Closing Protection Coverage-A Somewhat Distasteful but Advised Insurance Product

I sometimes wonder, how much wealthier I would be if I never paid for title insurance, homeowner’s insurance, commercial property insurance…  In the last 25 years or so, my house has never gone up in flames, no neighbor ever came by and said they own half my property, and when I owned rental properties, no floods or hurricanes swept them away. I have definitely paid out more in premiums over the years, than the insurance companies have paid me, and I get tired being one of the reasons that many insurance companies are doing well these days. I presume many of our Blog readers feel the same way. 

On the other hand, I presume that not many of us have made the Forbes List of the World’s Wealthiest People, and if our luck changed, few of us would be able to recover from an uninsured casualty that destroyed the home we live in or other major asset. No matter how low the odds may be that our home or commercial building will be destroyed, or that after a closing we’ll find out that someone else owns our property (or has a lien against it), or has stolen our funds from escrow, it almost always makes sense to insure against the loss, unless we can afford to self-insure. The reason is that most real estate related insurance (property, title) is relatively (in comparison to the risk of loss) inexpensive, and required by any lender financing real property.

While the State of Ohio has a formal fee schedule for title insurance, title insurance for most deals should not exceed $5-6/$1,000. Title insurance is designed to protect an owner's or a lender's financial interest in real property against loss due to title defects, liens or other title related matters. If there was a recorded highway easement across your property that the title company missed, or your home got sold at a tax sale, without your seller’s knowledge, or someone forged your seller’s name to a deed and sold the property to a third party, or someone accidentally placed a lien against your property (Lot 431) when they really meant to place the lien on Lot 341, you’ll be glad you bought title insurance.

What if an independent agent for your title company was also your escrow agent (which is very common), and that agent took the buyer’s funds and retired to Mexico (becoming more and more common). You are covered, right, because you took everyone’s advice and bought title insurance?

Unfortunately, no, unless you bought “Closing Protection Coverage”. Title agents are just that, agents to sell title insurance. The title agent is NOT an agent of the underwriter for escrow, closing and disbursement of funds purposes, so the insurance underwriter is not liable for such independent agent’s fraud or failing to adhere to escrow instructions, if such coverage is not in effect.

What is Closing Protection Coverage? It is basically (via issuance of a Closing Protection Letter) insurance that will bind the title underwriter to cover you in the event of a loss due to "theft misappropriation, fraud, or other failure to properly disburse settlement, closing or escrow funds..." by the licensed agent.

Is Closing Protection Coverage (“CPC”) required? There is no requirement that CPC be procured, but, pursuant to Section 3953.32 of the Ohio Revised Code (effective January 1, 2007) Ohio law now mandates that closing protection coverage be offered to all parties in a closing transaction – the seller, the buyer, and the lender.

How much does CPC cost? Rates for Closing Protection Coverage in Ohio are now (updated in 2013) as follows:

• $40 for a lender, its successors/assigns
• $55 for seller(s)
• $20 for buyer(s)/borrower(s)
• $20 for each additional title insurance applicant.

Is CPC advised? In light of its low cost, relative to the potential loss (my initial research indicates recent closing agent fraud claims ranging from $12,000 to $27,000,000), yes.

Certainly, you can reduce the risk of fraud/negligence by using an agency that has worked well for you in previous deals. When faced with the prospect of a new agent, it is important to ask about the agency’s experience, how long they have been in business, the qualifications of its personnel, and whether or not any claims have been made against the agency in the past. While you can lower the risk by carefully selecting the agent, the only way to eliminate the risk is to buy the coverage.  You don’t have to be happy about it. Most who buy the coverage are not. In one sense, CPC can be analogized to a protection racket that Tony Soprano would be proud of. As Robert Franco, in his “Source of Title Blog” (www.sourceoftitle.com/blog) characterized the coverage, “you [agents] have to tell them [customers] that there is a chance that you may steal their money and in order to be protected from your dishonesty, they must pay extra.” 

While I sympathize with the bad taste one gets when trying to rationalize CPC, the bottom line is that you can pay next to nothing at closing, or pay out up to everything you own, later.

CMBS Litigation: The Guarantor Actually Wins One

On April 7, 2014, the US District Court in the Southern District of New York granted summary judgment in favor of the Guarantor in CP III Rincon Towers, Inc. (Plaintiff) v. Richard Cohen (Defendant) (No. 10 Civ. 4638 (DAB).   The substance of the court action revolved around a CMBS mortgage loan on property located in San Francisco, CA that had gone into default. The Plaintiff was attempting to recover the full outstanding amount owed under the loan from the Defendant alleging that the violation of certain “bad boy” provisions under the Guaranty executed by the Defendant triggered full recourse liability.

The borrower on this loan was delinquent on certain owner’s association fees, the amount of which it was disputing with the owner’s association. The borrower had also not paid certain contractor invoices due to a dispute over the work completed. These disputes, combined with nonpayment of the related invoices, resulted in liens being filed on the mortgaged property. 

The Plaintiff, in filing its action against the Defendant, alleged that the resulting liens on the property violated three full recourse provisions in the Guaranty: the “voluntary Lien, Indebtedness (without lender’s prior consent) and Transfer.”   The Defendant moved for summary judgment in its favor stating that the liens in question did not fall under either of these 3 provisions and therefore did not justify the Defendant being subject to full recourse liability.  

The Court agreed with the Defendant.  

In negotiating the Guaranty with the Plaintiff’s predecessor who negotiated the loan, the Defendant and his counsel were quite aggressive in pushing back on the form language in the agreement. Kudos to the Defendant’s counsel for doing his job well.  The takeaway for any would-be borrower or guarantor is to not blindly accept the CMBS loan documents and assume there is no room for negotiation. There is. The so-called bad boy provisions that trigger loss recourse and full recourse on the CMBS loans are broadly drafted and, from the perspective of a borrower or guarantor, need to be tightened up. Borrowers and guarantors who sign commitment letters and term sheets with these provisions already contained within the commitment document are acting foolishly, as they have pulled the rug out from under their lawyers and have undercut their ability to do their job.  

In this court action, the Plaintiff had attempted to argue that the actions or inactions of the borrower, by not paying invoices on time and/or disputing amounts, where voluntary choices and therefore the resulting liens should be categorized as “voluntary.”  The court didn’t buy into the Plaintiff’s argument, finding instead that mechanic’s liens arise by force of statute, not by an agreement of the parties. The court also held that judgment liens are imposed on the losing party and again, cannot be construed as voluntary. Strike one against the Plaintiff.  

Second, while both parties agreed that the resulting liens on the mortgaged property was properly viewed as indebtedness, the loan agreements clearly limited the full recourse trigger to indebtedness that was incurred without the lender’s prior written consent. The court interpreted this to mean it only addressed situations where a lender’s prior written consent is required before entering into the indebtedness, liability or obligation. The borrower did not need lender’s consent before starting construction or paying association fees, therefore the court held that the circumstances in this case did not fall under the full recourse provision.  

Finally, the Plaintiff argued that the liens on the property should be considered a “Transfer” which was broadly defined in the loan documents to include acts that “encumber” the mortgaged property. The court reviewed the interpretations argued by both parties and found the language to be ambiguous. It then looked outside the terms in the loan documents and revised the negotiations of borrower and lender prior to entering into the loan. Based on such external (i.e. “extrinsic evidence”), the court held that the parties clearly never intended these sorts of liens to trigger full recourse liability. 

The bottom line for parties on CMBS loans—Negotiate to protect your interests. It is important to clarify what will and will not trigger full recourse or loss recourse liability. From a borrower perspective, narrower, more specific provisions are better. A borrower also needs to review how these provisions might be unwittingly triggered by borrower’s standard operational procedures or even the simple desire to restructure ownership for estate planning purposes. Finally, work to ensure the language in the agreements clearly reflects everyone’s intentions. Otherwise, a court will interpret it for you.

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CLE Updates: Upcoming Real Estate Educational Seminars

In one sign that spring is here, the number of educational seminars on real estate topics is blooming.  Below is information regarding several upcoming seminars:
1.  The Ohio State Bar Association (OSBA) is sponsoring a Land Use and Zoning seminar on Wednesday, May 21, 2014 in Cleveland- live- (The Ritz Carlton, 1515 W. 3rd St., 44113) and in Columbus--live and via webcast on Wednesday May 14, 2014 (OSBA offices, 1700 Lake Shore Drive, 43204). Click here to access the OSBA's seminars.

2.  Sterling Education Services (SES) is sponsoring a seminar titled "Landlord-Tenant Law" on Friday, April 25, 2014 in Akron, Ohio (Holiday Inn Akron West, 4073 Medina Road; 330-666-4131).  Log on to www.sterlingeducation.com or call 715-835-5132 to register.

3.  National Business Institute (NBI) is sponsoring a seminar titled "Road and Easement Law from A to Z" on Monday, June 2, 2014 in Cleveland (Holiday Inn Independence, 6001 Rockside Road) . Order Now via the Web or Call: 800-930-6182.

+ Don’t Forget 4. Early-bird OSBA Convention registration discount extended to April 18 Register today and save $50 off full or $25 off single day registration. The OSBA Annual Convention, April 30-May 2, at the Hyatt Regency Hotel in Columbus, continues to be one of the best CLE values available to Ohio lawyers. In addition to being a great value, they have planned many new and exciting features for the 2014 Convention, including: Special programming to celebrate and honor our military veterans for their service to our country; A larger selection of CLE courses: 51 sessions, organized into 5 different tracks; Shorter 60-90 minute CLE sessions; Comprehensive programming designed specifically for the general practitioner; and Sunrise and sunset CLE options to maximize your time at Convention. Offer expires April 18. Log on to www.ohiobar.org/convention, or call their member service center at (800) 232-7124.

How the Right App Can Save the Day

This post is a little off topic for our blog but I wanted to share how one of the apps that I wrote about in January saved the day in a transaction closing. Recently, I attended a closing for a combined asset/commercial real estate transaction. In all acquisitions, whether a business or commercial real estate, certain closing conditions have to be met or waived, then the wires are initiated to fund the purchase. All lenders and title companies have a hard deadline in the afternoon by which the wire has to be initiated or it is postponed into the next business day.

 

In my transaction, we were running up against the wiring deadlines and risked not closing on time. To make matters worse, we were conducting the closing outside of my law office, at the business location being acquired. The scanning and faxing capabilities at the off-site location were inadequate and further complicated our ability to timely provide the lender with the items it needed before the wire transfers could be authorized. In a last ditch effort to meet out deadlines, I pulled out my iPhone and opened up my scanner app called JotNot Pro.  Using this application I was ability to ‘scan’ each document with my phone’s camera, convert the scans into pdf’s, including a multi-page pdf of the lease, and attach them to emails to the lender. We sucessfully funded and closed the acquisition with minutes to spare. Without this application I seriously doubt we would have closed our deal that day.

 

In real estate, I can visualize situations where having a scanner app on a smart phone or tablet would be immensely useful for professionals, such as real estate agents, who would benefit from being able to have purchase agreements and other documents signed and delivered immediately without having to wait until they back it back into their offices. I know that there are more than one such scanning app and highly recommend that people consider downloading one to try.   
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