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Title Insurance Covers That Foreclosure Problem, Right?

In the minds of many buyers of distressed properties at foreclosure sales, the existence of ANY title insurance policy relating to the property — even if the buyer is not the insured — is seen as a “cure-all” for anything that might go sideways regarding the property’s state of title after the sale.

That’s far from the truth.

A recent decision from California’s Fifth Appellate District Court of Appeal — Hovannisian v. First American Title Insurance (ordered published here)– illustrates the point.

Background: Plaintiff buys property at a foreclosure sale; later learns of a senior lien

The deed of trust, default, and foreclosure

In August 2006, Wells Fargo’s predecessor made a $120,000 loan to North West Holdings, LP, which was secured by a deed of trust against property located at 639 N. 4th Street in Fresno.

The Wells Fargo Deed of Trust stated that it was a “FIRST DEED OF TRUST.”

Along with the loan, Wells Fargo was the successor to a lender’s policy of title insurance from First American Title Insurance Company covering the property and Wells Fargo’s deed of trust.

The loan fell into default, and Wells Fargo foreclosed via a trustee’s sale (nonjudicial foreclosure).  The plaintiffs (David and Linda Hovannisian) purchased the property for $28,792.

The notice of trustee’s sale recorded a few weeks before the sale stated that the property would be sold “without warranty express or implied as to title, use, possession or encumbrances[.]”  Likewise, the trustee’s deed recorded after the sale stated that the trustee conveyed the property “without warranty, express or implied[.]”

The senior lienholder surfaces

Three months after the sale, the plaintiffs received a letter from Duane Long, who claimed to own a first lien on the property and requested payment.

Plaintiffs researched and learned that, indeed, Long held a first deed of trust on the property that was recorded in 2003 — years before Wells Fargo’s deed of trust.

First American declines coverage

Plaintiffs wrote a letter to First American demanding that either Wells Fargo pay off the Long Deed of Trust to clear title to the property, or for First American to pay the Long deed of trust pursuant to its title policy.

First American declined on the grounds that plaintiffs were not the insured under the policy, and encouraged plaintiffs to work with Wells Fargo directly.

Plaintiffs wrote to Wells Fargo, after which Wells Fargo made a claim to First American.  First American denied the claim on the grounds that the foreclosure sale was expressly made without warranties, and because there was no continuing coverage under the policy because Wells Fargo no longer held an interest in the property.

Plaintiffs sue Wells Fargo, and take an assignment of the policy

Plaintiff sued Wells Fargo for “misrepresentation” in connection with the foreclosure sale based on the Wells Fargo deed of trust’s statement that it was in “first” position.

Wells Fargo tendered the claim to First American for defense and indemnity, but First American declined coverage.

Plaintiffs and Wells Fargo then entered into an assignment agreement, by which Wells Fargo assigned to plaintiffs its potential claims and causes of action against First American — specifically, First American’s failure to defend the lawsuit against Wells Fargo.

Plaintiffs sue First American

Armed with the assignment, plaintiffs sued First American for breach of contract (the title policy) and breach of the covenant of good faith and fair dealing (bad faith).

The trial court granted First American’s motion for summary judgment, and entered judgment for First American.

Plaintiffs appealed.

The Court of Appeal’s Opinion

The court of appeal sided with First American and affirmed the trial court’s judgment.

The court first explained the difference between title insurance and other types of insurance.  Title insurance only provides indemnity against harm caused by title being other than as disclosed in the preliminary report.  “Title insurance is fundamentally different from other types of insurance because it is not prospective in nature; it does not insure against title defects or liens that arise after the effective date and time of the policy.”

Looking to the policy, the court noted a condition titled “Continuation of Insurance,” under which coverage continued ONLY so long as Wells Fargo “retained an estate or interest in the land,” held indebtedness secured by a purchase money mortgage given to it by a purchaser, or had “liability by reason of covenants of warranty” given during the transfer of the property.

If none of those items justifying continuation of coverage existed, the court stated, then the “insurance ends and any risk of loss for defective title becomes the new owner’s problem.”

The court found that none of those items existed, since Wells Fargo no longer retained any interest in the property after the foreclosure sale, no longer held any loan related to the property, and gave no warranties whatsoever in connection with the foreclosure sale.  The court held: “At the point of conveyance to the Hovannisians, any preexisting defect in title became the Hovannisians’ problem and would require them to obtain their own title insurance to protect themselves.”

The plaintiffs argued that a covered harm arose during Wells Fargo’s ownership of the property because the title defect existed then — Wells Fargo’s lien was in fact second in priority, when the title policy identified it as first.

Rejecting this argument, the court got to the crux of its opinion: “There is no obligation to pay benefits under a title policy unless there is a loss; a secured lender suffers an indemnifiable ‘loss’ under a title policy only if the lender fails to recoup the debt because of an undisclosed senior lien.”  The underlying lawsuit sought recovery only for plaintiffs’ — not Wells Fargo’s — damage.  And the plaintiffs “could not state a claim that was adverse to Wells Fargo’s title or interest because they received an unwarranted deed after a public auction.”

Lesson

Title insurance is not as broad as many people — and many real estate veterans — assume.  Due to the limitations of title insurance (both as to its non-prospective nature and each policy’s lengthy “exclusions, exceptions, and conditions”), many foreclosure-related title problems are not covered.

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