Daily Development for
Tuesday, January 20, 1998

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

TITLE INSURANCE; COVERAGE; PRIORITY: Title insurer has no duty to defend challenge to priority insured mortgage where challenge is based upon failure of mortgagee to supervise use of loan proceeds, even when insurer is aware at time of insurance that mortgagee will disburse proceeds at closing and will not supervise their expenditure.

Rosen v. Nations Title Ins. Co., 66 Cal. Rptr. 2d 714 (Cal. App. 1997)

Debtor, a home builder, was in a reorganization bankruptcy. Debtor had some uncompleted homes which Debtor believed would produce a better return if they were completed before liquidated. Debtor petitioned the Bankruptcy Court for permission to borrow money for these purposes and for other actions to "preserve the assets of the estate," and to give to the Lender for this loan a "priming lien" on the uncompleted houses. The court agreed, and Lender here provided such mortgage loans.

Insurer provided title insurance for these priming loans. The insurance specifically covered the priority of the loans as against mortgages held by Bank, another creditor of Debtor. Bank had objected to the priming liens in the Bankruptcy Court. Lender closed on the priming loans and immediately disbursed the monies to Debtor. Insurer, at the time of insurance, was aware that it was the intent of the parties that the loan proceeds be disbursed immediately to Debtor and that Lender would not oversee the expenditure of these proceeds in any way.

Later, Bank sued to subordinate the Lender's mortgages to Bank's own mortgages on the properties because, it alleged, Debtor expended the proceeds for purposes not authorized by the Court's order. Lender tendered the defence to the insurer, which refused to defend. Lender then proceeded to defent Bank's action, and prevailed. Lender then sued insurer for bad faith failure to defend and breach of title policy. The trial court granted summary judgment to Insurer on the grounds that the policy insured title only based upon circumstances as they existed at the time of issuance, and the Bank's challenge in this case was based upon circumstances developing later.

On appeal, held: Affirmed.

Agreeing with the trial court the appeals court concluded that there was no expectation of coverage for challenges to title based upon negligent disbursement or supervision of expenditure of loan proceeds. With respect to Lender's response that the title insurer knew at closing that the parties were disbursing the proceeds immediately and did not intend to supervise their expenditure, the court responded:

"It is not significant whether the insured lost control of his funds, the knowledge of the insured and insurer when the policy was issued, or whether the funds were misappropriated or correctly disbursed. The critical fact is the time of the wrongful event in relation to the date of the policy."

The court concluded that there was no reasonable possibility that title policy coverage would be implicated by the outcome of Bank's suit, and that therefore the insurer had no obligation to defend.

Comment: When Insurer insured priority of the Lender with knowledge of the fact that Lender was disbursing promptly and not supervising proceeds, was Insurer insuring Lender from the possibility that a court would conclude that Lender had a duty to supervise exenditures? Wouldn't that conclusion have been based upon facts and law in existence at the time of disbursement? Should Insurer have excluded specifcally issues arising from disbursement of the proceeds here? It's a close call, but don't "ties go the insured" in title insurance policy interpretation?

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