Coverage exception in title insurance policies catches lenders’ lawyers off guard
This article by Kathleen Waters, President & CEO of LAWPRO, originally appeared in the December 26, 2014 issue of The Lawyers Weekly published by LexisNexis Canada Inc.
In September, LAWPRO received an unwelcome surprise – the first in a series of claims based on an exception to coverage in residential lender title insurance policies.
That first claim has been followed by six more (so far). Combined losses over this issue are approaching $2 million, with one of the claims reaching the policy limits of $1 million per claim. Surprises unwelcome to LAWPRO are equally unwelcome to the profession, so it’s important that real estate lawyers be made aware of this exception.
We have seen versions of this exception in title insurance policies from three different providers active in Ontario. The typical wording provides that, notwithstanding the coverage offered by the title insurance policy, the title insurer may deny coverage and has no liability to the insured in the event the proceeds of the insured mortgage are paid (or, in the case of one of the three versions we’ve seen, “payable”) to any person or entity other than the registered title holder, the holder of a prior registered encumbrance, an execution creditor, or other specified, limited types of payees.
How this leads to claims
Problems most commonly arise in private residential mortgage transactions where the lender and borrower are represented by separate lawyers. Where purchase funds in excess of $50,000 come from a private lender, title insurers require that the purchaser and the lender have separate legal representation.
Here is a typical claim scenario: after the lender’s and borrower’s lawyers complete their due diligence, the lender’s lawyer provides the mortgage advance to the borrower’s lawyer, in trust. The borrower’s lawyer pays the advance out as directed by the borrower. Typically, the lender’s lawyer would not see this direction.
In the files which have thrown up claims, the direction provides for funds to be paid to one or more third parties beyond those permitted in the exception, who ultimately turn out to be fraudsters: the “borrower” has been impersonated. The lender files a claim with its title insurer as a result of the fraud. The title insurer denies the claim, relying on the above-noted exception.
If the lender’s lawyer is not aware of the title insurance exception, or does not alert a lender client to its existence and highlight the potential for a denial of coverage if the mortgage proceeds are paid to parties other than those permitted in the exception, the lender is likely to pursue a claim for negligence against the lender’s lawyer.
Steering clear of trouble
Avoiding claims related to this exception means doing two things: communicating appropriately with clients, and being on the alert for mortgage fraud.
Communicating about this exposure requires, first of all, that the lawyer be familiar with the terms of the title insurance policy being used. When checking to see if a particular policy contains the relevant exception, lawyers can visit LAWPRO’s AvoidAClaim blog to review some of the exception clauses we’ve seen in connection with the claims we have received. This exception is not being added to TitlePLUS policies as a matter of course, although TitlePLUS underwriting requires the subscribing lawyer to advise if funds are going to non-permitted payees. Failure of the lawyer ordering the policy to comply with the underwriting requirement does not affect the lender’s coverage under the policy, although it could result in review of a lawyer’s status under the TitlePLUS Subscription Agreement.
Regardless of which title policy is chosen, it’s a lawyer’s duty to review carefully the policy terms with the client. Should the lawyer propose using a policy that contains this exception, the lawyer will need to explain the exception and advise the client that there may not be coverage where there has been a fraud and mortgage funds are paid to a party other than those permitted in the exception.
Especially where the lender and purchaser/borrower have separate representation, it may be appropriate to advise the lender to obtain assurances from the borrower and his/her lawyer that the funds will be paid only to permitted payees. Alternatively, it may be appropriate to attempt to negotiate a removal of the exception from the draft policy, or to approach other title insurers. At the end of the day, the lender’s options may be limited by the terms of the mortgage commitment in the subject deal. But the lender’s lawyer is in a much better position to avoid a claim if all title insurance options have been canvassed, it has been determined that the lender is (or is not) required to advance under the commitment, and written instructions have been obtained.