Title insurance is a critical component in the context of any loan secured by real estate and lenders typically require borrowers to purchase title insurance in connection with the mortgage granted to them as security.
Despite its importance, the details of a standard title insurance policy, and particularly the limiting provisions ordinarily included therein, are relatively unknown. Not surprisingly, many lenders have never carefully analyzed the terms of a title insurance policy and, hopefully, will never need to. But, if your loan recovery becomes dependent on making a claim under a title policy, here are three things you should know.
First, a loan policy of title insurance is not a guaranty that the title is perfect, or even marketable. The policy is an indemnity contract that covers an actual loss, rather than a guaranty of the state of the title itself or the loan amount secured by the mortgage. Why is this important? Because even if a lender determines that its mortgage is impaired, it would not necessarily be entitled to payment under its title policy unless and until it has sustained a loss. In Massachusetts, courts have determined that a lender’s right to payment under a title policy is not triggered until its mortgage is impaired due to a title defect and it has exhausted reasonable efforts to collect from the borrower and an unpaid loan balance remains. As explained in Falmouth Nat. Bank v. Ticor Title Ins. Co., 920 F.2d 1058, 1063 (1st Cir. 1990), “a mortgagee-insured’s loss cannot be determined unless the note is not repaid and the security for the mortgage proves inadequate.” This means that where the lender is granted multiple pieces of collateral for a particular loan, it may have to liquidate all other collateral before it can recover under the title insurance insuring the defective mortgage. This often means payment under a policy of title insurance may be months or even years in the future.
Second, a lender’s title insurance policy allows the title insurer to take any action it deems appropriate to cure a title defect first before being obligated to pay a loss. These types of curative efforts could include something as simple as obtaining a confirmatory mortgage or a release of a prior undischarged mortgage of record, or something much more complex such as title litigation. Whatever curative effort is undertaken, the policy gives the title insurer as much time as necessary to complete its efforts, as long as the title insurer acts in a reasonably diligent manner. Any title clearing efforts can take quite a while to resolve, particularly if litigation is necessary. The title insurer is not responsible for paying any loss while those efforts continue, even if title litigation gets tied up in the courts for a number of years.
Third, a loan policy of title insurance does not guaranty the market value of the property. In fact, the standard policy limits the liability of the title insurer to the amount of insurance stated in the policy, the loan balance, or the value of the property, whichever is the lowest.
While it is important to understand some of these limitations of title insurance, as described above, a lender’s policy is still critical to any real estate loan. More and more, we have seen the validity of mortgages challenged by borrowers in state and federal courts, as well as bankruptcy courts. One of the primary benefits of a title insurance policy is that in most cases, it will require the title insurer to defend the lender against challenges to the mortgage based on title defects. The defense costs in such actions can be considerable and without a title insurance policy, the mortgage lender would be in a position of having to defend the claim at its own cost. In addition, and often of most importance to a lender in a loan recovery situation, a title insurer may agree to insure the title of any purchaser at a foreclosure sale while it continues in its efforts to rectify a particular title issue. This allows a lender to sell the property even if there is a title defect since the purchaser can be assured of sufficient title insurance coverage.
Despite the limiting provisions in a standard title insurance policy, if a lender suffers a loss due to a title defect that cannot be cured, the title insurer will step up and pay the loss. The title insurer however will not pay more for a claim under a lender’s policy than the least of the policy limit (i.e., the amount of insurance purchased at closing), the fair market value of the insured property and the loan balance at the time of loss. This can be very important especially in situations involving the cross collateralization of multiple properties. Title insurance, while commonplace in real estate loan transactions, is a complex topic and requires a thorough understanding of the policy provisions and the best methods for dealing with title defects and making a claim under the policy.
This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.
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