What An Owner’s Policy Of Title Insurance Doesn’t Cover

Posted on by Phil Querin

Remember, “exceptions” noted in a preliminary title report (“PTR”)[1] or title policy, are the title insurance company’s exclusions from coverage. This means, for example, that if a homeowner suffered a loss arising from an easement shown as an exception on the policy, the title company is not on the hook, since that easement was listed as an “exception” to coverage under the policy.

Title companies are generally liable on claims only if they fail to list the item as an exception in the title policy. There are two categories of exceptions: “standard” and “special.”

Standard Exceptions.  These are the pre-printed exclusions from coverage that apply to all transactions. They are not unique to the specific property for which the insurance is being issued – they are found in the owner’s policies[2] issued to all buyers at the time of closing.

The standard exceptions to coverage found in owner title insurance policies include the following:

  • Governmental Regulations – Zoning, water rights, mineral rights, etc. that are promulgated by federal, state, and local jurisdictions.
  • Title Defects Known to the Insured – For example, a prospective buyer knows that there is a pre-existing dispute regarding the validity of a recorded easement or right of way on the property being purchased, but does not disclose it to the title insurance company prior to closing. A claim arising under these facts would not be covered by the title insurer.
  • Matters That a Correct Survey Would Disclose – For example, encroachments and other matters that would be revealed by an accurate survey. The title company does not perform a survey prior to issuance of the owner’s policy, so if there is an encroachment, say, by a fence over the land being sold, the title company is not liable, because there was no survey identifying it ahead of time. If there was a survey disclosing the encroachment in the PTR, the title company, knowing this in advance of closing, would exclude it from coverage in the policy.
  • Unrecorded Liens or Other Encumbrances – Since a title company is only responsible for reporting information on the public record, unrecorded lien rights are excluded from coverage in standard owner’s policies. However, construction liens in Oregon can be recorded anytime up to 75 days after labor or materials were provided to a property.

If a sale transaction closed say, 30 days into the 75-day period, and title transferred to the new owner, there would still be 45 days for the construction lien to be recorded against the property. This risk is greatest when there is new construction, or a recent substantial remodel on the property, resulting in the new owner essentially becoming responsible for payment of a lien they knew nothing about. However, homebuyers have certain statutory protections against this risk under ORS 87.007.  See Q-Law article: Homebuyer Protection Act.[3]

  • Parties in Possession – For example, someone occupying the property other than the record owner/seller. This could be an adverse possessor, squatter, trespasser, or tenant under an unrecorded lease. Again, this event is excluded from coverage, since the title company’s only responsibility is to report what it finds on the public record. It has no duty to “knock on doors” to determine who’s living at the subject property.

If a loss arises from an event that falls within one of the standard exceptions, there will be no title insurance coverage. Period.

Special Exceptions. This refers to those policy exclusions that pertain specifically to the property that is the subject of the transaction. They are based upon the information gleaned from the title company’s examination of the public record, i.e. the chain of title[4] of the property being transferred.

But, not all clouds or encumbrances affecting title are bad; some are actually necessary for the development and use of the land.  For example, say a buyer is acquiring a home located in a subdivision.  When that subdivision was first platted, certain utility easements would have been recorded against the property by the developer for installation and repair of the underground utilities, and services such as land line phones (remember them?), cable, electricity, sewer and water. These utility easements will appear on the title insurance policy as special exceptions. They generally are not objectionable, and will continue to show as encumbrances against the title, even after it has been transferred to the new owner.  The existence of these types of encumbrances do not render title “unmarketable” – in other words, they do not prevent a seller from meeting their obligation under the Sale Agreement to convey “marketable title” to the buyer.

One type of special exception that can show up on a PTR could be liens. There are many different types of liens: Some are voluntary, such as trust deeds (e.g. for the purchase money to buy the home), and some involuntary, such as money judgments against the seller. Other types of liens can include contractor’s liens for labor and material supplied to the property, and state and federal income tax liens.  Typically, all liens have to be dealt with by or before closing, so although they are disclosed in the PTR, they must be removed before closing, since they prevent the title from being marketable. Accordingly, liens will typically be satisfied by escrow withholding funds from the seller’s gross proceeds, in order to satisfy them. Of course, when problems arise is when the cost to satisfy the liens exceed the seller’s gross proceeds. In such cases, if the transaction is to close, either the lien holders must agree to reduce their claims (e.g. “short sale”), or the buyer or seller must bring extra proceeds to closing. Otherwise, there can be no closing.

The Role of the Real Estate Broker.  When the title company issues its preliminary report, it is usually provided to the seller, buyer and their respective brokers.  Should brokers read the report?   Although I believe the answer should be “Yes”, I do not believe the practice rises to the level of a “standard of practice” or “standard of care”. In other words, the failure of a broker to read the report is not, in my opinion, “professional negligence”. Real estate agents are not title experts, and should not be rendering opinions about the contents of the preliminary report or the significance of certain exceptions.

Then why should brokers read them?  I maintain that it’s important for brokers to have a familiarity with all aspects their transactions, and this includes the title phase. Accordingly, I believe it is a part of being a professional, to understand how title process works, and its significance at closing.  This can only occur by learning to read and understand the PTR.  After reading enough of them, one will become comfortable with the exercise – just as I had to do when I began practicing real estate law.[5]

Caveat: What brokers must also do, however, is resist the temptation to render an “opinion” about the meaning of an exception to their client.  If the client relies on the broker’s opinion, without checking further, the broker could be held liable to the client for the information imparted, if it is incorrect. In other words, if the broker renders an “opinion” they will be held to the standard of care of an “expert”.  So, metaphorically speaking, brokers should not take off their “real estate licensee hat”, and put on a “title examiner hat” (or any other “hat” e.g. lawyer, inspector, well or septic expert, FIRPTA, etc., etc.)

This does not mean real estate brokers should be silent observers in the transactional process.  If there is a problem, the title or escrow company will likely note it at the time the PTR is issued.  This is because if there are liens on the property, escrow will need to get payoff figures from the creditor, so that they can be cleared prior to closing.

Title officers and escrow officers are a good source of information.  Their contact information is noted in the PTR. If there is a problem or concern with title, the title officer should be contacted, as well as the escrow officer closing the transaction.  If a buyer wants their broker to make the contact and get additional information from title or escrow, extreme caution should be exercised in making sure that the information obtained is clear and correct. While good notes are helpful, I suggest confirming all important information in email, identifying the nature of the problem, and what the title or escrow officer says is necessary to correct the matter. The email should copy the client on all communications, with the invitation for the client to ask any questions or voice any concerns.  The broker’s job is not necessarily to answer the technical questions, but to get the client to the proper expert, or to encourage the client to contact their own attorney.

When the information is discussed with the client, it should be done with the caveat that the broker is not an expert in these matters, and that the client should conduct their own investigation, either through legal counsel of their choice, or another expert, to verify the nature of the problem and the solution. In all instances, brokers should check with their managing principal broker for directions, advice, and assistance. ~PCQ

[1] The preliminary title report (“PTR”) is issued at the start of purchase and sale transaction, i.e. shortly after escrow is opened. It gives the parties a snapshot of what purports to be all of the matters appearing on the public record affecting the property, such as easements, liens, mortgages, property taxes, etc. The OREF Sale Agreement makes the buyer’s satisfaction with the PTR a contingency to closing.  If the PTR discloses the existence of a problematic recorded encumbrance on title, the buyer would typically raise it as an objection, and the parties would try to negotiate a solution to the problem. If nothing can be negotiated, the buyer must decide whether to terminate the transaction and obtain a full refund of the deposit, or accept the encumbrance on title after closing. The title company can amend, update, supplement, or correct the PTR all the way up to closing. At the time of closing, the company makes a final check of the record title, to assure itself that it has all of the latest information. Then it issues the title insurance policy. If the company did everything right, the policy will show all of the recorded matters appearing on the public record as “exceptions’, i.e. those matters that are excluded from coverage. Generally, the only time the company has to pay a claim is when it misses something, and fails to show it as an “exception” on the report. So, the insurance policy is really a “guarantee” by the company that at closing, it has, through the PTR and policy, notified the buyer of everything on the public record affecting the property. Thus, title insurance is more akin to a warranty that the information is current and correct. Thus, it is not “insurance” as we normally think of insurance, where companies insure against “risks” such as illness in a health policy, death in a life policy, and fire or storm in a casualty policy. With title insurance, the “risk” has been eliminated or reduced by examiners checking the public record, and excluding those matters from coverage. This is why title insurance carriers have far few losses than typical insurance carriers, where there is true risk, actuarially speaking.

[2] An owner’s policy is the type of title insurance policy issued to buyers in residential real estate transactions, containing the standard exceptions and special exceptions, as discussed above. These policies are different than those issued to lenders who make purchase money loans to buyers and take back a note and trust deed. Lender’s policies have fewer standard exceptions – or to put it another way, lender’s policies of title insurance offer better coverage than that given to buyers.

[3] Title companies in Oregon usually provide buyers with a “free” special endorsement against unrecorded construction liens in those cases in which the buyer is obtaining financing, since the buyer is already paying for the lender’s policy of title insurance, which has this extended coverage. But beware! For cash buyers, i.e. with no lenders, the “free” endorsement opportunity doesn’t exist, so buyer’s purchasing new construction with cash should address this issue in their offer of purchase – e.g. asking the seller to pay for the extended lien coverage.

[4] A “chain of title” refers to the successive recorded conveyances and other events, such as easement, liens, mortgages, etc. affecting a particular property. Since every grantor conveying title to property must have first been a grantee, these successive conveyances form, metaphorically, a “chain”, linking the first conveyance to the last.

[5] While there were real estate classes in law school, they dealt with the legal aspects of property, and not the nuts and bolts of reading PTRs. Perhaps this has changed, but I doubt it; this is real world experience that is not usually addressed in law school, unless it offers some practicum courses taught by title experts.

Posted in Broker Risk Management, Miscellany, Realtor Risk Management, Realtors, Title Insurance | Tagged , ,
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