While the worst of the housing crisis may be over, a significant number of existing foreclosures remain, and new foreclosures continue apace. According to RealtyTrac, there were 122,060 new foreclosure filings in March 2015,1 and there are 842,773 properties in the U.S. in some stage of foreclosure.2 For those properties that are subject to judicial foreclosure, many will involve borrowers, who have asserted a variety of counterclaims against the mortgagee. These counterclaims may include allegations of breach of contract, fraud, misrepresentation, unjust enrichment, breach of duty of good faith and fair dealing, and the violation of numerous statutes, such as the Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act (RESPA), among others. Lenders have paid millions in attorneys’ fees defending against such counterclaims.
Fortunately, many mortgagees are protected by lender title insurance policies, which not only insure against defects in title, but also cover the cost of defending against claims alleging the invalidity or unenforceability of the insured mortgage or an assignment of the insured mortgage, including, among other things, (a) alleged fraud, undue influence or duress; and (b) various alleged procedural defects. Since many borrower counterclaims challenge the enforceability of the insured mortgage due to alleged statutory or other procedural violations, lender title insurance can provide mortgagees a means to defray the substantial cost of defending such claims.
For those mortgagees seeking coverage for the cost of defending borrower counterclaims in judicial foreclosure actions, here are five tips to maximize recovery from lender title insurance.
1. Giving Notice
Most lender title insurance policies require “prompt” written notice of covered claims. Each insured mortgagee should provide notice in the manner specified in the policy, whether in writing or otherwise, by the appropriate person to the proper party or agent of the insurer. However, policy terms and legal precedent in a majority of jurisdictions may require evidence of “prejudice” before late notice will justify a denial of coverage. In order to avoid arguments over prejudice and coverage for defense costs incurred prior to notice, mortgagees should notify the appropriate title insurer of a borrower’s counterclaim as soon as possible. As a practical matter, the insured’s broker may be able to assist in identifying the appropriate policies and in giving proper notice of claims.
2. Scope of Defense Coverage
Typically, when a liability insurer is obligated to defend any part of a suit, the insurer has a duty to defend the suit in its entirety. Many title insurance policies, however, include language stating that the insurer will not pay defense costs relating to causes of action alleging matters not insured by the title policy. At least one court has recently found that such language relieves the title insurer from the “all-or-nothing” duty to provide a “complete defense” typically associated with liability insurers.3 However, as a general rule, no right of allocation exists for the defense of non-covered claims that are reasonably related to the defense of covered claims. While some jurisdictions have not addressed this precise language in title insurance contracts, when possible, insureds should avoid or amend policy language limiting the insurer’s obligation to pay defense costs. Likewise, when defending under a policy with such limitations, defense counsel should be cognizant of the insurer’s allocation of defense costs in prosecuting the defense of borrower counterclaims.
3. “Created or Suffered” Exclusion
Most title insurance policies exclude coverage for defects, liens, encumbrances, adverse claims, or other matters “created, suffered, assumed, or agreed to” by the insured (the “Created or Suffered” Exclusion). Title insurers faced with a request to defend a borrower’s counterclaim alleging TILA or RESPA violations may assert that the “Created or Suffered” exclusion relieves the insurer of any duty to defend. However, as interpreted by courts, the “Created or Suffered” Exclusion applies to knowing or intentional conduct, as opposed to negligence by the insured. To the extent that claims under TILA, RESPA or other matters alleged against a lender do not require a showing of intentional, willful conduct, the “Created or Suffered” Exclusion may not preclude an insured mortgagee’s claim for defense against borrower’s counterclaims.
4. Selection of Counsel
Many lender title insurance policies state that the insurer has the right to select the counsel of its choice to defend covered claims. However, in some circumstances, the insurer may forfeit the right to select counsel based on its position regarding coverage for the claim. Upon receiving notice of a claim against an insured mortgagee, the title insurer has at least three options: (1) completely deny coverage for the claim; (2) defend under a reservation of rights or a non-waiver agreement; or (3) assume the insured’s unqualified defense without reservation. Clearly, if the insurer denies coverage, the insured is under no obligation to use the insurer’s preferred counsel. If the insurer agrees to defend while reserving the right to deny coverage for a future settlement or judgment, the “reservation of rights” may create a conflict of interest incompatible with the insurer’s exercise of control over the insured’s defense. Depending on applicable law, if the facts that will determine the viability of the insurer’s coverage defenses are the same facts that will be decided by the fact finder adjudicating the borrower’s counterclaims, the insured mortgagee may be entitled to select independent counsel to defend the counterclaims. Under those circumstances, and subject to applicable law, the insured may recover the reasonable attorneys’ fees incurred by independent defense counsel. Defense costs are typically outside the limits of most title insurance policies. Title insurers will, therefore, aggressively attempt to reduce the cost of the insured’s defense, including through billing audits and the imposition of so-called litigation guidelines. However, unless made a part of the insurance policy itself, billing guidelines do not alter the rights and obligations of the parties to the title insurance contract under which the obligation to pay defense costs is owed. Moreover, ethical obligations in some states may prevent defense counsel from agreeing to be subject to an insurer’s litigation guidelines.
5. Loan Modification and Subrogation Rights
Once the insurer has paid defense costs or any other amount under a title policy, the insurer is subrogated to the insured’s rights against third parties, including the borrower, to the extent of any payment. In recognition of these rights of subrogation, generally, insured mortgagees are permitted under the title insurance policy to modify the terms of payment, release security or substitute personal obligors—but only to the extent that doing so does not affect the enforceability or priority of the insured mortgage or the insurer’s subrogation rights. As a practical matter, in order to avoid taking actions that could jeopardize coverage (whether for defense costs or otherwise), lenders should give careful consideration to how negotiations with borrowers over loan modification may affect the insurer’s rights as subrogee.
By better understanding title insurance and the five issues addressed above, lenders may be able to recover some of the costs incurred in defending borrower counterclaims in judicial foreclosure actions.