A recent ruling by the 7th Circuit found that a title insurer had a duty to defend the construction lender in a mechanic’s lien suit when the lender did not have an obligation to continue funding the developer after default.

Home Federal Savings Bank v. Ticor Title Insurance Company, —F.3d—, 2012 WL 3871521 (7th Cir., Sept 6, 2012)

In Home Federal Savings Bank v. Ticor Title Insurance Company (Home Federal v. Ticor), Home Federal lent $95.5 million to finance the construction of an ethanol production plant. When the developer ran into trouble finishing the project, Home Federal refused to disburse the final payout. The developer subsequently defaulted on the loan and fired its general contractor, who then filed a mechanic’s lien to recover $6 million allegedly owed to the general contractor. When Home Federal sought to foreclose its mortgage, the general contractor counterclaimed, asserting that its mechanic’s lien had priority. Although the title policy insured against claims “alleging a defect, lien or encumbrance . . . ,” Ticor refused to defend Home Federal on the ground of an exclusion for claims “created, assumed or agreed to” by the insured. Shortly thereafter, Home Federal settled its dispute with the general contractor, and filed suit against Ticor for breach of contract.

The title policy expressly insured against loss or damage incurred by reason of the “enforcement or attempted enforcement of any statutory lien . . . prior to, at, or subsequent to the effective date of said policy . . .” Even though Indiana law gives priority to a commercial construction mortgage over all later recorded mechanic’s liens, the 7th Circuit held that the general contractor’s counterclaim was an attempt to enforce its lien, and therefore Ticor had a duty to defend against these allegations.

As for the standard “created or suffered” exclusion, the 7th Circuit discussed the conflicting decisions from various federal and state jurisdictions, and found that the overwhelming weight of authority limited the exclusion to losses caused by lender’s own intentional misconduct, breach of duty, or otherwise inequitable dealings. Because Home Federal had not contractually agreed to make adequate funds available to pay the developer and contractors, Home Federal was not required to disburse the entirety of its loan commitment after the developer defaulted. In the absence of a provision in the title policy requiring Home Federal to continue funding the developer after default, Home Federal had “no obligation to continue lending good money after bad,” and therefore did not intentionally create or suffer the loss.

The 7th Circuit found that Ticor breached its duty to defend, and was estopped to deny liability for the settlement as long as the settlement was reasonable and in good faith. The case was remanded to district court for review of the settlement.

Home Federal v. Ticor illustrates the distinction between having, and not having, a “disbursement agreement” in the title policy. The 7th Circuit found that where the lender breaches an express or implied duty to the title company to make sufficient funds available regardless of default, the exclusion may apply, not whether the title company assumed the responsibility to secure waivers and disburse funds.