Understanding Title Insurance and Common Endorsements - ABA YLD 101 Practice Series

By Gina Matthiesen

Many new real estate lawyers seem to be confused about what title insurance is, and is not, and also misunderstand the nature and purpose of title insurance endorsements. This confusion is not surprising, since title insurance is generally not covered in the property courses we take in law school. When your clients purchase real estate, they want good and marketable title to the property, and would be rather upset if they were to lose their property (and money) due to a hidden defect in title. Title insurance offers protection, through indemnification, to the insured from such losses. (Therefore, always advise your clients buy their own title insurance policy.) The purpose of this article is to generally explain what title insurance is and to list some common endorsements. This article will only discuss Owner's and Lender's policies. For more information concerning other policies, such as Leasehold or Construction Loan policies, and other available endorsements, please consult your local title agent and title company websites.

Title
First, it is important to understand what "title" to real estate is. To refresh your memory from property class, title to real estate is a "bundle" of legal rights, such as ownership, possession, exclusion, and right to alienation, which a person or entity has over a unit of real property, such as a parcel of land, a building, or a condominium unit. "Title" also commonly refers to the instrument (deed) which grants fee simple interest (ownership) of real property. However, title insurance may be purchased for several types of interests in real property, including fee simple, lien holder (the most common being the bank services the mortgage), and leasehold. When dealing with title insurance companies, please note that you may hear a title insurance agent refer to any of these interests in land, or their corresponding granting instruments, as "title."

Title Commitments and Title Policies
A title insurance policy is an indemnity contract that will reimburse the insured for losses in the event that another person or entity asserts a claim against the property that is covered by the policy. A purchaser of real property should purchase an Owner's Policy, and a mortgage lender should purchase a Lender's Policy. Do not make the new lawyer mistake of thinking that the Lender's policy will also indemnify the purchaser for losses, because it will not.

Another issue to be aware of are the risks that are covered themselves. The covered risks are found on the jacket of the title policy, and are subject to the exclusions, conditions, and exceptions from coverage. Additionally, Schedule A more specifically lists insured matters (name of the insured and title holder, insured's interest in the property, date of policy, amount of coverage, and legal description). The exclusions from coverage, which include things like losses caused by zoning restrictions or eminent domain actions commenced after the policy has been issued, or by fraud or liens caused by the insured, are also found on the jacket of the policy. Conditions, such as the limitations of liability and procedures for making claims, also appear on the jacket. Finally, exceptions are found in Schedule B, and include such things as encroachments, easements, prior mortgages, and other matters found in the title examination or shown by a survey of the property. Do not make the new lawyer mistake of thinking that losses from the encroachment that appears in Schedule B are covered by the policy, they are not.

Title examiners search the public records regarding the following four areas to create the initial title commitment: (1) real estate taxes and special assessments that appear in the public records affecting the specific property in question; (2) documents recorded against the specific property in question, generally going back for only the last 50 years (deeds, mortgages, condominium declarations, mechanics liens, leases, etc.); (3) a name search for documents recorded against the buyer and seller (judgments, federal and state liens, bankruptcies, etc.); and (4) a search for court documents as necessary, depending on the results of the previously listed searches. Also, the title examiner will add easements, encroachments, and other matters revealed by the survey of the property to the title commitment.

Once the title examiner finishes all the title searches listed above, the title company will issue the title commitment which lists the results of the examiner's searches. Additionally, the title commitment creates a contractual obligation for the title company to issue a policy, once the transaction is satisfactorily closed. Prior to close, the title company should update the title commitment, to see if any new matters affecting the property have been raised, and to remove any exceptions that have been cleared prior to close. The most important thing to remember is that the title commitment, and resulting policy, is NOT a guarantee of title. Nor is the title commitment an abstract of title, which would list all documents recorded, and therefore all potential documented claims, against the property since the original land grant from the United States government. Rather, the title commitment provides the current state of title, usually only dated to the prior deed, based on public documents and the survey, and provides directions leading to the acceptable completion of the transaction (real estate taxes to be paid, mechanics liens to be paid, mortgages to be released, documents to be recorded, etc.). The insurance policy, issued by the underwriter once the transaction is completed is simply the state of title that the title company is willing to insure.

Title Clearance
There are five general exceptions that will appear on any title commitment:

  1. Rights or claims of parties in possession not shown by public records;
  2. Encroachments, overlaps, boundary line disputes, or other matters which would be disclosed by an accurate survey and inspection of the premises;
  3. Easements, or claims of easements, not shown by the public records;
  4. Any lien, or right to a lien, for services, labor or materials heretofore or hereafter furnished, imposed by law, and not shown by the public records;
  5. Taxes or special assessments which are not shown as existing liens by the public records.

Generally, these exceptions can be deleted upon the production of a proper ALTA Survey, an executed ALTA Statement (promising, among other things, that neither party has entered into any undisclosed contracts effecting the property), and Extended Coverage Affidavit (promising, among other things, that neither party has entered into any undisclosed utility agreements effecting the property). You can view a sample ALTA Statement and Extended Coverage Affidavit at LandAmerica's "Document Library" http://www.landamericaillinois.com/RS-Illinois/Resources/Form_Library.html. Having all five of these exceptions removed is called "extended coverage," and costs extra to purchase. However, most purchasers of commercial real estate will want extended coverage despite the extra cost, and most lenders demand extended coverage as a condition to loan closing.

Many other exceptions (Schedule B items) can be removed either prior to or during closing. The most common exception, other than real estate taxes, that you will see will be Seller's mortgage(s) on the property. Generally, the Seller will pay off its prior mortgages from closing proceeds and obtain releases from its lender, which will clear the mortgage exception(s) from Schedule B. Real estate taxes will also be paid through closing, so the real estate tax exception will read "Taxes not yet due or payable". Some exceptions, such as those requesting the authority documents of any entity involved in either selling or purchasing the property, will be removed with the proper production of the entity's authority documents (corporate resolutions, partnership agreements, etc.).

Finally, some exceptions will remain on title, and the purchaser will either have to terminate the transaction (subject to any penalties imposed by the Purchase and Sale Agreement) or take the property subject to these exceptions. For example, the title company will not remove or insure over easements that are still in place, unless the easement has been clearly terminated. The title company will also not remove an exception for a "party wall" that separates the subject property from the neighboring property. The best approach to dealing with these exceptions is to work closely with both your client and the title company to discuss what can be done to either remove or reduce the risk associated with unwanted exceptions to title. However, do not make the new lawyer mistake of asking that utility easements be removed simply so your client can have a clean title commitment-your client probably wants both electricity and running water on the property!

Endorsements
Policy endorsements, such as Zoning or Access and Entry, can be purchased to expand the policy's coverage to include either a specific risk, or a category of risks, related to the subject property. Generally, residential buyers purchase no extra coverage, although their lender may demand a couple of endorsements, such as Variable Rate or Environmental Liens, as a condition for closing. Both purchasers and lenders involved in commercial real estate transaction will normally request or demand several endorsements. Here are short general descriptions of some of the more commonly requested endorsements:

Access and Entry-Direct (ALTA Form 17)
The Access and Entry-Direct endorsement may be issued for either the Owner's or Lender's Policy. The Access and Entry endorsement protects the insured against losses caused by the lack of a right of access to and from the land via a specific street(s). The underwriter will issue this endorsement after examining the survey to make sure that (a) there is actual vehicular and pedestrian access to a street(s) named in the endorsement; (b) the street(s) is physically open and publicly maintained; and (c) the owner of the land has the right to use the existing curb cuts along the named street(s). Please note that there is also an access and entry endorsement specific to indirect access (ALTA Form 17.1), such as by easement over another property, which will not be discussed in this article. Be sure to talk to your underwriter when requesting the Access and Entry endorsement, so you can supply any information besides the survey required for coverage. Owners and Lenders request this endorsement to ensure that access to the property is through the street(s) that they expected, rather than by an indirect route.

Comprehensive/Restrictions, Encroachments, and Minerals (ALTA Form 9)
The Comprehensive endorsement may be issued for either an Owner's or Lender's Policy. The Comprehensive endorsement protects the insured against losses caused by: (1) violations of enforceable covenants, conditions, or restrictions (CCRs) attached to the subject property; (2) encroachments that are somehow missed on a proper ALTA survey; and (3) the exercise of rights to remove minerals from the subject property. The underwriter will review the CCRs recorded against the land, investigate any liens against the land which may involve the CCRs or encroachments, and an ALTA survey of the land before issuing this endorsement. Generally, the title company will cautiously issue this endorsement when there are current actions against the property owners regarding CCR or encroachment violations, provided the violations are minimal. Otherwise, the endorsement will not be issued if there are current actions pending for such violations. This endorsement also will not be issued if any minerals are currently being mined on the land, or if there are other exceptions in Schedule B concerning minerals and mineral rights that have not expired or been released. Be sure to talk to your underwriter when requesting the Comprehensive endorsement, so you can supply all information required for coverage. This is an excellent endorsement to learn more about, since it is probably the most requested by both lenders and purchasers of commercial real estate. The following article provides an excellent explanation of the use of the Comprehensive endorsement: John C. Murray and Philip N. Webb, 2000. "Title Insurance Endorsements for Commercial Real Estate Transactions." http://www.firstam.com/listshortcut.cfm?id=3318&menu=688.

Creditors' Rights Endorsement (ALTA Form 21)
The Creditors' Rights endorsement may be issued for either the Owner's or Lender's Policy. The Creditors' Rights endorsement protects the insured from losses due to any interest created under the transfer and shown in Schedule A (covered matters) becoming void because of a fraudulent transfer or a preference under federal bankruptcy, state insolvency, or other creditors' rights laws. Coverage includes indemnification of the insured for courts costs needed to defend against claims brought under these statutes; for example, suits that may result in equitable subordination of the lender's interest (see 510(c) of the Federal Bankruptcy Code). However, coverage does not extend in situations where the insured knew of the fraudulent transfer or pending bankruptcy litigation (which was not yet filed or recorded), or in cases where the insured specifically transferred the property to avoid its creditors. Defending actions arising from creditors' rights laws can be very expensive, so title companies are rather cautious about issuing the Creditors' Rights endorsement. Be sure to talk to your underwriter when requesting this endorsement, so you can supply the extensive information required for coverage. The following article provides an excellent explanation of Creditors' Rights coverage: John C. Murray, 2007. "Creditors' Rights Coverage in Title Policies: Does Deletion of the Exclusion Imply Coverage?" http://www.firstam.com/content.cfm?id=3378.

Environmental Liens (ALTA Form 8.1)
The Environmental Liens endorsement is only issued for the Lender's Policy. The Environmental Liens endorsement insures the lender against losses caused by the loss of priority of its lien (the insured mortgage) over a governmental body's lien for charges incurred in relation to the cleanup and remediation of hazardous waste sites. However, the title company will except losses incurred due to the State's environmental protection lien statute from coverage. Generally, lenders want this coverage to protect their status as first lien holder, rather than because the site is a known hazardous waste dump. Be sure to talk to your underwriter when requesting the Environmental Lien endorsement, so you can supply any information required for coverage.

Variable Rate (ALTA Form 6)
The Variable Rate endorsement is only issued for the Lender's Policy. The Variable Rate endorsement insures the lender against losses caused by the invalidity, loss of priority, or unenforceability of its lien (the insured mortgage) resulting from provisions that provide for changes in the rate of interest. However, this endorsement does not insure the lender against losses resulting from violations of usury, consumer credit protection, or truth in lending laws. Also, this endorsement will generally only be issued to conventional lenders such as banks, savings and loans, and mortgage bankers. Be sure to talk to your underwriter when requesting the Variable Rate endorsement, so you can supply all information required for coverage.

Zoning - Improved Land (ALTA Form 3.1)
The Zoning endorsement may be issued for either the Owner's or Lender's Policy. The Zoning endorsement first assures the insured that the property is zoned a specific code (B-1 for example) and then lists the permissible uses of the property under that zoning code (Neighborhood Shopping District, which allows the following. . .). This endorsement covers losses incurred if government authorities later determine that the subject property does not comply with the listed zoning code. The underwriter will inspect the zoning code and survey to make sure that the subject property is in compliance with zoning restrictions before agreeing to issue this endorsement. For example, if the subject property complies with all the requirements of B-1 (Neighborhood Shopping District), the underwriter is likely to issue the endorsement. If the subject property is a factory situated in B-1, or exceeds the building height allowed by B-1, the underwriter will not issue the endorsement. Be sure to talk to your underwriter when requesting the Zoning endorsement, so you can supply all information required for coverage. Please note that there is also a zoning endorsement specific to unimproved land (ALTA Form 3), that will not be discussed in this article.

Concluding Remarks
It pays for you as a real estate lawyer to understand the basics of title insurance, so you can better advise your clients on title and insurance matters regarding the subject property. Additionally, understanding and being able to explain the coverage provided not only helps you guide the transaction efficiently, but also to quickly learn the local laws (such as property and transfer tax) affecting real estate transactions. Finally, understanding title insurance coverage will help your clients avoid financial losses and lawsuits, and you to avoid malpractice claims, in the future.


Resources:
American Land Title Association (ALTA). "Questions About Title Insurance" http://www.alta.org/consumer/questions.cfm
American Land Title Association (ALTA). "Policy Forms Online" http://www.alta.org/forms/
First American Corporation. "Reference Articles" http://www.firstam.com/listshortcut.cfm?id=5282&menu=602
First American Title Insurance Company. "Underwriting Library" http://ulj.firstam.com/ul/ulstart.do
LandAmerica Financial Group, Inc. "KnowYourClosing.com" http://www.knowyourclosing.com/
LandAmerica Financial Group, Inc. "Document Library" http://www.landamericaillinois.com/RS-Illinois/Resources/Form_Library.html
Chicago Title Company. "Information Library" http://www.chicagotitle.com/DesktopDefault.aspx?tabid=113

Resources

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About the Author

Gina Matthiesen graduated from the Chicago-Kent College of Law. Gina previously worked in the Title Insurance industry, as both an escrow and title agent. Currently, she practices real estate, business, contracts, and securities law at Bleakley & Associates, LLC located in Chicago, Illinois. She can be reached via email at: gmatthiesen@yahoo.com.

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