By Larry R. Rothenberg, Esq.
Weltman, Weinberg & Reis, Co., L.P.A.
A national title insurance company once listed 73 different scenarios giving rise to title insurance claims. Although title insurance provides important protection to the lender, there are many misconceptions regarding the nature and extent of that protection.
Some lenders have an erroneous understanding that, in the event of a defect in title where the defect was not excepted or excluded from coverage under the policy, the title company is obliged to purchase the insured mortgage from the lender for the balance due. While that may be one option, it is not the only alternative available to the title company.
Title Company’s Obligation
The American Land Title Association (ALTA) loan policy of title insurance imposes two obligations on the title insurer upon receiving timely notice from the insured of a claim. The first obligation is that the title insurer must provide for the defense of the validity, priority, and enforceability of the insured mortgage against the adverse claims that have been asserted. Hence, the title company may employ the lender’s attorney or may select a different attorney to represent the lender at the title company’s expense. If the defense against the claim is successful, the insured lender will have sustained no loss or damage, and, therefore, the title company will have no further liability.
The second obligation is that the title company must indemnify the insured lender against loss or damage, within the monetary limits of the policy, resulting from title defects that are not excepted or excluded from the coverage of the policy. If it is determined that the title is defective and that the defect impairs the security of the mortgage, the title company may elect one of the following three alternatives:
- Cause the defect to be removed within a reasonable time:
- Pay the amount of damages; or
- Purchase the mortgage from the insured lender for the balance then due on the loan.
It is important to understand what constitutes an adverse claim. A general denial in a judicial foreclosure does not constitute a claim sufficient to obligate the title insurer to defend the title. Rather, there generally must be an affirmative, factual attack on the validity, priority or enforceability of the mortgage before the title company is obligated to defend. Moreover, the nature of the attack must be within the scope of the policy coverage. For example, if a party were to claim that the mortgage is not enforceable due to tortious conduct by the insured lender, the claim would not be within the scope of the policy’s coverage
Determining the Amount of Damages
If there is a defect or even a total failure of title, the insured lender is not necessarily entitled to recover the full face amount of the policy or even the current balance due on the loan. The face amount of the policy and the balance due on the loan provide maximum limits; however, the amount of damages may also be limited by the value of the property.
For example, assume the balance due on the loan is $100,000, and the property is only worth $80,000. In the absence of the title defect, the lender could realize at most $80,000 by foreclosing. If the lender cannot foreclose or loses its priority due to the title defect, the title company is liable only up to the value of the real property, even though it is less than the amount of the mortgage. By recognizing that the loss due to the inability to foreclose is limited to the value of the real property, the title insurer is not liable for more than the lender could have realized through the foreclosure.
Similarly, if the defect does not impair the security of the mortgage, the title company may not be liable at all. For example, in one case,1 the loan policy covered 2,000 acres of land and was issued to insure a construction loan for $15 million. The title policy failed to list as an exception a prior $60,000 mortgage on 33 of the 2,000 acres. When the insured lender took a deed-in-lieu of foreclosure to the 2,000 acres and expected the title insurer to pay off the prior mortgage on the 33 acres, the court determined that the property had a value far in excess of the amount of both mortgages. Consequently, the court held that the lender had no claim because the defect did not impair the security, as the lender realized more than it would have realized through a foreclosure
There are many similar cases where courts have limited the recovery under a loan policy of title insurance to the extent that the security has been impaired by a title defect. On the other hand, cases have been held that in determining the amount of the loss, the title insurer is not entitled to the benefit of the insured lender’s business acumen regarding a later resale for profit of the real property. Nor is the title insurer’s liability increased if the insured loses money on a subsequent sale of the property.
Loan Policy Coverage After Foreclosure
A loan policy continues to provide coverage to the insured lender after the lender acquires title through foreclosure or through a deed-in-lieu. However, the extent of coverage, conditions, and measure of damages remain in accordance with the original loan policy. A loan policy is not automatically converted into an owner’s policy once the insured lender acquires title. Therefore, the title insurer’s liability on a claim under the loan policy is limited to the amount of the mortgage indebtedness insured under the loan policy or the value of the property, whichever is less. For example, if there are easements that were not listed as exceptions from coverage, an owner’s policy would definitely provide that coverage. However, a loan policy would only provide coverage to the extent the value of the property resulting from the easements war reduced below the amount of the mortgage indebtedness.
Obtaining an Owner’s Policy After Foreclosure
Because of the limitation of loan policy coverage, it is becoming increasingly common for a lender to obtain an owner’s policy after acquiring title through foreclosure, notwithstanding that the prior loan policy provides continuous coverage after foreclosure.
Even if the lender was insured with a loan policy, obtaining an owner’s policy after acquiring title through foreclosure gives added protection in three ways:
- It brings the coverage up to a more recent date
- It provides owner-type coverage instead of lender coverage so that a defect does not have to impair the security to qualify as a basis for a claim.
- Most importantly, it gives a greater assurance that the foreclosure was proper.
If the lender obtains an owner’s policy issued when it acquires title, defects in the foreclosure such as failing to include necessary parties or defects in service of notice on them will be covered. It will then be the obligation of the title insurer under the owner’s policy to reforeclose or compensate for the loss resulting from such defects.