TITLE INSURANCE: WHAT IT IS AND WHAT IT ISN’T
By: R. Scott Alagood
An extremely high percentage of real estate sales and financing transactions involve the issuance of title insurance of some type. In dealing with clients in residential or commercial transactions, I have found that most consumers of title insurance products do not fully understand what title insurance is, why they require it, and what benefits are conferred upon the insured in the event of a title defect. This article will address some common misconceptions about title insurance and explain what it is and what it isn’t.
Title Insurance is an American idea. It is a contract of indemnity which is predominantly used in the U.S. to insure a property owner or lender from defects in title which may affect the owner’s or lender’s interest in a particular parcel of real estate. There are two primary components of title insurance. First, it provides the insured an attorney (and other costs of “defense”) to represent the insured and the insured’s interest in the property which may be under legal attack. Secondly, in the event that the insured actually sustains a covered loss, title insurance will either remedy the problem, reinsure the risk, or compensate the insured for any damages sustained therefrom.
Prior to title insurance being readily available, Owners, potential Buyers, and Lenders had to rely upon title abstracts in order to know or understand what interest they had (or were acquiring) in a particular parcel of real estate. An abstract of title was simply a summary of the relevant documents which had been filed of record through the date of inquiry and which may have some effect on the title to the subject property. Most of the time an abstract would include or reference the particular documents affecting title and the recording information of the documents. It was up to the Owner, potential Buyer, or Lender to review the abstract in and determine for itself whether the interest conveyed or to be conveyed was acceptable. However, a title abstract in and of itself provided the intended user with little or no remedy in the event it was not correct. Sellers, Buyers and Lenders had to allocate the responsibility of any undisclosed title defects through the warranties contained in the Deed or the security agreements.
Title insurance typically insures fee simple ownership in real property or the priority of the lender’s lien with respect to the property secured by such lien. However, other incidents of real estate ownership may be insured, such as easements, leases, or life estates. With the proliferation of oil and gas production in urban areas over the past 20 years, newer title insurance policies typically will not insure title to the mineral estate of real property. However, there are certain types of surface improvements against interference from the mineral estate.
There are two basic types of title insurance policies. One type of policy insures the Owner of the real property against certain title defects (“Owner’s Policy”). The other type of policy insures a lender’s interest in the real property which is securing the repayment of a loan (“Mortgagee’s Policy”). Most Lenders require the Owner/Borrower to purchase the Mortgagee’s Policy of Title Insurance for the Lender as a condition of making any loan secured by real property. However, the acquisition of an Owner’s Policy of Title Insurance is simply a matter of choice on the part of the Owner or potential Buyer of real property. While some folks believe that it is customary for the Seller to pay for the Owner’s Policy premium, the payment of the Owner’s Policy is subject to negotiation in the Sales Contract and is typically a function of the price being paid for the property. Other good news for the Owner/Buyer/Borrower is that the issuance of a Texas Mortgagee’s Policy in connection with the issuance of a Texas Owner’s Policy only costs an additional $100.00.
The Texas Department of Insurance is authorized to regulate title insurance in Texas as codified in the Texas Title Insurance Act (Tex.Ins. Code Section 2501.001 et seq.). The Texas State Board of Insurance approves insuring forms, premium rate rules, and procedural rules for the title insurance industry in Texas. Texas title insurance is different than the overwhelming majority of jurisdictions in the United States in this fashion. Most other jurisdictions have adopted the forms and rules promulgated by the American Land Title Association (“ALTA”), which is a national trade association of title insurance underwriters and agents. The primary state trade association in Texas is the Texas Land Title Association (“TLTA”). While the TLTA is a private organization and has no legislative authority, the recommendations and input from TLTA are given great weight in the regulation of title insurance in Texas.
So, howe does title insurance differ from an abstract of title? For one, the sole purpose of an abstract of title is to conduct a diligent and thorough search of the applicable public records and to examine the state of title to a particular parcel of real estate based upon such inquiry. The duties and liabilities of the abstractor depend on conducting such search and examination in accordance with certain industry standards and in a non-negligent manner. To the contrary, a title insurance company is not a title abstractor and owes no duty to examine title. Its sole purpose is to provide the contractual indemnities and legal defense to insure against certain promulgated and/or express title defects. While examination of title is implicit in the business of issuing a sound title policy, such policy does not guarantee that the state of title as reflected in the policy is correct. Rather, if the insured finds itself faxing possible litigation or has been damaged as a result of a defect which is insured under the policy, then the issuer of such policy becomes liable thereunder to provide the insured with a defense and either resolve the defect, reinsure the risk, or pay for any damages resulting therefrom. Title insurance effectively takes the place of the Owner, Buyer or Lender having to prosecute a legal claim on its own and at its sole cost and expense under the contractual warranties contained in the Deed or security documents. By acquiring a policy of insurance, certain risks associated with a property’s title may be shifted to the title insurance carrier from the Owner or Lender.
While Title insurance is a very cost effective manner of shifting title risk, it certainly doesn’t cover all risks of ownership or lending associated with real estate. First, the amount of insurance is limited to the face amount of the policy. Typically, the face amount of the policy will be limited to the purchase price, fair market value of the property (and any improvements) at the time the policy was issued (or if later improved, at such date), or for a Mortgagee’s Policy, the loan amount . Also, title insurance underwriters are in business to make a profit. As such, the underwriters take extreme precaution to ensure that the risks they insure against are limited to those mandated by State law, and are sometimes reluctant to insure beyond what is minimally required by law or regulation. Similarly, all title insurance policies in Texas do not insure against certain predetermined risks. These risks which are set out in the policy are better known as exclusions. Additionally, following the title examination of the particular parcel of real estate, the policy will include specific exceptions to coverage which are either found of record or otherwise allowed by the Texas title insurance regulations.
In short, Texas title insurance is not a guarantee of title to the insured. It is a contractual agreement between the insured (Owner or Lender_ and the title insurance policy issuer to cover stated title risks associated with the ownership and financing of real property. In this respect, title insurance is more like your automobile or home owners’ insurance policies, rather than a guarantee of title. That’s not to say that a review of the precursor document to the issuance of a title insurance policy shouldn’t be performed by the Owner, Buyer or Lender prior to paying the applicable premium. To the contrary it is extremely important that the “commitment” for issuance of a title insurance policy be reviewed in addition to any documents which will constitute exceptions from coverage once the policy is issued. If possible, both the title insurance commitment and exception documents should be examined along with a current survey. The commitment should provide a good snapshot of the exceptions contained in the public records, while the survey will show the location of such exceptions on the ground and any other exceptions which are not found in the public records, but which are visibly apparent from an inspection of the property.