Real Estate Finance Notes 9/17/04

Title insurance

Title insurance is an odd thing. It’s not insurance in the typical sense. Typically, if you buy, for example, life insurance, the insurance company knows that it will suffer a loss, but it just doesn’t know when. Title insurance doesn’t work that way. If everything works right, the title insurance company should never suffer a loss, that is, there should never be a valid claim against the insurance policy. But not everything always works the way it should. There can be off record risks such as fraud. There can also be violations of zoning laws, covenants and restrictions, and so on. All of these are detectable and should be detected if title insurance works the way it should.

Here’s how it works: with the typical policy, you fill out Schedule A with the elements of the fee simple absolute. The Schedule A in the book at p. 236 is a bit different in two respects: not all of the risks are for the full policy amount. But it does have a space to fill in your interest in the land, for example: “fee simple absolute”. Inflation protection is available for title insurance policies. The other thing that makes title insurance different than most policies is that it’s a single-premium policy. At the time you purchase the property, you pay a premium that is calculated as a percentage of the amount of insurance, and then that’s it. It’s a one-time payment for coverage basically forever. If there’s a mistake in the policy, that is, if there is some loss that is covered by the policy, then the policy doesn’t necessarily pay the full amount of the loss. You do the same calculation of damages that you do with warranties of title. Title insurance only insures legal matters. It doesn’t deal with acreage or quality of the land.

Who pays for title insurance? In Central Ohio, the standard contracts have the seller pay for title insurance, not the buyer. Even though the seller pays for the title insurance, the buyer is entitled to pick the title insurance company. That’s a matter of federal law: the Real Estate Settlement Procedures Act. Under RESPA, the buyer has the right to pick the title insurance company.

In Schedule B, exceptions and exclusions are listed. “Schedule A giveth, and Schedule B taketh away.” If you look at Schedule B, you’ll see why there should never really be a claim under a title insurance policy. Exceptions should be everything that a diligent search of the public records would reveal: liens, leases, easements and so on. You’re not insured against losses resulting from any of those things. You have a vested fee simple absolute except for everything that’s in the public records and is a defect in the title. As a result, if the title insurance company is careful, then you won’t suffer any loss at all. If an encumbrance is not of record, you don’t take subject to it, and if it is of record, the title insurance policy doesn’t cover you. If you don’t read Schedule B, you don’t really know what insurance you have, if any.

In addition to the exceptions that are specific to that property, there are also exclusions that are general to all policies issued by the title insurance company. You can negotiate to have some of them removed for a price. The most important exclusion is the exclusion for things that are known by the buyer at the closing date but not known by the company. You can’t hide defects from the company, you must disclose all defects to the company. The Schedule B exceptions listed on p. 239 are more similar to the way we would see them drawn up on a policy issued in Ohio.

Is a title policy an opinion of title? Isn’t there an incentive on the part of the title insurance company not to search the title at all? It depends on how high the search costs are. You could do this on an actuarial basis. You could say: “We’ve been in this business a long time, and we know what the risk is.” You could charge a premium based on the historical risk rather than doing a search of the title. This may make more sense for the title insurance company than for the purchaser of the property, since title insurance won’t cover your full loss. If you sue, you might be disappointed that the title insurance companies aren’t trying to determine if the title is marketable. Is the title company obligated to be reasonable in conducting a search? What difference does it make? You might want to find a basis for tort liability if your policy doesn’t fully cover your loss.

What happens if you have something that is a matter of record but it’s not listed in Schedule B? Is the title insurance company liable? Sure they are! That’s exactly what they’re supposed to do. What if there is something that’s a matter of record, isn’t on Schedule B, but also comes within one of the exclusions? For example, “encroachments or questions of location, boundary and area, which an accurate survey may disclose”. You can’t rely on the policy to tell you that this condition doesn’t exist. Say there is an easement that a survey would reveal. Why would they be liable? The cases say there ought to be coverage: the exclusions can’t be relied on by the title company to eliminate Schedule B. Whether or not you have a duty to search, if you do the search and list something in Schedule B, then if you find it, you must include it there. The idea of title insurance is to provide protection from on-record risks. If you find an easement, for example, and then exclude it anyway, you’ve basically eviscerated the policy.

Most residential transactions are very low risk transactions, at least as far as things that lawyers could discover. There are lots of bad things that could potentially happen, but in practice, the system seems to work very well without lawyers. So Braunstein thinks it doesn’t make much sense to have lawyers involved in these highly routine, standardized residential transactions. If you read the title policy and saw something that you didn’t understand, you might want to get a lawyer involved. But generally, lawyers don’t need to be involved and lawyer don’t make much money being involved, partly because you don’t add much value.

Problems on Note 6, p. 242

What sorts of claims are covered by title insurance?

(a) Mechanics’ liens: these seem explicitly covered in the first policy, but excluded from the second one.

(b) Restrictive covenants: would this qualify as a defective title? Are you covered if someone else has the right to limit the use of your land?

(c) What if there is a reservation of oil and gas rights?

(d) What about a failure of delivery? That’s covered.

(e) How about dower rights? That means someone else owns an interest in your property.

(f) How about a claim against the insured owner made by a grantee of a deed from that owner based on a warranty in the deed? What’s the problem here? Let’s say B sues A for a breach of covenants of title. The insurance policy covers you and continues to cover you not only for losses that occur while you’re the owner, but also based on your warranties of title when you convey. The title insurance will be issued with A purchases the property, not when A sells the property.

The policy also includes the obligation to defend, which can be the most important obligation of the insurer. The cost of defense can be more than the potential liability.

Theories of mortgages

Possession is the deal. We want to try to understand the mortgagee’s and mortgagor’s right to possess the mortgaged property. These theories of mortgages are sometimes difficult because it’s so ingrained in us that the mortgagor is the one who has the right to possession. Why would you buy a house if it meant that a bank employee would be living in it instead of you? But that’s not the way the mortgage developed. We have different theories that give different possessory rights to the mortgagee. We know that after foreclosure, the mortgage is wiped out. Why would the mortgagee want possession prior to foreclosure? There are a number of reasons: they may want to stop waste or make repairs, in other words, they want to protect the collateral. If the mortgagor is doing something that the mortgagee doesn’t like, they may want to intervene. Maybe the property is a rental property and it’s vacant. Similarly, if the mortgagor is taking the rents and using them for some purpose other than to pay the mortgage, the mortgagee might want to stop that as well (“intercept” the rents). The ability to collect the rents depends on the right to possession.

The title theory of mortgage

This is based on the old-fashioned fee simple determinable. There is possession by the mortgagee that defaults to the mortgagor. This theory is most prevalent in the states closest geographically to England. The mortgagee, under the title theory, is the owner. The mortgagee is entitled to possession as soon as the mortgage is created. You could have a mortgage where you actually intended for the mortgagee to take possession, so that even if you’re in a title theory state, there will be an implied right of possession by the mortgagor, or the mortgage will say that the mortgagor has the right to possession even though the common law in that state would give the mortgagee the right to possession.

The lien theory of mortgage

This is the theory in most states, including Ohio. The mortgagee only acquires the right to have the property sold to pay the debt. These states don’t think of the mortgage as a conveyance at all. For the purposes of the Recording Acts, though, we treat mortgages just like conveyances. Lien states think of mortgages as granting a right to the mortgagee to have the property sold, either privately or by public sale, and then to have rights created by the mortgage attached to the proceeds. You don’t own the property. There’s no possessory right there or any interest in the property itself. You have an equitable lien that is capable of being turned into money.

Intermediate states

Ohio is probably a lien theory state, but there are cases that go both ways. In intermediate states, the mortgage only creates a lien, but there are possessory rights in the mortgagee. The mortgagee has the right to possession after default occurs. So conceptually, there are three different theories.

How does a mortgagee get possession? In a title theory state, possession can be gained on demand. In an intermediate state, possession can be gained on demand after default. In a lien theory state, you can only get possession by a voluntary act of the mortgagor, or when the mortgagor abandons the property, or when possession is authorized by the mortgage itself.

These theories of the mortgage don’t make much difference these days because we use the same sorts of instruments all throughout the country, and they have the same provisions. These theories may be important in other contexts, for example, in determining whether a mortgage severs a joint tenancy. But mostly, we’ll be thinking about what the mortgage instrument provides rather than what these theories would dictate.

Back to Class Notes