Title Insurance: What is it good for anyway?

John Lande, Iowa Bankruptcy Law, Iowa Construction Law, Iowa Commercial Litigation, Iowa Real Estate & Land Use, Dickinson Law Firm, Des Moines Iowa

Posted on 03/30/2018 at 10:22 AM by John Lande

A recent decision from the Eighth Circuit Court of Appeals may have property owners wondering what title insurance really covers.

Captiva Lake Investments v. Fidelity National Title Insurance Company is a familiar story involving construction loans, mechanics’ liens, and bankrupt contractors. National City Bank of the Midwest (“National”) agreed to provide a $21 million construction loan to Majestic Pointe Development Company, LLC (“Majestic Pointe”) to build a condominium project at the Lake of Ozarks in Missouri. National purchased title insurance from Fidelity National Title Insurance Company (“Fidelity”) to protect its interest in the real estate securing the construction loan. In a sign of things to come, a feasibility study prior to construction estimated that the construction financing and budget understated the necessary construction cost by between $3.8 million to $4.75 million.

Majestic Pointe defaulted on the construction loan halfway through construction and declared bankruptcy. Captiva Lake Investment, LLC (“Captiva”) purchased National’s interest in the property, which made Captiva a successor to Fidelity’s title insurance policy.

Title insurance generally indemnifies the policyholder from defects in title priority or lien priority. The American Land Title Association (“ALTA”) publishes title insurance forms that are widely used. In this case, Fidelity used the 1992 ALTA lender’s title form for the policy that Captiva ultimately came to own. That form typically exempts mechanics’ liens from title coverage. However, in this case National was able to convince Fidelity to delete the mechanics’ lien exemption. Thus, the Fidelity policy potentially indemnified Captiva for any mechanics’ liens.

This was good, theoretically, for Captiva because in a partially finished construction project there were plenty of mechanics’ liens to deal with. Captiva made a claim on the policy, and Fidelity initially hired counsel to defend the mechanics’ lien claims. However, Fidelity was not able to resolve the liens quickly enough for Captiva, so Captiva made a claim under the unmarketability-of-title provision of the policy. Fidelity denied coverage and filed a lawsuit seeking a declaration that the policy did not cover the mechanics’ lien claims because of exclusion 3(a) of the 1992 ALTA form.

Exclusion 3(a) is frequently litigated in title insurance disputes, because it excludes liens “created, suffered, assumed or agreed to” by the insured. In this case, National failed to abide by certain terms of the construction loan financing agreement by, for example, failing to obtain mechanics’ lien waivers before disbursing funds. Fidelity argued this demonstrated National’s intention to allow mechanics’ liens to be posted on the property.

The Eighth Circuit, however, did not adopt Fidelity’s reasoning, despite ruling that exclusion 3(a) denied Captiva coverage for the mechanics’ liens. The Eighth Circuit’s reasoning was much broader, because it concluded that, under Missouri law, a construction lender “agrees” to liens if the lender ceases funding a construction loan partway through construction. The Eighth Circuit reasoned that title insurance is not intended to bear the risk of insufficient construction funding. Thus, under Missouri law, if delays, defects, or cost overruns cause a default in the construction financing and the lender ceases funding, then the lender will not be able to rely on title insurance to defend against any mechanics’ liens.

The court also ruled that Captiva did not have coverage under the unmarketability-of-title clause. Captiva argued that under Missouri law mechanics’ liens arise on the date that the contractor starts work on the project. However, under Missouri law, the lien cannot be enforced until the contractor perfects the lien with the appropriate mechanics’ lien filing. At the time that Captiva acquired the deed to the property, there were no perfected liens on the property. As a result, at the time Captiva obtained title there were no impairments that rendered title unmarketable, even though mechanics’ lienholders had the right to perfect their liens after Captiva acquired title. Thus, the title insurance policy did not cover the mechanics’ liens.

Captiva was decided by a federal court under Missouri law. Nevertheless, there are some similarities between Missouri law and Iowa law that make Captiva instructive. Under Iowa law, mechanics’ liens arise when construction begins, so if work commences before the construction loan mortgage is recorded then the mechanics’ lien will have priority over the construction loan. Applying Captiva, a title insurance policy may not cover a subsequent lien dispute.

The Court’s ruling makes a difficult situation even more difficult for a construction lender that finds itself pouring money into a black hole. If the lender stops paying then it may mitigate its losses, but lose title insurance. On the other hand, a lender likely doesn’t want to keep pouring money into a project that isn’t going to be completed based on the hope that it will have title insurance coverage.

Even though title insurance is not common in Iowa, it is often a component of large construction projects. It is important to understand the implications of decisions like Captiva on mechanics’ liens under Iowa law, and make sure that knowledgeable counsel advises on all of the implications of title insurance, mechanics’ liens, and construction loan issues.

For any questions regarding mechanics' liens, title insurance, or construction loans, please contact John Lande

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed. 

- John Lande


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