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Title Insurance in Real Estate Purchases
Title insurance in real estate purchases has always struck me as a
mysterious and subtle thing. I remember reading a title policy for the first
time and asking, what coverage is the buyer really getting? And how does it
factor into the purchase agreement and the deal?
I’ve found over the years that buyers and sellers gloss
over title. Buyers say to themselves, I’m buying title insurance so I don’t
need to care about this or that title issue. Sellers say to buyers, you’re
buying title insurance, so you no longer have any title risk. They’re both
wrong.
In this article I will briefly explain what title really
means in a real estate purchase. I will discuss (1) how to review a preliminary
title report, (2) how to handle title exceptions, (3) how title fits into the
purchase agreement, and (4) what a title policy really gives you. Because
buyers buy title insurance, I will mostly take the buyer’s perspective.
#1 – Review the Preliminary
Report.
The preliminary report (the “prelim”) is usually the first
step in understanding title.
Legally, a prelim is an offer from the title company to
give insurance. When you accept the prelim, a binding contract is created
between you and the title company. Hence before accepting the prelim, review
it, the documents listed as exceptions in Schedule B and the proposed policy
itself.
Now, how do you review a prelim? Focus on the following:
- Verify that the seller holds fee title to the
property, and that your name, as the buyer, is exactly correct.
- Be sure that the legal description of the property is
identical to the description shown on any survey.
- Review the exceptions in Schedule B for third party
claims, including whether any encumbrances affect the desired use.
- Review the exceptions in Schedule B for any
restrictions on ownership, e.g. check the covenants, conditions and
restrictions (CC&Rs).
- Get copies of and read all documents referenced in
Schedule B (since these will be excluded from coverage).
#2 – Handle Title Exceptions.
After reviewing the title exceptions in the prelim, your
next step is clearing some of them.
First, in the purchase agreement you should require the
seller to remove all monetary liens by payoff prior to closing, except: (i)
financing that you will assume; (ii) current taxes constituting a lien not yet
due and payable at the closing; and (iii) bonds or assessments to be allocated
between the buyer and seller as of closing.
Second, negotiate with the seller for the removal, if
possible, of problematic non-monetary exceptions (e.g. easements). Consider
also having the title company remove all boilerplate exceptions that have no
basis in reality.
A few minor title exceptions show up in all prelims.
Ordinarily you don’t need to worry too much about these exceptions, namely:
- General and special city and/or county taxes which are
liens not yet payable.
- Lien of supplemental taxes assessed pursuant to
Division 1, Chapter 3.5 of the Revenue & Taxation Code.
- Utility easements, but depending on their location and
whether you intend to build over the easements.
- CC&Rs, unless they affect or prevent your intended use
of the property.
Remember that buying insurance coverage for a defect in
title does not fix the defect. Although insured for, the defect remains on your
property. If the defect is serious, consider walking away from the purchase no
matter whether you can get title insurance, because:
- Your policy limit is usually the purchase price for
the property. The policy will not pay anything more – not the policy
premium, closing costs, loan fees, repairs, improvements or anything else.
- The insurance company might deny your claim for
coverage.
- Even if the title company gives coverage, still, if a
defect ripens into an actual third party claim against the property, you
will suffer delays and consequential economic loss during the litigation
(which probably won’t be covered under the policy).
- The next buyer or a future lender might decline a deal
with the property based on the defect.
Conclusion: Remove all serious defects. If that is
impossible, don’t buy the property no matter what coverage is available.
#3 – Title Issues in the Purchase
Agreement.
Usually the seller promises marketable title in the
purchase agreement, no more. From the seller’s perspective, representations and
warranties about title are not necessary because the buyer should protect itself
with a title policy. The seller should also beware of giving a broad
representation that the property is “free and clear from all encumbrances” – as
applied to land, an encumbrance is almost anything including unknown
encroachments. Hence this representation is too broad.
Although sellers avoid representations about title, title
is usually a condition of closing. In this respect, the parties can attach the
prelim title report to the purchase agreement, and show on the prelim what title
exceptions the seller will remove as a condition to closing.
#4 – The Title Policy.
My last topic is the nature of a title policy. What kind
of protection are you buying? Do you even want a policy, given its cost? It
seems a bit funny to talk about first things last. This discussion is very
difficult, however, and I am afraid that if I started with it, no reader would
survive to the end of this article. So if you’ve read this far,
congratulations.
I will discuss only the CLTA Standard Coverage Policy,
because that is the policy that buyers commonly purchase.
CLTA title insurance insures title as shown in the public
records. Off-record items generally are not covered. That is, CLTA insures
that the liens and encumbrances listed in the prelim are the only ones of public
record, as of the date of issuance of the policy. You, the insured, are buying
peace of mind that the disclosed lien situation is correct, and there are no
other liens of public record. Also, CLTA insures that that the seller
actually owns the property – this covers problems related to fraud or forgery by
the purported grantor.
With a CLTA policy, you are uninsured for liens not on the
public record. Therefore, you should inspect the property for encroachments,
third-party possessory rights (e.g. tenants, adverse possession), boundary line
problems and anything else of interest that would not appear on the record.
Also, remember that you, as a bona fide purchaser, will take free of unrecorded
liens.
Parts of a CLTA Policy. The CLTA Policy is comprised of four
parts:
(1) Title page, which is pre-printed and tells you
the scope of your coverage and exclusions from your coverage;
(2) Schedule A, which tells you the amount of your
insurance (invariably the purchase price), the premium, your name as the
insured, the legal description, and any special coverage;
(3) Schedule B, which has two parts: Part I gives
preprinted exceptions to coverage (including the big exception – no coverage for
easements, liens and encumbrances not of public record). Part II lists the
specific title exceptions from the prelim, all of which are of public record,
plus a few extra exceptions that the title company tries to throw in (e.g. if
the current owner acquired title as a single person but is now married, there
may be an exception for any interest of the spouse).
- Here is the key to the CLTA policy – the policy covers
only encumbrances of record, then the policy removes from coverage
everything that the title company actually could find of record. You,
the insured, are left with little except peace of mind that the disclosed
lien situation is complete. You are insured that there is nothing else of
record out there (that is, in the chain of title). Is the peace of mind
worth the cost? I don’t know – all I know is that I buy title insurance and
so do my clients.
(4) Conditions and stipulations, which are more
preprinted terms. The most important term here is that the title company’s
liability terminates upon conveyance of the estate held by the insured, except
if the insured sells and receives back a purchase money deed of trust.
Conclusion.
Title is a subtle topic. Don’t
worry if you can’t understand it the first time, especially the CLTA policy
I’m no different. In every deal when reviewing title, I go back to the basics
of the CLTA policy. I always remind myself of the exact risks that I am
covering through title insurance and the real world value of the insurance
coverage vis-à-vis the risks.
I hope this article has helped
you understand title a little better. There is a lot more to a real estate
deal, however, than what I discuss here. As always, get competent legal counsel
for your real estate transactions.
Call
me to schedule a legal consultation:
510-796-9144
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