Title insurance is designed to pay for damages caused by any defects to title that the title company should have discovered but did not. Lender’s title insurance protects lenders who lose money due to a title defect, which is distinguished from an owner’s policy that protects the property owners. How to calculate a lender’s damages under a title insurance policy is an issue that courts have struggled to address in a consistent manner. Generally, courts are in agreement about when a lender suffers damages, which occurs after the borrower defaults and the security for the mortgage proves inadequate. In other words, even if a title defect is found on the property, if the lender continues to receive regular payments, then the lender has not suffered any damages.
Once a lender suffers damages, however, a question arises about what date should be used to determine the property’s fair market value. In Equity Income Partners LP v. Chicago Title Ins. Co., No. CV-11-1614-PHX-GMS, 2012 WL 3871505 (D. Ariz. Sept. 6, 2012) the court found that a lender’s damages should be calculated on the date of the loan with adjustments for any mitigating factors. Id. at *4. In contrast, other courts have determined the fair market value, by using the value of the property when sold at a foreclosure sale. See, e.g., RTC Mortgage Trust 1994 N-1 v. Fidelity Nat’l Title Ins. Co., 58 F. Supp. 2d 503, 535 (D.N.J. 1999). The latter method will cause lenders to bear the risk of market value decline.
For example, in May 2006, the lender in Equity Income loaned $2.4 million to the owners, who used the money to purchase a 13 acre lot of land, which had appraised at a value of over $2.9 million. Soon thereafter, the owners discovered that they could not legally access the property. Within several months of discovering this title defect, the owners stopped making regular payments on the loans and went into default. For a variety of reasons, the lender did not foreclose until 2011, after the real estate market in Phoenix had declined precipitously. If the court calculated the fair market value when the property was sold in 2011, the lender would have received far less than the $2.4 million it loaned. Instead, the Equity Income court calculated the loss to be the amount loaned, because the lender loaned the money in reliance of the title insurance policy. Accordingly the court found that the title insurer, not the lender, “should bear any risk of market value decline in the property.” Id. at *4.
Given the fact that courts have not used a single methodology to calculate damages suffered by lenders when title defects are discovered, this issue should be addressed early in a dispute, because the date the fair market value of the property is determined could drastically affect a lender’s recovery.