Daily Development for
Friday, April 26, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

This case is a bit dated, but raises some interesting issues worth reviewing. TITLE INSURANCE; EXCLUSIONS; "MATTERS CREATED SUFFERED, ASSUMED OR AGREED TO:" Title insurer has no duty to defend a claim to recharacterize a sale/leaseback transaction as a disguised mortgage where the recharacterization would arise from a finding that the parties "intended" a mortgage relationship. The "suffered, assumed or agreed to" exclusion covers relationships "intended" by the insured. TICOR Title Insurance Co. Of California v. FFCA/IIP 1998 Property Company, 898 F.S. 633 (N.D. Ind. 1995)

The parties had entered into a classic sale-leaseback transaction for a fast food franchise. The seller/lessee had the right to reaquire the property after ten years for the greater of the fair market value or the cost of acquisition. Buyer/lessor was an investment partnership that engaged in a number of these transactions. Title company insured the title of buyer/lessor, as it had insured title for hundreds of similar transactions handled by the restaurant franchisor.

The lessee declared bankruptcy and attempted to persuade the bankruptcy court to recharacterize the lease as a disguised mortgage. The buyer/lessor saw this as a challenge to its insured title, since the claim, if successful, would "convert" the title into a mortgage interest only. It tendered the defense of the title to the insurer.

The insurer refused to defend on the grounds that the Bankruptcy court, if it applied Indiana law, would recharacterize the interest only if the parties were found to have "intended" a mortgage relationship, rather than a sale, leaseback. The court interpreted the insurance policy exclusion for interests "sufferred, assumed or agreed to" by the insured as applicable to recharacterizations of the insured interest based upon a court determination that the insured intended some interest other than that described in the policy. As the lessee's challenge to the title could only succeed if the court determined that the insured and the lessee had both "intended" a mortgage, rather than a sale/leaseback, the court concluded that the challenge did not implicate the insurance. There was no possibility that the challenge would result in an adverse consequence to the insured covered by the policy.

Comment: Several other cases have reached the same result posited by the court here: Transamerica Title Ins. Co. v. Alaska Federal S.&L. Assoc. Of Juneau, 883 F.2d 775 (9th Cir. 1987); Bidart v. Amerian Title Ins. Co. 734 P.2d 732 (Nev. 1987). Also, see generally Anno. 84 ALR 3d 515. Nevertheless, the editor concludes that the courts are not looking closely enough at the arguments for the insured.

The language of the policy, to begin with, does not state expressly that the insured receives no insurance for all arrangements which it "intends." It states that there is no exposure for interests that the insured "suffered, assumed or agreed to." Of course, parties must be viewed as having "agreed to" the known logical consequences of their intentional acts. But "intent" in this context may be quite different from the concept of "intent" as it is commonly used in cases recharacterizing sale-leaseback transactions.

In the sale/leaseback cases, the courts are defending the common law concept of the equity of redemption by applying it to cases in which parties are the functional equivalents of borrower and lender even though they style their relationship differently. The policy considerations at work in these cases have very little to do with any concept of knowledgeable consent or acceptance of any particular relationship. Clearly, in most cases, if the parties knew that there was a danger that their legal relationship would be recharacterized as a mortgage, they would never have participated in the transaction.

Furthermore, the title companies, in reviewing the circumstances of the transaction and reaching a view as to the legal validity of the interests the transactions purports to create, are doing precisely what the insureds have always expected title companies to do and what title companies hold themselves out as capable of doing. The insured fact is not whether a given instrument has been signed or recorded, but whether all of the underlying facts give rise to a stated legal estate in the insured. Of course, the title companies do not generally insure all risks of validity of instruments, but it should be incumbent upon them, in their form language, to be specific about the risks they exclude. Where the parties to a given transaction believe that they have created a certain legal relationship, and intend no other, and the title company insures that this relationship exists, then how can one conclude that the insured has "suffered, assumed or agreed to" some other result?

The author's private conversations with a number of title officers who wrote policies in the early 80's, when many of these transactions came about, indicate that the majority of them believed that recharacterization was an insured risk and many defended against recharacterization. The tough stand now being taken by the companies reflects a new thinking occasioned by the rampant missaplication of recharacterization by result-oriented bankruptcy courts, which significantly has increased the litigation and hence the risk in this area.

Comment 2: In a thoughtful article in the last edition of the ABA Real Property, Probate & Trust Law Journal, Tom Homburger and Brian Gallagher analyze the reported case and conclude that it is correct. To Pay or Not to Pay: Claiming Damages for Recharacterization of Sale Leasback Transactions under Owner's Title Insurance Policies, 30 ABA Real Prop. Prob. & Tr. Law Journ. 443 (1995). Their argument is that the title insurer should not be expected to review and understand the numerous detailed facts that might affect a court's decision that a transaction should be recharacterized. The editor agrees with this policy argument, but concludes that it ought to be up to the title companies either to ask the right questions (as they do, for instance on the issue of "possession notice" by requiring a survey and occasionally getting affidavits) or to reflect that concern on the face of the policy. Failing that, since the insurers control completely the language of their own insurance risk, the policy should not be read in such a way as to protect them from risks that the insured properly assumes would be covered.

Commnent 3: There have been one or two cases in which bankruptcy courts have viewed the issue of recharacterization as one of federal bankruptcy law, rather than state common law. In this case, the more recent policies that contain bankruptcy exclusions might not apply. But an interesting situation arises if state law would characterize a relationship in one way and bankruptcy law another way. In such cases, did the parties to the early 80's policies believe that the risk of federal recharacterization of state law recognized relationships was an insured risk?

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