Title Insurance Against What?

Buyers of real property in California routinely purchase a policy of title insurance. In the case of single-family residential property, the buyer usually receives a CLTA form of policy; in commercial and industrial and large acreage purchases, the buyer usually requests an ALTA policy affording broader coverage, but requiring a survey of the land. Explaining what these policies cover and don't cover is a subject for a treatise, not a newsletter. However, when the buyer learns that his policy does not cover something which he reasonably believed would be covered, and when an appellate court confirms the surprising lack of coverage, then I see a topic worth highlighting.

Let us start with the general rule: A title-insurance policy insures good and marketable title to the property based upon documents recorded in the Official Records, unless the policy lists as "exceptions" specified documents in the Records. Therefore, if an item exists in the Official Records, but the policy fails to list it as an "exception," then the insured owner can make a claim against the insurance company for any loss caused by the missed "exception." Simply stated, there is coverage for the omitted "exception."

Examples of commonly missed "exceptions" include tax liens, judgments, easements, and sometimes even a deed of trust. But let us take a less common example - a notice recorded by a city stating that a violation exists on the property. The violation may concern zoning, lack of permits, non-compliance with the building code - in short, anything covered by the city's ordinances. Would you believe that you could make a claim on your policy if the company missed such a notice of violation altogether? If you do, you will be disappointed.

In the case of Elysian Investment Group v. Stewart Title Guaranty Company , decided in 2002, the appellate court ruled that a notice of violation recorded by a city, but not listed as an "exception" in the policy, did not trigger coverage under the policy. The violation consisted of a garage conversion done without permits and creating a second dwelling unit. The city wanted the garage reconverted to its original condition. The buyer purchased the property from a lender who had foreclosed and who therefore sold the property in 'as-is' condition. The lender knew about the code violation, but did not disclose it to the buyer.

In ruling that the insurance company rightfully denied the claim, the appellate court made a number of distinctions which only a lawyer (but not this lawyer) could love. First, the court pointed out that a title-insurance policy insures against "defects in title" and the notice of violation did not make the buyer's title defective in any way. While the notice signaled physical problems with the property, the buyer still had good title to the property, albeit that the property would have to be re-constructed.

Second, the court acknowledged that the city held the right to re-convert the garage on its own and then to assess a lien against the property to recover its costs. In other words, the notice of violation was really a monetary lien about to be born. Yet the court reasoned that future action by the city would have to occur before the lien was imposed and "title insurance does not insure against future events." The fact that the buyer might have to use his own money for the re-conversion apparently did not impress the court either.

Third, the court explained away express language in the policy which seemed to create, through a process of exclusion and exception, coverage for the buyer. The policy's language stated that the policy did not cover any loss resulting from governmental regulations, "except to the extent that a notice of the enforcement thereof . . . has been recorded in the public records at Date of Policy." I would have thought that language would have turned the tide in favor of the buyer. But it did not. The court invoked the hyper-technical rule that an exception to an exclusion does not create coverage. Even without that rule, the court went on to explain, since a notice of violation is not a "notice of enforcement," coverage could not exist anyway. The court gave no definition for "notice of enforcement."

Finally, the court denied that the notice of violation affected marketability of the buyer's title to the property. The court quoted another enigmatic rule to the effect that: "One can hold perfect title to land that is valueless; one can have marketable title to land while the land itself is unmarketable." To translate, loss of market value due to a physical problem with the property makes no difference.

The final count looks like this: A title company can miss a recorded notice of code violation; the buyer cannot use the property without curing the violation; the buyer cannot re-sell property without conceding a price discount for the trouble and expense created by the violation; and the buyer cannot walk away from the violation without having the city put an assessment lien against the property; and still the title insurance company need do nothing at all. I have difficulty accepting that predicament.