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Title Insurance or Title Opinion Letters?

Justin L. Earley and Sterling Scott Willis

Summary

  • Title insurance has been the least-cost-avoider method of title assurance for over 160 years.
  • Standard title insurance policy covers enforceability, all three of these typical opinions as to status, power, authorization, execution, and delivery.
  • History shows that the tools of credit risk must differ from the tools of collateral risk.
Title Insurance or Title Opinion Letters?
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The Federal Housing Finance Agency recently introduced equitable housing finance plans pursuant to which Fannie Mae and Freddie Mac would accept written attorney opinion letters in lieu of a lender’s title insurance policy in certain limited circumstances. The impetus for the agencies’ actions stems from a desire to lower transactional costs for low-income homebuyers. These actions have generated considerable pushback from the title insurance industry. This article will illustrate the historical origins of why title insurance supplanted attorney opinion letters by comparing attorney title opinion letters to lender title insurance policies. Also, looking to commercial transactions, we will discuss whether several items frequently contained in a real estate finance opinion letter are duplicative of what is covered by a lender’s title insurance policy, and whether these opinions are really necessary. Because of the risks pointed out below, it is very unlikely that title opinions will gain acceptance in lieu of title insurance policies for commercial real estate financings, but the issues remain for consideration.

Background

Any lender making a secured loan faces two problems: credit risk and collateral risk. Lenders specialize in credit risk, which we define as predicting the future likelihood that the borrower will pay the loan back on time. By its nature, credit risk involves attempting to predict an uncertain future. Lenders utilize a variety of tools to analyze, quantify, and be compensated for credit risk, perhaps most obviously by adjusting the interest rate they charge. Credit risk exists whether the loan is secured or not. Indeed, even in a secured loan a typical lender hopes never to realize on collateral, as owning property is not a lender’s business competency.

Collateral risk is different. For purposes of this article, we define collateral risk as the possibility that the lender’s collateral fails, leaving the loan unexpectedly unsecured. There are numerous components to this, including legal concepts of proper attachment and perfection, which we do not take up here. Instead, we focus on the most fundamental form of collateral risk: the possibility that the borrower does not own the collateral at all, or that the borrower’s interest in the collateral is junior to the interests of others.

Collateral failure risk is materially different from credit risk. Collateral failure risk involves analyzing the past and present, rather than predicting the future. Put simply, the borrower either owns the interest in the collateral with rights superior to those of others, or the borrower does not. The answer is knowable at the time of making the loan. Even if (as is not uncommon) there is some legal uncertainty about the borrower’s rights vis-a-vis other potential interest holders, in general that uncertainty can be resolved through litigation and quieting title, prior to making the loan. By contrast, no amount of investigation or court action can remove the uncertainty surrounding credit risk. The present and past are knowable; the future is not.

The real estate markets have learned that the methods used for addressing credit risk and collateral risk must differ. The tools developed for each do not readily extend to the other. As we discuss below, the technological methods currently en vogue (machine learning, artificial intelligence, statistical modeling, etc.) are tools of prediction. While they may perhaps be useful in analyzing credit risk, they are poor fits for handling collateral risk. Addressing collateral risk is a matter of due diligence, maintenance, and repair. Legal practitioners know that collateral risk must be removed, not predicted, because the consequences of an incorrect prediction can be unacceptably severe: an unexpectedly unsecured loan. Removing these “fat tail” risks through due diligence and correction means incurring small but frequent costs to prevent rare but catastrophic losses.

With regard to real estate, the process of diligencing and removing collateral risk is called “title assurance.” In the earliest days of the United States, title assurance was not complex. Titles came directly from the English Crown, and the first purchasers of land from the Crown had little to worry about. The sovereign was the supreme power, and there would be little reason to question whether the Crown had the title promised. However, as conveyances continued and chains of title grew more complex with time, the rule of caveat emptor came into play, because in America the burden of diligencing land title status falls on the vendee. Buyers and lenders thus began to hire professionals to perform title assurance on behalf of their clients. Lawyers therefore entered the practice of analyzing titles and providing title opinions as the output of their work.

As Robert A. Thompson noted in his seminal book, Real Estate Opinion Letter Practice,

[f]or many years, especially in jurisdictions in the eastern part of the United States, lawyers played an important role in assuring owners and lenders with respect to title to real property. The normal law school curriculum for the traditional first year property course, with its heavy emphasis on estates in land, conveyancing and recording acts, reflects the fact that, traditionally, tracing and affirmation of title have been viewed fundamentally to be the lawyers’ task. The attorneys’ abstract of title or title opinion was in many cases an absolute prerequisite for the closing of real estate transactions. In a very few states that tradition continues even to the present.

“In most jurisdictions today, however, the lawyers’ abstract of title opinion has been replaced by a title insurance policy.” Thompson’s book explained that, over time, title insurance supplanted attorney opinions for a variety of reasons, including: (1) most real estate financing lawyers’ lack of sufficient expertise to examine title to property; (2) the various advantages of what is covered in a title insurance policy as opposed to a title opinion; and (3) the risks covered by title insurance that are not covered by a title opinion letter.

As a result, the practice has evolved with almost universal acceptance of title insurance policies in lieu of title opinions in almost all states. He concludes, “[as] a result of all of these considerations, issues of title to real property and the existence and priority of liens are now typically addressed by title policies rather than legal opinions. Only in jurisdictions where title insurance is unavailable can an attorneys’ title opinion ever be justified.” He also notes that “the rejection of title opinions where title insurance is available has now attained the status of orthodoxy.”

Why? History again provides the answer, through the case of Watson v. Muirhead. In that case, a buyer sued on account of failure to spot a title problem. Noting the public policy problems that would arise from holding conveyancers strictly liable for making a mistake when the very nature of examining titles requires the exercise of judgment on questions where reasonable minds can disagree, the court declined to do so. Instead, the court applied the “reasonable person” standard for malpractice, and concluded that since the judgment call was reasonable, the conveyancer was not liable for the title problem.

The case illustrates the three core problems with attorney title opinions: First, the buyer or lender must prove negligence on behalf of the opinion-giver, which is generally quite difficult to do. Second, the buyer or lender must absorb the litigation costs of suing the opinion-giver, either directly (through fees) or indirectly (through reduced recovery via contingency fees). And third, even if the buyer or lender succeeds in their lawsuit, the opinion-giver may not have the wherewithal to pay the judgment received, as one “can’t get blood from a turnip.”

Title insurance arose in the wake of Watson v. Muirhead because title insurance solved each of these three problems. First, by issuing a contract of insurance rather than an opinion, the legal rule for recovery changed. If the title was not in the condition insured, the buyer or lender need only make an insurance contract claim; the “reasonable person” test is irrelevant. Second, by building the payment of title-defense costs into the policy coverage, the buyer or lender’s recovery was not bled out by legal fees in pursuit of the opinion-giver. Indeed, modern title policies do not even reduce the amount of insurance by the legal costs the title carrier incurs—a significant benefit. Finally, because title carriers are regulated by state departments of insurance and required to maintain sufficient capital to pay all claims, the risk of the judgment-proof opinion-giver is mitigated.

For these reasons, title insurance has been the least-cost-avoider method of title assurance for over 160 years. It has been market-proven as superior to attorney opinion letters. Recognizing this fact and the malpractice risk they face in giving title opinions, over the course of those years, most attorneys have simply left the space and declined to take on title opinion engagements.

This position was codified in the Real Estate Opinion Letter Guidelines. Guideline 4.0.c provides as follows:

4.0.c Real Property Title Opinions.

Because of the availability of title insurance, the existence of difficult factual issues, and the need for title searches beyond the capacity and expertise (and/or the scope of engagement) of most real estate attorneys, opinions requested as to the ownership of property, the effectiveness of the lien and security instruments or exceptions to or encumbrances on title to real property are inappropriate. Opinions as to the form of a mortgage or deed of trust necessary to create a lien against real property collateral and the recitation of the procedures necessary to perfect and provide record notice of such lien are, on the other hand, frequently given. Neither such a “form of documents” opinion nor a general enforceability opinion implies a substantive title opinion, and no express disclaimer of such opinion is necessary.

To understand further how and why title insurance policies came to supplant attorney opinion letters as the superior method of title assurance, it helps to compare and contrast the fundamental things that they each do. The examples cited in the Real Estate Opinion Letter Guidelines identify three of the main similarities contained in both title opinions and title insurance policies: (1) who owns the property that is encumbered by the security interests, (2) what recorded title encumbrances affect the property covered by the security instrument, and (3) what is the priority of the security instrument with respect to other recorded liens. The similarities between title opinion letters and title insurance policies are all based on what is recorded in the public records.

However, there are title risks that emerge when: (1) relevant documents may not be recorded in the public records; (2) documents may not be properly indexed or recorded in the public records, and (3) substantively defective documents are filed in the public records. These three areas of risk highlight the principal differences between title opinion letters and title policies.

If an attorney is knowledgeable in preparing title opinion letters, the title opinion would normally reflect all recorded matters that affect title to the subject property. But there are numerous things that may affect title that even the most diligent title attorney could never discover: whether because they are not recorded at all, or because (even if recorded) they are missed due to the complexity of the land records system, or are otherwise undetectable from the documents alone. Most all of these defects are within the scope of the stock title insurance policies, since the covered risks in the ALTA title insurance forms cover “any defect in or lien or encumbrance” on the title. Among the specific effects covered in a title insurance policy that seldom would come to the attention of a title opinion preparer are the following:

  • Fraud
  • Forgery
  • Duress
  • Incapacity
  • Impersonation
  • Improper execution of documents
  • Improper recording
  • Defective judicial proceedings
  • Boundary line disputes if there is not a current accurate survey
  • Priority over unrecorded or inchoate mechanics liens
  • The validity of the lien of the insured’s security instrument*
  • The enforceability of the lien of the insured’s security instrument*
  • The priority of the lien of the insured’s security instrument*
  • The right of access to the subject property unless it is included in the current survey obtained for the closing
  • Back chain creditor’s rights
  • Preferential transfers for non-timely recording or failure of constructive notice

* It would be risky, and unwise, for an opinion giver to give these title opinions since (as noted above) they are customarily not given, but one can imagine them being given.

In addition to what is covered by a basic lender’s title insurance policy, there are also numerous endorsements to a title insurance policy that are available and that are seldom covered by an attorney’s title opinion letter. These include:

  • Present violations of restrictive covenants that restrict the use of the land
  • Any charges or assessments in favor of homeowner’s associations
  • Enforced removal of existing structures on the land and encroachments onto adjoining land or easements
  • Failure of title by reason of the right of first refusal that was (or could have been) exercised as of the date of the policy.

In addition to not covering numerous risks that a title insurance policy insures against, there are other factors that make title policies more desirable for lenders than title opinions. This includes the duty of defense that is in all title insurance policies.

Overlap of Title Policies and Closing Opinions

Most customary closing opinions rendered in a commercial real estate finance transaction include opinions as to the enforceability of the security instruments and a “form of documents” opinion that provides that the security instruments are in a form sufficient to create a lien on all right, title and interest of the borrower in and to the real property. For example, in the Illustrative Opinion that accompanies the Real Estate Finance Opinion Report of 2012, these typical opinions can be phrased as follows:

3.5 Enforceability. The Borrower Transaction Documents are enforceable against the Borrower in accordance with their terms.

3.6 Form of Security Documents. The Mortgage is in a form sufficient to create a lien on all right, title and interest of the Borrower in and to the Real Property.

In order to give these two standard opinions, it is typical to make certain assumptions with respect to title to the property and matters with respect to the Security Documents. These typical assumptions include:

(b) The Borrower holds the requisite title and rights in and to any property involved in the Transaction.

(g) The Security Documents have been or will be duly and properly recorded or filed and duly and properly indexed in all places necessary (if and to the extent necessary) to create the encumbrance and lien provided therein.

(h)The description of the [real property] is accurate and reasonably identifies the [real property].

All three of these typical assumptions that are contained in real estate finance closing opinions are conceptually addressed by a title insurance policy—rather than simply assumed to be true.

While it is customary in real estate finance transactions for the borrower’s counsel to include opinions with respect to the enforceability of the security instrument and a form of documents opinion, it is fair to ask why these opinions should be needed when a lender’s title insurance policy has been obtained in connection with the transaction—which is almost the universal case for commercial real estate financings.

Covered Risk 9 in the ALTA Loan Policy of Title Insurance provides indemnity against “[t]he invalidity or unenforceability of the lien of the Insured Mortgage upon the Title.” Covered Risk 9 then goes into laundry-list detail as to some of the various risks:

Covered Risk 9 includes, but is not limited to, insurance against loss caused by:

  1. forgery, fraud, undue influence, duress, incompetency, incapacity, or impersonation;
  2. the failure of any person or Entity to have authorized a transfer or conveyance;
  3. the Insured Mortgage not being properly authorized created, executed, witnessed, sealed, acknowledged, notarized (including by remote online notarization), or delivered;
  4. a failure to perform those acts necessary to create an Insured Mortgage by electronic means authorized by law;
  5. a document executed under a falsified, expired, or otherwise invalid power of attorney;
  6. the Insured Mortgage not having been properly filed, recorded, or indexed in the Public Records, including the failure to have performed those acts by electronic means authorized by law;
  7. a defective judicial or administrative proceeding; or
  8. invalidity or unenforceability of the lien of the Insured Mortgage as a result of the repudiation of an electronic signature by a person that executed the Insured Mortgage because the electronic signature on the Insured Mortgage was not valid under applicable electronic transactions law.

As is made clear by the first sentence of Covered Risk 9, and in particular the provisions of 9.c and 9.f, most of the assurances in an enforceability opinion or a form of documents opinion as it relates to the insured security instrument are also covered by the title insurance policy. Thus, it may be argued that despite the historical tradition of including them in a standard closing opinion, they may be redundant and unnecessary when a lender’s title insurance policy is obtained as part of the transaction. That being said, there are typically numerous contractual provisions in a security instrument that are unrelated to the enforceability or validity of the lien that a secured lender will want to know are enforceable. Common examples of these include the duty to pay taxes, maintain insurance, maintain the property, and comply with usury laws (for which a title endorsement may be available). In addition, the security instrument is just one of many loan documents covered by a typical closing opinion, and opinion recipients historically have requested enforceability opinions covering each loan document.

As a building block to issue an enforceability opinion, the opinion giver normally will also provide opinions with respect to the status of the borrower, its power to execute and deliver the security documents, and the authorization, execution, and delivery of the security documents. Since a standard title insurance policy covers enforceability, all three of these typical opinions as to status, power, authorization, execution, and delivery are in substance subsumed within the covered risks provided by a title insurance policy as regards the Insured Mortgage. These are further set forth in Sections 9.b and 9.c of the stock ALTA policy. But opinion recipients nevertheless require the building block opinions for all loan documents.

It may therefore be argued that there is no reason to require a form of document opinion when there is title insurance since the form of document is ultimately addressed in material substance by Covered Risk 9.c. Also, the ability of a security instrument to “create” the lien on the real property is also covered by Covered Risk 9.c. As noted in the Local Counsel Opinions Letter Report:

(a) Creation. The determination as to whether or not the form of a document is sufficient to create a lien on real property is state specific and involves an analysis of requirements established under law of the Local Opinion Jurisdiction. When title insurance is issued in a loan transaction, an opinion on this subject is unnecessary.

We do not contend that opinions of borrowers’ counsel are irrelevant, nor do we contend that it is universally improper or unfair for lenders’ counsel to demand that borrowers’ counsel opine on things that are already addressed in material substance by title insurance policies. We recognize that opinion practice is (like everything else in a commercial real estate financing transaction) a matter of negotiation and transaction party leverage. It is logical for a lender to ask that borrowers’ counsel cover all of the loan documents in a deal and to give customarily provided opinions, even if the lender already has title insurance coverage for the very same risk, since this will give the lender more comfort should the loan transaction go sour and litigation erupt. Whether or not a lender will demand that opinion, and whether or not a borrower’s counsel will give that opinion, depends on the facts and relative negotiating leverage of the parties. Nevertheless, opinion recipients should be mindful of the protections afforded by title insurance in negotiating their opinion requirements.

Instead, our purpose is to show that the examples above are isolated instances of where opinion practice still touches land title issues. Because of the great breadth of coverage that title insurance policies offer to lenders, in most circumstances, attorney opinions are economically noncompetitive with title insurance policies. Title insurance policies offer materially identical risk mitigation measures through a standardized form that does not require expensive negotiations that burn through billable hours, and the marketplace has long accepted that as canon. For these reasons, we do not see attorney opinion letters as a title assurance / collateral risk mitigation method making a comeback in commercial real estate transactions.

Conclusion

Finally, we close with a few thoughts on why efforts to repackage attorney opinion letters into a technology product using some sort of machine learning / artificial intelligence / predictive modeling algorithm are inapt for addressing collateral risk—at least in their present state of technological development. Presently these proposals are circulating in the residential real estate markets. History shows that the tools of credit risk must differ from the tools of collateral risk, and that credit risk and collateral risk must be borne by different parties who deal with each one differently.

In the 1920s, the business of title insurance and the business of mortgage lending began to mix, when banks began providing title insurance, and title insurance carriers began providing “mortgage guaranty insurance,” guaranteeing lenders that their loans would be paid back. This mix turned out to be volatile. The tools, competencies, and capital structure for addressing collateral risk are not the same as the tools, competencies, and capital structure needed for addressing credit risk. This unstable admixture exploded in the Great Depression that soon followed, wiping out a huge percentage of the title insurance capacity in New York.

Policymakers responded by passing what are now called the “monoline statutes,” laws and regulations that (generally speaking) serve as a two-way barrier between the “business of title insurance” and other lines of insurance. In essence, the monoline statutes provide that no one but a licensed title insurance carrier can offer title insurance, and that a title insurance carrier cannot offer any other line of insurance but title. The monoline statutes thus codified the rule that, for the health and welfare of the real estate markets, credit risk must be separated from collateral risk. As one commentator sums up these outcomes from the Great Depression:

When banks failed because of mortgage defaults, their title insurance divisions went along with them. A result was that title insurers began to choose, and state legislatures began to require, a disassociation of the selling of title insurance from banking and mortgaging.

The current efforts by certain “disruptors” in the real estate market would seek to break down this well-considered firewall by wrapping the predictive methods of credit risk in the previously-abandoned cloak of an attorney opinion letter. While they vary in their specifics, in general, some proposals seem to be of the effect that an attorney would write a title opinion based not on in-depth research about the history of a land title, but rather on some sort of probabilistic output by a computer program. These proposals are doubly dangerous because not only would they attempt to insert the tools of credit risk where they do not belong, they would also unearth the three core problems that led to the creation of title insurance in the first place.

In other words, these proposals would take every method that has proven inadequate or dangerous for addressing collateral risk, painfully learned over a century and a half of real estate practice, package them up, and release them into the wild once again. As demonstrated above, these proposals lack historical understanding, and we do not doubt at all that they would be disruptive. But it certainly is not the sort of disruption that the real estate markets are looking for.