Title Insurance Claims 101
How to navigate the title insurance claims handling process in order to avoid bad faith traps.
Title insurance is unique in the world of insurance. It indemnifies a policyholder for losses caused by defects in the title found to have existed on the date of the policy. As a result of its unique nature, title insurance is often misunderstood, which can lead to lengthy, costly litigation and difficulty settling cases. Title insurance is not casualty insurance, thus it is also difficult to reconcile with the claims handling parameters of many bad faith insurance statutes that place time limits on insurers. Title insurance policies provide many options to an insurer for resolution of a claim; many of these options are at times difficult to reconcile with bad faith statutes. This article will discuss the basics of what title insurance is and how to navigate the claims handling process to avoid bad faith traps.
Professor Barlow Burke states in the Law of Title Insurance that title insurance is utilized in real estate transactions involving the sale of real property where the “title to land is transferred, along with possession from the vendor to the purchaser.” Title insurance was created to protect lenders and/or owners against any defects in the title to the real property sold. Today the most commonly used form for title insurance is the version drafted by the American Land Title Association (ALTA), which can be found at http://www.alta.org. There are two types of policies: a lender’s policy and an owner’s policy. The court in Cale v. Transamerica Title Insurance (1990) recognized that “[t]here is a fundamental distinction between the indemnifiable loss of an insured lender and the indemnifiable loss of an insured owner of property by virtue of title defects or undisclosed liens.” The court pointed out that the Lender’s policy protects against a loss caused by the insured debt not being repaid “because the value of the security property is diminished or impaired by outstanding lien encumbrances or title defects.” The court further noted that an owner’s policy, in contrast, protects against the owner’s loss of the full market value of the property resulting from outstanding title defects and liens.
Whether for an owner or lender, before the policy is issued a title examination is performed. A title examination generally reveals any problems with the chain of title. After the examination, a policy is issued which includes a description of the relevant property and a schedule containing the “exceptions from coverage.” The exceptions can include encumbrances located during the title examination, such as other mortgages. The policy also contains any endorsements requested by the lender or owner. Common endorsements include: Access and Entry; Minerals and Other Subsurface Substances; Survey Endorsement; and Single Tax Parcel (a full list of available endorsements can be found on the ALTA website). Endorsements provide coverage for matters otherwise excluded from coverage.
Professor Burke advises that title insurance is a contract of indemnity not guarantee, stating that “[t]itle insurers eliminate risk before issuing a policy, as opposed to casualty insurers, which assume risk for events that may occur after the policy is issued.” The court in Swanson v. Safeco Title Insurance Company (1995) recognized that “[t]itle insurance does not guarantee perfect title; instead, it pays damages, if any, caused by any defects to title that the title company should have discovered but did not.” The policy, according to Professor Burke, indemnifies the purchaser for losses that are caused by defects in an insured property that existed on the date on which the policy is issued. The loss must be actual, as discussed in Falmouth National Bank v. Ticor Title Insurance Company; “the mere existence of a defect covered by the policy in and of itself is not sufficient to justify recovery.” The court in Falmouth also stated that “[t]he policy of title insurance…does not constitute a representation that the contingency insured against will not occur.” The court further noted, “[t]he importance of the contract not being one of guaranty is primarily that the insurer’s liability to pay monetary compensation under the policy does not arise immediately upon the existence of a covered defect being proved.” In Stewart Title Guarantee Company v. West, (1996), the court recognized that “[a]s an indemnity agreement, the insurer agrees to reimburse the insured for loss or damage sustained as a result of title problems, as long as the coverage for the damages incurred is not excluded from the policy.” Therefore, Professor Burke concludes, not only must there be a proximate cause or connection between the indemnity and the insured’s loss, the loss must not be specifically excluded from the policy. Furthermore, title insurance is not directed at future risks, but risks that are already in existence on the date the policy is issued. Professor Burke also notes that title insurance policies are expected to “hold the position to which insureds were entitled at their closing.” The position of the lender differs from that of the owner, and, as previously noted, each policy is different with regard to when damages are owed and the valuation of those damages.
When a claim is made under an owner’s policy, various provisions in the policy are triggered, including sections 5, 7, 8, and 9. Section 5 provides that the insurance company shall provide a defense if legal action is brought against the policy holder. Section 5 also provides that the insurer, instead of making a payment under section eight, can initiate a suit to correct the defect. This dovetails with section 7, which provides the insurer the option to make a payment to the policy holder for the damages under section 8, or pay a third party to remedy the defect. Thus, if the defect is an encumbrance that can be removed, the title insurer can either facilitate the removal of the encumbrance, or pay the expenses the insured incurred removing the encumbrance. However, if the encumbrance cannot be removed, the damages change from the cost to remove the encumbrance to the damage caused by the existence of the encumbrance itself. Section 8 should be addressed at this point.
Section 8 is often misunderstood, as shown by many cases. Section 8 provides that: “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 damages by reason of matters insured against by this policy.” Section 8(a) limits the insured’s recovery to the “lesser of (i) the Amount of Insurance; or (ii) 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.” A California Appellate Court in Overholtzer v. Northern Counties Title Insurance Company (1953) held that the measure of damages was the depreciation of the market value of the real property that was caused by the existence of defect. Other courts have followed Overholtzer, specifically Swanson, finding that the “insured's loss, if any, is the difference between the fair market value of the property if no impairment existed and the fair market value of the property with the impairment.” This analysis varies slightly depending on the type of encumbrance or title defect, but the principle remains the same - the insured is entitled to the diminution in the value of the property. The courts in Miller v. Ticor Title Insurance Company and Levy Gardens Partners 2007, LP v. Commonwealth Land Title Insurance Company, in analyzing the types of damages covered by an owner’s policy, found that all other types of damages are excluded, including loss of use damages and any other losses whether or not related to the value of the title. One other issue with 8(a), not addressed by this article, is determining the date upon which to base the valuation of the property.
The terms of a lender’s policy are conceptually similar to that of the owner’s policy; however, sections 7 and 8 differ because of the nature of the Lender’s policy. The insurer can still remedy the defect or pay the amount of the damages, but it also has the option to purchase the indebtedness. Section 8(a) is also expanded. Payment under 8(a) the lender’s 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.” The Court in Falmouth noted an additional distinction, that a lender’s loss “cannot be determined unless the note is not repaid and the security for the mortgage proves inadequate.” The actual loss is the deficit in the security caused by the defect and until the lender can no longer recover that amount, there is no loss.
The myriad of options available to title insurer and the fluidity of when a loss occurred can often lead title insurers to run afoul of some state’s bad faith statutes. Any state that requires an insurer to pay a claim within a certain time period after satisfactory proof of loss or other such standard, can create a problem for title insurers. The option to cure the defect in a title is likely to take more than thirty days, oftentimes more than sixty days. In those instances the insurer or its counsel should explain to the claimant that under the terms of the policy the insurer is allowed to remedy the defect in several possible ways and then advise the claimant of the intended action of the insurer, preferably within the time period provided by the bad faith statute of the state in which the claim was made.
Often the biggest hurdle encountered by an attorney defending a claim is educating the claimant or the claimant’s attorney about the title policy and what it actually provides. In doing so, it is important to have a diminution in value appraisal done early so that all involved can understand the ultimate value of the case under 8(a). Claimants are often surprised that their claim is not worth the amount they paid for the property or that they are not entitled to loss of use. Also, being straightforward with the claimant regarding the solution the insurance company is pursuing should help mitigate any issue caused by a bad faith statute time limit. For example, if an insurer chooses to negotiate with a third-party to remove a defect, a best practice would be to inform the claimant of the plan of action, with an estimated time of resolution, and then provide updates on the progress. If the negotiations later fail and the insured files suit alleging bad faith, there will be adequate documentation that the insurer was actively pursuing a resolution provided for under the policy.
The unique nature of title insurance makes claims handling and litigating challenging, but it also allows one to be creative in solving title problems. Having a complete understanding of the claim and the title policy in the beginning will help alleviate surprises throughout the process. Lengthy, expensive and unpredictable litigation may also be avoided.