With mortgage defaults on the rise, a growing number of lenders are being forced to foreclose on their collateral, either judicially or non-judicially, exercising the private power of sale. Once a lender determines that it must take title to the property securing the loan, it is important that the lender understand what title coverage it has and needs during and after the foreclosure process. What protection does a Trustee Sale Guaranty and/or Litigation Guaranty provide the lender? Does the lender’s current Lender’s Title Policy provide it with sufficient protection, or does the lender want to obtain a new Owner’s Title Policy? The following is a description of the title protection that a Trustee Sale Guaranty and Litigation Guaranty provide a California lender and a brief discussion of the factors to consider when deciding whether to obtain an Owner’s Title Policy after a foreclosure sale.
Trustee Sale Guaranty/Litigation Guaranty—An Assurance, Not Insurance
One of the first decisions a California lender must make after deciding to foreclose is whether to do so judicially or non-judicially (i.e. a trustee’s sale). If the lender takes the non-judicial foreclosure route, it should purchase a Trustee’s Sale Guaranty from a title insurance company and if it decides to foreclose judicially, it should purchase a Litigation Guaranty from a title insurance company. The purpose of the guaranties is not to provide title insurance. Rather it provides assurance to the foreclosing party that the proper parties are being provided notice with respect to the sale. The Trustee’s Sale Guaranty provides assurances to the trustee of the name of the vested owner of the property and the proper posting, recording and mailing of the notices in the foreclosure process (Cal. Civ. Code §2924(b)). The Litigation Guaranty provides assurances to lender’s counsel of all possible interest holders or claimants who might be proper defendants to the judicial foreclosure litigation. The failure to properly notify these parties will invalidate the sale. Both the Litigation Guaranty and the Trustee Sale Guaranty must purchased at the commencement of the foreclosure process before, in the case of a non-judicial foreclosure, recording the notice of default and, in the case of the judicial foreclosure, filing the judicial foreclosure action.
In some situations, a lender will want to proceed under both a non-judicial and judicial course of action if it has not decided whether to try and seek a deficiency judgment against the borrower (in California, deficiency judgments are only allowed following a judicial foreclosure). In that case, it would behoove the lender to request that the title company give the lender a pricing package which provides the lender with a reduced rate for both the Trustee’s Sale Guaranty and Litigation Guaranty, thereby making it feasible to purchase the dual-track guaranties.
In many instances, though, the lender will commence both a non-judicial and judicial course of action even though it knows, at the onset, that it only intends to foreclose non-judicially to avoid the time and expense of litigation. The reason for filing the judicial foreclosure action in these instances is that the lender wants to have a receiver appointed to protect its collateral during the non-judicial foreclosure process, and this requires a judicial process such as judicial foreclosure (in California, the lender can pursue both paths and not elect its remedy until the last moments). Since the lender has no intent of pursuing a judicial foreclosure, there is no need for a Litigation Guaranty and the lender need only purchase the Trustee Sale Guaranty. However, in instances where the lender wants to start a non-judicial foreclosure action that it does not intend on pursuing (e.g., in order to gain negotiating leverage over a borrower), the lender will still need to purchase a Trustee’s Sale Guaranty because title companies will likely refuse to even commence a non-judicial foreclosure without a Trustee’s Sale Guaranty.
Is the Lender’s Policy Sufficient?
Once the lender forecloses (assuming it is the entity that purchases the property at the foreclosure sale) the lender must decide whether its existing Lender’s Title Policy will be sufficient title coverage after it takes title to the property or whether it should purchase a new Owner’s Title Policy. The Lender’s Title Policy stays in effect once title is transferred to the lender, but although the lender has title coverage, the title coverage differs from that of a new Owner’s Policy in two ways.
The first difference lies in the measure of damages. It must be remembered that the original Lender’s Title Policy remains a Lender’s Title Policy; it continues to insure the lender (now property owner) in the original loan amount. Further, the measure of damages under a Lender’s Title Policy is generally the lesser of the policy limits and the balance of the loan. Since the loss under a title insurance policy is measured by the diminution of value to the property, it is only when that value has eaten up all the unencumbered equity in the property that the loss begins to affect the loan portion. Too much equity-over-loan amount would bode poorly for the insured. So, in an appreciating market, the existing coverage under the continuing Lender’s Title Policy might be insufficient to protect the lender in the event of a title claim. Let’s take the example of a purchase money mortgage. A borrower buys property in 2002 for $100 million and takes out a loan to finance that purchase in the amount of $75 million. The lender then gets a Lender’s Title Policy in the amount of $75 million. In 2006, the borrower defaults on the loan and the lender is forced to foreclose and take title to the property. If by the time of the foreclosure, the borrower had paid down its loan to $60 million and the property value has appreciated to $125 million, the Lender’s Title Policy would insure the lender for up to $60 million (the lesser of the policy limits and loan balance). In 2008, a $30 million title issue is discovered. In this case, the Lender’s Title Policy would provide the lender with no coverage for the title claim since the $30 million title problem would still leave the lender with property valued at $95 million, well over the amount of the $60 million coverage. If the lender had purchased an Owner’s Title Policy in 2006 it would be covered for the entire amount of the loss. As demonstrated above, in an appreciating market the lender would suffer a loss and its Lender’s Title Policy would not provide sufficient title coverage.
In a depreciating market, however, the lender would suffer a smaller loss on the same size claim. Using our example above, if at the time of the $30 million title loss, the property value had decreased to $75 million, then the lender would own a $75 million asset insured for only $60 million. The first $15 million loss in value would not affect the insurance; the title company would cover the lender for $15 million (the first $15 million being loss of equity that is not covered by the policy). Continuing on this analysis, if the property had depreciated to a value below that of the loan balance, any loss would be a covered loss even under the original Lender’s Title Policy.
The second difference between the two policies is the date of coverage. The original Lender’s Title Policy continues after the foreclosure but the Date of Policy remains as of the date of the loan origination. If a lender relies on its existing Lender’s Title Policy, it is not insured for the foreclosure itself. If an issue arises with the foreclosure, the title company will not protect the lender for any loss it suffers as a result of the foreclosure problem because the existing Lender’s Title Policy only protects the lender for events that occur prior to the date of issuance of that policy (i.e., matters on record as of the date of the loan origination). For example, if the trustee conducting the trustee’s sale makes a procedural mistake during the trustee’s sale and the mistake causes the sale to be set aside or invalidated, the lender has no title policy to protect its interest in the property. The lender’s recourse in that situation would be to sue the trustee for damages.
The trustee’s duties and obligations arise from the deed of trust and by statute. The trustee has a general duty to conduct the foreclosure sale openly and fairly, and failure to do so opens the trustee up to both civil and criminal liability. For instance, California Civil Code Section 2924h(g) makes it unlawful for a person to offer or accept from another consideration not to bid, or to fix or restrain the bidding. Civil Code Section 3333 extends the trustee’s liability to all other damages proximately caused by its wrongful conduct, regardless of whether the damages were foreseeable or not. If the lender had an Owner’s Title Policy, however, it would have a title claim rather than having to resort to a tort suit against the trustee in order to cover its damages. In addition, in the event the coverage on the Owner’s Title Policy is not sufficient to compensate the lender for the damages sustained by the invalidation of the sale, the lender could still sue the trustee for those excess damages. It is important to note, however, that neither the Owner’s Title Policy nor a Lender’s Title Policy would protect the lender in the event that the procedural mistake during the foreclosure sale was caused by the lender. In that circumstance the lender would have no title protection and they would not be able to sue the trustee for damages.
In addition to determining whether to proceed to foreclose judicially or non-judicially, California lenders must decide whether to obtain a Trustee’s Sale Guaranty or a Litigation Guaranty, and whether to obtain a new Owner’s Title Policy after the foreclosure sale is completed. Although a lender will have to bear an additional cost, it is important to obtain a Trustee’s Sale Guaranty or Litigation Guaranty, whichever is applicable, to assure the lender that it is properly noticing all necessary parties to the foreclosure (and, practically speaking, any lender that wishes to complete a non-judicial foreclosure sale will be required by the foreclosure trustee to purchase the Trustee Sale Guaranty as a condition to that trustee filing the notice of default and conducting the sale). However, the decision of whether to obtain an Owner’s Title Policy after foreclosure must be made on a case-by-case basis. As is discussed above, an Owner’s Title Policy provides the lender with greater title coverage in the event that the value of the property has appreciated, and it also provides the lender with affirmative coverage that the foreclosure sale was properly conducted, which can be very valuable to the lender particularly when it goes to resell the property.