Lender Liability for the Acts of Settlement Agents

Suppose you are lender's counsel. You receive a call from a homeowner who has just been served with a summons and complaint foreclosing the mortgage from his prior closing, which he thought your bank, as his new lender, had paid off. Your stomach falls into a pit. You confirm that yes, your bank provided the homeowner with a mortgage a few months ago. You also confirm that the bank your mortgage paid off at the closing is the bank that is bringing the foreclosure action. You are not panicking yet, because if as you suspect, the bank's closing attorney absconded with the pay-off funds, the title company, under its closing protection letter (CPL), will cover your loss. CPLs indemnify lenders or mortgagees against loss caused by improper acts or omissions by the lender's settlement agent such as the improper execution of the loan documents or the misappropriation of the loan funds. Then you examine the loan file and you discover to your horror that the property is located in New York. Now you begin to panic.

What's the Problem?

You recall that there is problem with CPLs in New York. You go online and see if your memory is correct or if you are having a senior moment. You discover that your worst fears ring true. Your research reveals that on Dec. 14, 1992, New York's Superintendent of Insurance issued Circular Letter No. 18 (1992), which prohibited New York-licensed title insurers from issuing CPLs in that state. The Superintendent found that CPL issuance exceeded title insurers' statutory license and writing authority because such letters constitute fidelity insurance.

“Consequently,” said the letter, “under no circumstances should a title insurer licensed in this State issue closing protection letters in the future with respect to New York real property transactions.” The Superintendent provided one exception: Title insurers are not precluded from issuing agent authorization letters confined to the title insurer's liability as principal to its agent, within the scope of the agent's authority.

An Opinion Letter issued on Dec. 28, 2005 (Opinion No. 5-12-24) affirmed the prior prohibition and answered a question left open by the Superintendent's earlier letter: When the title agent also acts as the lender's attorney, the agent authorization letter is limited to activities within the scope of the agent's duties as title agent. Therefore, when the title agent is also the lender's counsel, an agent's authorization letter issued to the lender provides no comfort to the lender regarding the funds that the lender entrusts to its attorney.

Two Cases in Point

What happens in New York, you wonder, when in the absence of a CPL, the attorney to whom the lender forwarded the funds that were intended to fund a mortgage, misappropriates the lender's funds? Two cases are directly on point.

In Fidelity National Title Insurance Company v. Consumer Home Mortgage Inc., 272 A.D.2d 512 (2000), the Consumer wired funds to the law firm, Ferrara & Associates and its named partner, Perry Ferrara, to act as the settlement service provider for a refinance mortgage closing. Ferrara was supposed to disburse the funds at a closing to pay off the borrower's prior mortgage. When Ferrara's check to the prior lender was dishonored, Fidelity refused to record the mortgages for lack of consideration, and filed a declaratory action requesting the court to determine its obligations under its title policy. The court held that Fidelity properly denied coverage pursuant to a clause in its policy, which excluded coverage for a loss suffered by a lender where the lender “created, suffered, assumed, or agreed to” the loss. (ALTA Loan Policy Form, Exclusion 3(a)). Here, the court imputed Ferrara's action to the Consumer, because the Consumer had designated Ferrara as its settlement service provider, wired the funds to his escrow account and further authorized him to perform certain functions on its behalf at the closing. Commerce, and not Fidelity, had to bear the cost of the loss because “the loss should fall on the one who enabled the fraud.”

In a more recent case, Fidelity National Title Insurance Company v. Cole Taylor Bank, 2012 WL 2814001, the settlement agent stole the funds for her own use, as in Commerce. Attorney theft has now become an equal opportunity sport. Fidelity denied Cole Taylor's claim for reimbursement based upon the “created, suffered, assumed or agreed to” exclusion in the policy. Cole Taylor argued that because the settlement agent in this case was also a title agent for Fidelity, the agent was Fidelity's agent for all purposes and not just for issuing the title policy. However, under its agency agreement with Fidelity, the attorney was prohibited from engaging in settlement activities. In upholding Fidelity's denial of coverage, the court rejected Cole Taylor's argument that because of custom and practice, Fidelity's agent had apparent authority to act on Fidelity's behalf. The court noted that Cole Taylor was unable to point to any words or conduct by Fidelity that would cause Cole Taylor to believe that the attorney was acting as settlement agent on Fidelity's behalf. The fact that Fidelity audited its agent's escrow account was legally insufficient to establish that its title agent was acting as Fidelity's settlement agent as well.

Other States

New York's rule is not universal. In states such as Michigan where title companies issue CPLs regularly, the courts have held that the letters impose liability on title companies independent of the policy. Fifth Third Mortgage Company v. Hance, 2011 WL 4501573.

Another solution is for the insurers to charge a premium for the letter, as in New Jersey, where the title underwriter is entitled to charge a $75.00 special risk premium for the issuance of a closing service letter. In that state, the cost of the title insurer's risk is borne by the entire marketplace, a concept generally inherent in insurance coverage. In New York, however, the Insurance Department chose banning CPLs entirely instead of imposing the cost of the risk upon lenders (and ultimately upon consumers). One can debate the wisdom of the respective positions. What is incontrovertible is that the lender's exposure to a settlement's agent theft of the funds entrusted to the agent is simply a cost of doing business in New York. The decision as to whether the cost is worth it is up to you, as lender's counsel, and up to your accountants.

Other Solutions?

An afterthought occurs to you. Why not divide the settlement process into two parts: the first devoted to the execution of the documents and the second to the disbursements of the funds? Let the settlement agent perform the first, but wire the funds to the title underwriter instead of to the settlement agent? That way the underwriter cannot invoke the “created, suffered, assumed or agreed to” policy exclusion. Title underwriters are willing to provide a disbursement service at no or little cost to the lender (which you can always pass on to the borrower anyway), provided that one of the underwriter's agents is insuring the title. Usually, underwriters are willing to provide its disbursement service only if the transaction is $1 million or more, but they have been known to make exceptions. Even though few members of the bar misappropriate funds, to avoid the loss to the lender and the inconvenience of cleaning up afterwards, it might be worthwhile to turn the disbursement function over to the title underwriters. The cost of doing business in New York just went down.

Marvin N. Bagwell is Chief New York State Counsel for Old Republic National Title Insurance Company and is based in Westbury, NY.

Suppose you are lender's counsel. You receive a call from a homeowner who has just been served with a summons and complaint foreclosing the mortgage from his prior closing, which he thought your bank, as his new lender, had paid off. Your stomach falls into a pit. You confirm that yes, your bank provided the homeowner with a mortgage a few months ago. You also confirm that the bank your mortgage paid off at the closing is the bank that is bringing the foreclosure action. You are not panicking yet, because if as you suspect, the bank's closing attorney absconded with the pay-off funds, the title company, under its closing protection letter (CPL), will cover your loss. CPLs indemnify lenders or mortgagees against loss caused by improper acts or omissions by the lender's settlement agent such as the improper execution of the loan documents or the misappropriation of the loan funds. Then you examine the loan file and you discover to your horror that the property is located in New York. Now you begin to panic.

What's the Problem?

You recall that there is problem with CPLs in New York. You go online and see if your memory is correct or if you are having a senior moment. You discover that your worst fears ring true. Your research reveals that on Dec. 14, 1992, New York's Superintendent of Insurance issued Circular Letter No. 18 (1992), which prohibited New York-licensed title insurers from issuing CPLs in that state. The Superintendent found that CPL issuance exceeded title insurers' statutory license and writing authority because such letters constitute fidelity insurance.

“Consequently,” said the letter, “under no circumstances should a title insurer licensed in this State issue closing protection letters in the future with respect to New York real property transactions.” The Superintendent provided one exception: Title insurers are not precluded from issuing agent authorization letters confined to the title insurer's liability as principal to its agent, within the scope of the agent's authority.

An Opinion Letter issued on Dec. 28, 2005 (Opinion No. 5-12-24) affirmed the prior prohibition and answered a question left open by the Superintendent's earlier letter: When the title agent also acts as the lender's attorney, the agent authorization letter is limited to activities within the scope of the agent's duties as title agent. Therefore, when the title agent is also the lender's counsel, an agent's authorization letter issued to the lender provides no comfort to the lender regarding the funds that the lender entrusts to its attorney.

Two Cases in Point

What happens in New York, you wonder, when in the absence of a CPL, the attorney to whom the lender forwarded the funds that were intended to fund a mortgage, misappropriates the lender's funds? Two cases are directly on point.

In Fidelity National Title Insurance Company v. Consumer Home Mortgage Inc., 272 A.D.2d 512 (2000), the Consumer wired funds to the law firm, Ferrara & Associates and its named partner, Perry Ferrara, to act as the settlement service provider for a refinance mortgage closing. Ferrara was supposed to disburse the funds at a closing to pay off the borrower's prior mortgage. When Ferrara's check to the prior lender was dishonored, Fidelity refused to record the mortgages for lack of consideration, and filed a declaratory action requesting the court to determine its obligations under its title policy. The court held that Fidelity properly denied coverage pursuant to a clause in its policy, which excluded coverage for a loss suffered by a lender where the lender “created, suffered, assumed, or agreed to” the loss. (ALTA Loan Policy Form, Exclusion 3(a)). Here, the court imputed Ferrara's action to the Consumer, because the Consumer had designated Ferrara as its settlement service provider, wired the funds to his escrow account and further authorized him to perform certain functions on its behalf at the closing. Commerce, and not Fidelity, had to bear the cost of the loss because “the loss should fall on the one who enabled the fraud.”

In a more recent case, Fidelity National Title Insurance Company v. Cole Taylor Bank, 2012 WL 2814001, the settlement agent stole the funds for her own use, as in Commerce. Attorney theft has now become an equal opportunity sport. Fidelity denied Cole Taylor's claim for reimbursement based upon the “created, suffered, assumed or agreed to” exclusion in the policy. Cole Taylor argued that because the settlement agent in this case was also a title agent for Fidelity, the agent was Fidelity's agent for all purposes and not just for issuing the title policy. However, under its agency agreement with Fidelity, the attorney was prohibited from engaging in settlement activities. In upholding Fidelity's denial of coverage, the court rejected Cole Taylor's argument that because of custom and practice, Fidelity's agent had apparent authority to act on Fidelity's behalf. The court noted that Cole Taylor was unable to point to any words or conduct by Fidelity that would cause Cole Taylor to believe that the attorney was acting as settlement agent on Fidelity's behalf. The fact that Fidelity audited its agent's escrow account was legally insufficient to establish that its title agent was acting as Fidelity's settlement agent as well.

Other States

New York's rule is not universal. In states such as Michigan where title companies issue CPLs regularly, the courts have held that the letters impose liability on title companies independent of the policy. Fifth Third Mortgage Company v. Hance, 2011 WL 4501573.

Another solution is for the insurers to charge a premium for the letter, as in New Jersey, where the title underwriter is entitled to charge a $75.00 special risk premium for the issuance of a closing service letter. In that state, the cost of the title insurer's risk is borne by the entire marketplace, a concept generally inherent in insurance coverage. In New York, however, the Insurance Department chose banning CPLs entirely instead of imposing the cost of the risk upon lenders (and ultimately upon consumers). One can debate the wisdom of the respective positions. What is incontrovertible is that the lender's exposure to a settlement's agent theft of the funds entrusted to the agent is simply a cost of doing business in New York. The decision as to whether the cost is worth it is up to you, as lender's counsel, and up to your accountants.

Other Solutions?

An afterthought occurs to you. Why not divide the settlement process into two parts: the first devoted to the execution of the documents and the second to the disbursements of the funds? Let the settlement agent perform the first, but wire the funds to the title underwriter instead of to the settlement agent? That way the underwriter cannot invoke the “created, suffered, assumed or agreed to” policy exclusion. Title underwriters are willing to provide a disbursement service at no or little cost to the lender (which you can always pass on to the borrower anyway), provided that one of the underwriter's agents is insuring the title. Usually, underwriters are willing to provide its disbursement service only if the transaction is $1 million or more, but they have been known to make exceptions. Even though few members of the bar misappropriate funds, to avoid the loss to the lender and the inconvenience of cleaning up afterwards, it might be worthwhile to turn the disbursement function over to the title underwriters. The cost of doing business in New York just went down.

Marvin N. Bagwell is Chief New York State Counsel for Old Republic National Title Insurance Company and is based in Westbury, NY.