A major defect in title to a recently purchased property can cost the new owner a great deal – from the costs of defending the title to liability for a lien originally the responsibility of the former owner.
This is why title insurance coverage is very important in real estate transactions, particularly those transactions involving short sales. Title insurance protects the buyer and the buyer’s lender against losses caused by title problems. It is a type of indemnity insurance with lots of terms and conditions, exclusions and exceptions. Where abstracts of title were once the predominant method used for title evidence, today title insurance is by far the preferred choice.
How does title insurance work? For a stated premium normally paid by the seller per the offer to purchase, the title insurance company agrees to compensate the buyer for specified losses relating to the title of the subject real estate. The scope of the coverage is specified by identifying the risks that are covered and by stating the exceptions and exclusions. If a claim is made, the title insurance company generally has the right to pay off the claim, negotiate a settlement of the claim, or prosecute or defend any legal actions. Many consider the duty to defend the most important protection provided by the title insurance.
There are two stages to obtaining title insurance: the commitment and the policy. The title insurance commitment shows the status of the title before closing and also indicates the terms under which the title insurance company will issue a title insurance policy after closing, along with the scope of that insurance. The coverage will depend on the extent of successful compliance with the requirements of the commitment and which exceptions to the title insurance coverage were successfully removed.
It is important to order the title insurance as early as possible to allow the title insurance company sufficient time to meet the deadlines called for in the offer to purchase. Unless otherwise modified, the standard provision of the offer states that the title commitment shall be furnished to the buyer at least three business days prior to closing, showing merchantable title to the property as of a date no more than 15 days before delivery of the commitment. This title commitment can be subject only to standard title insurance requirements and exceptions and liens that will be paid from closing proceeds.
One of the key components of the title insurance commitment is the effective date. This is the “as of” date, in other words, the date through which the information provided in the commitment is guaranteed as current and accurate. This date should be as near to the date of closing as possible because the effective date determines the length of the “gap” between the commitment information and the date of closing.
The standard title commitment exceptions include, among other things, the gap period: “Defects, liens, encumbrances, adverse claims or other matters, if any, created, first appearing in the public records or attaching subsequent to the effective date hereof but prior to the date the proposed insured acquires for value of record the estate or interest or mortgage thereon covered by this Commitment.” This gap exception puts the buyer at risk for any title defects that appear of record after the effective date of the commitment and before deed is recorded.
In many cases, the actual risk involved will vary depending upon the financial status of the seller. One way to delete the gap exception and provide more complete coverage for the buyer is to have the title insurance provide a “gap endorsement.” The offer to purchase can be written to have the seller provide and pay for the gap endorsement. Absent this agreement, the buyer would order and pay for this additional protection.
In some transactions, however, the title company may elect not to issue a gap endorsement. If the financial status of the seller is such that the risk to the title insurance company is too great, a gap endorsement may not be available to the buyer even if the seller is willing to provide an affidavit certifying that the seller has not filed bankruptcy, received notice of any pending lawsuit, permitted any lien or encumbrance to attach to the subject property or conveyed any interest in the property since the effective date of the commitment.
Because of the increasing potential for gap insurance to not be available in transactions involving short sales, it becomes more important than ever for buyers to obtain legal counsel early on in the transaction. One potential option is for the transaction to close in escrow. Under the terms of an escrow agreement drafted by the parties or an attorney (this agreement is not to be drafted a licensee per Wis. Adm. Code § RL 18.07), the title company is given the opportunity to research the “gap” period to determine if any additional liens and/or encumbrances, etc., have been filed against the subject property. If there are none, the closing can be completed and the final disbursements made.
On the other hand, if additional defects against the title are discovered, the escrow agreement could provide the buyer with a choice: 1) allow the transaction to be completed, knowing that the buyer will be responsible for defects noted, or 2) terminate the transaction. Once again, the parties should have access to legal representation in this critical step in the transaction.
Working with short sales can be a risky business. However, knowledgeable brokers can help a seller minimize the damage to the seller’s credit and effectively work with buyers to help them find good value in a short sale transaction.
For more information, please see Legal Update 96.02, “Title Insurance,” available online at www.wra.org/LU9602, and Legal Update 09.03, “Working with Distressed Sales,” also online at www.wra.org/LU0903.
Keving King is General Counsel for the WRA.