Volume 18, Number 6
REAL ESTATE LAW
Why You Need Title Insurance
By Marietta Morris Maxfield
Several recent investment scenarios underscore the need for title insurance to protect investors and lenders. Title insurance offers reliable protection for an owner's investment through an owner's title policy and guarantees a lender's priority through a mortgagee title policy, usually titled a loan policy.
Misfortune at the Baja Beach Club. In 1972 the Agrarian Reform Ministry of Mexico erroneously approved a map of execution that formed the basis of a 1973 presidential resolution that granted property located on the Baja Peninsula to a local land cooperative group. The group later leased the twice-titled land to developers or directly to American retirees. These retirees were subject to eviction based on a provision in the Mexican Constitution prohibiting foreigners from owning property on the peninsula.
In 1970, the president of Mexico issued a resolution that authorized a Mexican bank to act as trustee for a foreign beneficiary and lease land in the restricted area for the benefit of the foreign investor. In 1989, the maximum lease term was extended. The standard trust contract provides that the beneficiary is the owner of the improvements built on the land. It also provides that at the end of the lease, the trustee bank must sell the land and improvements and pay the proceeds to the beneficiary.
To promote tourism and industry, in 1970, the president of Mexico issued a resolution that authorized a Mexican bank to act as trustee for a foreign beneficiary and lease land in the restricted area that includes land 100 kilometers from the border and 50 kilos from the Mexico coast line. In 1989, the maximum lease term was extended from 30 to 50 years. The standard trust contract (called a "fideicomisco") provides that the beneficiary is the owner of the improvements built on the land. It also provides that at the end of the lease, the trustee bank must sell the land and improvements and pay the proceeds to the beneficiary. Although the leases at the Baja Beach Club were not held by Mexican Banks in legal "fideicomiso" form, the Mexico Supreme Court ruled that the Baja leases were void, because the president of Mexico had previously granted the same land in 1952, thereby rendering void the 1973 presidential grant to the Ejido.
The losses suffered by American investors on the Baja Peninsula serve as a warning to all foreign investors to cover their real estate investments with a title insurance policy. There is a strong probability that if the Mexican developer had ordered a title policy, the title examiner would have discovered the 1972 map error, and the American investors could have avoided the entire fiasco by leasing from lawful owners. If the error had not been discovered, the title insurance company would have paid 100 percent of the policy amount to each policyholder that filed a claim.
The Stoval Strip-A "vacancy" in Texas. When Texas became a state, it dedicated all public land not officially granted to individuals and not held for other public purposes to a permanent fund for the support of public free schools. Some land in Bastrop County was left over from two large Mexican or early Texas land grants that did not quite meet. Such a discrepancy is known as a "vacancy." Although this was public land, the state never claimed it, and the surrounding landowners eventually asserted ownership.
In 1999, a local company conducted a comprehensive title search while looking for property on which to expand. Inquiries from the company prompted the General Land Office to order a new survey, which identified as state property a vacancy consisting of a strip of land (Stoval Strip). Since the land belonged to the state, the General Land Office was required to sell the property. Accordingly, the General Land Office offered every landowner whose property encroached on the strip a first option to purchase the land.
Those landowners who had purchased owner's title policies when they acquired their property merely filled out the appropriate forms required by the state. The underwriters paid the General Land Office on behalf of the insureds, including all taxes and fees. These title policyholders walked away with clear title to their land encroaching on the Stoval Strip. However, those landowners who failed to purchase owners' title policies will have to wait to learn whether state legislators and voters will approve a constitutional amendment granting them clear title to their property.
Forged deeds in New York. Title insurance also covers owners and lenders for forgery losses. A New York man succeeded in forging deeds and selling several houses or apartment buildings. It took only one day for the salesman to tour the area, make a list of vacant properties, obtain copies of pertinent deeds, and file his forged deeds. In a short time, the new owner of record (the salesman) had advertised these properties and entered into contracts with ready buyers.
A buyer loses 100 percent of the investment if property is purchased from a deed forger that has no ownership interest in the property. Owner's and loan title insurance policies cover forgery losses that cause any title failure of the insured property or the land securing an insured mortgage. In cases of total title failure, the title underwriter will pay the title policyholder 100 percent of the total policy amount.
Low-cost and long-term coverage. The purchaser of an owner's title insurance policy pays a one-time premium at closing that covers the insured under that policy until the property is sold or until the lease ends. The policy continues to cover a property for as long as the policyholder owns the property. The loan policy covers the term of the loan underlying the insured mortgage. This coverage extends to the lender and the lender's assignees.
The simultaneous rate for a loan policy is a token amount if purchased simultaneously with the issuance of an owner's title policy covering real estate with the same legal description as the mortgage securing the loan. Lenders require new title policies in connection with refinancing loans or home equity loans. The homeowner/borrower usually pays the premium on the loan policy.
Constructing title insurance alternatives. Proposed alternatives to title insurance fail to provide the same protection as title insurance. In the early 1990s, proponents of casualty insurance for title-related matters criticized the delay connected with the issuance of a loan policy. To address the problem, they advocated elimination of the preliminary title search that is required to guarantee good and indefeasible title to the land securing the mortgage and recommended fixing the title when and if someone complained after the closing of a loan.
Some lenders have suggested substituting the borrower's credit for inquiring into the ownership of the land underlying the mortgage. One large lender tried writing secured loans based on a certificate of ownership and encumbrances, without a complete title search. The certificate offered some assurance to the lender, but no protection was offered to the borrower/owner. These alternatives offer no protection against the real estate scams and fraud that often surface during a real estate title search. Such approaches also ignore the fundamental role of title insurance, which has provided stable and reliable real estate records for the American public. In addition to abandoning the clean up of the land records, which the title insurance process helps facilitate, casualty insurance is more expensive because the premiums must be paid annually to keep the policy in force. In contrast to title insurance, which requires one-time premium, casualty insurers must charge annual premiums to sustain reserves for casualty risks.
Title insurance has taken an intelligent approach to casualty risks by factoring several types of casualty risks into the one-time policy premium (that is set to sustain reserves necessary to protect title policyholders). Title underwriters also issue insured closing letters (ICLs), which guarantee the honesty of the title agent, who receives the lender's funds or the buyer's funds (or both) and holds the funds in the agency escrow account before the closing. In case of defalcation, the title underwriter guarantees the lawful owner a refund of all money fraudulently stolen or missing from the escrow account.
Secondary market and mortgage-backed securities. For decades, Fannie Mae and Freddie Mac have listed title insurance in their requirements for including loans in the mortgage pools purchased for the secondary market. Title insurance has been integral to the due diligence required to protect the integrity of registrations of mortgage-backed securities. Title insurance assures the integrity of mortgages, which constitute the underlying value of real estate securities sold on the secondary market.
Credit agencies that rate real estate securities offerings require title insurance endorsements tailored to the character of the real estate underlying the mortgages. For example, certain endorsements are used for mortgage participations sold by a single-purpose entity on a single site, whereas different endorsements are required for multisite participations. Some class actions are based on allegations that fraudulent loans sold to the public turn out to be loans without real parties and without actual underlying mortgages. Lawyers use title insurance as part of the due diligence defense to these class actions.
Marietta Morris Maxfield is vice president/special counsel of Stewart Title Guaranty Company in Houston, Texas.
This article is an abridged and edited version of one that originally appeared on page 8 of Probate and Property, May/June 2001 (15:3).