A new decision in Ash v. North American Title Co. holds that (1) contract damages based upon a bankruptcy were not foreseeable, and (2) an escrow holder was  entitled to a jury instruction  as to intervening or superceding causes (i.e., the bankruptcy).  The decision also highlights a potential for some judges to try to impose greater responsibilities on escrow holders.

Currently, California  law requires an escrow holder to be responsible only for following strictly the escrow instructions; it has no duty to police the transaction or the parties to it.  ( See Summit Financial Holdings, Ltd. v. Continental Lawyers Title Co. (2002) 27 Cal.4th 705 (“Summit”).)  Because an escrow holder represents both parties to an escrow, it cannot have a full agency relationship with one without being in complete conflict with the other.  ( See Lee v. Title Ins. & Trust Co. (1968) 264 Cal.App.2d 160 (“Lee”).)  As a result of the potential for conflict, courts have stated that escrow holders are liable only for failing to comply with their explicit instructions, not for policing their parties (except in clear cases of fraud).

In Ash, the jury found an escrow holder (and the seller) at fault for a delay in the closing of an escrow.  The jury awarded significant contract and tort damages to the buyer for his alleged harm caused by the delay.  The appeal focused on  the calculation of damages and responsibility for them.  However, the dissent creates concern over the extent of an escrow holder’s “fiduciary duties” to the parties to an escrow in a way that potentially conflicts with the mandates of Summit and Lee.

Factual Background.  Plaintiff Buyer sought to buy Seller’s property as part of a 1031 tax-deferred exchange, to defer paying capital gains taxes.  (26 U.S.C. sec. 1031 (“Section 1031”).)  Escrow was set to close on a Friday in order to fall within the protections of Section 1031.  Unknown to the Buyer but known to the escrow holder, the Seller wanted to record certain trust deeds against the property (to be paid off when escrow closed), which delayed the closing.  Unfortunately, on the following Monday, the 1031 qualified intermediary (LandAmerica) filed for bankruptcy.  The bankruptcy court refused to release Buyer’s deposited funds—even though they were not owned by the debtor, LandAmerica—until far too late for the Buyer to take advantage of Section 1031’s deferral of capital gains taxes.

Damages for Breach of Contract.  Contractual liability was fairly straightforward; the question of damages was more complicated.  The jury found that Seller and escrow holder had breached the contract by delaying the close of escrow.  The historical precedent of Hadley v. Baxendale (1854) 156 Eng.Rep. 145, dictates that contract damages are available for all foreseeable damages arising from a breach .  “Foreseeable” damages are those that arise directly from the breach (aka “direct damages”) and are so probable that they are assumed to have been within the parties’ contemplation at the time the contract was made.  If a loss is not foreseeable, it is a “special damage” beyond the parties’ expectations.  A breaching party will only be liable for special damages if the unusual circumstances giving rise to the loss was actually known by the breaching party or were matters of which the breaching party should have known.

Here, the appellate court found that there was no evidence that the Seller or escrow holder knew or should have known (a) that LandAmerica would file for bankruptcy, or (b) that the bankruptcy court would not release depositors’ funds for such a long time.  All parties—from escrow holder to Seller and Buyer to LandAmerica’s own personnel—attested to their surprise at the bankruptcy.  Based on this universal view, neither the Seller nor the escrow holder could be found liable for special damages resulting from the intervening bankruptcy.  Moreover, direct damages were precluded because there was no evidence that LandAmerica’s bankruptcy was “foreseeable.”  As a subjective matter, there was no evidence that anyone predicted the demise of LandAmerica.  As an objective matter—or, to put it another way, as a matter of law—“bankruptcies normally are not within the contemplation of the parties at the time of a contract.”  (Ash, supra, 2014 WL 612988 *7 [citations omitted].)  The court of appeals directed the trial court, on remand, to reduce the contract damages against the Seller and escrow holder by the amounts attributable to the bankruptcy.

Damages for Breach of Fiduciary Duty.  The Buyer claimed that the escrow holder breached its fiduciary duties to him, resulting in his loss.  Breach of fiduciary duties can be negligent or intentional.  If a party is negligent, an intervening cause of the loss can reduce his liability, and a superceding cause may even eliminate his liability.  The rationale is, with highly unusual intervening acts, the chain of causation is broken and the loss deemed unforeseeable.  The trial court refused to instruct the jury on the concepts of intervening and superceding causes (i.e., the bankruptcy) which, in the case of a negligence claim against the escrow holder, could have provided a complete defense to liability.

The court’s majority had insufficient information to know whether the alleged breach was negligent or intentional.  Although it suffered from the same dearth of information, the dissent purported to identify “fiduciary” obligations by the escrow holder that it allegedly breached:  (1) to follow Buyer’s instruction to obtain his funds from LandAmerica a few days before the anticipated closing on November 21, 2008; (2) to report the Seller’s intent to encumber the property with added grant deeds as material changes to the escrow instructions; (3) to refuse to accommodate Seller’s efforts if it created delay in closing; (4) to disclose the reason for the delay (and not just the fact of delay); (5) not to enter into the alleged “side-agreement” with the Seller, which is how the dissent interpreted the recording of the new deeds of trust; and (6) to disclose these alleged conflicts to Buyer.

Some of these points may fall within strict adherence to the escrow instructions.  However, others appear to be expansions of the requirement to follow escrow instructions strictly and to transfer theburden of policing the transactions barred by Summit and Lee.