Court of Appeals Decided Date of Valuation for Lender’s Title Policies
September 22, 2015
Thomas A. Stoops
Stoops, Denious, Wilson & Murray, PLC
There is some controversy in Arizona about the date of valuation for owner’s policies and lender’s policies on title insurance. We have written articles that were critical of the position of the Arizona Court of Appeals with regard to owner’s policies. The rule established is that the date of valuation for the calculation of loss, assuming that there is a title defect covered by an owner’s policy, is the date in which the title defect is discovered. We have been critical of that because it means that the title company who issues the title insurance policy always has the benefit of any downside in the real estate market, since the loss is calculated based on the value of the property on the date that the title defect is discovered, and it never has to pay more than the face of the title policy.
Until recently, there was some uncertainty on the issue of the date of valuation on a lender’s policy. Of course, a lender does not have the same upside potential with regard to real property that an owner does, since at most the lender will get the return of its loan amount, and so the question was, when should the date of valuation be? Of course, the title insurance industry strongly urged that the date of valuation should be the date of foreclosure since it could always argue that the property had diminished in value. The Court of Appeals, Division One, in the case of First American Title Insurance Company v. Johnson Bank, 716 Ariz. Adv. Rep. 10, decided otherwise.
The facts of the case are fairly simple. First American issued two title insurance policies to Johnson Bank on December 2, 2005 and another on June 19, 2006. These policies insured Johnson Bank’s interest in two properties held by The Equitable Troon K, LLC (“Troon K property”) and Three Sticks Management Group, LLC (“Troon H property”). The policies insured the Troon K property for $1,000,000 and the Troon H property for $1,050,000, which reflected the exact amount Johnson Bank loaned to the owners. First American issued separate title insurance policies to the owners of the properties. In 2008, the owners sued First American to recover damages under their owner’s title insurance policies, alleging certain undisclosed covenants, conditions, and restriction (“CC&R’s”) existed that prohibited commercial development on both properties. The owners then defaulted on their obligations to Johnson Bank, and on September 22, 2010, Johnson Bank obtained title to the two parcels through foreclosure credit bids. Johnson Bank then made claims under its lender’s policies, asserting the CC&R’s prevented both properties from being developed for commercial purposes, and that these CC&R’s were not listed exceptions to the title insurance policies.
First American and Johnson Bank disagreed as to the date for calculating alleged diminution in value to the property. Johnson Bank argued that the date the loans were issued should be the date used to calculate any diminution in value. First American argued that the date of foreclosure should be utilized for this calculation.
The Court of Appeals, Division One, noted that, “This court has previously held the date for valuing a property under an owner’s title insurance policy is the date the title defect is discovered,” citing, Swanson v. Safeco Title Ins. Co., 186 Ariz. 637, 641, 925 P.2d 1354, 1358 (App. 1995). Of course, this is the ruling that we have previously criticized in earlier articles. The Court of Appeals went on to say that the title insurance policies contain no specific applicable language, and the Court notes that there is no statute or other binding legal precedence in Arizona that determines the starting date of comparative valuation for evaluating covered losses under a lender’s policy. The Court of Appeals stated that, “The standard title insurance policy provisions in question is Section 7(a) (iii), which states: “(a) The liability of the Company under this policy shall not exceed the lease . . . (iii) the difference between the value of the insured estate or interest as insured and the value of the insured estate or interest subject to the defect, lien or encumbrance insured by this policy.” The Court observes that the failure of the provision to specify the date the loss is to be calculated creates an ambiguity.
Johnson Bank urged the Court of Appeals to follow a federal district court case, Equity Income Partners LP v. Chicago Title Ins. Co., 2012 WL 3871505 (D. Ariz. Sept. 6, 2012), in which the U.S. District Court held that the date of the loan was the proper valuation date. The Court of Appeals went on the note, “We agree with the reasoning in Equity Income Partners, and hold that where the undisclosed defect in title has caused the borrower’s default, the date of the loan is the proper date to measure a property’s diminution in value as a result of the undisclosed title defect.” The Court stated that the undisclosed title defect frustrated the intended use of the property, and was the direct cause of the borrower’s default and subsequent foreclosure by the lender. The Court noted, “Because such default is a result of the undisclosed title defect, the title insurer should bear the consequences of that default, not the lender.” The Court stated, “[a]llowing the insurer to wait to value the [property] in a falling real estate market works to the insurer’s benefit, a result that does not construe an ambiguity in the policy in favor of the insured.” The Court went on to note that, “Unlike an owner, a lender stands to gain nothing when market forces cause property to appreciate . . . [a]ny other rule would not give
the insured the protection for which he bargained and for which he paid.” The Court went on to say, “Under these specific circumstances and in the absence of a specified date of comparative valuation identified in the policies, we hold the date to measure any diminution in property value is the date of the loan.
While we applaud this decision the exact same reasoning should apply to owner’s policies. Almost any owner purchasing an owner’s policy who has property insured for the value at the time of the close of escrow thinks that their coverage is in that amount. To the contrary, the insurance company issuing an owner’s policy knows it never has to pay more than the face amount of the policy, but can always argue that by the time the title defect is discovered the property has gone down in value. This is contrary to the common sense belief by any lay person who is purchasing real property. At least the Court accurately addresses the expectations of lenders. It should be kept in mind that the decision of the Court of Appeals is highly fact dependent and may be changed if the title company decides to change the standard form title policy to remove the ambiguity. It is also not clear what the result would be if the title defect was not the cause of the borrower’s default.