The typical title insurance policy is not assignable, does not continue coverage for the transferor after these transfers (except for deed warranties) and does not include a transferee in its definition of "insured." See generally Joyce Dickey Palomar, Limited Liability Companies, Corporations, General Partnerships, Limited Partnerships, Joint Ventures, Trusts--Who Does the Title Insurance Cover?, 31 Real Prop., Prob. & Tr. J. 605 (1997) (discussing who qualifies as an insured). In some circumstances, title insurance coverage may be preserved at a nominal cost or by paying a new title insurance premium. Other circumstances may justify proceeding without title insurance coverage for the new owner. This article considers this problem and proposes some solutions.
Estate Planning Transfers
An estate plan frequently involves the owner's conveyance of real estate during his or her lifetime. The most common transfer occurs when the owner establishes a revocable living trust. These popular estate planning devices can avoid probate proceedings following the transferor's death, provide a management vehicle for assets if the transferor is incapacitated before death and assure family privacy and ease of administration. A transferor typically establishes the trust and transfers all of his or her assets to the trustee (often the transferor) before death.
Lifetime gifts of real estate interests also are common for estate planning purposes. These gifts may be made outright to children or other beneficiaries to take advantage of the $10,000 per person annual gift tax exclusion or the unified credit for estate and gift tax purposes ($625,000 in 1998 and rising to $1 million by 2006). A donor may even make taxable lifetime gifts instead of taxable transfers at death because the donor pays the federal gift tax, the donee receives the entire gift and the donor is not paying gift tax on the amount of the gift tax. In contrast, in a taxable transfer at death, the entire estate is subject to estate taxes, so that funds used to pay the estate tax on the transfer are themselves subject to the estate tax (requiring considerably more value in the estate to yield the same net benefit to the donee).
Often lifetime gifts of real estate interests are made to irrevocable trusts for the benefit of children or other beneficiaries. These trusts allow a designated trustee to control and manage the property until the beneficiaries have reached an appropriate age to receive the property outright or even to hold the property in trust for the lifetime of the beneficiaries to take advantage of generation-skipping tax planning opportunities.
Individuals frequently transfer real estate to family corporations, partnerships and limited liability companies. These conveyances can permit the transferor to retain some control over the entity while making gifts of interests to family members and other beneficiaries. Substantial valuation discounts for transfer tax purposes are often available through this type of planning because the transfer is of an interest--typically a minority interest at that--in an entity, rather than a transfer of the property itself.
A transferor will usually make estate planning conveyances of real estate interests by limited warranty deed or quitclaim deed. The transferor and his or her advisors will frequently not analyze title insurance considerations in the context of these conveyances.
Who Is an "Insured"?
The most commonly used forms of owner's title insurance policy do not expressly cover the transferees in pre-death estate planning transfers. The ALTA 1992, 1990, 1987 and 1970 forms of owner's policy all define "insured" as the party named as the insured in the policy and "those who succeed to the interest of the named insured by operation of law as distinguished from purchase including, but not limited to, heirs, distributees, devisees, survivors, personal representatives, next of kin, or corporate or fiduciary successors." The ALTA 1979 and 1987 forms of residential policy both provide continuation of coverage for "anyone who receives your title because of your death."
Clearly, transferees by operation of law and on death are intended to be covered by the standard owner's policy, but purchasers are not. The estate planning transfers addressed in this article are typically gifts, not sales, and are not considered transfers by operation of law. If a claim is made, the title insurer may assert that the transferee is not an insured and deny coverage.
This defense might be considered extreme when the transfer is from the named insured to a revocable trust of which the named insured is trustee. Under the express language of the policy, however, the trust or trustee is not an insured. If the loss is large, a title company may well deny coverage. In a more complex transfer, such as to a family limited partnership, limited liability company or subchapter S corporation, through which family members acquire interests in the property or the transferee, a title company is likely to deny coverage on the same basis.
Newer forms of title insurance policies may be available in some states for an additional premium to address pre-death transfers to trusts. For example, in California, First American Title Insurance Company's "Eagle Protection" owner's policy expands the continuation of coverage provisions of the typical residential policy. That policy form includes protection for the "trustee or successor trustee of a trust in which you are the trustor/settlor to whom you transfer your title after the Policy Date." If that form of policy was issued and the named insured transfers the property to the trustee of a trust of which the insured is the trustor, then coverage continues and the discussion that follows is moot. In general, however, title to property transferred pursuant to pre-death estate planning transfers is probably not insured by the transferor's title policy.
Techniques to Continue Coverage
If this gap in title insurance coverage is recognized at the time of the transfer or shortly thereafter, there are several possible solutions that may be achieved with the title insurer.
* Additional Insured endorsement. The most common technique to close the gap is for the title company to issue an "Additional Insured" endorsement to the existing title insurance policy. An Additional Insured endorsement will specifically amend the policy to add the trust or other new title holder as a named insured. A form of Additional Insured endorsement accompanies this article.
The cost of an Additional Insured endorsement may be minimal--$100 or less. Many title companies will issue the endorsement on request for donees (including trustees of inter vivos trusts) who are acquiring title from the insured owner. Especially for transfers to entities other than trusts, the title company will require full disclosure of all particulars of the transaction, including the status and relationship of all parties. For its underwriting, the title company will want to determine whether the transfer is truly donative in nature and whether the transaction will other-wise expand the insurer's risk.
The coverage of an Additional Insured endorsement is no greater than that afforded by the original policy. Thus, the additional insured has no coverage for title defects arising after the original issuance date of the policy and the liability limit of the policy will not reflect any increase in property value from the original issuance date of the policy. Additionally, the endorsement provides no protection for the additional insured if the deed to the donee is itself defective for some reason. This last concern may result in malpractice exposure to the estate planner for errors in the deed. For example, in some states the property should be deeded to the trustee rather than to the trust itself. Many title companies consider transfers to a trust rather than the trustee as voidable, undermining title insurance coverage.
* New policy. The issue of continuing coverage and the problems attendant to an Additional Insured endorsement can be resolved by obtaining a new title insurance policy effective on recording the estate planning transfer, naming the transferee as insured and increasing the coverage to the current value of the property. The obvious downside to this approach is cost. A full premium will be due that, depending on the jurisdiction, can be considerable. In some jurisdictions, a lower reissue rate may apply.
* Warranty deed. The ALTA owner's policy forms generally provide that coverage continues "so long as the insured shall have liability by reason of covenants of warranty made by the insured in any transfer or conveyance of the estate or interest." The named insured involved in an estate planning transaction may be able to preserve the coverage of the original title policy by warranting title to the transferee (subject to the matters excepted in the original title policy), thus activating the continuation of coverage provision. If a title defect is discovered, the transferee could make a claim back against the transferor, who would be able to tender the claim to the title insurer. An obvious advantage of this solution is that there is no title insurance premium payable on the transfer.
In some states this technique would not be effective in an estate planning context because recovery under a warranty deed is limited to the consideration paid. Because the transferee has paid no consideration, the warranty would be ineffective. Thus, the named insured would have no liability for the warranty, and the continuation of coverage provision would not apply.
Even in states where the warranty is enforceable, the effectiveness of this technique is limited by the scope of the initial policy. As with the Additional Insured endorsement, the coverage would be limited to the initial date of policy issuance, would not afford coverage for defects in the transfer in question and would be
subject to the dollar limits of the initial policy.
The derivative nature of the transferee's claim under the title policy creates several additional concerns. Perhaps most basic is that the transferee must make a claim back against the transferor for breach of warranty to trigger any title insurance coverage. Although intended ultimately to be a claim against the title company,
this claim may appear to the transferor as a personal attack and may result in family squabbles. The transferor is faced with a suit by a seemingly ungrateful family member arising from an attempted gift. Also, the warranty ordinarily runs with the land and could be enforced against the original transferor by a successor property owner. These problems could be mitigated, perhaps, with a limitation on the transferor's warranty liability to the amount of recovery, if any, under the title insurance policy and a limitation of the warranty so that it only runs to the initial transferee.
Another defect in this approach is that the transferor's warranty covenant is personal to the transferor. Thus, if the transferor dies, claims must be made against his or her estate within the applicable statute of limitations. Nevertheless, title defects may not be discovered until after the limitations period has expired. In that case, there is no transferor liability on the warranty and, thus, no title insurance liability under the continuation of coverage provision.
* "Fairway" endorsement. If the estate planning transfer involves the substitution of the estate planning entity as a general partner into an existing partnership or a change of form from general to limited partnership, limited liability company or corporation, then title insurance coverage that would otherwise be lost may be preserved by negotiating a so-called "Fairway" endorsement to the existing title policy. The Fairway endorsement assures that the new partner or newly constituted partnership (depending on the jurisdiction's legal theory of partnerships) is considered an insured. This endorsement was first requested by insureds and issued by title companies in response to Fairway Development Co. v. Title Insurance Co. of Minnesota, 621 F. Supp. 120 (N.D. Ohio 1985). In Fairway, the court held that the transfer of the interests of two partners in an insured partnership to the remaining partner and a new partner terminated the original partnership and its title insurance coverage.
Many title insurers have become accustomed to underwriting and issuing Fairway endorsements. Even if an estate planning transfer does not involve a partnership or does not fit the parameters of a Fairway endorsement, an insured may be successful in obtaining a similar endorsement by analogizing it to a Fairway endorsement.
Mountain or Molehill?
The risk of losing title insurance coverage when an individual transfers title to himself or herself as trustee is quite real. When that risk can be eliminated for the nominal cost of an Additional Insured endorsement, the money is well spent.
If the title company will not issue the endorsement for a nominal cost, the lawyer and client are faced with a more difficult question of whether the significant premium cost is justified to avoid the risk of losing title insurance coverage. A similar question is posed for increases in property value that may have occurred after issuance of the initial title insurance policy, even if an Additional Insured endorsement is issued (or, indeed, whether or not any transfer has occurred). Should the transferee purchase a new title insurance policy or increased coverage endorsement to increase the amount of the title insurance?
Most real estate owners do not purchase new title insurance coverage as their properties increase in value. As time passes, title insurance is forgotten. Title risks that seemed so real on initial acquisition (missed mortgages, forgeries and the like) fade from memory. An owner may reason that if many years have passed and no title problems have surfaced, the likelihood that they will ever arise is remote. If the use of the property and neighboring properties is static, the risk of this approach may be minimal. But, in a dynamic environment, where construction is anticipated or occurring, uses are intensifying and values are escalating, long-dormant title issues may surface, including boundary problems, defective legal descriptions, disputes over access and other easements and encroachments. Lawyers should advise their clients that these risks can be addressed by buying new title insurance coverage. Otherwise, the lawyer may be ex-posed to future malpractice claims.
Other title insurance concerns may arise in the context of estate planning transfers, including coverage for outright gifts of partial interests and the effect of not recording estate planning real estate transfers. Of course, new title insurance resolves any questions about partial interest transfers. An Additional Insured endorsement can cover the definition of who is an insured, but it will not address problems arising since the issuance of the original policy.
To avoid transfer taxes and increased property tax assessments and to protect confidentiality of the transaction, some lawyers may be tempted to execute and deliver deeds for estate planning transfers but then not record them immediately. Failure to record may enable the parties to try to unwind a transaction privately. In the event of a title insurance claim, the title company may never become aware of the transfer or its reversal and so may never assert a coverage defense to the claim. This approach is not recommended. It may subject the parties to defenses and exposure for concealing material facts relating to the claim, not to mention possible tax fraud.
For their clients' and their own protection, when completing inter vivos transfers for estate planning purposes, lawyers should carefully consider the necessity for obtaining title insurance coverage, at least in the form of endorsements to existing title insurance policies. The safest course is to obtain a new title insurance policy, but the premium cost may be difficult to justify if the client would not be increasing its title insurance coverage in the absence of the estate planning transfer. Nevertheless, at a minimum, lawyers should discuss the consequences of not obtaining such coverage with their clients when making estate planning real estate transfers.