by John E. Taylor
Yes. Not to put too fine a point on it.
A typical real estate transaction involves two transfers: a deed from seller to buyer and a deed to secure debt, also called a “security deed,” from the buyer to its lender. By signing and delivering the deed, the seller conveys to the buyer, and makes certain promises (or “warranties”) regarding, title to the property. By signing and delivering the security deed, the buyer, as borrower, conveys the property to the lender to secure the loan, subject to the lender’s obligation to cancel the security deed upon full payment. A security deed also contains warranties by the borrower to the lender regarding the title to the property.
A deed general warranty deed is the customary type of deed in a residential transaction; a limited warranty deed (“special warranty deed” in some states) in a commercial deal. With either deed the seller (or “grantor”) warrants to the buyer (or “grantee”) that the seller has the right to sell the property, that no one will disturb the grantee’s “quiet enjoyment” of possession of the land and that the title is free of undisclosed encumbrances. A limited warranty limits the latter two warranties to matters “by, through or under” the grantor: matters caused by the acts or omissions of the grantor or others somehow claiming through the grantor, such as a tenant or lender. A security deed routinely includes the general warranties, with the grantor in that case being the borrower.
A grantee may have a claim against a grantor for breach of these warranties. For example, upon the buyer’s losing the property, and the lender’s losing its security, due to foreclosure of an undisclosed security deed, the lender will have a claim for breach of warranty against the buyer/borrower under the security deed and the buyer/borrower will have a breach of warranty claim against the seller. These claims may be worthless, however, if the obligors may are insolvent or in any event unable to pay. The parties must also assert the claims within legally-specified time periods.
The lender will routinely require a title insurance policy instead of relying on the deed warranties. By delivering a title insurance policy to the lender, the title insurance company agrees to compensate the lender for damages caused by, among other things, undisclosed encumbrances such as prior, undisclosed security deeds, and title problems not disclosed by review of the public records, such as fraud or missing heirs. The lender also gains the benefit of the (at least presumed) solvency of the title insurance company and the absence of the time limits that apply to breach of warranty claims.
One option of the title insurance company to resolve a claim against its policy based on, for example, a prior security deed, may simply be to pay it off. By doing so, the title insurance company buys, or is “subrogated to,” the lender’s claim against the borrower for breach of the warranties in the security deed. The title insurance company then has the right to sue the borrower to recover the amount it paid to satisfy the security deed, subject to the restrictions and requirements applicable to suits on the warranties. The borrower can avoid this risk by purchasing an owner’s title insurance policy, placing the title insurance company in the position of both enforcing, and defending against the enforcement of, the warranties in the security deed. The best and recommended practice is for the insured amount of the owner’s policy to equal the purchase price, but some buyers elect to obtain coverage only up to the amount of the loan, to protect against a possible subrogation claim. Owner’s title insurance in either amount will protect the insured against a warranty subrogation claim by the title insurance company, but an owner’s policy in the amount of the loan will not protect the owner’s full investment in the property.
A buyer should also obtain title insurance absent a lender. Again, the continuing solvency of the title insurance company will likely be more dependable than that of the seller. The policy will protect against matters not disclosed by an examination of the public records. Upon subsequent sale of the property, the coverage of the title insurance policy will continue to the extent of the selling owner’s liability for breach of its warranties in the sale deed.
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