Title insurance is a vital component of most real estate transactions. Owners purchase insurance to protect their ownership interest in real property, and lenders require insurance to protect their liens on real property. The terms, conditions and general exclusions of an insurance policy are generally provided in the policy jacket, and property specific exceptions to the coverage are listed on a schedule that is incorporated into the policy. Owner and lenders alike often choose to supplement the coverage outlined in the policy jacket with endorsements, which title insurers offer for various fees.
One popular endorsement has been the ALTA 21, which is commonly referred to as creditors’ rights coverage. Two of today’s most popular forms of insurance policies, the 1992 form and the 2006 form, exclude coverage for losses resulting from claims made by the previous owner’s creditors. Specifically, if the ownership interest or lien interest in the real property is found to be void under certain federal bankruptcy, state insolvency, or similar creditors’ rights laws, the standard coverage provided by a title insurer would not cover such a loss. The creditors’ rights coverage, where available, deletes the exclusion to provide explicit coverage for losses resulting from a transaction creating the ownership interest or lien interest being deemed a fraudulent conveyance, fraudulent transfer or preferential transfer by a bankruptcy court. Title insurers in certain jurisdictions, including New York, Texas and Florida, never offered the creditors’ rights coverage. Regulators that oversee title companies in these jurisdictions took the position that the risk of a fraudulent conveyance, fraudulent transfer or preferential transfer was a credit risk that title insurance was never intended to cover.
Shift to Endangered Status
Because the creditors’ rights coverage has provided protection against a seller’s post-closing bankruptcy, Lewis and Roca has routinely advised our clients to purchase the creditors’ rights coverage when available. However, beginning in 2008, title insurers began to show signs of reluctance to issue this endorsement. Title insurers began to request burdensome, additional underwriting information, including copies of the financial statements of sellers and their parent companies. We began to hear how the creditors’ rights coverage is an “extra-hazardous risk” and subject to review by the title company’s lead underwriter. Ultimately, on many occasions, title companies refused to issue the endorsement coverage on owner’s policies. Lenders, however, continued to obtain the creditors’ rights coverage, even if at an increased cost. However, lenders will likely no longer have the option of this additional coverage.
On February 2, 2010, the ALTA Board of Governors met and unanimously voted to withdraw and decertify the ALTA 21 endorsement beginning on March 8, 2010. ALTA, an acronym for the American Land Title Association, is a national trade association that represents the interest of title insurance companies across the country. The eleven-member Board of Governors is responsible for creating association policy, managing the financial health of the association, overseeing the work of 33 committees, and ensuring the overall welfare of the association. Excluding New York, Texas and Florida, most major title insurers with whom our firm works are members of ALTA, and we have already received notices from two major insurers announcing that they will no longer provide creditors’ rights coverage.
What Prompted the Extinction?
The cause for the decertification of the creditors’ rights endorsement is simple: money. Our title insurer contacts tell us that the four most common causes for title claims are fraud, mechanics’ liens, errors made by the title insurer upon issuing the policy and creditors rights. The financial crisis that began in 2007 resulted in a sharp increase in bankruptcy filings, especially among companies with strong ties to real estate. As many of these companies sold real estate prior to (and often in an attempt to avoid) filing bankruptcy, creditors of these sellers have subsequently challenged the integrity of the sales. Insureds who purchased the creditors’ rights coverage with their title insurance policies quickly turned to the title insurers for relief. The consequence has been an increase in creditors’ rights claims of both owners and lenders. This increase prompted title insurers, as well as national title insurance associations such as ALTA, to re-evaluate the creditors’ rights coverage and, ultimately, to withdraw the option to purchase the additional coverage. These insurers argue that they are in the business of evaluating risk based on documents recorded in the county records and not the financial state of third-party sellers. They tell us that the instincts of the regulators in Texas, New York and Florida, where creditors’ rights coverage has never been provided, have proved correct.
What Does this Mean?
The primary consequence of the decertification of the creditors’ rights coverage is a shift in risk from the insurer to the insured. While most creditors’ rights coverage has historically been associated and offered in conjunction with lenders’ title policies, both owners and lenders should protect against this risk. Lenders advancing loan proceeds to borrowers for the purchase of real property should require, in addition to standard diligence on borrower, sufficient diligence on land sellers to enable lenders to assess the risk of creditors’ rights claims resulting from the land sale. The real estate and bankruptcy attorneys at Lewis and Roca are prepared to assist in this process and to advise both buyers, borrowers and lenders on how best minimize the adverse creditors’ risk.
This Client Alert has been prepared by Lewis and Roca LLP for informational purposes only and is not legal advice. Readers should seek professional legal advice on matters involving these issues.
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