Fraud coverage: Some title insurance policies may not protect your lender client – and may leave you in the cross-hairs
Fraudulent real estate transactions arising out of identity theft continue to be a concern as many real estate lawyers fall victim to unscrupulous imposter clients. Identity fraud has become increasingly difficult to detect as the quality of false identification and other documents improves. Further, fraudsters enlist the assistance of others to play the role of banker or other “neutrals” who will purportedly confirm the legitimacy of the transaction for a fee, thereby thwarting efforts by real estate lawyers to conduct effective due diligence on the transaction. The TitlePLUS program attributes approximately 18% of claims costs to fraud related claims.
The advent of fraud coverage offered by title insurance has provided reassurance to the extent that fraud coverage protects your innocent client as the victim of fraud. The typical scenario that title insurance may cover occurs in circumstances in which an imposter impersonates a homeowner in order to obtain mortgage financing by offering a mortgage against the homeowner’s property as security for the loan. The fact that the mortgage security was granted to the lender by an imposter without the true homeowner’s knowledge makes the mortgage invalid. The invalidity of the mortgage means the lender effectively loses any security for the underlying loan as against the mortgaged property. Lenders who have purchased title insurance that includes fraud coverage will typically be covered for any actual loss suffered arising out of the invalidity of the mortgage.
In an environment where increasingly sophisticated identity thefts make it difficult for real estate lawyers to discover fraud in the context of a real estate transaction, title insurance has been the best protection for title related fraud, especially for mortgage lender clients. Most title insurers offer title related fraud coverage which covers the scenario set out above. However, as with any type of insurance policy, certain limitations may apply. For example, some title insurers are now including an exception in the policies issued to private lenders for fraud coverage where the mortgage funds are distributed to third parties. The typical wording of this type of exception provides that, notwithstanding the coverage offered by the policy, the company may deny coverage and has no liability to the insured in the event the proceeds of the insured mortgage are paid to any person or entity other than the registered title holder, the holder of a prior registered encumbrance, execution creditor or other specified, limited types of payees (see this earlier post for more details).
This type of limitation in coverage can become problematic where the lender and borrower are represented by separate counsel, such as in private mortgage transactions over $50,000 where the lender and borrower are required to be separately represented. In that circumstance, the lender’s lawyer provides the mortgage advance to the borrower’s lawyer, in trust. The borrower’s lawyer accepts a direction from his/her client as to how the mortgage advance is to be paid out. The direction provides for funds to be paid to one or more third parties. Typically, the lender’s lawyer would not see this direction. If the lender’s lawyer is placing a policy of title insurance for the client, it is incumbent on the lawyer to review whether the policy will contain this type of exception and, if so, advise the client accordingly. The lawyer should communicate with the client to determine whether any further steps are warranted in the circumstances.
While some title insurers have recently added this type of exception to some policies, you should know that this type of exception is not being added to TitlePLUS polices as a matter of course (although TitlePLUS underwriting requires the subscribing lawyer to advise if funds are going to parties that do not appear to have any connection to the transaction).
If you place a title insurance policy on behalf of a lender client and do not advise that client about the limitations of coverage, including any exceptions contained in the policy, you should expect to find yourself the target of an E&O claim. If the lender’s claim is denied by a title insurer, it’s a good bet that the lender will start a negligence action against you as the next step to a possible recovery.
As always, while title insurance can provide useful protection in cases of title fraud, it is up to you as a real estate lawyer to help your clients understand the protection offered by a particular policy of title insurance. As always, you should advise your clients based on the precise circumstance of the transaction. Not all policies of title insurance are the same. Make sure that you explain the level of protection provided by any available policy. Depending on the coverage afforded, you should review whether additional steps need to be taken to protect your client’s interests.
This article is by Nadia Dalimonte, Claims Counsel at LAWPRO.