Can a Lender's Own Acts Void Its Title Policy?

History

It all began with Ticor v. Countrywide (Chancery Division, Cook County, Illinois Circuit Court filed on July 18, 2008 under Index No. 2008-CH-25938). In this action, Ticor specifically asked the court for a declaratory judgment that it had no duty to indemnify Countrywide because the latter's own gross negligence in underwriting its loan led to its loss.

Ticor alleged that Countrywide failed to obtain full documentation for the loan, verify the borrower's employment, and verify the borrower's savings or even the borrower's Social Security Number. The borrower did not make a single payment on the loan and as a result, Countrywide foreclosed and auctioned off the property. The purchasers at the auction discovered the body of the true owner's son when they inspected the property. The Public Administrator determined that the true owner's estate had been defrauded out of title by a conspiracy involving the mortgage broker, the new purchaser, the title agent and possibly others. The deed into the borrower from the deceased property owner was an obvious forgery (the deed was on a form that was not printed until three years after the decedent's death) ' a fact suggesting readily discoverable fraud. Countrywide filed a claim with Ticor based upon the borrower's fraud. Ticor rejected the claim and filed an action to rescind its title policy on the grounds that but for Countrywide's gross negligence in making the loan, the fraud would have never occurred. Countrywide, according to Ticor, had “the last clear chance to avoid the fraud” and Ticor had no obligation to indemnify Countrywide.

What Happened Next

There has been no activity on the Ticor v. Countrywide docket (unconfirmed suspicions are that the parties are in settlement discussions), but the mere filing of the case unnerved the lending bar and left it wondering whether title companies would use a lender's underwriting practices to deny title claims. The wait would not be long.

On Aug. 8, 2009, Fidelity National Title filed suit against Aurora Bank in the Superior Court, Orange County, CA (Index No. 30-2009-00290878) requesting the court to rescind its policy. In this case, Fidelity's policy insured that Aurora held a first mortgage for $604,000 and a subordinate loan for $94,000 on real property owned by the borrowers. Under California's practice, Aurora and not Fidelity closed the transaction. Unfortunately, as alleged by Fidelity, Aurora neglected to pay off a prior home equity loan for $75,000 given by the borrowers to Washington Mutual. The borrowers went into bankruptcy and WAMU foreclosed its home equity loan, thereby terminating Aurora's two mortgages. In its complaint to rescind Aurora's title policy, Fidelity argued that in issuing the policy, it had justifiably relied upon Aurora's loan underwriting practices. Those practices did not comply with proper loan underwriting standards in that Aurora failed to verify, among other factors, the borrower's income, credit and ability to pay. By the way, as noted by Fidelity, Aurora was previously known as Lehman Brothers Bank, whose systematic aggressive and predatory lending practices were well known.

Two days later, on Aug. 10, 2009, Lawyers Title filed suit against American Internet Mortgage (“AIM”) in the Superior Court, Los Angeles County, (Case No. BC419565) and also asked the court to rescind the title policy it had issued to AIM. In this case, AIM, previously owned by Countrywide, allegedly informed Transnation Title (Lawyers' predecessor in interest) that AIM had closed on a loan on July 8, 2008. However, the loan did not actually close until July 25. In that 17-day period, the borrower closed on five additional loans with different lenders for an amount totaling $1.2 million. As a result AIM's mortgage ended up in sixth rather than first position. Fidelity said it was all AIM's fault because AIM failed to follow established and proper loan underwriting standards and had reckless disregard for such standards. It should be noted that the same law firm that brought suit against Aurora on Fidelity's behalf also brought suit against AIM. Therefore, the allegations of negligent loan underwriting were virtually identical.

The lending bar, though concerned, was somewhat relieved that all of the foregoing cases involved one title company family (Fidelity owns Lawyers and Ticor) and only involved residential property. Certainly, no underwriter would sue to set aside a policy issued in a commercial transaction.

In June 2007, First, American issued a $486 million loan policy to Credit Suisse insuring additional construction financing for the development of Lake Las Vegas, a resort located 20 miles northeast of Las Vegas in Henderson, NV. As construction continued, the economic downturn hit and contractors started to file mechanic's liens in the millions of dollars. First American undertook to defend Credit Suisse in these actions. Then First American discovered that the “loan product” that it had insured permitted the developers to take out their profits before paying the contractors. First American also discovered that in the to-be-expected bankruptcy proceeding, Credit Suisse had obtained an order permitting it to provide debtor in possession financing to the bankrupt developers with lien priority over the financing insured by First American. In September 2009, First American brought suit in the United District Court for the southern District of Nevada, Las Vegas Division (Case No. 2:2009cv01743) asking the court to rescind the policy it had issued to Credit Suisse. The basis for the request ran in First American's Complaint from (a) to (m), but all boiled down to the allegation that Credit Suisse's loss arose from matters excluded from the policy coverage because such matters were “suffered, created, assumed or agreed to by Credit Suisse.”

The Chill Is Real

The foregoing cases confirm that the chill emanating from various title claims department is not imaginary. The title companies are not waiting to be sued by their insureds for breach of the policy. The underwriters are instead bringing suit against their insureds for causing the losses through the insureds' own negligent or reckless underwriting. In effect, the underwriters are saying that the lenders have no coverage under the title polices when the lenders “created, suffered assumed, or agreed to” the losses. This strict scrutiny of the lender's claim and denial of coverage is especially likely to occur when the claimant is a “bad boy lender,” a situation that has suffered negative publicity in the press, i.e., Countrywide, Lehman Brothers or Credit Suisse.

The question for both the title underwriters and the lenders, which, let's face it, need each other to prosper, is whether the chill in the air is a harbinger of the common cold or Ebola. For the underwriters, finding valid ways not to pay huge claims, caused in their minds by bad boy lenders with lax if not negligent or reckless loan underwriting, is a matter of economic survival. For the policyholder, the question is whether title insurance is worth the cost if the lender will have to defend its loan underwriting practices whenever its counsel files a claim. None of the cases discussed above have been decided by a court ' yet. If and when the decisions start to come down, we will see if the era of insurer strict scrutiny of its policyholder's practices will survive. Until then, lenders should expect the chill to continue.

Marvin Bagwell is the president and CEO of Bagwell & Associates Title Agency, located in New York City.

Attorneys filing title claims have begun to notice that the reception from the underwriters has become downright chilly. Claims departments are re-
sponding slower, but denying claims much more quickly. There is anecdotal evidence that claims that were once given due consideration and the title underwriters once paid without much “drama” are now routinely denied. Even when they might admit having liability, claims departments now demand much more information from claimants before making a final decision regarding liability ' and certainly before issuing a check. Title companies now strictly adhere to the terms and conditions of the policy boilerplate. There is much less give and take. A lot of this is understandable. Title companies have been hit by the economic crisis just as severely and perhaps more so, as any other participant in the real property industry. It has long been recognized that claims go up in an economic downturn just as the underwriters' ability to pay decreases. But is there more going on in this new era of strict scrutiny for title claims? Is the evidence merely anecdotal?

The 'Acts of the Insured' Exclusion

Paragraph 3 of the Exclusions from Coverage section of the American Land Title Association loan policy form used in New York excludes policy coverage for “Defects, liens, encumbrances, adverse claims or other matters ' created, suffered, assumed or agreed to by the Insured Claimant.” This provision is generally referred to as the “acts of the insured” exclusion. The evidence does indeed suggest that title underwriters have begun to put title claims made by lenders through the “acts of the insured” test much more frequently these days than they did in the past. Underwriters have served notice that they will not only deny claims where in their view, the lender's own act, such as “grossly negligent” or “reckless” loan underwriting may have led to the loss, but they will also fire a preemptive strike against the claimant as well.

History

It all began with Ticor v. Countrywide (Chancery Division, Cook County, Illinois Circuit Court filed on July 18, 2008 under Index No. 2008-CH-25938). In this action, Ticor specifically asked the court for a declaratory judgment that it had no duty to indemnify Countrywide because the latter's own gross negligence in underwriting its loan led to its loss.

Ticor alleged that Countrywide failed to obtain full documentation for the loan, verify the borrower's employment, and verify the borrower's savings or even the borrower's Social Security Number. The borrower did not make a single payment on the loan and as a result, Countrywide foreclosed and auctioned off the property. The purchasers at the auction discovered the body of the true owner's son when they inspected the property. The Public Administrator determined that the true owner's estate had been defrauded out of title by a conspiracy involving the mortgage broker, the new purchaser, the title agent and possibly others. The deed into the borrower from the deceased property owner was an obvious forgery (the deed was on a form that was not printed until three years after the decedent's death) ' a fact suggesting readily discoverable fraud. Countrywide filed a claim with Ticor based upon the borrower's fraud. Ticor rejected the claim and filed an action to rescind its title policy on the grounds that but for Countrywide's gross negligence in making the loan, the fraud would have never occurred. Countrywide, according to Ticor, had “the last clear chance to avoid the fraud” and Ticor had no obligation to indemnify Countrywide.

What Happened Next

There has been no activity on the Ticor v. Countrywide docket (unconfirmed suspicions are that the parties are in settlement discussions), but the mere filing of the case unnerved the lending bar and left it wondering whether title companies would use a lender's underwriting practices to deny title claims. The wait would not be long.

On Aug. 8, 2009, Fidelity National Title filed suit against Aurora Bank in the Superior Court, Orange County, CA (Index No. 30-2009-00290878) requesting the court to rescind its policy. In this case, Fidelity's policy insured that Aurora held a first mortgage for $604,000 and a subordinate loan for $94,000 on real property owned by the borrowers. Under California's practice, Aurora and not Fidelity closed the transaction. Unfortunately, as alleged by Fidelity, Aurora neglected to pay off a prior home equity loan for $75,000 given by the borrowers to Washington Mutual. The borrowers went into bankruptcy and WAMU foreclosed its home equity loan, thereby terminating Aurora's two mortgages. In its complaint to rescind Aurora's title policy, Fidelity argued that in issuing the policy, it had justifiably relied upon Aurora's loan underwriting practices. Those practices did not comply with proper loan underwriting standards in that Aurora failed to verify, among other factors, the borrower's income, credit and ability to pay. By the way, as noted by Fidelity, Aurora was previously known as Lehman Brothers Bank, whose systematic aggressive and predatory lending practices were well known.

Two days later, on Aug. 10, 2009, Lawyers Title filed suit against American Internet Mortgage (“AIM”) in the Superior Court, Los Angeles County, (Case No. BC419565) and also asked the court to rescind the title policy it had issued to AIM. In this case, AIM, previously owned by Countrywide, allegedly informed Transnation Title (Lawyers' predecessor in interest) that AIM had closed on a loan on July 8, 2008. However, the loan did not actually close until July 25. In that 17-day period, the borrower closed on five additional loans with different lenders for an amount totaling $1.2 million. As a result AIM's mortgage ended up in sixth rather than first position. Fidelity said it was all AIM's fault because AIM failed to follow established and proper loan underwriting standards and had reckless disregard for such standards. It should be noted that the same law firm that brought suit against Aurora on Fidelity's behalf also brought suit against AIM. Therefore, the allegations of negligent loan underwriting were virtually identical.

The lending bar, though concerned, was somewhat relieved that all of the foregoing cases involved one title company family (Fidelity owns Lawyers and Ticor) and only involved residential property. Certainly, no underwriter would sue to set aside a policy issued in a commercial transaction.

In June 2007, First, American issued a $486 million loan policy to Credit Suisse insuring additional construction financing for the development of Lake Las Vegas, a resort located 20 miles northeast of Las Vegas in Henderson, NV. As construction continued, the economic downturn hit and contractors started to file mechanic's liens in the millions of dollars. First American undertook to defend Credit Suisse in these actions. Then First American discovered that the “loan product” that it had insured permitted the developers to take out their profits before paying the contractors. First American also discovered that in the to-be-expected bankruptcy proceeding, Credit Suisse had obtained an order permitting it to provide debtor in possession financing to the bankrupt developers with lien priority over the financing insured by First American. In September 2009, First American brought suit in the United District Court for the southern District of Nevada, Las Vegas Division (Case No. 2:2009cv01743) asking the court to rescind the policy it had issued to Credit Suisse. The basis for the request ran in First American's Complaint from (a) to (m), but all boiled down to the allegation that Credit Suisse's loss arose from matters excluded from the policy coverage because such matters were “suffered, created, assumed or agreed to by Credit Suisse.”

The Chill Is Real

The foregoing cases confirm that the chill emanating from various title claims department is not imaginary. The title companies are not waiting to be sued by their insureds for breach of the policy. The underwriters are instead bringing suit against their insureds for causing the losses through the insureds' own negligent or reckless underwriting. In effect, the underwriters are saying that the lenders have no coverage under the title polices when the lenders “created, suffered assumed, or agreed to” the losses. This strict scrutiny of the lender's claim and denial of coverage is especially likely to occur when the claimant is a “bad boy lender,” a situation that has suffered negative publicity in the press, i.e., Countrywide, Lehman Brothers or Credit Suisse.

The question for both the title underwriters and the lenders, which, let's face it, need each other to prosper, is whether the chill in the air is a harbinger of the common cold or Ebola. For the underwriters, finding valid ways not to pay huge claims, caused in their minds by bad boy lenders with lax if not negligent or reckless loan underwriting, is a matter of economic survival. For the policyholder, the question is whether title insurance is worth the cost if the lender will have to defend its loan underwriting practices whenever its counsel files a claim. None of the cases discussed above have been decided by a court ' yet. If and when the decisions start to come down, we will see if the era of insurer strict scrutiny of its policyholder's practices will survive. Until then, lenders should expect the chill to continue.

Marvin Bagwell is the president and CEO of Bagwell & Associates Title Agency, located in New York City.