Daily Development for Friday, October, 17, 2008
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

This piece is from the computer of Bushnell Nielson, lightly edited.

TITLE INSURANCE; MARKETABLE TITLE; ENCROACHMENTS: Although an insured in Arkansas may not be able to recover from a title insurer for an negligent title search, the insured will have a claim under marketability coverage when the insured land includes a building that projects into a public street based on an airspace lease that is not insured, which contains defects that are not excepted, the encroachment made title unmarketable, effectively providing coverage for the lack of a valid assignment of that lease.

Chicago Title Ins. Co. v. Arkansas Riverview Development, LLC, ___ F.Supp.2d ___, 2008 WL 4004892 (E.D.Ark.).

The Arkansas Bar Foundation sold its Little Rock building to Gary Canada, who assigned the contract to Arkansas Riverview Development, LLC. The deed described the property as platted lots and a vacated alley. The legal description in the title insurance policy issued by Chicago Title matched the deed.

The Foundation was either sloppy or forgetful. Its building had been allowed to project out over Garland Street based on a 1971 air rights lease from the City of Little Rock. The contract leading to the title insurance activity in this case said that Riverview would buy the land "together with all appurtenances thereto, including, without limitations, air rights." However, no assignment of the lease was prepared.

Riverview began refurbishing the building after closing. When it sought to build additional stories on top of the building, including in the airspace over Garland, Riverview asked for and received an assignment from the Foundation. However, the lease required prior consent of the City for an assignment and it also gave a neighboring hotel a right of first refusal. Riverview did not get the consent or waiver of the hotel's rights.

The Chief Executive Officer of the City Advertising and Promotion Commission sent a letter to the Foundation and Riverview saying that the lease had been violated due to the failure to get the City's consent before the "attempted conveyance" of the lease, because no notice had been given to the hotel, and because the proposed addition would violate a height restriction in the airspace lease. 

This curious means of advertising and promoting the city was followed by a revocation of the building permit. Riverview sued the City of Little Rock and Capitol City Hotel Limited Partnership to enjoin the revocation of the permit, seek a declaration that the assignment of the airspace rights was valid, and to quiet title to the airspace rights. An injunction was issued, and then the dispute was settled. The building plans went forward, and the addition was allowed to go above the height restriction. Riverview paid the hotel money to release its right of first refusal. The City of Little Rock conveyed the airspace rights in fee simple to Riverview.

Riverview then made a claim on its title insurance policy for all of its expenses. Chicago Title denied the claim and filed a declaratory judgment action. Riverview counterclaimed for breach of contract and negligence. Chicago Title moved for summary judgment on both claims.
The federal court first ruled that Arkansas does not recognize a claim for abstractor liability on a title insurance contract. Riverview noted that the jurisdictions "are divided on the issue of whether a title insurer may be liable in tort for a negligent title search," citing Palomar, Title Insurance Law (which strongly advocates for such a claim). However, not in Arkansas:

“Although the Arkansas cases are not crystal clear, this Court is satisfied that it would be inconsistent with Arkansas law to impose tort liability on a title insurer for a deficient title search, at least in a case such as this where the plaintiff requested only title insurance and not a title report.”

<The court acknowledged that two Arkansas cases have held that there is a "duty on the part of title companies to make a reasonable search of the relevant records to detect clouds or defects in title." These are Welch Foods, Inc. v. Chicago Title Ins. Co., 341 Ark. 515, 521, 17 S.W.3d 467, 471 (2000); and Bourland v. Title Ins. Co. of Minn., 4 Ark.App. 68, 73, 627 S.W.2d 567, 570 (1982). However, neither said that "a violation of this duty creates liability in tort rather than for breach of contract." The court quoted Comment, Title Insurance: The Duty to Search, 71 YALE L.J. 1161, 1181 (1962), which said that "a court must be careful not to confuse the preliminary question of whether the insurer is liable for a negligent search with the later question of whether that liability is contractual or tortious in nature." In neither Welch nor Bourland did an insured bring suit for negligent misrepresentation of title.
The court also noted that, in Arkansas, a lawsuit on an abstract of title is a contract action, not a negligence claim. The same must be true of a claim against a title insurer, the court said. This distinction is important, because "the Supreme Court of Arkansas has held that negligent performance of an insurance contract is not a tort in Arkansas," citing a 2006 case. Also, the court said, negligent misrepresentation under Restatement (Second) of Torts § 552, which is the foundation for an abstractor liability claim, is not a valid cause of action in the state, citing a 1994 case.

Finally, Riverview tried to shoehorn its claim into one for "constructive fraud," which Arkansas does recognize. The court said that was not the claim Riverview pled, however, so it declined to address the issue. The court concluded by saying that title insurance is a contract of indemnity, no more and no less. The court did say that, if a separate title search contract had been made, the result "might be different." However, there was no such separate contract.

But the court took away Chicago Title’s victory on the abstractor negligence issue when it considered whether there  was coverage under the policy. Chicago Title's agent, had removed all standard exceptions from the policy, including the survey exception. Exception 3 in Schedule B recited two recorded amendments to the airspace lease, and a separate lease of a parking structure shared with the hotel. However, it did not except the original 1971 airspace lease, which was not in the chain of title. There was also a detailed exception for all of the encroachments shown on the survey provided to the agent at or before closing. Most telling, according to the court, was that "Chicago Title excepted all of the matters shown on the survey that might cloud title to Lots 4, 5 and 6 of Block 99 except the fact that the building was located partly on that tract and partly in the airspace above Garland Street."
The court said that, while "the issues are complicated and the parties have extensively discussed them in excellent briefs," most of the case boiled down to two issues: was title marketable when conveyed and, if not, "does the title insurance policy except or exclude the matter that rendered the title unmarketable?" The court answered the first question:

“The Court has no hesitation in saying that Arkansas Riverview Development did not have marketable title to Lots 4, 5 and 6 of Block 99 when the title insurance policy was issued. … "A marketable title is one that a prudent person with full knowledge of all of the facts would be willing to accept." … No prudent person with full knowledge of all of the facts would be willing to accept title to Lots 4, 5 and 6 of Block 99 with a building built partly on those lots and partly on adjacent property without also obtaining rights to the adjacent property. A person could not have peaceful enjoyment of such property.”

It discussed a case in which the fact that a hotel's wall encroached onto neighboring land without right was found to render title unmarketable.

Chicago Title argued the difference between salability of the land and marketability of its title, and cited First United, Inc. v. Chicago Title Ins. Co., 366 Ark. 508, 237 S.W.3d 15 (2006) for the rule that salability does not trigger policy coverage. In that case, a judgment in favor of time share interval owners would be imposed against a lender if it assumed ownership of the project on foreclosure. The Arkansas Supreme Court found that the lender would have the right to possess, control, and dispose of the property. The judgment made the property "unattractive to potential purchasers," but did not make title unmarketable.

Quoting from First United, this court found that Riverview "did not 'have the right to possess, control, and dispose of the property' because there were 'conflicting claims to the property,' i.e., the fact that someone else owned the right to the airspace above Garland Street where a large portion of the building was located. … Therefore, … the title was unmarketable."

The court acknowledged that, "[h]ad the standard exceptions not been removed, coverage might well be defeated by" the survey exception. The building in the street was shown on the survey. Chicago Title argued that "the fact that the building straddled the line does not mean that there was an encroachment," but rather was a non-covered trespass. The court again quoted Professor Palomar, from Patton and Palomar on Land Titles § 676, in finding that a building is an encroachment, and "[i]f the encroachment is substantial, it constitutes an encumbrance that justifies a purchaser in rejecting title." The court also used the policy and the company website against the insurer:

“The definition of encroachment on Chicago Title's website does not require that the construction onto the property of another be a trespass. … Because the policy does not define the term encroachment, and because the term encroachment can mean a trespass but also can mean construction onto the property of another even when there is no trespass, the term is ambiguous, so doubt as to its meaning must be resolved against Chicago Title.”

The court thus construed the policy as being ambiguous for lack of a definition of a word that is found only in the very exception whose removal the court said created "coverage" in the first place. This is the circularity trap that is a common snare in survey exception cases. However, the court recognized the circularity, and held alternately that the marketability coverage was invoked no matter how the exception might be construed:

“Arguments about the meaning of the terms in [the survey] exception do not change the fact that Chicago Title insured that Arkansas Riverview Development had marketable title [or] that Arkansas Riverview Development did not have marketable title because it did not receive an assignment of the airspace rights on which a substantial portion of the building sat.”

The court moved on to the long, detailed exception number 3 for lease rights between the city, the hotel and the Foundation, which it admitted created a "more difficult issue" about coverage. The court said the exception was not broad enough:             

“The difficulty is that the original lease of the airspace rights from the City to the Bar Foundation, executed in 1971, is not listed in the special exceptions, but the 1973 amendment to and the 1994 extension of the original lease are.”

Chicago Title argued that an exception for an instrument that refers to another instrument is sufficient to except both instruments, citing Arkansas law to that effect. Riverview cited another rule of contract interpretation, that the mention of one class of things implies the exclusion of all members of the class that were not mentioned. Again, it was Professor Palomar to the rescue for the insured: "[I]f a lien, encumbrance or other title defect is to be excepted from coverage, the title insurer must use clear, precise and unambiguous language in the exception." Palomar, Title Insurance Law, § 7:17:

“The special exceptions excepted the 1973 amendment to and the 1994 extension of the original lease but not the original lease; and they removed the standard exception for matters that would be shown by a survey and then excepted the matters shown on the survey without mentioning the elephant in the room-the fact that the building was built partly in the airspace above Garland Street pursuant to the original lease, which was not listed in the exceptions, and the 1973 amendment, which was. Because the special exceptions do not clearly, precisely, and unambiguously except the fact that the building was built partly on the tract that was conveyed and partly on a tract that was not conveyed, the special exceptions do not defeat coverage.”

In the Reporter’s view, Palomar's treatise overstates the actual holding of the cases interpreting the contract. For example, when a policy excepted an easement as being set forth in a mortgage, but not the easement itself, the exception was sufficient. Sullivan v. Tomgil Building Corp., 260 N.Y.S. 2d 465 (Sup. Ct. 1965). See further cases recited in § 12.7.1, Title and Escrow Claims Guide. The court did not address such cases, although they were no doubt cited by the insurer in what the court admitted was an excellent brief.

The court also rejected other policy defenses. The real issue seems to have been whether or not Chicago Title consciously assumed the risk from Riverview that the building was an encroachment without right which the city could demand be removed. The excepted lease documents referred to the 1971 airspace lease. Nonetheless, the court made short shrift of Chicago Title's argument that this problem was "created" by the insured and thus fell under Exclusion 3(a):

“[Chicago Title argues] that Arkansas Riverview Development's problem was created by the failure … to comply with the requirements in the original lease that it obtain written consent from the City to assign the airspace lease and that it give a right of first refusal to the Camelot Hotel or its successors. Chicago Title characterizes these failures as "lease compliance problems" as opposed to defects in title … . However, the … title insurance policy contains no exception or exclusion for "lease compliance problems." … Chicago Title argues that … Arkansas Riverview Development elected to take an assignment of the lease to the airspace rights and agreed to undertake all of the obligations of the Bar Foundation pursuant to the lease, which then created the problems about which it now complains. Again, that is simply not true. What made the title to Lots 4, 5 and 6 of Block 99 unmarketable was the fact that the building on that tract also occupied another tract that was not conveyed

The court did not even mention the definition of "land," which excludes any rights in adjacent streets. The court also said the post-policy exclusion did not apply because, it held, the marketability problem existed on date of policy and was not created by the defective assignment of air rights signed after the policy date. The court also found that Exclusion 3(b) did not apply, because the encroachment was disclosed to Beach Abstract by the survey. The court again implied that the risk of the lack of rights in the street was consciously transferred to Chicago Title simply by delivery of the survey.

Reporter’s Comment:  This decision is another example of how the marketability coverage can be used to manufacture "coverage" for rights that are not insured and which do not even exist, reading the limits of the insured estate or interest out of the policy. The court makes a valid criticism of the lack of a specific exclusion for disputes over the interpretation or enforcement of insured interests. The editor's draft policy form, introduced in the September issue, addresses these issues. If you are interested in participating in the project of drafting clarifying language for a proposed title insurance policy, please send an email to bnielsen@reinhartlaw.com to review the current draft of the policy on a title insurance claims website. The password-protected website also provides a user group forum for claims issues between claim administrators and retained counsel.

The Reporter for this item was Bushnell Neilson writing in his excellent Title Insurance Newsletter, which subscribers certainly can find out about by contacting Bush at his email address set forth above. 

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