Quantum of Solace: Title Insurance Coverage and Failures of Title
Lawyers and real estate professionals all know that it would be imprudent in the least to walk away from the closing of a real estate transaction as a buyer without a title insurance policy insuring that marketable title has been vested in the name of the buyer with coverage (the “Amount of Insurance”) equivalent to the purchase price. Moreover, it is common in development deals to finish the construction project with an owner’s title insurance policy in hand insuring an amount of coverage equal to the full investment in the development (i.e., the cost of the land plus the cost of construction). Armed with their title insurance policies, many owners, developers and real estate professionals, however, might be soundly sleeping through the night with a significant misunderstanding as to how much will be recoverable under their title insurance policy if title proved to be unmarketable. As our nascent economic recovery gains momentum and real estate development begins to rebound, it is worthwhile to stop and spend a moment visiting this matter, especially in the context of a failure of marketable title worst case scenario.
The commonly used ALTA Owner’s Title Insurance Policy Form adopted in 2006 is instructive and must be consulted when considering this issue. Section 8 under the pre-printed standard “Conditions of the Policy” addresses “Determination and Extent of Liability.” It provides in the “small print” as follows:
This policy is a contract of indemnity against actual monetary loss or damage sustained or incurred by the insured claimant who has suffered loss or damage by reason of matters insured against by this policy.
(a) The extent of liability of the [Title Insurance] Company for loss or damage under this policy shall not exceed the lesser of
(i) the Amount of Insurance; or
(ii) the difference between the value of the “Title” [(i.e., the estate or interest described in Schedule A of the policy)] as insured and the value of the Title subject to the risk insured against by this policy.
Hence, since Title being vested other than in the titleholder specified in Schedule A of the Policy and Title proving to be unmarketable are both covered risks under the Policy, if Title were ultimately determined to be vested in another party or otherwise proved unmarketable, the measure of recoverable loss or damage under the Policy would never exceed the “value” of the Title as insured regardless of the Amount of Insurance that was purchased. The title insurance company surely will rely on Section 8(a) and take the position that the fair market value of title to the property “as insured” accordingly sets a ceiling on the insured’s recovery regardless of the amount of insurance that was purchased. Interestingly, Section 4 of the Conditions of the Policy provides further that in the event the Company is unable to determine the amount of loss or damage, the Company may at its option require as a condition of payment that the insured claimant furnish a signed proof of loss and that the proof of loss must describe the defect, lien encumbrance or other matter insured against by the Policy that constitutes the basis of loss or damage and state to the extent possible the basis of calculating the amount of the loss or damage. To be sure, however, it is the title insurance company and not the insured which will make the determination of the amount of recoverable loss in the final analysis and that amount will likely never exceed the actual fair market value of title to the property.
This means that if the market value of your newly developed property is less than your investment in the same, that lesser fair market value undoubtedly will be asserted by the title insurance company as a cap upon your recovery even if it is less than the amount of insurance you purchased. Accordingly, in a new construction/development scenario, the fact that you spent many millions of dollars in acquiring the land and developing your property is irrelevant to the determination of your loss. Your largely, if not entirely, empty brand new shopping center, office building, or other development will be valued at its fair market value. This could be based on appraisal valuations utilizing the capitalization of net operating income even if your new project is not yet fully leased-up and stabilized and/or significantly discounting sales comparables since your project is not yet leased up. Similarly, an ultra-expensive custom “dream house” with luxury finishes may be valued by neighborhood sales comparables that suggest a fair market value far less than the out-of-pocket cost of development. [Remember the old adage: You never want to own the most expensive house in the neighborhood!] These approaches to valuation would likely yield an insurance recovery of far less than the actual cost of development/Amount of Insurance which was purchased.
In conclusion, title insurance is not intended to guaranty a minimum recoverable value for your real estate. As a contract of indemnity against actual loss, it will key its determination of loss to the fair market value of the property as insured should there be a failure of title. Depending on the jurisdiction, it is accordingly worth exploring whether a special endorsement to your policy might be available altering these loss determination provisions from the standard policy provisions especially where new commercial construction is involved and the cost of development is likely to initially exceed the value of the newly completed asset.