;
;
;Daily Development for Tuesday, November 6, 2007
;by: Patrick A. Randolph, Jr.
;Elmer F. Pierson Professor of Law
;UMKC School of Law
;Of Counsel: Blackwell Sanders Peper Martin
;Kansas City, Missouri
;dirt@umkc.edu
;
;FORECLOSURE; TITLE INSURANCE; INADEQUATE CONSIDERATION: Arizona appellate court holds that when foreclosure sale is set aside because purchase price is "grossly inadequate" and "shock[s] the court's conscience," an exclusion in the purchasers' Owner's Title Policy against losses for failure to pay value bars the purchasers from recovering the fair market value of the home from the title insurer.

;
;First American Title Insurance Company v. Action Acquisitions, LLC, 2007 WL 3146837 (Ariz. App. Div. 1), Oct. 30, 2007.

;
;[Note that the Reporter is employed by the defendant in this case. See the editor’s pithy rejoinder as the end.]
;
;I imagine this is the kind of bizarre lawsuit we may start seeing more of as title insurance companies (and lenders, appraisers and other parties to residential transactions) become a target for "quick-buck" artists out there hoping to cash in on the housing downturn. In this case, the home was worth between $300,000 and $400,000 and was encumbered by a $162,000 deed of trust. The purchasers, professional foreclosure entities named (perhaps aptly), "Action Acquisitions, LLC" and "Free for Now, LLC," (together, "Purchasers"), respectively, paid only $3,500 (the amount of unpaid homeowners' association assessments plus costs) for between $138,000 and $238,000 of equity; their successful bid was between 1.5 percent and 2.5 percent of the equity they acquired.

;
;According to the court, "Purchasers' practice is to bid only the minimum required to cover the homeowners' association liens that have been foreclosed upon." In this case, after the statutory redemption period expired, the Purchasers bought a $400,000 Owner's Title Policy for the home from Capital Title Agency, which policy was underwritten by First American Title Insurance Company ("First American"). The home's previous owner subsequently filed a motion to set aside the sale because "the price Purchasers paid was so inadequate that it shocked the conscience." Purchasers notified First American, seeking a defense to the action. First American retained counsel to defend the Purchasers. The Arizona superior court that heard the foreclosure action then granted the motion to set aside the sale, and Purchasers filed a claim against First American under the Owner's Policy, asserting a loss of $400,000. (Query: Why did the superior court approve the sale to the Purchasers in the first p

lace, as it knew – or certainly should have known – of the vast discrepancy between the value of the home and the price paid by the Purchasers? If the previous owner had not finally woken up and filed a suit to overturn the foreclosure sale, Purchasers' normal method of operation would have worked perfectly.)

;
;First American refused to pay the claim and filed a claim for declaratory judgment, arguing that coverage was barred under 1) Exclusion 4(a) of the Policy (providing that Purchasers were not insured against loss resulting from "risks . . . that are created, allowed, or agreed to by [Purchasers]," and 2) Exclusion 5 of the Policy, which excluded loss "resulting from . . . failure to pay value for [the] Title." Purchasers filed a counterclaim against First American and a third-party complaint against Capital Title, alleging bad faith and breach of the covenant of good faith and fair dealing, fraud and fraudulent misrepresentation, negligence and negligent misrepresentation, breach of fiduciary duty and constructive fraud and consumer fraud.

;
;The Superior Court found for First American under Exclusion 4(a) of the Policy, stating that the Purchasers "knowingly incurred the risk that the sale could be set aside." The Superior Court did not deem it necessary to address First American's argument that Exclusion 5 also barred coverage. The appellate court, on the other hand, affirmed the Superior Court's ruling but relied entirely on Exclusion 5, holding that Exclusion 5 "bars coverage of the loss Purchasers incurred when the purchase was set aside"; the appellate court therefore deemed it not necessary to consider Exclusion 4(a). The appellate court agreed with First American's argument that the word "value" in Exclusion 5 means "substantial value" or "fair and adequate value" as compared to the actual cash value of the property acquired at the foreclosure sale. The appellate court cited several cases, from both Arizona and other jurisdictions, holding that purchasers who acquire property for a grossly inadequate price are

 not bona fide purchasers for value. According to the appellate court, "by arguing that 'value' effectively means 'any consideration,' Purchasers would render the exclusion all but meaningless." The appellate court also cited the general rule stated in sec. 8.3 cmt. B of the Restatement (Third) of Property: Mortgages, i.e., that a foreclosure sale may be invalidated if the price paid is less than 20 percent of the fair market value.

;
;The appellate court rejected the Purchasers' assertion that because Capital Title was aware of the price for which Purchasers acquired the home, the entire $400,000 claim should be paid. The appellate court noted that "the nature of title insurance is that it covers risks to title other than those that are specified in the policy. In this case . . . an insurer that is aware of the possibility that a sale will be set aside for failure to pay value will expressly exclude coverage for that risk" (emphasis in text). The court further noted that Purchasers' practice was to bid in the bare minimum required to cover the homeowners' assessment liens foreclosed upon, and that by doing business in this manner, "they take a calculated risk that a purchase will be set aside for failure to pay sufficient value." The court further reasoned that because most foreclosure sales are not challenged by the homeowner, Purchasers "may enjoy a windfall," because in many cases the Purchasers would be ab

le to sell the home at or near its fair value for an (often) exorbitant profit. According to the court, title insurers should not, on public policy grounds, be in the business of guaranteeing Purchasers' a sizable profit on their speculative bid at a foreclosure sheriff's sale. The appellate court also rejected Purchasers' argument that if Exclusion 5 of the policy were held to prevent coverage by the Purchasers, the coverage under the policy would illusory and a nullity, noting that "the Policy provided Purchasers a wide variety of valuable coverages," including unknown easements, title defects and access impediments.

;
;Reporter’s Comment 1: The facts in this case virtually cried out for the decision (by both the superior court and the appellate court) that the foreclosure sale should be overturned and the title insurer not required to pay the $400,000 liability amount under the Owner's Policy. This is probably as clear a case for equitable intervention by a court that could be imagined. Unfortunately, as the appellate court points out, very few distressed homeowners facing foreclosure have the inclination, time or money to bring an action to set aside a foreclosure sale, and they rarely even put in an appearance or an answer. And it would certainly be unfair to permit speculative foreclosure sale purchasers (who are solely in this type of business to make a profit; the court noted that Purchasers "acquired most of the homes for bids of only $3000 to $6200") to "insure" or "guarantee" their anticipated profits even if the sale were later set aside, by purchasing an Owner's Title Policy for an am

ount far in excess of the amount they voluntarily bid at the foreclosure sale and then be able to recover the grossly higher amount from the title insurer. As noted earlier, with the current severe downturn in the housing market, we can expect to see more of these types of actions against various parties involved in residential real estate transactions; hopefully homeowners will not capitulate with respect to grossly inadequate bids for their property at foreclosure sales and will realize that they have legal rights also.

;
;Reporter’s Comment 2: On the other hand, it always makes sense to pay your homeowners' association assessments (at least when it appears you are able to), which normally are quite low in relation to the value of the property. In this case, the facts are somewhat unusual because the homeowners were foreclosed upon because they didn't make assessment payments of $3000 on a home worth as much as $400,000. It at least seems that the homeowners (obviously not the victims of poverty) could have come up with the $3000 somewhere and avoided the time, hassle, and expense of challenging the price paid at the foreclosure sale, or else contested the foreclosure sale while it was pending -- since they were able to pay attorneys to contest it after the redemption period expired. (Although this certainly does not excuse the actions of Purchasers that were rejected by the appellate court.)

;
;Reporter’s Comment 3: It is somewhat worrisome that, as the appellate court notes in a footnote, "Capital Title did not dispute Purchasers' assertion that it was aware of both the estimated fair market value of the home and the amount Purchasers paid for it." At what point (if any) could the discrepancy be low enough that the court (or some other court) would still set aside the sale but perhaps permit a purchaser to make a successful claim against the title company to pay the higher liability amount under the Owner's Policy? Note that the Purchasers did not purchase the title policy until after the expiration of the statutory redemption period, so that Capital Title knew exactly the amount of the bid and the approximate value of the property; thus there was no fraud, misrepresentation, or withholding of information from Capital Title on the part of Purchasers. Fortunately for the title agent and underwriter, the term "value" in Exclusion 5 has been decided under existing case la

w in a manner favorable to title companies and agents, i.e., it does not mean "any" consideration but instead means valuable and adequate consideration. As noted by the appellate court, "the purpose of [Exclusion 5] would be served by interpreting it consistently with the authorities that set out the requirements for a bona fide purchaser or that, in this context, establish when a foreclosure sale may be set aside for failure to pay adequate value."

;
;Editor’s Comment: The editor supposes there is something in the policy that might support the title company’s escaping liability here, but he doesn’t agree that the “value” requirement ought to be the basis for such relief.

;
;There can be little doubt that the purpose of the policy’s language that there is no coverage if “value” is not paid is to avoid liability where the insured is not a “bona fide purchaser for value” and therefore does not take free of unrecorded interests.  But the definition of what constitutes sufficient value to constitute a “bona fide purchaser for value” varies from one jurisdiction to the next and RARELY is it read to mean the same as “adequate consideration” as the court (and Jack) would appear to have it mean here. 

;
;Given the court’s analysis, which stresses an interpretation of the language of the policy only, and does not tie its analysis to the meaning of the term “value” as it appears in the recording acts literature, an insured in a state that does recognize any significant payment as “value” for recording act purposes might find itself uninsured because the court reads that term differently in the policy.  This result could obtain whether or not the insured was a foreclosure purchaser.  Not a good thing.

;
;The fact is that foreclosure sale purchasers frequently do not pay “adequate consideration” as that term is variously defined.  They pay the amount necessary to win at foreclosure.  No less an authority than the U.S. Supreme Court has recognized that we shouldn’t expect more from foreclosure sales than an open and fully noticed auction.  Remember the Durrett controversy - resolved (mostly) in In re BFP?   

;
;The bottom line is that it’s neither a sin nor a crime for a third party to buy at foreclosure sale for a low price.  And those who buy at such foreclosure sales are certainly entitled to strike a bargain with a title insurer to insure their foreclosure title.  If, as should always be the case, the title insurer is aware that it’s insuring a title derived from a foreclosure sale, shouldn’t we expect it to state more specifically that it’s not insuring against the risk of a court’s undoing the sale?  The editor certainly thinks so.  Back to the drafting room, Jack.  Don’t rely on this case. 

;
;The Reporter for this item was Jack Murray of First American Title Insurance Company’s Chicago Office.
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