What Do I Need to Know About Title Insurance
We all know that title insurance is a necessity when purchasing real estate, but many do not have a sufficient understanding of what title insurance is really for and steps we can take to deal with title insurance companies to prevent being embroiled in a title dispute. Litigating title disputes can often be long, expensive, and often difficult to predict the outcome with any certainty. For that reason, having a solid grasp of what title insurance can do and cannot do is important for any would be purchaser of real estate.
The condition of title is one of the most important due diligence items for a buyer of real estate. Purchasers usually want title to real estate to be clean, or as lawyers describe it to be “marketable.” Marketable title does not mean title that is completely free from any liens or claims, but merely title that is sufficiently free from doubt that an informed and reasonable buyer would accept it. For example, some legal descriptions for properties will exclude mineral rights, or contain easements for sewer, gas, or other utility lines. Technically, these are claims or “encumbrances” against title, but most would not consider these types of claims to be a sufficient “cloud” on title to render it unmarketable since those types of claims typically do not affect a buyer’s right to enjoy the property.
WHAT IT A PRELIMINARY TITLE REPORT?
Title insurance does not remove defects nor does it guarantee marketable title, but merely provides a means of recovery if title does prove unmarketable for a reason that is covered under the policy. In a typical real estate transaction, one of the initial first steps in escrow is that the title insurer will issue a “Preliminary Title Report” (“Prelim”). This is a crucial document for buyers to understand as part of their overall due diligence. Contrary to popular belief, a Prelim is not a guarantee of the condition of title and title companies are generally not liable for errors appearing on the Prelim. I’ve seen cases where title insurance companies made mistakes on the Prelim, but unfortunately there was no recourse against the title insurance company because the Prelim is merely an offer, not a binding representation of title. Therefore, although Prelim is a good starting point for conducting due diligence on the condition of title, but depending on the property, additional due diligence may be needed above and beyond what appears on the Prelim. Additionally, following a Prelim the Title Company issues a commitment for title and issues their title policy off of this commitment. It is the terms of the actual policy that comes from the Title Commitment that you need to be most certain about as the Prelim is not binding on the insurance company.
UNDERSTAND THE EXCEPTIONS TO YOUR POLICY
The most important part of reading the Prelim and the Commitment that follows is understanding the exceptions. The Commitment will list the exceptions which are items that would not be covered under the policy. Exceptions may be specifically listed, such as existing mortgages, unpaid taxes, federal tax liens, recorded easements, etc. There are also general exceptions that are typically listed as an Exhibit to the Prelim or Commitment as a “Schedule B” Exception. These exceptions are usually described very generally and in legalese (i.e. most purchasers don’t pay attention to it). However, it is important for the purchaser to have a general understanding of these general exclusions so that if there is a potential issue on the property that is possibly excluded under these general exceptions, the purchaser can consult with the right professionals (lawyers, inspectors, surveyors, etc.) to determine what are the risks, and what steps can be taken to fix the defect (or else re- negotiate the price or cancel the deal).
For example, boundary disputes and encroachments from neighbors are typically not covered under a title policy. If the physical inspection of the property shows some doubts as to the boundary lines (e.g. no walls or physical marker showing the boundary lines or trees along the property line that create doubt as to whose side of the property it is on), then further due diligence, hiring professionals, or conducting a survey would be recommended. Even though standard policies may not cover certain risks, additional coverage might be available to cover these types of claims for an additional fee if you inquire.
Furthermore, standard title policies typically cover only matters in the public record (recorded liens, easements, judgments, etc.) and do not cover issues not shown in the public records.
As such, the Prelim and Commitment should not be the sole resource for determining whether there are issues with title, but if there are any doubts, these should be independently researched, or any doubt should be addressed directly with the seller and/or title rep. For example, if the seller has been sued, or owes taxes to the IRS, these issues may not appear on the Prelim or Commitment if nothing has yet been recorded, but those issues could definitely affect your interest in the property, and so consider confirming with your seller that they are not aware of any unrecorded interests that could affect title or conduct your own independent due diligence. In addition, Prelims and Commitments may disclose the existence of a lien, but fails to provide specific information about its details, and in those cases, actual copies of the lien documents should be obtained from title or the seller.
GETTING A SPECIAL ENDORSEMENT
Any questions regarding the condition of title should be discussed with the title officer and/or attorney so that further investigation can be done to determine what can be done with respect to any title issues that arise during escrow. Sometimes a title insurer may be willing to issue a “special endorsement” to cover a particular title issue that would not otherwise be covered under the policy, but it is incumbent on the buyer as part of his/her due diligence to inquire about these issues, and of course, preferably during the due diligence period while the buyer still has the right to negotiate or cancel the deal. These types of inquiries should be made in writing so there is a record documenting the discussion. I have experienced situations where a title insurer initially denies coverage for a claim stating that they were not aware of the issue, but then had to reverse course when presented with written evidence that the issue was discussed with the title company during escrow.
Finally, as with any insurance company, it is important to make sure you are working with a reputable company that will be there for the long haul. Getting a policy on the cheap from an unknown company will be useless if that company goes out of business. Choice of title companies are negotiable, although if the seller is paying for title insurance, they will usually insist on their own title company. Make sure that company is legitimate and has an established history and track record.
Fortunately, most homeowners will never need to make a claim on their title insurance. However, anyone who has experience litigating these types of disputes knows that the outcome is frequently hard to predict, and is often determined by which party has the most resources. If a claim ever arises requiring litigation, you’ll want to have the resources of an insurance company defending your interests, and in order to maximize that possibility, it is important to perform your due diligence on the property, on the title insurance company, and the details of the policy they propose to issue for your property.