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Stories of the return of mortgage fraud have been rife in the UK market in the past 12 months. However, the scale of the problem is beginning to become clear.

In August, Bradford & Bingley - before it was nationalised - announced it had taken an £18m impairment charge to cover suspected mortgage fraud. More telling was its assertion that the bank, which specialises in buy-to-let mortgages, had not been specifically targeted by fraudsters nor is it any more vulnerable than other lenders.

It has simply been more transparent as to the scale of its problem. The Association of Chief Police Officers estimated mortgage fraud in this country may now be worth £700m a year and KPMG's Fraud Barometer suggested we are only now seeing the tip of the iceberg. They report that in the first half of 2008, nine cases of mortgage fraud alone had a combined value of more than £20.8m.

The explosion in house prices in the past decade combined with readily available, cheap credit has created a climate in which mortgage fraud could prosper, particularly in the sub-prime, buy-to-let and newbuild sectors.

The availability of pre-packaged loans, streamlined application processes and self-certification may also have reduced scrutiny of the value of offered security and the borrower's ability to pay. Put into reverse, with the slow down in the property market, prevailing financial uncertainty and the credit crunch, lenders are only now beginning to uncover the full extent of the problem and the scale of their potential losses.

Of course, the term 'mortgage fraud' itself covers the full spectrum of activity from the dishonest opportunist who exaggerates his income to obtain more credit than he would otherwise be entitled, through to sophisticated criminal activity including identity fraud, over-inflated valuations, mortgages taken over properties yet to be built, fictitious borrowers and shotgunning - where several loans are obtained on the same property from different lenders. Such complex fraud may often involve and even rely upon the unwitting assistance of a solicitor, broker or valuer, or worse.

While redress against the fraudsters themselves may be the lender's preference, they may prove difficult to prosecute. The courts have ample powers under the Proceeds of Crime Act 2002 to impose restraint orders to prevent dissipation of assets and confiscation orders to deprive the fraudster of the ill-gotten gains. Much more commonly, however, the real fraudster will be long gone before the fraud is uncovered - often only after several months' build up of mortgage arrears have led to possession proceedings. Faced with a significant shortfall where the value of the recovered property does not cover the monies lent, it is more likely that the lender will look to those who could or should have safe-guarded its interests: the solicitors, surveyors or valuers who failed to carry out sufficient checks or to ask sufficient questions to uncover the fraud.

All of this echoes the boom-to-bust cycle of the early 1990s where the property crash was followed by a round of professional negligence actions by lenders against their advisers. The liabilities of solicitors and other professionals were examined by the courts in a series of test cases. In the leading case on this area, the lender brought 87 claims for negligence against a number of Bristol solicitors for losses suffered in transactions where the mortgages had proved defective or fraudulent and the security inadequate or non-existent. The court had no difficulty in identifying a number of areas where the conduct of the solicitors had fallen short of the standards of the competent and diligent professional. In such cases, the solicitors were found liable for the difference in the sums lent and the net amount recovered on the sale of the properties subject to any contributory negligence which would suggest the lender would have lent anyway.

Insurers have been keen to run arguments of contributory negligence by the lender. A solicitor as a fiduciary owes a duty to his client and is expected to act in good faith. He also has a relationship of trust with his client. Where a breach of fiduciary duty can be established the scope for arguing contributory negligence is reduced. Therefore such claims are increasingly made.

For those professionals whose standards have slipped, professional negligence may be relatively easy to establish. Both the Law Society and Council of Mortgage Lenders have issued guidelines signalling clearly how solicitors should identify the badges of mortgage fraud. Lax professional standards, failure to act in accordance with the Law Society’s guidelines, or to operate sensible identity checks for clients or to carry out prudent valuations may be hard to excuse, and the professional indemnity insurers may be reluctant to risk trial. However, there will be those instances where after investigation it becomes apparent that the professional has not so much been negligent as complicit with the fraudster. This raises more difficult considerations for the lender.

Two of the most frequently asked questions in professional negligence actions are

i) when dishonesty, as opposed to negligence or breach of fiduciary duty can and should be alleged against a professional; and

ii) what effect that will have on the professional's insurance cover. Bear in mind that smaller firms may have a level of cover which is inadequate to meet a large claim.

The Fraud Act 2006 creates a general offence of fraud which can be committed by false representation and or by failing to disclose information. A professional caught up in mortgage fraud is likely to fall foul of one or both. Sometimes the professional's involvement will be obvious from the outset and the regulatory bodies may already be involved. In other instances, fraud may only become apparent well into a negligence claim, as the scale of the professional's involvement is uncovered.

Unlike allegations of simple negligence, the advantage of establishing fraud or breach of fiduciary duty by the professional is that liability is easier to determine and the claim of contributory negligence is weakened. Counter-allegations of imprudent lending or contributory negligence do not apply. This may significantly increase the level of damages recoverable from the professional.

However, the allegation of fraud can be a double-edged sword and in many cases it may be more prudent to pursue a claim of breach of fiduciary duty. The primary exclusion in most professional indemnity insurance relates to claims arising out of "dishonest or fraudulent conduct committed or condoned" by the professional. This makes it a difficult call before alleging fraud against a sole practitioner where there is a real risk of the insurer withdrawing cover, thereby reducing the likelihood of any recovery and leaving the lender looking at whether the professional himself has any assets worth attacking. Even if the professional is in a multi-partner practice, that may be no guarantee of insurance protection. If all of the partners are involved in dishonesty whether through conduct or having condoned it, the exclusion clause can still operate. Only where there are wholly uninvolved partners may insurance cover still hold.

That may leave the lender looking to the Law Society Compensation Fund, a fund of the last resort designed to protect the victims of dishonest solicitors. Its policy to date has been not to compensate mortgage lenders, founded on its own internal guidelines which enable it to withhold monies from those who have contributed to their own losses.

Claims against professionals are set to rise again. Compared to the claims made in the last recession, the new frauds are often more sophisticated and involve bigger numbers than their predecessors. Remedies can be available to the lender but key strategic decisions need to be made at the outset to maximise the prospects of recovery.

Steven Mills and Clare Stothard are partners in the banking and finance department of Matthew Arnold & Baldwin