The Journal of The DuPage County Bar Association

Back Issues > Vol. 26 (2013-14)

The Nature of Title Insurance and the “Law Of Unintended Consequences” in Real Estate Transactions
by Joseph Fortunato, Jr.

In United Community Bank v. Prairie State Bank & Trust, 2012 IL App (4th) 110973 (July 11, 2012), the actual holding is relatively straightforward – the failure by a title insurance company to discover an intervening judgment lien does not defeat the right of equitable subrogation by a mortgage lender, which is an exception to the common law rule of “first in time, first in right” when determining the priority of encumbrances. By law, the Plaintiff bank making a first mortgage to a purchaser has priority over an intervening judgment creditor to the extent of the amount of loan proceeds used to discharge a construction mortgage, which was the senior encumbrance. But it is in dicta where the Appellate Court for the Fourth District created potential issues for the real estate practitioner.

Plaintiff James McDonough (“McDonough”) borrowed from Plaintiff United Community Bank (“United”) to buy a duplex from a builder, giving a mortgage to United. Apparently unbeknownst to McDonough, United and the title insurer (Commonwealth), Defendant Prairie State Bank and Trust (“Prairie”), had recorded a judgment lien against the builder. Prairie’s judgment lien was recorded prior in time to United’s mortgage. But prior to both encumbrances, there was recorded a construction mortgage the builder had given to Illinois National Bank (“National”). The builder and McDonough entered into their contract in between the recording of National’s mortgage and the recording of Prairie’s judgment lien. The contract was not recorded. Plaintiffs argued that because the new mortgage from United was used to pay off the earliest lien (National’s mortgage), United was equitably subrogated to National, stepping into its shoes as senior lienholder [the Court also discussed the issue of equitable conversion, which is outside the scope of this article1].

The trial court disagreed with Plaintiffs, denied their Motion for Summary Judgment, and granted Prairie’s Cross-motion for Summary Judgment. Specifically, the Court found that Commonwealth, which the Court considered to be the real party in interest, had erred in its title search when it overlooked Prairie’s lien, and rejected Plaintiffs’ theories of equitable conversion and equitable subrogation. In its opinion, the trial court stated that the “misfeasance” of Commonwealth “had created the situation. Had they competently done their job… the transaction would not have closed.” The trial court apparently believed that the title insurer would pay the claim; everyone else would suffer no harm; and, therefore, equity did not require the invocation of the doctrines of equitable conversion and equitable subrogation, when “…to do so would only reward a negligent non-party. Just doesn’t seem fair”. Upon Motion to Reconsider, the trial court engaged in a refreshing exercise of the application of common sense, suggesting that Plaintiffs were not “completely innocent,” and potentially vicariously liable, having “delegated responsibility (for the title search) to a negligent third-party does not relieve them of the responsibility” of conducting a reasonable search.

The Fourth District affirmed in part and reversed in part. It disagreed with the trial court that equitable subrogation was defeated by the title insurer’s “apparent mistake in the title search” (failure to raise the judgment lien). It held that United had priority over Prairie to the extent of the amount of the new loan proceeds used to discharge the balance of the senior encumbrance, the construction mortgage. It also disagreed that Commonwealth was a necessary party, noting that no one had sued Commonwealth.

Had the Court stopped at this point, holding that the new lender was equitably subrogated to the rights of the construction lender to the amount used to discharge the balance on the construction loan, real estate practitioners might have proceeded in blissful ignorance of the potential “butterfly effect” posed by the Court’s statements in dicta.

The Court found persuasive the holding in First Midwest Bank, N.A. vs. Stewart Title Guaranty Co., 218 Ill. 2nd 326 (2006), stating that the purpose of a title insurance commitment or policy is not to provide information to consumers2, but instead to describe the risks which the title insurer is willing to assume. There is no duty on the part of a title insurer to the parties to a transaction where title insurance is purchased to discover a judgment lien. The title search was not a service to others; Commonwealth did the search for itself. “Thus even if in its search Commonwealth discovered the judgment lien but consciously and intentionally (emphasis by the Court) omitted the lien from the exceptions to coverage, [then] that would be  Commonwealth’s business and no one else’s.”

This case illustrates the manner in which life has changed for the transactional practitioner. Instead of ordering a tract search to gather information regarding the state of title, a practice which transactional lawyers have undertaken and title insurers have encouraged for years, this Court would have the parties review abstracts of title for the information sought. The notion that the parties should review abstracts of title is considered outdated even by lawyers in downstate Illinois. The doctrine of equitable subrogation has been roundly criticized as an artificial means to allow title insurers to avoid the consequences of their negligence, and as a theory it does not stand up to strict scrutiny; the doctrine of “first in time, first in right” works just as well in this context. Equitable subrogation provides insurers with another means of defense generally not available to others. Clearly, if the builder in the case at bar held title free of a mortgage, there would be no prior mortgage to which United could subrogate and Commonwealth would be required to indemnify Prairie. Should the result be different merely because the seller’s property was encumbered?

If insurers need not pay claims, the incentive to purchase insurance is greatly diminished. The justification of the action of the title insurer that it was performing the search for itself and no one else does not, in the words of the trial court, “pass the smell test”.

The author finds other disturbing features in the opinion as same would relate to many real estate transactions. Title insurers, in the author’s experience, never “consciously and intentionally” omit known liens from coverage; if so, one would expect there to be consequences to the title insurer under its title insurance policy. After all, title insurance is a form of consumer protection. The policy creates a contractual relationship between the insurer and the insured. Is the insurer free to breach the contract? What is actually covered by the title insurer?

The 2006 ALTA Owner’s Title insurance Policy covers (1) title to the estate or interest described in Schedule A being vested other than as stated therein; (2) any defect in or lien or encumbrance on the title; (3) unmarketability of title; (4) lack of right to access to and from the land. The ALTA Loan Policy adds a fifth element: the invalidity or unenforceability of the lien of the insured mortgage upon the title. The balance of the discussion of title insurance in this article will focus on the issue of unmarketability of title.

The ALTA website contains comments on the meaning of the title insurance policy and describes unmarketability of title thusly: “Your Title is unmarketable, which allows someone else to refuse to perform a contract to purchase the Land, lease it or make a Mortgage loan on it.” But the Court in the United Community Bank case appears to consider this provision ineffective, stating that the insurer could consciously and intentionally omit reference to a lien. Is the court suggesting that contracts, like records in athletic events, are made to be broken? If so, consider the mechanics of a claim for unmarketability of title to real estate. Buyer purchases a parcel of real estate from Seller and obtains a policy of title insurance. If Buyer discovers a judgment lien or other lien that was placed of record prior to the date Buyer acquired title, Buyer may have a claim on the title policy due to coverage item (2) above – any defect in or lien or encumbrance on the title. But the policy is also intended to cover unmarketability of title, and here it gets trickier.

Most standard residential sales contracts (including the Multi-Board Residential Real Estate Contract 5.0 commonly used in Metropolitan Chicago) contain the following language: “The commitment for title insurance furnished by Seller will be conclusive evidence of good and marketable title as therein shown, subject only to the exceptions therein stated.” (Emphasis supplied): The term “conclusive” is defined in Black’s Law Dictionary as “…not admitting of explanation or contradiction… final… irrefutable…beyond question or beyond dispute”. If the content of a commitment for title insurance, which describes the state of the title prior to closing and which is used by the insurer as a basis for the issuance of the policy, is conclusive as to what constitutes “good and marketable title,” then on what basis may Buyer complain thereafter that the title Buyer obtained is neither good nor marketable? Insurance does not exist in a vacuum – Buyer must be able to establish that Seller has breached the contract by not conveying marketable title to Buyer in order to have a cause of action. But Buyer seems to have waived that right by agreeing, at the time the contract is signed, that whatever the title insurer says is good and marketable title is in fact good and marketable title.3 And by so agreeing, is not Buyer precluded from asserting to the title insurer, in making a claim on the policy, that the title Buyer received from Seller is unmarketable? Buyer may have waived any right to bring an action against Seller for breach of contract – Buyer agreed in advance to accept as marketable whatever the title insurer offered to insure. If Buyer, as a result of such waiver, has no cause of action to assert against Seller, has Buyer suffered damage that is compensable by insurance?

Fortunately, the element of coverage under the policy that insures against any defect in or lien or encumbrance on the title appears to have escaped the dictum of United Community Bank unscathed. So, is this all simply an academic exercise? It is submitted that the possibility exists that the title to property could be unmarketable not due to an intervening lien, but due to other circumstances.

Where a title insurer disclosed a covenant contained in recorded plat providing that no construction could be undertaken within ten feet of any boundary line, and which covenant rendered title unmarketable, despite the willingness of the title insurer to offer to “insure over” the title problem as to present and future owners, it was held that the title defect was sufficient to allow the buyer to refuse to close, the court citing with approval the doctrine that “(t)he law has long recognized that a buyer cannot be compelled to buy a lawsuit.”4

Title insurance coverage for unmarketability of title to real estate is jeopardized by the confluence of the dictum in United Community Bank and the standard form contract language quoted above. One approach for the cautious practitioner will be to attempt to supplant the term “presumptive” for the term “conclusive” in the standard form contract language in the exercise of the authority provided lawyers in the Attorney review paragraph. Another approach will be to replace the term “conclusive” with the term “presumptive” in the next version of the Multi-Board Residential Real Estate Contract.

In response to counsel for sellers concerned with such a change in standard contract language, it is submitted that sellers will not be adversely affected one iota. Their potential liability for breach of warranty of title in a deed ought to remain covered by title insurance in the same manner. The possibility that a title insurer might deny coverage on account of contractual waiver by buyers would be precluded. Without the “deep pocket” of insurance coverage, effective actions against sellers would seem unlikely. Sellers unsure of their exposure in this regard would be best advised to limit their warranties of title by use of a Special Warranty Deed.5

While one could argue that the title insurance policy, being a contract of indemnity, is not affected by the provisions of the agreement between the parties to the sales transaction, this author is not convinced, in light of the opinion in United Community Bank, that the courts would not hesitate to create a construct, in the manner of the doctrine of equitable subrogation, to further insulate the title insurance industry from liability for negligence. It is conceivable that a court that would rely upon the doctrine of equitable subrogation while also straining to apply the doctrine of equitable conversion to the analysis of the facts in United Community Bank might adopt a theory akin to equating the insurer as an intended thirdparty beneficiary of the contract between the parties to a real estate transaction, relying upon the above-quoted language of the Title paragraph in the contract.

In the final analysis, the transactional practitioner must refrain from the tendency to remain isolated from the world of the litigators and fact-finders, but instead strive to raise awareness of the unintended consequences that arise in the context of transactional work due to the misapplication of legal theories not congruent with current transactional practice. 

1 The doctrine of equitable conversion has been criticized as “…a fiction … its application is limited to the extent necessary to accommodate equity…” The City of Decatur vs. Ballinger, et al, (4th Dist., April 16, 2103), 2013 IL App (4th) 120456.

2 The notion that title insurers merely “sell policies” but not “information” is dispelled by the fact that title insurers gladly sell tract searches knowing that consumers use such searches for the information contained therein without any intention of purchasing insurance, as well as by the insertion of the omnipresent “Notes for Information” section in title insurance commitments.

3 Some might doubt that a contractual waiver as described above would be upheld. For an interesting (and somewhat disturbing) analysis of the extent to which courts in Illinois uphold the doctrine of “freedom of contract,” see Eastern Savings Bank v. Flores, (1st Dist., August 24, 2012), 2012 IL App (1st) 112979.

4 Nelson v. Anderson, 5th Dist., February 21, 1997, 286 Ill.App.3rd 706, citing with approval May v. Nyman, 3 Ill.App.3d 580, 278 N.E.2d 97 (1972); Winters v. Polin, 309 Ill. App. 458, 33 N.E.2d 497 (1941)

5 The discussion of the difference between general and special warranty deeds is worthy of a separate article. 

Joseph R. Fortunato, Jr., Prior to joining Momkus McCluskey, he was a sole practitioner and then a principal at Fortunato, Farrell, Davenport & Arnold, Ltd. (1983-2007) and at Fortunato, Knobbe, Davenport & Arnold, Ltd. (2007-09). In August 2009, he joined Momkus McCluskey as a partner heading up the firm’s Real Estate Practice Group. Joe concentrates his practice in real estate transactional work (commercial and residential) and real estate litigation. Joe was President of the Illinois Real Estate Lawyers Association from 2002-04 and a member of the Board of Directors of IRELA since 1998.

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