In its recent decision in Associated Bank, N.A. v. Stewart Title Guaranty Co., 2012 U.S. Dist. LEXIS 104528 (D. Minn. July 27, 2012), the United States District Court for the District of Minnesota had occasion to consider when a loss is valued for the purpose of coverage under a title insurance policy.  

The underlying action in Associated Bank involved a fraudulent scheme allegedly propagated on an apparently unsuspecting borrower. In 2007, Associated Bank loaned the borrower approximately $450,000 to help finance the borrower’s purchase of vacant land. In return for the loan, the bank received a signed promissory note secured by a mortgage. Associated Bank, in turn, purchased title insurance from Stewart Title, which among other things, insured against “the invalidity or unenforceability of the lien of the insured mortgage upon the title.” The policy obligated Stewart Title to defend Associated Bank “incurred in defense of the title or the lien of the insured mortgage.”  

It was subsequently determined that the borrower did not knowingly sign the promissory note and, in fact, had no knowledge of the mortgage given to Associated Bank. He claimed that at the time he signed the promissory note, it was blank and that he had been led to believe by other parties that the note was for an unrelated real estate investment. While the borrower did not attend the closing on the mortgage, Associated Bank failed to attend as well and thus did not learn of the alleged fraud until long after the fact. The other parties to the scheme allegedly received and converted the loan proceeds without the borrower’s knowledge. When monthly loan payments on the mortgage were not paid, Associated Bank initiated a foreclosure action. The borrower thereafter commenced a third-party action against the various parties that defrauded him, but he also asserted in his answer to Associated Bank’s complaint the affirmative defense that the promissory note and mortgage were obtained by fraud, and thus unenforceable.  

In light of this affirmative defense, Associated Bank tendered the matter to Stewart Title, claiming that it was entitled to a defense in light of the borrower’s allegation that the mortgage was unenforceable. Associated Bank also advised of a mediation scheduled in the matter. Stewart Title, however, did not respond to Associated Bank’s communications. Associated Bank subsequently settled with the borrower. By that time, the market value of the property secured by the mortgage was worth $126,000. Notwithstanding, the borrower agreed to pay Associated Bank the amount of $175,000. Associated Bank subsequently brought a declaratory judgment action against Stewart Title, seeking recovery of its attorneys’ fees associated with the underlying action, as well as the difference between the unpaid portion of the original mortgage, approximately $450,000, and the $175,000 Associated Bank was paid pursuant to the settlement.  

With respect to the indemnity portion, Associated Bank argued that its loss should be measured at the time the loan was initiated, not at the time the foreclosure action concluded. Stewart Title, on the other hand, contended that Associated Bank did not recognize a loss until the foreclosure action resolved, at which time it was determined with finality that the mortgage would not be repaid. By then, the property had declined in value from $450,000 to $126,000. Stewart Title argued, therefore, that “the loss sustained by Associated Bank on its loan was not due to the invalidity of the Mortgage, but rather due to a decline in the value of the Property securing the loan,” and as such, was uninsurable.

While the court could find no Minnesota case law directly on point, it noted the majority view in other jurisdictions that a mortgagee’s loss cannot be measured until the note has not been repaid and the security for the mortgage is shown to be inadequate. The court found this rule to be consistent with the purpose of title insurance, explaining:  

A title insurance policy "does not guarantee either that the mortgaged premises are worth the amount of the mortgage, or that the mortgage debt will be repaid." … Rather, the "insurable value of a mortgage on real estate is the fair market value of the realty which secures the mortgage, and is not controlled by the original purchase-price of the mortgage."  

The court observed that had the borrower not challenged the validity of the mortgage, and Associated Bank simply allowed to proceed with the foreclosure, it likely only would have been able to sell the property for $126,000, which was the market value of the property at the time. Having recovered $175,000 as a result of the settlement, the court agreed that Associated Bank did not sustain a loss for which Stewart Title was obligated to indemnify.  

The court nevertheless concluded that Associated Bank was entitled to a defense from Stewart Title. Notwithstanding the fact that the borrower questioned the validity of the title in an affirmative defense, rather than a counterclaim or other form of direct claim, the affirmative defense asserted a claim adverse to Associated Bank’s title, thus triggering Stewart Title’s defense obligations under the policy.