COVER STORY, JULY 2009

THE ABCs OF TITLE INSURANCE FOR COMMERCIAL REOs
Lenders need to be aware in this real estate climate.
Michael Cerrina and Ashley Caro Ritter

Cerrina

It has been predicted that lenders will soon be hit by a wave of commercial real estate loan defaults. This predicted rise in defaults increases the likelihood that lenders will soon find themselves in a position of having to take ownership of real property, which they once held only as security for loans either through foreclosure or a deed in lieu of foreclosure. There are many factors that lenders need to take into account before doing so. One such factor is title insurance.

In California, a lender has three main options when obtaining title to commercial real property through a foreclosure: (i) to rely on its current title insurance policy under the continuation coverage paragraph set forth in the policy jacket; (ii) to obtain an owner’s title insurance policy; or (iii) to obtain an interim title binder. An interim title binder is a commitment from a title company to issue a specified policy within a certain period of time in the future.1 While available in California, title binders are not available in most jurisdictions, including New Mexico, Arizona and Oregon.2 If a lender chooses to rely on its existing policy, the advantages are clear – a lender does not have to spend the time or incur the expense to negotiate an owner’s policy/title binder, nor does a lender have to pay the cost for obtaining the same. 

Ritter

There are, however, three primary disadvantages in choosing to rely on a lender’s title insurance policy after a lender acquires commercial real property through foreclosure. First, a lender’s policy will not insure that a foreclosure has been properly conducted.3 Second, a lender’s policy will only cover those matters arising prior to the date of the policy and not the date of the transfer. Third, the damages under a lender’s policy are more limited than those under an owner’s policy.4 The measure of damages in a 2006 ALTA lender’s title insurance policy, for instance, is the difference between the value of the insured estate or interest and the value of the insured estate or interest subject to the defect insured against by the policy, limited by both the amount of coverage and the unpaid secured indebtedness plus certain expenses, advances and amounts.5 Moreover, an insured lender is only entitled to indemnification for the unpaid balance of the secured indebtedness if the security for the loan proves to be inadequate because of a senior lien or title defect, rather than for loss due to any diminution in the value of the security.6 Alternatively, the measure of damages in a 2006 ALTA owner’s title insurance policy is the difference between the value of the insured estate or interest and the value of the insured estate or interest subject to the defect insured against by the policy, and is limited only by the amount of coverage.7

Conversely, if a lender obtains an owner’s title insurance policy upon acquisition of foreclosed property, the benefits are threefold. An owner’s policy provides coverage as of the date that a foreclosing lender acquires title to the property. In doing so, the owner’s policy insures against foreclosure defects, as well as any insured title defects that arose after the date of the lender’s policy, but prior to the date of the owner’s policy. Additionally, the measure of damages in an owner’s policy is more extensive than that in a lender’s policy.

The two major drawbacks in obtaining an owner’s title insurance policy are the expense and time. Obtaining an owner’s policy requires reviewing new exceptions that have appeared on title since the date of the lender’s policy and negotiating the form and content of the owner’s policy.

Purchasing an interim title binder can help alleviate some of these costs. While still requiring its purchaser to review new exceptions that have appeared on title since the date of the lender’s policy and negotiating the form and content of the title binder, the benefit of a title binder is that it gives its holder the right to obtain the coverage of an owner’s policy (if needed) during the interim period (generally 2 years), and, if the holder sells the property during the interim period, to provide title insurance for the new owner at no additional cost.8 The cost of a title binder is only slightly higher than the cost of an owner’s policy.9 This can provide significant savings for a lender if a lender intends to sell the property within the interim period and the lender is, for instance, in a jurisdiction where the seller is responsible for the payment of the title insurance premium.10

When obtaining title to commercial real property through a deed in lieu of foreclosure in California, a lender’s title insurance options depend on whether the lender elects to keep its deed of trust of record. If a lender elects to do so, a lender can rely on its existing title insurance policy, but a CLTA 107.11 endorsement, insuring against loss sustained by merger of the deed of trust with the insured estate, should be obtained.11 Today, many lenders who elect to maintain their deeds of trust also take title in newly formed entities. In this situation, the newly formed entity should obtain either an owner’s policy or a title binder. If a lender chooses not to keep its deed of trust of record, a lender’s title insurance options become similar to those of a foreclosing lender with comparable benefits and drawbacks.

An informed title insurance decision can provide comfort and protection to a lender navigating the loan default wave. An uninformed title insurance decision, however, can have significant consequences. It is important that a lender discuss the benefits and limitations of each option with a knowledgeable title officer and/or attorney prior to acquiring title to secured commercial real property.

Michael Cerrina is a partner and Ashley Caro Ritter is an associate in the Los Angeles office of the law firm of Allen Matkins.

1 Alice L. Akawie & Rod Pasion, Selecting Title Insurer and Initiating Title Process, in California Title Insurance Practice 41, 56 (Cal. CEB ed., 2d ed. 1997).

2 Telephone interview with Glen M. W. Trowbridge, Vice President/Senior Nat’l Underwriting Counsel, First Am. Title Ins. Co. (Apr. 30, 2009). 

3 See Oscar H. Beasley et al., Structure and Coverage of Title Insurance Policy Forms, in California Title Insurance Practice, supra note 1, at 125, 168.

4 Marjorie Floyd Burchett et al., Lender’s Policies and Endorsements, in California Title Insurance Practice, supra note 1, at 261, 302.

5 See Burchett et al., supra note 4, at 298; see also Am. Land Title Ass’n, ALTA Loan (Lender’s) Policy (2006), reprinted in Alice L. Akawie et al., California Title Insurance Practice app. at 769 (Cal. CEB ed., 2d ed. 1997).

6 See Theodore R. Forrest, Jr. & Timothy R. Sullivan, Theories and Defenses in Title Company Actions, in California Title Insurance Practice, supra note 1, at 375, 389-90.

7 Am. Land Title Ass’n, ALTA Owner’s Policy (2006), reprinted in Alice L. Akawie et al., California Title Insurance Practice app. at 791 (Cal. CEB ed., 2d ed. 1997).

8 See Akawie & Pasion, supra note 1, at 56-59.

9 Id.at 58.

10 See id.

11 Burchett et al., supra note 4, at 303.

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