Real Estate Finance Notes 9/9/04

Title assurance

The three types of deeds

The warranty deed – this contains the five or six warranties that we’ll be talking about. This one contains the most promises. You warrant, for example, against all encumbrances. If there is an encumbrance, the warranty is breached.

The limited warranty deed – this doesn’t warrant that a predecessor in interest didn’t mess up the title.

The quitclaim deed – this says, in essence, I’m conveying to you whatever I own. If I own nothing, you get nothing. If I own an unencumbered fee simple, then you get that.

All three of these deeds are, in essence, contracts.

Warranties of title

Warranties of title are just contracts. They’re only as good as the solvency of the person who makes the warranty. It can be a long time before any defect is discovered! It could be hard to collect at the time you find out the title is bad. Also, you don’t really know what the state of the title is. You’re just being promised that the other person has good title. You don’t get any evidence of the truth of the promise. The other systems for title assurance give you at least some evidence that the person who is saying the title is good has actually checked to some degree if that’s the true state of affairs. So warranty titles are a little “flaky”: it’s a “band-aid”. In most states, including Ohio, if you call something a “warranty deed”, all the statutory warranties are automatically included.

In Ohio, the warranties are listed at R.C. 5302.06. “The grantor covenants with the grantee, his heirs, assigns, and successors…” This means that the all of the covenants run with the land. In some states, the present warranties don’t run with the land; only future warranties. This statute says that both past and future warranties run with the land. The importance of that is that if A transfers to B and B transfers to C, there’s a breach, and A’s the one with the money, you want to be able to sue A. We don’t want C limited to an action against his immediate predecessor in interest. It is warranted that “he is lawfully seized in fee simple of the granted premises”.

It is warranted that the property is “free and clear from all encumbrances”. What are encumbrances? They’re bad things like mortgages, easements, leases: anything that takes away one of the sticks out of the bundle of sticks that constitutes a fee simple absolute. The only thing that isn’t considered an encumbrance is if you own less than you purport to convey in the deed. The most important encumbrance would be a monetary encumbrance such as a mortgage or judgment lien. It is warranted that “he has good right to sell and convey the same”. This comes up in situations involving corporations. Maybe only the president has the power to transfer real estate, but the deed is signed by the vice-president or secretary.

The grantor also “warrants” the title: this means that it is promised that no one with a paramount title to the grantor will evict the grantee. The grantor also promises to “defend” the grantee and his heirs and successors. That’s kind of tricky: if you sue someone to defend your title, you can sue the grantor for attorney’s fees. But if you lose, you have to pay your own attorney’s fees.

General warranty deed

You don’t have to use the form in R.C. 5302.05, but if the legislature gives you a form that will work, why reinvent the wheel? It’s very short, too. You put in the person’s name, and then their marital status. Why does the marital status matter? You want to know who has to execute the deed. In Ohio, there are still dower rights in limited circumstances. If it’s a married person, the spouse must execute the deed. You include the grantee and their tax mailing address. You describe the land, which is often a plat in a subdivision. It could also be a “metes and bounds” description, where you start at a certain place and then follow a certain path. You also mention if there are any restrictions such as encumbrances, reservations, exceptions, and so on. You also include a reference to the instrument by which the grantor obtained the property. Also, if you note that the person is married, you have the spouse release dower rights. The form says that only the signature of the grantor is necessary, but in fact to get the deed recorded, you must get an acknowledgement in front of a notary. The only way to be sure that the grantor is really who they say they are by way of the notary’s gatekeeping function.

Brown v. Lober

What are they claiming as the breach of the covenant here? They thought they had all the coal rights, but the grantor reserved two-thirds of the rights. They claim that the covenant of warranty has been breached. The court holds that there was no constructive eviction. The coal company searched the title and found there was a reservation of two thirds of the interest in the coal. The plaintiffs claim that this constitutes an eviction because the grantor didn’t tell them about this reservation. But the court holds that this isn’t an eviction because the plaintiffs weren’t denied possession of the subsurface. One thing that doesn’t constitute eviction is the fact that you turned out not to have good title: you must have more than just that. Was there a breach of the covenant of seisin? Absolutely. They didn’t own it, because the grantor had reserved two-thirds of the coal. They lose because the statute of limitations for bringing an action for breach of the present covenant had started to run on the date of the delivery of the deed, which was over ten years ago. This seems like an odd position for the plaintiffs to be in. They say it’s too late to bring the action for breach of covenant of seisin, but it’s too early for them to bring an action for quiet enjoyment.

This is an example of a case where it was not prudent to rely on the lender. The surface was enough collateral to rely on for the loan, and so they didn’t care about the subsurface rights. But once we get past the statute of limitations on the covenant of seisin, the likelihood of an actual eviction based on this title defect gets increasingly less probable. If they haven’t shown up in ten years, they probably won’t show up at all. To award damages in a case like this creates a substantial risk of miscalculation: you might be awarding damages for a bad thing that’s never going to occur. Why not just live with the uncertainty? In that way, what the court does here makes sense. Say the coal company starts mining the coal, and then the person owning the outstanding two-thirds interest shows up and complains. What result then? Would we advise the coal company to start mining the coal? If the seller has the means to pay the previous grantor, then they reimburse the person who really owns the two-thirds. Doesn’t that require that the person who owns the two-thirds to come forward and claim it? The other reason to start mining the coal is because the only way that they’re ever going to clear up their title is to acquire the coal by adverse possession. But in order to possess the coal, you must use it in some way.

What damages would they be entitled to when the true owner comes forward? Can they get the value of the coal? They basically get rescission. In whole or in part, what the grantee will get as a remedy for the breach of covenants of title is the consideration that the grantee paid. Basically you just unwind the transaction. If I bought the land for $10,000 and it turns out that the grantor didn’t own any of it, I get the $10,000. If I happened to build a factory on that land or the value of the land went way up, it’s just too bad. You don’t get expectation damages, you just get back what you paid. In this case, however, at worst, only a portion of the land will be lost. The only defect we know of has to do with the subsurface rights.

Let’s say the purchase price is $50,000 and the value of two-thirds of the coal is $75,000. How much does the grantee recover from the grantor? You won’t get more than rescission, and in fact you’ll get less. You haven’t lost everything; you’ve only lost a portion. Your loss is greater than the consideration you’ve paid. You would think that in the case of this partial loss you would get the $50,000 back. What you’re entitled to is some ratio of the value of the coal relative to the value of the entire property that you purchased. Let’s say the true value of the property is $150,000, so you’ve lost 50% of the value of the property. That’s your recovery: you get 50% of the consideration paid. That’s not a great remedy for several reasons. You’re not getting back your entire damages. You’re getting nothing for improvements made to the land or future appreciation. These breaches of covenant can be outstanding for a long time. It doesn’t seem fair to make people bear a contingent liability for a long time for a large and hard-to-determine amount. So we limit liability to return of the consideration.

What the court does makes sense, but it creates a problem in terms of mining this coal. They take a risk if they mine it in that the people who truly own the coal could show up, claim conversion, and attempt to get punitive damages.

The Recording Acts

These are remedial legislation that create an exception to the common law. But they don’t replace the common law. The common law says “first in time, first in right”. If I sell to A on day 1 and B on day 2, A wins at common law because A bought first. This wasn’t a problem in feudal England, but it’s a problem today. Unless you have some way of checking title, you have no way of knowing if A sold the property. The presumption is always that the first transferee wins. The burden switches to the second transferee to show that there is an exception to the common law rule, namely, the Recording Acts. These acts vary a little by state. Typically, they require that the second transferee be in good faith. In order for the second transferee to win, the second transferee must be innocent. They must not have known about the earlier transfer.

The purpose of the Recording Acts is to protect people who acted in good faith and property in commerce. The person must say that they took without notice and for value. The property wasn’t just given to the transferee. Finally, the property right at issue must be one capable of being recorded. This is the interplay between the statute of frauds and the Recording Acts. The statute of frauds says that if you will transfer an interest in real property, it must be in writing. The Recording Acts say that you better record the writing or else it won’t count. But there are exceptions to the statute of frauds. In any case where your interest is based on an exception to the statute of frauds, that is, an interest that can be created without a writing, it’s also an exception to the Recording Acts, and you revert to common law.

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