’s Consumer Fraud Act (CFA), and found the sale-leaseback violated New Jersey’s Homeowner Security Act (HOSA) as well as two federal laws, the Truth in Lending Act (TILA) and the Home Ownership and Equity Protection Act (HOEPA).  He found the O’Briens’ damages were $116,971, which constituted the difference between the new mortgage of $646,000 and the amount paid to benefit the O’Briens.  This amount was trebled to $350,374 under the CFA.  He also found Cleveland’s failure to make required disclosures under TILA and HOEPA resulted in damages totaling $240,875 (finance charges and fees), plus statutory damages under HOSA in the amount of $50,000.  Lastly, he awarded $46,000 for Cleveland’s breach of contract, bringing total damages to $690,210.

The plaintiffs’ lawyer has since filed an application for almost $34,000 in attorney’s fees, and has asked the judge to treble the amount to almost $102,000.  The plaintiffs are also seeking punitive damages. 

            Most notably for New Jersey real estate attorneys, the judge determined Gahwlyer was a civil co-conspirator in the transaction, and that Cleveland’s scam would have failed without Gahwlyer’s services.  Although the O’Briens were not Gahwlyer’s clients, he still breached a legal duty owed to them, and committed several ethical violations in the process.  Noting that “Gahwyler should have withdrawn from representing Mr. Cleveland as soon as the nature of the transaction became known to him,” Gahwlyer was held jointly liable with Cleveland for all damages awarded.  In addition, the judge referred the matter to the U.S. Attorney’s Office, the Passaic County Prosecutor’s Office, and the Office of Attorney Ethics.  The result was an ethics complaint accusing Gahwlyer of violating multiple ethics rules for:

• Counseling or assisting a client in illegal, criminal or fraudulent conduct
• Failure to provide a written fee agreement
• Conflict of interest
• Failure to make prompt disposition of funds
• Knowingly making a false statement of fact or law to a tribunal
• Knowingly making a false statement of material fact to a third person
• Commission of a criminal act
• Conduct involving dishonesty, fraud, deceit and misrepresentation
• Conduct prejudicial to the administration of justice

            To date there have been no hearings in the disciplinary proceedings, but the Deputy Ethics Counsel prosecuting the violations plans to make use of the judge’s opinion. 

            Mortgage defaults and repurchase requests continue to rise as ripple effects from the housing bust.  With delinquencies and foreclosures still running at record highs, there is no sign the demands will begin to abate anytime soon.  New Jersey has a long history of involving – and sometimes requiring – lawyers to be involved in any real estate transaction, be it the closing of a new mortgage, re-financing of an existing one, or modification of a troubled loan.  The current economic climate is undoubtedly difficult for real estate lawyers as well, and many are seeking income wherever they can find it.  The O’Brien case highlights the many severe pitfalls which can befall a lawyer involved in mortgage transactions during these troubling times, particularly when they involve unconventional financing. 

Update on Fee-Shifting in New Jersey Legal Malpractice Cases 

Although the O’Brien case permitted the award of counsel fees pursuant to the CFA, readers familiar with New Jersey know attorney’s fees can independently be awarded in legal malpractice actions pursuant to the landmark 1996 New Jersey Supreme Court decision in Saffer v. Willoughby.  Along with the six-year statute of limitations in professional negligence actions, this makes New Jersey one of the most challenging states in the country for legal malpractice defendants. 

About a year and a half ago (Fall 2008) we reported on the efforts afoot in New Jersey to change this harsh environment for legal malpractice claims.  In 2008 the New Jersey State Bar Association (NJSBA) drafted legislation to reverse the Saffer fee-shifting rule, and reduce the statute of limitations to two years.  Since then the NJSBA found legislative sponsors and the bill was introduced in both the State Assembly (A-2858) and Senate (S-1815).  The legislation is now being considered by judiciary and commerce committees in both legislative houses, and still faces many challenges ahead.  We will continue to keep our readers updated on this important legislation.