Thursday, October 4, 2012

FYI: 7th Cir Limits Title Policy Exclusion for Losses "Created or Suffered" by Insured

The U.S. Court of Appeals for the Seventh Circuit recently held that a title insurer breached its duty to defend a mortgageedespite the title insurer's attempt to apply the exclusion for claims "created, suffered, assumed or agreed to" by the lender, ruling that the exclusion only applies to losses caused by "the insured's own intentional misconduct, breach of duty, or otherwise inequitable dealings."   A copy of the opinion is attached.
A property developer obtained a construction loan commitment from plaintiff bank ("Bank") for over $95 million, to be disbursed in installments, in order to finance the construction of an ethanol production plant in Indiana.  To secure its loan, Bank took a mortgage on the property and protected its mortgage against conflicting claims and liens with title insurance purchased from Defendant title insurance company ("Insurer").  
Pursuant to the title insurance policy, Insurer was required to conduct a title search "[a]t the time of each disbursement of the proceeds of the loan . . . for possible liens" filed up to "the date of such disbursement," thus protecting Bank against any mechanic's liens that might be filed against the property.  As construction proceeded, Bank would disburse loan funds to the developer, obtain lien waivers from the contractors paid with the funds, and provide those waivers to Insurer as part of its process of updating the policy after each title search.
The policy required Insurer to defend Bank in litigation against liens and other risks, and insured Bank to the extent of amounts already disbursed to the developer, up to the amount of the total loan commitment.   Importantly, however, the policy also contained an exclusion from coverage for claims "created suffered, assumed, or agreed to" by Bank. 
As additional protection against mechanic's liens, Bank purchased a mechanic's lien endorsement ("Endorsement") to the policy to insure against "enforcement or attempted enforcement" of mechanic's liens "having priority over or sharing on a parity with" Bank's mortgage and arising from construction work on the ethanol plant before or after the effective date of the title policy.
The property developer eventually defaulted on the loan, Bank thereafter withheld disbursement of the final installment of the loan, and the developer's general contractor filed a mechanic's lien on the property.  Bank subsequently filed a lawsuit against the property developer in Indiana state court to foreclose on the ethanol plant property.   Also named as a defendant was the general contractor, which counterclaimed against Bank and cross-claimed against the developer, asserting in part that its $6 million mechanic's lien claim was superior to Bank's mortgage.     
Bank tendered the defense of the mechanic's lien claim to Insurer.  Insurer acknowledged in a letter to Bank that the mechanic's lien claim was an attempt to obtain a judgment determining that its lien was prior to and superior to Bank's mortgage.  Nevertheless, Insurer refused to defend and indemnify Bank.  Bank eventually settled with the general contractor on the counterclaim without any contribution from Insurer.
Subsequently filing suit against Insurer in federal district court, Bank alleged that Insurer acted in bad faith and breached its duty to defend against the counterclaim and to indemnify Bank for its settlement with the general contractor. 
Both parties filed cross-motions for summary judgment.  The district court granted summary judgment for Insurer based on the policy exclusion for claims "created suffered, assumed, or agreed to," reasoning that Bank had withheld loan funds that could have satisfied the mechanic's lien.  The Seventh Circuit reversed and remanded.
Addressing Insurer's various assertions as to why it had no duty to defend against the counterclaim, including the contention that the counterclaim did not trigger that duty because the counterclaim was not an "attempted enforcement" of a statutory lien seeking priority over or parity with Bank's mortgage, the Seventh Circuit examined the Endorsement and the policy exclusion for liens "created, suffered, assumed or agreed to" by Bank.  
In so doing, the Seventh Circuit noted among other things that the Endorsement expressly required Insurer to defend and indemnify against the enforcement or attempted enforcement of any claims asserting priority over or parity with the mortgage.  In addition, as the Court further noted, although the policy limited the amount of any recovery to the amount actually disbursed, the Endorsement specified that Insurer would cover and thus defend against any construction-related claims arising before or after the effective date of the policy. 
The Court also rejected Insurer's other arguments, including that it had no duty to defend because the contractor's lien could not legally be equal or superior to the mortgage, because applicable Indiana law gives priority to commercial construction mortgages over all later-recorded liens.  See Ind. Code § 32-28-3-5(d).   Pointing out that the insurance policy required defense of all claims attempting to enforce a lien as having priority over or parity with the mortgage, the Court ruled that Insurer had a contractual duty to defend irrespective of the merits of such claims.  
Moreover, the Seventh Circuit rejected Insurer's arguments that Bank improperly withheld the final disbursement of loan funds to the property developer, and thereby essentially caused the mechanic's lien claim, and that Bank was merely seeking an inequitable windfall.  Noting that there was no disbursement agreement in this case to disburse funds after the developer's default, and that the Endorsement covered claims filed after the effective date of the policy, the Court ultimately concluded that Bank owed no duty to Insurer to continue funding the loan after default and that the overwhelming weight of authority limited the applicability of the "created suffered, assumed, or agreed to" policy exclusion to losses caused by "the insured's own intentional misconduct, breach of duty, or otherwise inequitable dealings."  
Citing a lack of evidence that Bank had engaged in intentional misconduct and the absence of a disbursement agreement, the Seventh Circuit ruled that Insurer breached its duty to defend and was estopped from denying liability for the settlement of the counterclaim.
Accordingly, the Seventh Circuit reversed and remanded with instructions to enter summary judgment in favor of Bank.

Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
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