UNDERSTANDING AND PLANNING TITLE INSURANCE IN COMMERCIAL REAL ESTATE

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1 UNDERSTANDING AND PLANNING TITLE INSURANCE IN COMMERCIAL REAL ESTATE First Run Broadcast: April 23, 2013 Live Replay: August 31, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Title insurance is a requirement of every commercial real estate transaction and yet its role is often misunderstood or overlooked as merely a piece of expensive boilerplate. But no bank will lend on a project without it and no investor will commit equity unless the underlying title of the property is investigated and insured. Failure to understand the complex web of details of a title insurance policy can easily cost property owners, investors, lenders and developers the essential financial benefit of underlying bargain. This program will provide you with a guide to understanding the role of title insurance in commercial real estate transactions, including the process of obtaining a policy, integrating policies into operative transactional documents, the relationship of policies to obtaining funding for a deal, and how to get the most out of your policies. Understanding title insurance in commercial real estate transactions Detailed review of ALTA forms, including recent changes Coverage exclusions and policy conditions Owner-covered risks and loan covered risks Special issues involving financially distressed real estate Maximizing benefits of title insurance, the policy of obtaining a policy, and integration with the underlying deal Robert Bozarth is National Agency Counsel of Fidelity National Title Group, based in the company s Richmond, Virginia office. He has more than 30 years experience in all aspect of title insurance in commercial real estate transactions. He is a Fellow of the American College of Mortgage Attorneys and the American College of Real Estate Lawyers. He is a member of the Title Insurance Forms Committee of the American Land Title Association and has written and spoken extensively on title insurance, including as a chapter contributor to Title Insurance Law, a treatise published by the University of Oklahoma. Mr. Bozarth earned his B.S. from the University of Virginia and his J.D. from the University of Virginia School of Law.

2 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Essential Title Examination in Real Estate & Curing Defects Teleseminar August 31, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER August 24, 2015 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

3 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: August 31, 2015 Seminar Title: Location: Credits: Program Minutes: Essential Title Examination in Real Estate & Curing Defects Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

4 T I T L E I N S U R A N C E I N C O M M E R C I A L R E A L E S T A T E T R A N S A C T I O N S April UNDERSTANDING TITLE INSURANCE IN COMMERCIAL REAL ESTATE TRANSACTIONS a. Real Estate Conveyancing Risks i. The Closing ii. Title and Lien risks iii. Legal environment iv. Transactional risks b. Financial strength i. Insurance holding company financials ii. Title insurance company financials c. Managing Risk with Reinsurance or Coinsurance 2. THE ALTA FORMS, INCLUDING RECENT CHANGES a. Policies i. Covered Risks ii. Exclusions iii. Conditions iv. Schedules b. Endorsements i. ALTA vi. ALTA xi. ALTA ii. ALTA 9 Series vii. ALTA xii. ALTA iii. ALTA 12 Series viii. ALTA xiii. ALTA iv. ALTA 13 Series ix. ALTA 35 Series xiv. What s coming? v. ALTA 28 Series x. ALTA 36 Series 3. SPECIAL ISSUES INVOLVING FINANCIALLY DISTRESSED REAL ESTATE 4. MAXIMIZING THE BENEFITS OF TITLE INSURANCE, AND INTEGRATION WITH THE UNDERLYING DEAL a. Organizational Issues 1 P a g e b. Setting Conventions Robert S. Bozarth FIDELITY NATIONAL TITLE GROUP robert.bozarth@fnf.com

5 1. UNDERSTANDING TITLE INSURANCE IN COMMERCIAL REAL ESTATE TRANSACTIONS a. Real Estate Conveyancing Risks In a real estate transfer, the parties face two basic risks. First, a short term closing or escrow risk that funds deposited with a title insurer or its agent may be lost in an insolvency or defalcation that occurs between the placement of the escrow order and the closing and disbursement of all funds. There may be a post-closing escrow of funds in some cases, but most cases do not involve post closing escrows. The closing or escrow risk terminates when the closing or escrow process has been successfully completed. Second, a basic long term policy risk that the policy has adequate coverage for the buyer s needs. The policy risk involves the coverages stated in the title insurance policy, and those added to the policy by endorsements. These policy risks can be organized as (i) title risks, (ii) lien risks and (iii) transactional risks. The policy risk also includes the possibility that the insurer may not survive through the entire period that the Insured holds its interest in the real property. In title insurance, the policy risk requires a policy term co-extensive with the policyholder s interest in the land. i. The Closing The extent of liability for escrow matters is usually governed by an escrow agreement, and you should expect most title insurers and agents to be careful about the liability that they assume. An escrow agent should be liable for its own negligence if it causes a loss, but escrow agents usually decline to assume liability for an unexpected failure of a depository institution, like a bank, especially if the customer designates the institution. In addition, the escrow agent will require the parties to hold it harmless if it follows the escrow instructions or directions from the parties. If the parties cannot agree to the disposition of the amounts in escrow, the escrow agent will usually reserve the right to interplead the fund with a court to allow the parties to work out a solution without involving the escrow agent any further. The closing or escrow risk to the parties to the transaction is relatively low when the escrow is held by a direct operation or branch of the title insurance company. As we shall see, 2 P a g e

6 title insurers are required to hold financial reserves to protect their customers, so funds deposited in escrow are protected by those reserves. A title insurance agent, on the other hand, is usually an independent company that has a contract with a title insurance company to issue the title insurance company s policies on real estate transactions. Many independent title insurance agents have agency contracts from two or more title insurance companies. A full service agent has the authority to search and examine the title, underwrite the risk within its authority limit, and issue the policy. The agency contracts usually specify a limited agency, only for the purpose of issuing title insurance policies. Strictly speaking, an agency contract between a title insurer and its agent does not encompass the closing and escrow processes. Of course, some agencies are owned and operated by title insurance holding companies or even the title insurance company, itself. However, as separate entities, they will have a contract that is usually indistinguishable from the contracts given to independent agents. Approved attorneys are lawyers in the general practice of law whose title certifications will be accepted by a title insurance company. The approved attorney with a real estate conveyance can certify the Title to the title company, which will then issue a policy after the approved attorney closes the transaction. It is not as formal a relationship as an agency, and, although the approved attorney searches and examines the title; the title insurance company actually underwrites the risk based on the approved attorney s report on the title and issues the policy, delivering it to the approved attorney. Many title insurance orders are placed with title insurance agents and approved attorneys, but what happens if an agent or approved attorney becomes insolvent? 1 If a transaction has closed and a policy was issued, the insolvency should have no effect on the policyholder s policy risk. If the agent or approved attorney stops operations after closing, but before issuing a policy, the insured can demand a policy from the title insurance company based on the title insurance commitment. Policy risk is relatively simple because it is the liability of the title insurance company, not the agent or approved attorney. 1 Insurance Companies cannot seek protection in bankruptcy because they are excluded by 11 U.S.C. 109 from being a debtor in bankruptcy. An insolvent agent or approved attorney can seek protection under the Bankruptcy Code because they are not insurance companies. 3 P a g e

7 4 P a g e The escrow risk is not so simple. The agency contract does not extend to the closing and escrow operations of the title insurance agents. Agents are not required to maintain reserves for losses nor do they have capitalization requirements like insurance companies do. The closing and escrow functions of an approved attorney are functions included within his or her practice of law. As a result, most title insurance consumers would be leery of depositing escrow funds with an agent or approved attorney unless the consumer can get an undertaking by the title insurance company that issues the policy to guarantee that the funds deposited will not be lost and that the agent or approved attorney will comply with the closing instructions from the parties. Some sort of protection is necessary if agents are to be a viable source of title insurance for customers. Closing Protection Letters. The solution is the Closing Protection Letter, an ancillary form of insurance offered by title insurance companies when one of its title insurance policies has been issued by an agent or approved attorney. The liability of the title insurer for an escrow loss at one of its direct offices is greater than its liability for losses of funds deposited with title insurance agents under Closing Protection Letters. Closing Protection Letters are limited assumptions of liability for the acts of another party, an agent or approved attorney, so the direct liability for its own actions has a much broader scope. Title insurers are sometimes asked for a Closing Protection Letter covering a transaction at a direct operation, but a letter might be construed as a limitation of its direct liability, so it might backfire on the recipient. The American Land Title Association (ALTA) adopts forms for Closing Protection Letters. Currently there are two forms adopted by the ALTA on December 1, One letter applies to single, specific transactions. The other form can be used to insure multiple transactions originating from a single agent or approved attorney. The new versions were in reaction to the decision in JP Morgan Chase Bank, N.A. and FDIC v. First American Title Insurance Company, 795 F. Supp. 2d 624 (E.D. MI 2011), where the court allowed the FDIC to pursue a claim on Closing Protection Letter after it sold the mortgage covered by the letter to JP Morgan Chase Bank. The insuring provisions of the ALTA Closing Protection Letter (12/1/2011) provide: Blank Title Insurance Company (the Company ), in consideration of your acceptance of this letter, agrees, subject to the Conditions and Exclusions set forth below, to indemnify you for actual loss of settlement funds incurred by you in connection with the closing of the Real Estate Transaction conducted by the Issuing Agent or Approved Attorney on or after the date of this letter, provided:

8 5 P a g e (A) the Company issues or is contractually obligated to issue title insurance for your protection in connection with the closing of the Real Estate Transaction; (B) you are to be the (i) lender secured by an Insured Mortgage, as defined in the ALTA Loan Policy ( ), its assignee or a warehouse lender, (ii) purchaser of an interest in land, or (iii) lessee of an interest in land; and (C) the aggregate of all funds you transmit to the Issuing Agent or Approved Attorney for the Real Estate Transaction does not exceed $ ; and further provided the loss arises out of: 1. Failure of the Issuing Agent or Approved Attorney to comply with your written closing instructions to the extent that they relate to (a) the status of the title to that interest in land or the validity, enforceability and priority of the lien of the mortgage on that interest in land, including the obtaining of documents and the disbursement of funds necessary to establish the status of title or lien, or (b) the obtaining of any other document, specifically required by you, but only to the extent the failure to obtain the other document affects the status of the title to that interest in land or the validity, enforceability and priority of the lien of the mortgage on that interest in land, and not to the extent that your instructions require a determination of the validity, enforceability or the effectiveness of the other document, or 2. Fraud, theft, dishonesty or negligence of the Issuing Agent or Approved Attorney in handling your funds or documents in connection with the closing to the extent that fraud, theft, dishonesty or negligence relates to the status of the title to that interest in land or to the validity, enforceability, and priority of the lien of the mortgage on that interest in land. If you are a lender protected by this letter, your borrower, your assignee and your warehouse lender in connection with an Insured Mortgage shall be protected as if it was addressed to them. It is apparent that the coverage is limited. It only applies to a failure to follow the closing instructions or fraud to the extent that they relate to the title or lien of the mortgage. If an agent violates the lender s closing instructions by depositing funds with an institution that is not approved by the lender, the lender may have a claim under the letter if the funds are lost in an insolvency of the unapproved institution. However, if there is no violation of the closing instructions in the selection of the escrow deposit holder, its insolvency will not trigger a claim under the Closing Protection Letter. If the title insurance company has the liberty to select the depository institution for an escrow of funds under the closing instructions, and that institution fails, it will be liable for the loss nonetheless, so escrows placed with title insurance companies are safer than escrows placed with agents with a Closing Protection Letter. The title insurance company s liability for loss under the Closing Protection Letter does not exceed the least of (i) the amount of the settlement funds, (ii) the its liability under its title

9 insurance policy at the time the claim is made, or (iii) the value of the lien of the Insured Mortgage or interest in the land insured by the title insurance policy. In addition, if a payment is made under a title insurance policy, that payment reduces the liability under the letter by the same amount, and payment under the letter also constitutes a payment under Section 10 of the Conditions of the title insurance policy. A claimant must send notice of its claim under a Closing Protection Letter within one year from the date of the closing. The letter does not cover a seller who may expect a substantial payment for the equity in the property as a result of the sale. Many commercial customers avoid the problem with depositing funds with agents by using a national commercial office or business unit of the title insurer to place orders with direct (company) or agency offices. The national commercial office or business unit will hold the cash escrows and disburse them according to the closing instructions so the customer does not have to risk placing an escrow deposit with an agent. There is no additional cost for employing a national commercial office or business unit, and they can add much efficiency to a transaction. ii. Title and Lien Risks Title Risks. The title insurance industry developed in response to concerns about title and lien risks. The closing risk to a party in a real estate transaction usually lasts for a relatively brief time measured in days, weeks or months. Lien risks for a lender frequently ends with satisfaction and release of the mortgage, but it may extend longer if the lender takes title to the property through foreclosure or a deed in lieu of foreclosure. The title risks to an owner last for the entire period that the policyholder owns the property, and often extends beyond a sale if the policyholder gives warranties of title to a purchaser. In the case of title and lien risks, the term of the coverage usually extends for years or decades. It may be enough for a party to determine the current financial strength of an escrow holder, but for a title insurer, the party must assess the financial strength as a predictor of the company s viability over a long term. Early title guarantee policies only insured the accuracy of a title search at the records office. 2 They did not include hidden risks like forgery, fraud, lack of authority, undue 2 The opinion in Fairway Development Company v. Title Insurance Company of Minnesota, 621 F. Supp. 120 (N.D. Ohio 1985) construed an Ohio guaranty policy, although it did not say so. In addition to its limited coverage, that policy defined Insured only as the insured named in Schedule 6 P a g e

10 influence, duress, incompetency, incapacity, or impersonation. The current 2006 ALTA policy forms are quite explicit about many hidden risks included in the policies, and the coverage is written broadly enough that it includes other risks not listed. Covered Risk 2 of the policies is the best example. The seven Covered Risks below from the ALTA policies adopted on are the title risks, although one might argue that Covered Risk 5 concerning land use is really ancillary to Title. You will find these covered risks, in this order, in both the ALTA owner s policy and loan policy. SUBJECT TO THE EXCLUSIONS FROM COVERAGE, THE EXCEPTIONS FROM COVERAGE CONTAINED IN SCHEDULE B, AND THE CONDITIONS, BLANK TITLE INSURANCE COMPANY, a Blank corporation (the Company ) insures, as of Date of Policy and, to the extent stated in Covered Risks 9 and 10, after Date of Policy, against loss or damage, not exceeding the Amount of Insurance, sustained or incurred by the Insured by reason of: 1. Title being vested other than as stated in Schedule A. 2. Any defect in or lien or encumbrance on the Title. This Covered Risk includes but is not limited to insurance against loss from (a) A defect in the Title caused by (i) forgery, fraud, undue influence, duress, incompetency, incapacity, or impersonation; (ii) failure of any person or Entity to have authorized a transfer or conveyance; (iii) a document affecting Title not properly created, executed, witnessed, sealed, acknowledged, notarized, or delivered; (iv) failure to perform those acts necessary to create a document by electronic means authorized by law; (v) a document executed under a falsified, expired, or otherwise invalid power of attorney; (vi) a document not properly filed, recorded, or indexed in the Public Records including failure to perform those acts by electronic means authorized by law; or (vii) a defective judicial or administrative proceeding. (b) The lien of real estate taxes or assessments imposed on the Title by a governmental authority due or payable, but unpaid. (c) Any encroachment, encumbrance, violation, variation, or adverse circumstance affecting the Title that would be disclosed by an accurate and complete land survey of the Land. The term encroachment includes encroachments of existing improvements A, which explains why the court refused to allow subsequent partners to benefit from a policy that named the original partners to the partnership that held title to the land. The decision caused a stir, but there was little risk that the holding would be applied to an ALTA policy with its expansion of the definition of insured. 7 P a g e

11 8 P a g e located on the Land onto adjoining land, and encroachments onto the Land of existing improvements located on adjoining land. 3. Unmarketable Title. 4. No right of access to and from the Land. 5. The violation or enforcement of any law, ordinance, permit, or governmental regulation (including those relating to building and zoning) restricting, regulating, prohibiting, or relating to (a) the occupancy, use, or enjoyment of the Land; (b) the character, dimensions, or location of any improvement erected on the Land; (c) the subdivision of land; or (d) environmental protection if a notice, describing any part of the Land, is recorded in the Public Records setting forth the violation or intention to enforce, but only to the extent of the violation or enforcement referred to in that notice. 6. An enforcement action based on the exercise of a governmental police power not covered by Covered Risk 5 if a notice of the enforcement action, describing any part of the Land, is recorded in the Public Records, but only to the extent of the enforcement referred to in that notice. 7. The exercise of the rights of eminent domain if a notice of the exercise, describing any part of the Land, is recorded in the Public Records. 8. Any taking by a governmental body that has occurred and is binding on the rights of a purchaser for value without Knowledge. In addition to the Covered Risks, many title risk coverages are included in endorsements. For example, endorsements like the ALTA 8.2 Commercial Environmental Protection Lien Endorsement, the ALTA 9 Restrictions, Encroachments Minerals, or Covenants Conditions and Restrictions endorsement series, the ALTA 13 Leasehold series, the ALTA 17 Access and Entry series, ALTA 18 Tax Parcel series, the ALTA 19 Contiguity series, the ALTA 22 Location series, ALTA 25 Survey series, ALTA 26 Subdivision series, ALTA 28 Encroachment series, and the ALTA 35 Mineral and other Subsurface Substance series all address title risks. Lien Risks. The loan policies add the lien risks that are specific to lenders. Title insurance differs from Property/Casualty insurance (like homeowners or commercial general liability) by insuring lenders in a separate policy instead of adding a loss payable provision in the policy that directs payments to the lender until its lien is paid, with the remainder to the borrower. That doesn t mean that both the borrower and lender will be paid for the same loss in title insurance. The title insurance owner s policy contains a Liability Noncumulative provision as Section 11 of the Conditions that reduces the Amount of Insurance of the policy by

12 any amount paid under a policy that insures a Mortgage excepted to in the owner s policy, and the amount so paid is a payment to the Insured under the owner s policy. The reason for the two policies is the loan policy can be evidence for due diligence if the loan secured by the Insured Mortgage is assigned, and, of course, it includes the lien risk coverages that are missing in the owner s policy. These lien coverages are: 9. The invalidity or unenforceability of the lien of the Insured Mortgage upon the Title. This Covered Risk includes but is not limited to insurance against loss from any of the following impairing the lien of the Insured Mortgage (a) forgery, fraud, undue influence, duress, incompetency, incapacity, or impersonation; (b) failure of any person or Entity to have authorized a transfer or conveyance; (c) the Insured Mortgage not being properly created, executed, witnessed, sealed, acknowledged, notarized, or delivered; (d) failure to perform those acts necessary to create a document by electronic means authorized by law; (e) a document executed under a falsified, expired, or otherwise invalid power of attorney; (f) a document not properly filed, recorded, or indexed in the Public Records including failure to perform those acts by electronic means authorized by law; or (g) a defective judicial or administrative proceeding. 10. The lack of priority of the lien of the Insured Mortgage upon the Title over any other lien or encumbrance. 11. The lack of priority of the lien of the Insured Mortgage upon the Title (a) as security for each and every advance of proceeds of the loan secured by the Insured Mortgage over any statutory lien for services, labor, or material arising from construction of an improvement or work related to the Land when the improvement or work is either (i) (ii) contracted for or commenced on or before Date of Policy; or contracted for, commenced, or continued after Date of Policy if the construction is financed, in whole or in part, by proceeds of the loan secured by the Insured Mortgage that the Insured has advanced or is obligated on Date of Policy to advance; and (b) over the lien of any assessments for street improvements under construction or completed at Date of Policy. 12. The invalidity or unenforceability of any assignment of the Insured Mortgage, provided the assignment is shown in Schedule A, or the failure of the assignment shown in Schedule A to vest title to the Insured Mortgage in the named Insured assignee free and clear of all liens. 9 P a g e

13 Creditors Rights, the Gap and the Duty to Defend. Finally, two Covered Risks in both the owner s policies and loan policies end the list of insurance provisions. Covered Risk 9 (Owners Policy) or 13 (Loan Policy) address a limited creditors rights risk, and Covered Risk 10 (Owners Policy) or 14 (Loan Policy) address the gap risk created where a transfer or financing is closed and the documents for the transaction are recorded after the closing, allowing a possibility that an adverse matter might get recorded between the closing and recording. The creditors rights risk insured by Covered Risks 9 and 13 respectively is a title risk because it only applies to potential preferences 3 or fraudulent transfers 4 in past transfers of the Title. The coverage does not apply to the transfer creating the interest insured by the title insurance policy, so it is a title risk. The gap risk can affect the title itself and the priority of the lien of an Insured mortgage, so it is a mixed title and lien risk. In addition, at the end of the Covered Risks, the policies include and unnumbered section, that from a claims perspective, is just as important as all of the Covered Risks. It states the title insurer s duty to defend an Insured against a challenge to any matter insured against by the policy. In claims, this duty to defend costs title insurers as much as the duty to indemnify for matters insured against by the policy in the Covered Risks and endorsements. Like the lien Covered Risks, the following is taken from the ALTA Loan Policy : 13. The invalidity, unenforceability, lack of priority, or avoidance of the lien of the Insured Mortgage upon the Title (a) resulting from the avoidance in whole or in part, or from a court order providing an alternative remedy, of any transfer of all or any part of the title to or any interest in the Land occurring prior to the transaction creating the lien of the Insured Mortgage because that prior transfer constituted a fraudulent or preferential transfer under federal bankruptcy, state insolvency, or similar creditors rights laws; or (b) because the Insured Mortgage constitutes a preferential transfer under federal bankruptcy, state insolvency, or similar creditors rights laws by reason of the failure of its recording in the Public Records (i) (ii) to be timely, or to impart notice of its existence to a purchaser for value or to a judgment or lien creditor. 14. Any defect in or lien or encumbrance on the Title or other matter included in Covered Risks 1 through 13 that has been created or attached or has been filed or recorded in the Public Records subsequent 3 4 See, Bankruptcy Code, 11 U.S.C See, Bankruptcy Code, 11 U.S.C P a g e

14 to Date of Policy and prior to the recording of the Insured Mortgage in the Public Records. The Company will also pay the costs, attorneys' fees, and expenses incurred in defense of any matter insured against by this Policy, but only to the extent provided in the Conditions. There is one more difference of immediate significance to policyholders between the ALTA Owners Policy and the ALTA Loan Policy. Section 8(a) of the Conditions limits the liability of the title insurance company for losses. The owner s policy version provides: This policy is a contract of indemnity against actual monetary loss or damage sustained or incurred by the Insured Claimant who has suffered loss or damage by reason of matters insured against by this policy. (a) The extent of liability of the Company for loss or damage under this policy shall not exceed the lesser of (i) (ii) the Amount of Insurance; or the difference between the value of the Title as insured and the value of the Title subject to the risk insured against by this policy. Compare that to Section 8(a) of the Conditions of the loan policy: This policy is a contract of indemnity against actual monetary loss or damage sustained or incurred by the Insured Claimant who has suffered loss or damage by reason of matters insured against by this policy. (a) The extent of liability of the Company for loss or damage under this policy shall not exceed the least of (i) the Amount of Insurance, (ii) the Indebtedness, (iii) the difference between the value of the Title as insured and the value of the Title subject to the risk insured against by this policy, or (iv) if a government agency or instrumentality is the Insured Claimant, the amount it paid in the acquisition of the Title or the Insured Mortgage in satisfaction of its insurance contract or guaranty. [Emphasis added]. The difference means that the unpaid Indebtedness owed to the insured lender remains as an upper limit to its recovery for a loss under the loan policy even if the Insured has taken title to the land that secured its loan. So, unlike under an owner s policy, a lender may not recover a loss if the value of the land subject to the matter causing the loss is still greater than the unpaid indebtedness that the Insured Mortgage secured. The rationale is that the lender will still have adequate security for the repayment of its borrower s debt. There is no truth to the myth that a loan policy converts to an owner s policy when the Insured takes title to the land. 11 P a g e

15 That last Section 8(a)(iv) applies to the Government Sponsored Entities like Fannie Mae, Freddie Mac, the Veteran s Administration, etc., that insure or guaranty mortgages on the residential secondary mortgage market. iii. The Legal Environment Each of the fifty states, the District of Columbia, and the U.S. Territories has its own real estate law, and the variations can be significant. Purchasers and lenders involved in a transaction outside their area of experience must rely on the advice of locals to manage risks in the transaction. A title insurance company can relieve some of the anxiety caused by working in an unfamiliar jurisdiction. The title insurance policy should reassure its Insured that the transaction documents are valid and enforceable in the jurisdiction and that a lien of an Insured Mortgage was properly perfected. In addition, there may be some transactional issues not addressed by the title insurance policy, but covered by endorsements. Usury is a good example. Usury is not a title issue at all, so title insurers can only insure against loss if the lien of an Insured Mortgage is invalid or unenforceable if the loan secured by the Insured Mortgage violates the usury law of the state where the Land is located. The coverage may appear timid when the Insured really wants the insurer to insure that the loan is not usurious, but title insurers are stopped from insuring features of the loan itself because the statutes that define title insurance restrict this line of insurance to the insurance of titles and liens. However, title insurers don t want a claim based upon the invalidity or unenforceability of the lien of the Insured Mortgage because the loan violated a state usury statute, so they usually issue the endorsement only if the loan itself fits into one of the exemptions from the application of the usury law. The national title insurers must have a presence in every state of the union, and have state counsel for each state. In most cases those state counsel live and are licensed in the state. The exceptions occur in the smaller markets. A state counsel reviews transactions for issues like usury and only allows a policy or endorsement to be issued if he or she is satisfied that it does not pose a risk of loss to the title insurance company. The title policy should confirm the opinion of local counsel on the issue. If it does not, the customer and title insurer can discuss the opposing positions to reach an agreement. 12 P a g e

16 This is a substantial feature of the role of title insurance in the United States, even though the U.S. jurisdictions are relatively similar in their real estate law when you compare them to jurisdictions internationally. Curiously, many multinational business organizations having a headquarters or significant operation in the United States will accept an assertion from counsel outside the United States that title insurance is not needed in their jurisdictions. Most of the rest of the world uses a title registry system (like Torrens) instead of a deed recording system like those in most of the United States. They argue that the state guaranties its registry, so insurance is unnecessary. However, few registries record the title documents. They only post the existence of the documents on the certificate of title. If a party wants to review a document referenced on the certificate, it must go to the holder of title to see if the holder has a copy. If the document is old, the holder may not have a copy. In England, solicitors manage risks like this by seeking an insurance policy from a title indemnities company, but a title indemnity policy does not cover all of the possible title risks as an ALTA policy does in the United States. It only covers the specific risk identified by the solicitor who ordered it. If a policy insures against loss caused by a restrictions in an 1836 document, it does not cover a loss of title, or even a loss caused by restrictions in an 1876 document. Compared to the ALTA policies, the British title indemnity model is cold comfort for all but that one issue that it addresses. In addition, a title certificate is only evidence of the matters that the registry defines. A party to a transaction cannot negotiate with the registry to expand its coverage to address an issue that might arise in the development of the land. In the United States, commercial customers routinely order title insurers to address title issues important to the anticipated use of the land, or specific coverages that the customer wants. iii. Transactional Risks Some of the ALTA endorsements insure loss caused by matters arising in the transaction itself. Often, the coverage will be phrased as a lien coverage: The Company insures against loss or damage sustained by the Insured by reason of the invalidity, unenforceability or lack of priority of the lien of the Insured Mortgage as.... However, the focus of the endorsement is to insure that the specified transactional element does not impair the lien of the Insured Mortgage. 13 P a g e

17 Many of the endorsements are familiar, like the ALTA 6 Variable Rate Mortgage Endorsement, the ALTA 10 series Assignment of Mortgage endorsements, the ALTA 11 series Mortgage Modification endorsements, the ALTA 14 series future advance endorsements, the ALTA 24 Doing Business Endorsement, and the ALTA 27 Usury Endorsement. Some newer transactional risk endorsements include the ALTA 29 series interest rate swap endorsements, the ALTA 30 series shared appreciation endorsements, the ALTA 32 series construction loan endorsements and the ALTA 36 series energy project endorsements. Transactional risks may not fit into the neat pigeonholes required for standard forms, so most of the tailored or proprietary coverages that title insurers issue would fall into this category as well. The availability of these non-standard coverages varies among the states because the business of insurance is regulated by state insurance departments, not by any federal regulator. Each state approaches regulation in its own way. Some allow title insurance companies the freedom to compete with their insurance rates and insuring forms, so there is no inhibition to craft endorsement forms tailored to specific risks in a transaction. Others require the insurance companies to file their premium rates, or their forms, or both. A small number of states actually promulgate the rates and forms that title insurers must use, and there is little, if any flexibility in those states to tailor coverages to a transaction. b. The Insurer s Financial Strength i. Insurance Holding Company Financials The larger companies in title insurance are owned by publicly traded holding companies. The holding companies operate by the same rules that other publicly traded companies follow, but they are also subject to insurance holding company acts that prevent the holding company from impairing regulatory protections imposed on the insurance companies. These holding company acts are imposed by state laws enacted to protect policyholders and the general public. The enactments are based on the model Insurance Holding Company System Regulatory Act of the National Association of Insurance Commissioners (NAIC). The Insurance Holding Company System Regulatory Act, or a variation of it, has been enacted by every state in the United States. The act requires holding companies to make annual reports, supplemented monthly, to enable the insurance regulators to overlook the holding 14 P a g e

18 company s activities with its insurance subsidiaries. Holding companies must report transactions between the holding company and its insurance subsidiaries, transactions between insurance subsidiaries and any other holding company subsidiaries or affiliates, acquisitions of insurance companies by the holding company, or any subsidiary or affiliate, and payment of dividends by an insurance company that have been approved by the insurance company s domiciliary insurance regulator. Regulated insurance holding companies also may own non-insurance subsidiaries as well. For example, the holding companies for title insurers own 1031 exchange facilitation companies as well because they share the same point of sale with the title insurance companies on real estate exchanges. Even though a title insurer and an affiliate 1031 exchange company may join together to market their products, the title insurer can accept no liability for exchange company transactions or deposits, so the two services must be evaluated separately. A holding company for a title insurer also typically owns hundreds of non-insurance subsidiaries like title insurance agents, data providers, and transaction due diligence providers, many focused on real estate conveyancing. Within the industry, the holding companies are viewed as families of title insurance companies. There are now four major title insurance families: Holding Company Major Title Insurance Subsidiaries State 5 FIDELITY NATIONAL FINANCIAL, INC. FIRST AMERICAN FINANCIAL CORPORATION OLD REPUBLIC INTERNATIONAL COMPANY STEWART INFORMATION SERVICES, INC. Alamo Title Company Chicago Title Insurance Company Commonwealth Land Title Insurance Company Fidelity National Title Insurance Company First American Title Insurance Company American Guaranty Title Insurance Company Mississippi Valley Title Insurance Company Old Republic National Title Insurance Company Stewart Title Guaranty Company Stewart Title Insurance Company of New York TX NE NE CA CA OK MS MN TX NY 5 The state designated after each title insurance subsidiary in this table is the domiciliary state for that company. It acts as the company s primary insurance regulator. 15 P a g e

19 It is enough to know that insurance companies can be owned by publicly held holding companies, and that insurance holding companies are subject to some regulation by state insurance regulators, as well as regulation by the Securities and Exchange Commission, etc. They are rated by Standard & Poor s, Moody s Investor Service and A.M Best, as well. To search these services online, you must register on the rating service s website. You can also call up SEC 10-K, 10-Q, other filings and company ratings by links in the holding company web pages. 6 The holding company websites also contain links to annual reports. However, the financial information in all of these reports consolidates the results from all of the subsidiaries of the holding company, including non-insurance subsidiaries with that of the parent, so you can t isolate the financial information for an insurance subsidiary in its parent s financials. It should be no surprise that an insurance holding company can seek protection, or liquidation, in bankruptcy, as LandAmerica Financial Group demonstrated on November 26, Consequently, the financial strength of the parent can have a significant impact on its insurance subsidiaries, even if that impact is nothing more than a taint that drives all potential customers to other insurance companies. On the upside, a healthy insurance holding company with a troubled insurance subsidiary is in a position, and has an incentive, to rescue the troubled insurer with a contribution to its capitalization. If the holding company allows an insurance subsidiary to fail, the public may lose confidence in all of the holding company s insurance subsidiaries. So, verifying the strength of the financials of your insurance company s parent can reduce your risk of a title insurance company failure, at least in the near term, but it shouldn t end your investigation. You should inspect the insurer s financial situation as well, if you can. ii. Financial Analysis of Title Insurance Companies If you have checked the holding company s financials, is there any need to verify the financial strength of the insurance subsidiary? Yes. State regulators supervise a title insurer s posting of reserves, and do not permit one title insurer to assume the risk of another (except by a 6 THE FIDELITY NATIONAL FINANCIAL, INC. - FIRST AMERICAN CORPORATION - OLD REPUBLIC INTERNATIONAL COMPANY - STEWART INFORMATION SERVICES, INC P a g e

20 reinsurance transaction). For example, regulators do not permit one title insurer to aggregate risk on policies issued by another company with an ALTA 12 Aggregation Endorsement, even if the two companies are affiliates or a parent and subsidiary. Coinsuring companies cannot share a title risk jointly and severally. Title insurer A cannot pay claims losses from its reserves for policies issued by title insurer B, even if title insurer B is an affiliate or subsidiary of title insurer A. If the consolidated financials of a holding company do not reveal the resources that each of its subsidiary insurers can apply to your transaction or loss, it is not enough to review the parent s financials in the belief that all of its assets back up your client s risk. A title insurer s policy liability is limited to the assets of the issuing title insurance company, so where can you find the financials of the individual title insurance company? As subsidiary companies, you cannot expect to find separate SEC filings for them. No 10-Ks, no 10-Qs, no glossy annual reports to shareholders; so where can you go to find financial information on the title insurance company? The NAIC requires each insurance company to file an Annual Statement with each insurance regulator where the company is authorized to do business. The title insurance industry s Annual Statement is commonly referred to as the Form 9 and a bound copy has a dreadful orange-pink cover. You can request a copy from the title insurer, but most holding companies publish a PDF version online in their investor relations section of their web pages. There is a limited print run on bound copies, so your best bet is to find a PDF version. The only thing you will miss is that awful cover. These are statutory financial statements that follow an NAIC statutory model, not Generally Accepted Accounting Principles. The differences are not that great to an analyst. There are some new terms like Surplus as Regards Policyholders and Admitted Assets, but the statements begin with a balance sheet showing assets, liabilities, surplus and other funds. The Operations and Investment Exhibit shows the company s income for the year and its effect on Surplus as Regards Policyholders. There are cash flow exhibits, notes to financial statements and many exhibits detailing the accounts in the main exhibits. The GAAP and statutory conventions are not all that different, so you should have no trouble following the information presented in a Form P a g e

21 The ALTA publishes its industry research on title insurance industry annual and quarterly financial data on its website. 7 It includes a consolidation of the basic Form 9 schedules for the industry, for each family and copies of the schedules for each company. The consolidations include only statutory financials, so they include only the insurance company results for the industry and family statements. The year end Statistical Analysis is particularly useful for comparing the relative financial strength of title insurance families and individual title insurance companies with one another. Title insurers are not rated by the major rating agencies like Standard & Poor s, Moody s Investor Service or A.M Best. They only rate the holding companies. For title insurance ratings you must go to Lace Financial 8, Demotech, Inc. 9 or Fitch Ratings. 10 Sections 109(b)(2) and 109(d) of the Bankruptcy Code exclude domestic insurance companies from being debtors under Chapters 7 (liquidation) and 11 (reorganization) of the code. 11 An insurance company is subject to financial oversight by its domiciliary insurance regulator instead. There are three stages in the process of insurance department oversight of a troubled insurer. Supervision applies when a company is out of compliance with the regulator s requirements, but not seriously. A supervised company operates independently, but must meet specified targets to lift the supervision. Rehabilitation applies to more serious failings. 12 A U.S.C. 109(b)(2) and 109(d) The following are some of the standards set by the Nebraska statutes for rehabilitation: Grounds for rehabilitation Grounds for rehabilitation. The director may apply by petition to the district court of Lancaster County for an order authorizing him or her to rehabilitate a domestic insurer or an alien insurer domiciled in this state on any one or more of the following grounds: (1) The insurer is in such condition that the further transaction of business would be hazardous financially to its insureds or creditors or the public; (2) There is reasonable cause to believe that there has been embezzlement from the insurer, wrongful sequestration or diversion of the insurer's assets, forgery or fraud affecting the insurer, or other illegal conduct in, by, or with respect to the insurer that if established would endanger assets in an amount threatening the solvency of the insurer; 18 P a g e

22 state regulator may impose rehabilitation in a court proceeding if state law requires that. Companies in rehabilitation usually have a member of the regulator s staff assigned to supervise the reorganization at the company s headquarters. Finally, a company that cannot be rehabilitated is ordered into liquidation. 13 A liquidation of a title insurance company is scary because there are fifty states with differing procedures, and title insurers have both policy and escrow risks. 14 Most other lines of insurance have only policy risks, so insurance regulators are not familiar with escrow risks. In addition, title insurance is a small industry compared to most other lines of insurance. Regulators spend little time on title insurance, so when they must liquidate a title insurer, the applicable state law may be a poor solution for policyholders, creditors and shareholders. You might also check to see if the state where the land is located has a guaranty fund to compensate insurance losses if a title insurer fails. In many states, guaranty funds do not cover all insurance lines. 15 The usual exceptions are annuities, life, disability, accident and health, (7) Without first obtaining the written consent of the director, the insurer has transferred or attempted to transfer, in a manner contrary to the Insurance Holding Company System Act or sections to , substantially its entire property or business or has entered into any transaction the effect of which is to merge, consolidate, or reinsure substantially its entire property or business in or with the property or business of any other person; (8) The insurer or its property has been or is the subject of an application for the appointment of a receiver, trustee, custodian, conservator, or sequestrator or similar fiduciary of the insurer or its property otherwise than as authorized under the insurance laws of this state, such appointment has been made or is imminent, and such appointment might oust the courts of this state of jurisdiction or might prejudice orderly delinquency proceedings under the Nebraska Insurers Supervision, Rehabilitation, and Liquidation Act; The NAIC adopted a Insurer Receivership Model Act in 2005, but no bill to enact the model act has been submitted in a state legislature. The Nebraska grounds for liquidation are brief: Grounds for liquidation. The director may petition the district court of Lancaster County for an order directing him or her to liquidate a domestic insurer or an alien insurer domiciled in this state on the basis: (1) Of any ground for an order of rehabilitation as specified in section whether or not there has been a prior order directing the rehabilitation of the insurer; [see, note 12 on page 9]. (2) That the insurer is insolvent; or (3) That the insurer is in such condition that the further transaction of business would be hazardous, financially or otherwise, to its insureds or creditors or the public. 15 For information on property/casualty insurance guaranty funds, generally, see, The National Conference of Insurance Guaranty Funds, 19 P a g e