First American Title Insurance Co v. Johnson Bank

Citation: Not availableDocket: CV-15-0244-PR

Court: Arizona Supreme Court; August 19, 2016; Arizona; State Supreme Court

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The Supreme Court of Arizona addressed the calculation of damages under a lender’s title insurance policy where undisclosed encumbrances impacted property value and its intended use. The court determined that the date for measuring the lender's loss due to an undisclosed title defect, which led to borrower default, should be the date the title policy was issued, rather than the foreclosure date. The court remanded for further proceedings to assess whether the title defect was the cause of the borrowers' default. First American Title Insurance Company had issued two policies to Johnson Bank, which failed to disclose certain covenants and restrictions that impeded commercial development on the properties securing loans totaling $2,050,000. After the property owners defaulted due to these restrictions, they successfully sued First American. Johnson Bank later claimed damages under its title policies, disputing the appropriate date for calculating property value diminution. The superior court initially sided with First American, valuing the properties as of the foreclosure date, but the court of appeals reversed this decision, stating that without a specified valuation date in the policies, the date of the loan should be used instead.

First American's failure to discover and disclose the CC&R's resulted in a breach of the policy when the loans were issued. The court has remanded the case for judgment in favor of Johnson Bank regarding the valuation-date issue. The case is significant as it presents a novel issue in Arizona law, and the court has jurisdiction under the Arizona Constitution and state law. The review of the summary judgment is de novo, favoring the party against whom the judgment was made, and the interpretation of insurance contracts is also conducted de novo, adhering to the contracts' plain meanings and the parties' intent. The title insurance policies in question are standard ALTA loan policies that insure against losses due to title defects, liens, or encumbrances, with coverage amounts corresponding to Johnson Bank's loans totaling $2,050,000. The policies require claimants to notify the insurer of losses and provide proof, though they do not specify a date for loss calculation. A key provision states that the insurer's liability is limited to the difference between the insured value and the value subject to defects. Johnson Bank argues that "as insured" refers to the valuation date coinciding with the policy issuance, while First American contends it pertains only to the policy's conditions. First American further asserts that the policy's lack of a specific valuation date does not render it ambiguous, suggesting that the date of foreclosure is implicitly the relevant valuation date since losses occur only upon foreclosure.

The court of appeals determined that the language in policy section 7(a)(iii) is ambiguous due to its failure to specify "the date the loss is to be calculated." This ambiguity arises from the provision being open to multiple interpretations, and no additional evidence clarifies the parties' mutual intent regarding the valuation date. First American Title contends that the loss is only recognized when the lender forecloses, implying that foreclosure is the sole reasonable valuation date. However, the court clarifies that while the exact loss may not be calculable until foreclosure, the valuation can be assessed based on the property’s value at the policy date, considering the defect. The policy requires the lender to submit a written claim and proof of loss upon discovering a title defect, yet these prerequisites do not define the valuation date. The court references prior cases where similar policy clauses were deemed unambiguous in different contexts, specifically involving undisclosed senior liens, which could justify using the foreclosure date for valuation. However, the court rejects the notion that foreclosure is universally the only valuation date for all lender title insurance policies, indicating that the circumstances of each case must be considered.

The title defect in this case involves undisclosed CC&Rs that allegedly hindered property development, leading to loan defaults, rather than an undisclosed lien. The court of appeals found ambiguity in the title insurance policy regarding the valuation date for calculating the lender’s loss. Citing Leo Eisenberg Co. Inc. v. Payson, the court noted that a contract is ambiguous if it can be reasonably interpreted in multiple ways, and ambiguities should be construed against the insurer. No Arizona statute or binding precedent establishes a specific starting date for property valuation under a lender's title insurance policy. Title insurance is defined as protection against losses from liens, defects, or unmarketability of property titles, and a title commitment serves as a report offering to issue insurance but does not represent the property’s title condition. Consequently, reliance on a title commitment as a representation of title condition is unreasonable. First American contended that the valuation date should align with the loan date, arguing that only title commitments were issued, which do not serve as representations of title. However, Johnson Bank's claim is solely for breach of the title insurance policy, a contract claim that does not require proof of reliance or misrepresentation.

No identifiable legislative goals influence the issue at hand. Social policies and the overall transaction between the parties suggest that the policy date should be used as the valuation date. The insurer holds control over title defects and can mitigate risks through thorough title searches. First American's inadequate title search failed to uncover adverse CC&Rs from 1985, hindering the property owners' intended use and causing Johnson Bank to lose benefits from its loan agreements. The insurance premium was based on the insured amount, aligned with Johnson Bank's loans. First American's policy required it to cover losses due to title defects. Valuing damages at the foreclosure date would allow the insurer to benefit from a depreciating market, despite the title defect leading to default. Using the policy date enables the insurer to assess whether to cure the defect or pay damages accurately. It would also prevent the insurer from evading responsibility for the insured's consequential damages. The risk assessment must consider the real estate market downturn. Although First American claims the court improperly allocated market risks, the policies do not expressly exclude coverage for losses related to market declines. A material title defect that prevents property use and causes borrower default may lead to recoverable damages linked to market downturns. While using the policy issuance date for valuation might shift some loss to the insurer due to market conditions, it does not contradict policy language or relevant social policies in this context.

Reasons for using the policy date to measure a lender's loss in a declining market stem from the goal of future indemnification for the insured and ensuring full compensation for actual losses. Banks assess the risk of loan non-repayment, including market declines, when entering loan contracts, not after defaults occur. Although lenders face risks from market downturns, the value of their security interest at the loan's inception serves as a hedge against such risks. Property owners are less likely to default if their property can be developed as intended, which lenders consider during the loan process. 

In the context of determining damages from First American's incomplete title search, social policy supports using the policy issuance date as the valuation date. The absence of a specific valuation date in title insurance policies allows for a case-by-case assessment of insured losses. If the foreclosure date were the sole valuation date, it would hinder the evaluation of actual losses in individual cases. Title insurers can modify their policies to provide clarity on valuation dates if desired. 

Using the issuance date does not transform First American’s indemnification policy into a mortgage insurance policy or a guarantee of title. Title insurance compensates for damages caused by title defects not discovered by the insurer, rather than guaranteeing perfect title. A title defect does not constitute a breach; the policy only indemnifies against actual monetary losses resulting from discoverable defects or encumbrances. The lender must demonstrate an actual loss, and the policy applies only where a title defect caused the loss. The insurer is not liable if borrower defaults arise from personal circumstances or general market downturns unrelated to the title's condition. Thus, employing the policy issuance date as the valuation date does not alter the nature or scope of the policy’s coverage.

The court of appeals based its decision primarily on *Equity Income Partners v. Chicago Title Insurance Co.*, which adopted reasoning from *Citicorp Savings of Illinois v. Stewart Title Guaranty Co.* First American contends that the appellate court incorrectly favored a 'minority view' over a 'majority view' seen in cases like *First American Bank*, where a majority of jurisdictions determined that a title insurer’s liability to a mortgagee should be assessed based on the foreclosure date in the absence of specific policy language. However, this case does not involve an undisclosed senior lien, making those majority cases less relevant. 

The 'minority view' applies here, as it addresses scenarios of total title failure, measuring damages from the loan date. The court emphasizes applying a 'rule of common sense' in policy interpretation, asserting that ambiguity does not necessitate favoring the insurer's interpretation unless the court genuinely cannot discern the policy's application to the case facts. The court will interpret the policy, specifically section 7(a)(iii), against First American, allowing the policy-issuance date to be used for damage calculations if the title defect caused defaults on Johnson Bank’s loans. 

The dissent argues for using the foreclosure date to assess Johnson Bank’s loss, but the majority finds this argument flawed, stating it relies on incorrect assumptions and irrelevant legal principles. The dissent questions the parties’ intent regarding the damage-valuation date, acknowledging the policy's ambiguity without presenting extrinsic evidence to clarify intent. It also incorrectly claims that the majority's interpretation imposes inconsistent duties on the title insurer. The policy broadly indemnifies against losses due to title defects and does not explicitly state a damage-valuation date. The majority's conclusions align with the policy’s terms and do not conflict with Arizona's statutory framework, as the claim hinges solely on the title insurance policy and not on other legal theories.

The dissent acknowledges the ambiguity in First American’s policy but fails to adequately analyze relevant social policies and the overall transaction. It incorrectly claims that common law and statutory duties are being imposed on First American, relying on inapplicable misrepresentation cases. The dissent also argues that First American had no duty to discover and disclose title defects, a position not advanced by First American and irrelevant since Johnson Bank does not allege a tort or claim breach of duty. Instead, Johnson Bank seeks indemnity for monetary losses due to the title defect, which is based on the contract and not on any extra-contractual duty. First American admits responsibility for the loss in collateral value due to the title defect, contradicting the dissent’s argument. The court concludes that First American, being well-positioned to identify the title defect, should bear the risk of the policy’s ambiguity. While evaluating the claims, the court agrees with First American that there is no evidence linking the title defect to the borrowers’ default, thus the court of appeals erred in granting summary judgment to Johnson Bank. On remand, Johnson Bank must prove the title defect caused the default to use the policy date for valuation; otherwise, the foreclosure date will be used.

The court vacated the court of appeals' opinion, reversed the judgment favoring First American, and remanded the case to the superior court for further proceedings. Johnson Bank sought attorney fees under A.R.S. 12-341.01 but the request was denied, allowing for the possibility of seeking fees in the superior court if Johnson Bank prevails after remand. Chief Justice Bales dissented, agreeing that the title insurance policy is ambiguous regarding whether the loss should be measured at the policy issuance or foreclosure date due to undisclosed title defects. He contended that losses should be measured as of the foreclosure date, which aligns with Arizona's statutory framework and the nature of the transaction. Bales criticized the majority's approach of attributing market downturn losses to the title insurer, emphasizing that the insurer's duties should not extend beyond the policy's terms. He reiterated that title insurance is a contract of indemnity rather than a guarantee of title, and thus, the insurer cannot be held accountable for undisclosed defects unless a duty to discover them exists in relation to the coverage offered.

Courts have established that title insurers do not have an implied duty to search title records for defects when providing title insurance. Any obligation to investigate title conditions arises only from a voluntary assumption of duty beyond the insurance contract itself. A lender cannot reasonably expect that an offer of title insurance will inform them about the value of their security interest or protect against market risks if the insurer has no contractual duty to disclose title defects. Under Arizona law, the responsibility to discover or disclose title defects lies with an abstract of title, which must reveal all recorded documents affecting the title chain, rather than with a title insurance policy. A title commitment, which is an offer to issue a title insurance policy, does not carry such a duty to disclose defects and is explicitly exempted from it. Once escrow closes, the title policy is issued based on the terms of the title commitment and does not represent the condition of the title. Courts in Washington and California, sharing similar statutory definitions, have reached analogous conclusions, affirming that a title insurer owes no duty to lenders regarding the title condition, emphasizing that any research conducted is for the insurer's benefit, not the insured's.

Courts are not mandated to require title insurers to identify and disclose title defects when providing title insurance, as established in California law. Title insurance policies do not summarize public records, nor do they imply that insurers are providing information about the title's condition. Instead, any title search performed by the insurer is solely for its benefit and does not affect the insured party. Under Arizona law, the title insurer, First American, was not obligated to find or disclose any title defects to Johnson Bank prior to the loan being issued. If a defect is subsequently discovered that leads to financial loss, First American is liable only for the lesser of the unpaid loan balance, the cost to remedy the defect, or the decrease in value due to the defect, with loss being measured at the time it actually occurs, specifically at foreclosure.

The majority's decision to assess loss from the date of policy issuance contradicts the nature of title insurance and mischaracterizes the insurer’s responsibilities. It suggests that the lender’s damages arose from the insurer’s failure to properly investigate and disclose defects, implying a duty that does not exist. The majority's reliance on a treatise regarding loss measurement does not adequately differentiate between lender and owner policies, as owner policies might justifiably use the issuance date for loss assessment due to immediate equity impairment. The majority incorrectly assumes that the title insurer had a duty to discover and disclose defects, which leads to an ambiguous interpretation of the title policy that favors the insured unfairly. The dissent argues that First American’s issuance of title insurance did not impose a duty to uncover defects, and if the lender desired assurances about title condition, it could have sought a title abstract or taken on risk through a different contractual agreement. The dissent emphasizes that the title policy should not be interpreted as adopting a loss measurement inconsistent with the parties' intent or Arizona's title insurance statutes.