Conflicting Opinions on Date of Loss Under Lender's Title Insurance Policy

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VOL. 222 NO. 39 OCTOBER 3, 2016 njlj.com

REAL ESTATE, TITLE INSURANCE & CONSTRUCTION Law Conflicting Opinions on Date of Loss Under Lender’s Title Insurance Policy By Michael R. O’ Donnell and Michael P. Crowley

mong the many business risks involved in loan- Aing money, a lender must be aware of potential title issues affecting the property securing its loans, including undisclosed prior liens and other encumbrances that may reduce or destroy the lender’s security. Although much of this risk is ameliorated when a lender obtains a title insurance policy, an issue arises when an insured lender suffers a loss because of a Photo By ISTOCK title issue: the date on which the The date of loss matters to the date of the loan, the lender’s loss is calculated under the poli- because lenders’ title insurance recovery is likely subject to any cy. Some title insurance policies policies typically limit liability to post-closing real estate market tur- define which date should be used the lesser of the amount listed bulence. to calculate the loss—for example, on the policy, the amount of the Although New Jersey courts certain title insurance policies in indebtedness, or the difference in have followed the majority rule use in Texas state that the measure value of the insured property with when addressing a disputed date of damages is “based on respective and without the defect. Therefore, of loss, they have not engaged in values determinable as of the date the date on which the loss is deter- an in-depth analysis of the con- of this policy.” However, most mined affects whether the lender flicting viewpoints. Recently, how- policies do not. can recover the full amount loaned. ever, two courts in other states Moreover, if the court addressing addressed these differing per- O’Donnell is a partner in the Commercial a dispute between the lender and spectives and came to opposite Litigation Practice Group and a member of the Executive Committee at Riker Danzig Scherer title insurance company follows conclusions. These two recent Hyland & Perretti in Morristown. Crowley is an the majority rule and uses the date decisions from courts in Georgia associate in the firm’s Commercial Litigation Practice Group. of the foreclosure sale, as opposed and Arizona aptly summarize the methods by which the date of loss subsequently was entered in favor to the defendant lender insuring under a lender’s title insurance of the insured. two properties which secured the policy is calculated, and provide On appeal, the title insurance lender’s loans in the total amount an indication of how New Jersey company challenged the date of of $2,050,000. The policies did courts might address the same in the loss, among other things. The not list certain covenants, condi- the future. appellate court, citing to “the tions and restrictions that prohib- majority view” of other jurisdic- ited commercial development on Court of Appeals of Georgia tions, agreed and reversed the either parcel. On June 29, 2016, the Court of lower court’s decision. It held that In 2010, after the borrowers Appeals of Georgia addressed this the insured did not actually suffer defaulted, the properties were sold date of loss issue in Old Republic a loss until the date of the fore- at a trustee’s sale and purchased Nat’l Title Ins. Co. v. RM Kids, closure and that the loss should by the lender, which subsequently 788 S.E.2d 542 (Ga. Ct. App. not be measured until then. It notified the title insurance com- 2016). There, a lender issued a distinguished the cases cited by pany of claims under its title insur- loan in the amount of $11,400,000 the insured by noting that those ance policies. The lender asserted for the purchase of the insured cases involved an owner’s title that the restrictions prevented both property, which was to be used insurance policy, and that “[t]he properties from being developed for a residential development. fee interest of an owner is imme- for commercial purposes and were A previous deed to the property diately diminished by the pres- not listed as exceptions under the included an exhibit stating that ence of lien since resale value will policies. As in RM Kids, the lender there were “petroleum contamina- always reflect the cost of removing argued that the date of the loan tion” issues and, therefore, that a the lien[,] but, … [a] mortgagee’s should be used to calculate damag- number of limitations for the use loss cannot be measured unless es, while the title insurance com- of the property existed. The title the underlying debt is not repaid pany argued that damages should insurance policy did not except and the security for the mortgage be based on the value of the prop- either the petroleum issue or the proves inadequate.” Therefore, the erties at the date of the foreclosure limitations disclosed in the prior Georgia Court of Appeals adopted sale. deed. the majority view and held that Both parties sought declaratory After the insured lender dis- any loss should be measured as of relief in Superior Court, with the covered these issues, it filed a the date of the foreclosure sale. court granting judgment in favor claim with the title insurance com- of the title insurance company, Arizona Supreme Court pany. When the title insurance holding that the parcels should be company did not respond to the Although it followed the valued as of the foreclosure date. claim, the insured sued for cover- majority of courts, the RM Kids On appeal, the Arizona Court of age and, while this litigation was decision was especially significant Appeals reversed, holding that, “in ongoing, the lender purchased the in light of a decision issued by the the absence of a specified date of property at a foreclosure sale for Arizona Supreme Court just two comparative valuation identified $750,000. Before trial, the trial weeks earlier in First Am. Title in the policies, the date to mea- court ruled that the date of the Ins. Co. v. Johnson Bank, 372 sure any diminution in property insured’s loss for the purpose of P.3d 292 (Ariz. 2016). There, the value is the date of the loan.” The measuring damages was the clos- plaintiff title insurance company Arizona Supreme Court granted ing date of the loan, and a verdict issued two title insurance policies review on the issue of “how to calculate damages under a lender’s adopted by the Court of Appeals proves inadequate,” and that the title insurance policy that failed below and which measures the date of the loss should be “the to disclose encumbrances substan- loss using the date of the loan, date of the sheriff’s sale[.]” See tially affecting the value of the was applicable because it involved Green v. Evesham Corp., 179 N.J. property and thwarting its intend- situations where the title defect Super. 105, 109 (App. Div. 1981); ed use.” “caused” the borrower to default. Trico Mortgage Co. v. Penn Title Upon review, the Arizona The court therefore remanded the Ins. Co., 281 N.J. Super. 341, 354 Supreme Court stated that using case to determine if the lender (App. Div. 1995); cf. Summonte v. the foreclosure date as the valu- could prove the title defect caused First Am. Title Ins. Co., 180 N.J. ation date would allow the insur- the borrowers’ default and subse- Super. 605 (Ch. Div. 1981) (“the er to profit from a depreciating quent foreclosure, which would insured [owner] suffered a loss real estate market, even when the justify using the date of the loans immediately upon the acquisition title defect caused the borrower to as the valuation date. Otherwise, of title and that loss was in every default. Specifically, it stated that: the court found that the proper sense ‘actual’”). valuation date should be the fore- Nonetheless, absent an updat- [I]n resolving the ambi- closure date. ed title insurance policy that guity in [the title insur- specifies the date of loss, the Effect on New Jersey Law ance company’s] policy by Arizona court’s comment that the evaluating relevant social Although neither decision con- title insurance company was “in policies and the parties’ stitutes binding authority in New the best position to timely dis- transaction as a whole, we Jersey, these decisions highlight cover and disclose the title defect” quite properly consider that two different methods by which allows for courts to eschew blan- [the title insurance compa- other jurisdictions are interpreting ket rules regarding the date of the ny] was in the best position lenders’ title insurance policies. loss and default to whichever date to timely discover and dis- Both courts addressed situations results in a higher payment for close the title defect, and in which the insured properties an insured. Therefore, regardless to thereby avoid the risk of contained restrictions on develop- of the holdings of previous New loss in a depreciating real ment that precipitated title claims Jersey decisions, lenders and title estate market, but failed to and both courts acknowledged the insurance companies involved in do so. majority view of other jurisdic- New Jersey real estate transac- tions, but they reached different tions should be aware of these Most importantly, the court conclusions. conflicting decisions as they may explained that the decisions of As in Georgia, New Jersey affect how title insurance poli- the “majority view,” which would courts have adopted the majority cies are interpreted in New Jersey measure the loss as of the fore- rule and held that, unlike with an going forward.■ closure date, involved situations insured owner, an insured lender’s in which the title defect was an “loss cannot be measured unless undisclosed senior lien. The court the underlying debt is not repaid held that the “minority view,” and the security of the mortgage

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