Calculating Title Insurance Claims: Reduction in Value vs. Insured Claim

by Pepper Hamilton LLP

First Am. Bank v. First Am. Transp. Title Ins. Co., 759 F.3d 427 (5th Cir. 2014)

After a mortgagor filed bankruptcy, a lender brought claims under a ship mortgage insurance title policy. The lender appealed the district court’s determination of the amount due under the policy, contending that the court used the wrong date of valuation, miscalculated the value of one of the insured vessels, and improperly made certain deductions.

The lender made a $28 million loan to the debtor to finance operation of a gaming vessel (Ocean Jewel) that was secured by mortgages on the Ocean Jewel and two high speed catamarans that transported customers to and from the Ocean Jewel (Emerald and Sapphire). The title insurance policies for the vessel mortgages covered actual loss for damage from designated risks, including lack of priority of the mortgage over any statutory lien for “Necessaries” (as defined by law) provided to the insured vessels “prior to or after the Date of Policy whether or not the statutory liens for Necessaries arises prior to or after the Date of Policy.” Claims were limited to no more than the difference between (1) the value of title as insured and (2) the value of title subject to the defect.

At the time the debtor filed bankruptcy, all three vessels were encumbered by liens from debts owed to suppliers of necessaries. In addition, the bankruptcy court approved an agreement with a company (TBSR) to provide berthing to the vessels, with payment to be secured by a first priority lien on each of the vessels.

The court also approved a sale of the Ocean Jewel and the Sapphire. However, the Sapphire sank before the sale could be completed. The purchaser agreed to reduce the purchase price by $500,000 and to exclude the Sapphire from the sale. So, the Ocean Jewel was sold for $6.45 million. There was a carveout of $1.11 million from the sale proceeds for the benefit of the estate, ~$1.16 million was distributed to holders of necessaries liens and the lender received ~$4.2 million.

After the Sapphire was abandoned by the bankruptcy estate, TBSR filed an in rem action, had the vessel seized and sold it at a public auction for a ~$100,000 credit bid by TBSR. The Emerald was also abandoned, after which it was purchased by another company for a $10,000 credit bid.

For the shuttles, the district court initially agreed that the lender’s claims were limited to the two credit bids: Liability was limited to the amount by which payments to necessaries lien holders reduced the lender’s recovery. Since the shuttles sold for the credit bids, that was an appropriate measure of the potential recovery. However, in a prior appeal the 5th Circuit concluded that the reduction in value could not be determined solely based on the foreclosure sale bids.

On valuation:

  • The lender hired a marine surveyor and appraiser who concluded that the values of the vessels were: Ocean Jewel – $10.8 million, Sapphire – $2 million, and Emerald – $200,000.
  • However with respect to the Ocean Jewel claim, the title company tendered ~$1.16 million on the basis that the claim could not exceed the amount received by the necessaries lienholders.
  • With respect to the shuttles, although the Sapphire sold for ~$100,000 and the Emerald sold for ~$10,000 at the foreclosure sales, the parties learned that the Emerald’s hull and the Sapphire had each been resold for $500,000.

The district court determined that according to the terms of the policies value was to be determined as of the date of the judicial sales, since that is when the lender incurred an insured loss. The court did not consider the lender’s appraisals since they determined value well in advance of the sales. Rather the district court concluded that the resale price, rather than the foreclosure sale price, was the best indicator of value for both the Emerald and the Sapphire.

On appeal to the 5th Circuit, the lender contended that the policies were ambiguous on the issue of timing. Although the policies did not specify a date of valuation, the 5th Circuit agreed with the district court that applicable case law required use of the foreclosure date since that is when the lender actually incurs a loss. The court distinguished cases in which there was a total failure of title (since the mortgagee would not have made the loan if it knew the mortgage was valueless) and claims under owners’ policies (on the theory that an owner suffers a loss immediately upon discovery).

While acknowledging that some courts have found similar language to be ambiguous, the 5th Circuit concluded that the state supreme court would agree with the majority view:

A title insurance policy provides for indemnification “only to the extent that [the insured’s] security is impaired and to the extent of the resulting loss that it sustains.” It does not “guarantee either that the mortgaged premises are worth the amount of the mortgage or that the mortgage debt will be paid.” As we recently held, a mortgagee does not suffer a loss under a title insurance policy governed by [applicable state] law until its title actually fails.

The lender also contended that title insurer should have paid the difference between the sale price and the amount the lender received from the sale of the Ocean Jewel. However, the lender did not show how the amount carved out for the benefit of the estate or any payments other than those to the necessaries claim holders came within the covered risks.

Finally, the lender disagreed with the district court’s deduction of the TBSR credit bid of ~$89,000 from the title insurance on the basis that it was not on account of a necessaries lien. However, the 5th Circuit agreed with the district court that the super priority lien granted to TBSR by the bankruptcy court did not constitute a covered lien. It was appropriate to deduct this amount since TBSR was entitled to make that claim regardless of whether it characterized its credit bid as being based on its first priority lien or its other maritime lien claims.

Although there are differences between ship mortgage title insurance and real property mortgage title insurance, they share the feature that there are a variety of nuances to what constitutes a covered claim such that a mortgagee may not be able to recover the benefit of what it views as the value of its insured collateral.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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