Title Insurance Coverage and Protection
The Insured and Successors
In the last few years, title insurance has become more widely used in Ontario, and elsewhere in Canada, in commercial real estate financings. Title insurance has particular value when used in securitizations of residential or commercial mortgage portfolios.
Title Insurance Coverage and Protection
A title insurance policy is not the same as a real estate title opinion provided by a lawyer. It is an insurance contract that provides the specific coverage outlined in the insurance policy. In some ways, the coverage can be broader than that provided by an opinion, because it can insure against risks that a lawyer cannot really investigate and opine on, like fraud or forgery. In other ways it is narrower, largely because a title insurance policy has strict policy limits, only compensates for monetary loss or damages, and does not provide coverage over some matters that an opinion may cover (eg, the loss of a future expectation or right).
A title insurance policy provides two distinct forms of protection. The first is founded in the duty to indemnify. Title insurance is an indemnity contract and as such, provides reimbursement for actual loss. The second, a right that is also contained in many other types of insurance policies, is called the 'duty to defend'. The insurer will pay legal defence costs and related costs and expenses in the event of a claim that threatens the insured party's title interest in the property.
In a mortgage securitization transaction, a portfolio of residential or commercial mortgages is effectively sold to investors. This is typically done by selling a mortgage portfolio to an issuer of further securities, generally a single-purpose entity. The issuer will issue debt instruments to investors and will utilize the cash flow generated by the underlying mortgages to service those debt instruments. In the Canadian market, the investors are usually institutions looking for secure investments with yields higher than government bonds.
Generally, the lender enters into an agreement (or agreements) with the securities issuer whereby the lender will continue to service the mortgage portfolio, in exchange for renewal and other fees generated by the portfolio. Continued servicing by lenders is an important feature which allows lenders to maintain contact with their clients and profile in the marketplace. At the same time, securitization allows lenders to free-up capital to offer higher-margin products to the same clients.
In a typical securitization transaction, the lender may sell the mortgage portfolio at a discount. This allows the return on the securities issued to be adjusted to the market rate, while at the same time providing additional margin to cover the costs of the securitization transaction. However, the portfolio could also be sold at a premium if market yields have dropped below the average risk-adjusted yields in the portfolio.
The lender will also provide warranties in respect of the portfolio. Typical warranties include the following:
- that the mortgages comply with all applicable laws;
- that there are no rights of set-off;
- that there are no prepayment rights, or that such rights are limited; and
- that the seller has all requisite corporate authority to enter into the transaction and the sale has been duly authorized.
The lender will agree to indemnify the securities issuer if any of the warranties are breached. The preferred method in this regard is for the lender to buy back the offending mortgage at its net present value, based on current market rates. This effectively crystallizes any potential loss to the securities issuer.
With title insurance, a number of other items that would ordinarily be the subject of such warranties are insured by the policy. These items include the following:
- title to the estate or interest of the mortgage;
- any defect in, lien or encumbrance on, the title other than as shown in the policy;
- unmarketable nature of the title;
- lack of a right of access to and from the land;
- the invalidity or unenforceable nature of the mortgage;
- the priority of any lien or encumbrance over the insured mortgage;
- construction liens; and
- the invalidity or unenforceable nature of any assignment.
In a securitization transaction there will generally be some type of credit enhancement in the form of a covenant or guarantee by a well-rated financial institution, in addition to the lender. A direct or indirect government guarantee of the portfolio, such as Canada Mortgage and Housing Corporation (CMHC) insurance, obviates the need for credit enhancement. But an uninsured mortgage or debt portfolio may require something further, even where the lender is one of the major chartered banks, and particularly if the securitized portfolio is sold in the United States, where the chartered banks create less of an impression than they do in Canada. Title insurance can assist with some of the credit enhancement functions, by relieving the lender from liability in a number of areas. This also has the collateral effect of relieving the lender from the time-consuming need to deal with or correct problems in these areas.
The financial ability of the title insurers themselves to meet their obligations as insurers should be considered, particularly in larger transactions where reinsurance with another title insurer or even other insurers or reinsurers may be required. Four of the five insurers currently offering loan policies in Ontario, for example, do so through Canadian branches of their US parents or affiliates. Canadian policyholders, therefore, have access to the assets of these American insurers - some of the largest and most financially sound in the industry. These companies are state-regulated but produce detailed financial statements, based on statutory insurance accounting principles prescribed by the National Association of Insurance Commissioners, the central insurance regulatory authority in the United States. They are also credit rated by a number of American rating agencies.
The standard loan policies in use in Ontario expand the definition of the 'insured' to include the named insured (ie, the original lender), together with:
- the owner of the indebtedness secured by the insured mortgage and each successor in ownership of the indebtedness;
- any governmental agency or crown corporation that is an insurer or guarantor, under an insurance contract or guarantee, insuring the indebtedness secured by the insured mortgage; and
- parties that acquire the estate or interest in the land by foreclosure, trustee's sale, conveyance in lieu of foreclosure or other legal manner which discharges the insured mortgage.
These types of provisions ensure that the title insurance policy continues in effect even after the mortgage has been sold to an assignee in the secondary mortgage market.
While the loan policy provisions reserve the insurer's rights and defences against successors, the standard policy (reflecting the needs of lenders and the secondary market) states that these rights and defences may not be asserted against successors in ownership who acquire the indebtedness as purchasers for value and without knowledge of the asserted defect, lien, encumbrance, adverse claim or other matter insured against by the policy. These items might otherwise be asserted by the insurer as being within the prior knowledge of the original insured who made the loan.
In addition to enhancing uniformity and certainty across jurisdictions, title insurance offers a number of other advantages in securitization and portfolio transfer transactions.
As noted, residential mortgage lending is increasingly becoming a commodity business. In the past several years, yields have fallen and spreads have narrowed significantly. Reducing the cost of the mortgage transaction itself is therefore critical. This allows lenders to amass the volume of transactions required for a securitization. Cost savings are principally achieved by eliminating and reducing the off-title searches presently required in a purchase or mortgage transaction by a competent solicitor. Title insurers will insure these areas, accepting small risks that solicitors are not prepared to accept and should not accept. Examples of these areas include:
- work orders and zoning compliance;
- access to the lands;
- compliance with restrictions and registered agreements; and
- failure of existing structures to be constructed with a valid building permit.
Residential loan policies insure against any violation, variation or adverse circumstance affecting title that would have been disclosed by an up-to-date survey, including encroachments other than boundary walls or fences. The survey cost can be one of the most significant cost elements in a residential purchase or mortgage transaction. Up-to-date surveys are rarely available, except in new home transactions. Consequently, either the purchaser/borrower is faced with a significant survey cost, or the lender must take the risk that the situation on the ground has not adversely changed from that reflected in whatever survey is available. This coverage in the residential loan policy avoids both considerations. Unfortunately, this coverage is not available in the standard commercial loan policies, although it is commonly available on loans under C$1 million or where the fundamental survey risks are low, in the insurer's view.
In order to recover against a lawyer, the mortgage holder must prove negligence and obtain a judgment against the lawyer. The lawyer's 'errors and omissions insurance coverage' is insurance for the lawyer, not the client, and is provided on a 'claims made in court' basis, which means that the lawyer must be insured at the time of the claim to receive coverage.
There are circumstances where coverage may not be in existence when the claim is eventually made (eg, withdrawal from practice, death or insolvency). Claims may exceed the errors and omissions coverage of the individual lawyers or law firms. Finally, the lawyer must comply with the policy conditions and, where there is a basic breach of conditions (eg, failure to report or a refusal to cooperate), coverage can be lost. Title insurance coverage, on the other hand, continues for the life of the mortgage.
The securities market cannot, in practical terms, make risk assessments of numerous individual lawyers and law firms who may have given title and mortgage-priority opinions in a mortgage portfolio. The alternative is for the lender to take this risk, which to some degree may negatively impact on the credit assessment of the lender and require further credit enhancement. Essentially, the credit enhancement in this regard is provided by the title insurer. In addition, the legal opinions may contain qualifications which the lender may agree to accept. Again, the securities market cannot assess each individual opinion to evaluate the qualifications and the risks imposed thereby. Title insurance offers uniformity and certainty in this regard.
The use and acceptance of title insurance in real estate financings in Ontario and elsewhere in Canada is increasing rapidly. In sophisticated residential and commercial mortgage securitizations title insurance is now customary and expected. Law firms acting for either the mortgage lender, or the underwriter of the securitization, may arrange for the purchase of title insurance and settle the terms of the applicable policies with the insurer.
For further information on this topic please contact David Thring or Bruce McKenna at Lang Michener by telephone (+1 416 360 8600) or by fax (+1 416 365 1719) or by e-mail ([email protected] or [email protected]).
The materials contained on this web site are for general information purposes only and are subject to the disclaimer.