FYI: 11th Cir Rules Against Insured Under Title Policy Exclusion for Defects "Assumed or Agreed to" by the Insured

The U.S. Court of Appeals for the Eleventh Circuit recently held that a title insurance policy exclusion for defects "assumed or agreed to" by the insured precluded coverage, where the evidence showed that the insured had actual knowledge that there was no right of access to and from the property securing the loan. 

 

A copy of the opinion is available at:  http://www.ca11.uscourts.gov/opinions/ops/201210495.pdf.

 

A number of real estate investors formed a company ("Company") to purchase a parcel of raw land in Lincoln County, Georgia for purposes of developing a residential subdivision.  Company financed the land acquisition with a purchase money loan from a local state bank ("Bank") with the intention of funding the development through another source.  Bank obtained personal guaranties from two of Company's principals as well as additional collateral from other investors in Company.  Bank also took out a title insurance policy with defendant title company ("Title Insurer"). 

 

The title policy insured "owners of real property or others having an interest in such real property . . . against loss by encumbrance, defective titles, invalidity, adverse claim to title, or unmarketability of title by reason of encumbrance or defects not excepted in the insurance contract."  Ga. Code Ann. § 33-7-8.  While the policy generally covered loss or damage incurred due to a "lack of right of access to and from the land," there was a provision excluding coverage for defects "assumed or agreed to" by the insured.

 

Shortly after Company's acquisition of the land, Company's development plans stalled.  One of the obstacles Company faced was that the property was landlocked, lacking access to any public road.  Being aware of this condition prior to its purchase of the property, Company had originally planned to obtain an easement across adjacent property, but later abandoned that idea for reasons of cost.

 

Company later filed a claim with Title Insurer under the provision insuring against loss due to lack of access to and from the land.  Title Insurer denied the claim on grounds that Bank, and not Company, was the insured party. 

 

Facing mounting interest costs on the land purchase loan and problems in securing funding for development, Company later unsuccessfully attempted to modify the loan, among other things.  Company also encouraged Bank to file a claim with Title Insurer based on the "lack of access" provision in the policy.  In response, Bank declined to make a claim, stating among other things that Bank knew at the time of loan origination that there was no designated access to the property. 

 

Company later defaulted on the land purchase loan and, after Bank indicated that it would pursue the personal guarantees, Company's investors formed a new business  ("Loan Owner") that purchased Company's promissory note from Bank, thereby stepping into Bank's shoes. 

 

Next, Loan Owner filed an insurance claim against Title Insurer based on the lack of access provision.  Accordingly, Title Insurer, as part of its investigation of the claim, had a Bank executive with personal knowledge of the loan transaction execute an affidavit stating that at the time it extended the loan and took out the title insurance policy, Bank was fully aware of the property's lack of dedicated access.  The Bank executive died shortly before the lawsuit was filed. 

 

Title Insurer subsequently denied the claim, citing a provision in the policy excluding coverage for matters "assumed or agreed to" by the insured.  Loan Owner filed suit in state court, seeking damages for breach of contract and penalties for acting in bad faith.  Title Insurer removed the case to federal court.  The parties filed cross-motions for summary judgment on the issue of Title Insurer's liability under the policy.  The lower court granted summary judgment to Title Insurer, ultimately concluding that the policy exclusion negated coverage for losses arising from "defects, liens, encumbrances, adverse claims or other matters . . . assumed or agreed to by the insured claimant."  Loan Owner appealed. 

 

The Eleventh Circuit affirmed based on the consistent evidence that when it made the loan, Bank had "assumed" the landlocked condition of the property within the meaning of the exclusion to the title insurance policy.  

 

As you may recall, Rule 807 of the Federal Rules of Evidence, the so-called catch-all rule, permits admission of a hearsay statement "(1) if it is particularly trustworthy; (2) it bears on a material fact; (3) it is the most probative evidence addressing that fact; (4) its admission is consistent with the rules of evidence and advances the interests of justice; and (5) its proffer follows adequate notice to the adverse party."  See Fed. R. Evid. 807(a), (b).

 

Rejecting Loan Owner's various assertions, including the argument that the lower court's interpretation of the insurance policy was inconsistent with Georgia law because, according to Loan Owner, the insurance policy guaranteed coverage "without exception" for losses resulting from lack of access, the Eleventh Circuit pointed out that losses and damages arising from "defects, liens, encumbrances, adverse claims or other matters . . . assumed or agreed to by the insured claimant" were expressly excluded from coverage.   In so doing and stressing that only "assumed" losses were excluded, the Court agreed with the lower court's assumption-of-the-risk analogy whereby a plaintiff has a priori consented to take his chance of injury from a known risk, pointing out that the phrase "other matters" in the policy exclusion would be meaningless if it did not refer to anything besides the four items that preceded it.  See Vaughn v. Pleasent, 471 S.E.2d 866, 868 (Ga. 1996). 

 

Emphasizing that, contrary to Loan Owner's assertion, Bank was not required to unearth evidence of a title defect before making the loan, and that Bank had actual knowledge about the lack of access to the property and thus fully appreciated how lack of access affected the value of the property prior to making the loan, the Court also noted that there was no obligation on the part of Title Insurer to investigate prior to issuing its policy whether or not the property was landlocked. 

 

Turning to Loan Owner's argument that the admission of the affidavit of Bank's president at trial was improper because the affidavit constituted inadmissible hearsay, the Court agreed with the lower court's analysis under Rule 807.  Notably, with respect to Loan Owner's assertion that it lacked the requisite notice of Title Insurer's intent to rely on the affidavit well before any "trial or hearing", the Court pointed out that the affiant's death occurred prior to the filing of the lawsuit and that the affidavit was provided to Loan Owner well before any briefing on the dispositive motions took place. 

 

The Eleventh Circuit thus concluded that summary judgment was proper based on the considerable and consistent evidence presented, including the affidavit of the now-deceased Bank president and testimony as to Bank's knowledge of and lack of concern with access to the property, as it was only extending a purchase money loan for the land, not a loan for its development.  Consequently, the Court reasoned, Bank's only concern was simply obtaining adequate collateral for the purchase loan.  

 

Accordingly, having determined that "no reasonable factfinder could doubt" that Bank knew about the property's lack of access and appreciated its significance, the Eleventh Circuit concluded that, because Bank had "assumed" the landlocked condition of the property, Title Insurer was entitled to summary judgment.

 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
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Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mtwllp.com

 

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FYI: Cal App Ct Reverses Ruling In Favor of Lender on Construction Loan, Citing California Homeowner Bill of Rights

The California Court of Appeal, First District, recently ruled in part that triable issues of material fact existed as to whether: (1) a successor bank assumed a failed bank's liability for claims related to a construction loan under a "purchase and assumption" agreement; (2) the failed bank and the successor bank owed borrower a duty of care partly in light of policy considerations set forth in the recent "California Homeowner Bill of Rights" and other legislation governing loan servicing; and (3) the borrower stated claims for "fraudulent" or "unfair" practices under California's unfair competition law.

 

The Court also ruled that the lower court improperly took judicial notice of the purchase and assumption agreement, where the content and legal effect of the agreement itself were in dispute.

 

A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/A134019.PDF

 

Plaintiff-borrower ("Borrower") obtained a construction loan from a bank ("Failed Bank") that eventually became insolvent and went into receivership under the Federal Deposit Insurance Corporation ("FDIC").  Over the course of construction, Borrower allegedly sought but was unable to obtain reimbursement of pre-paid construction costs or disbursements of up-front funds pursuant to the loan agreement.  Such alleged funding problems supposedly caused Borrower to incur delays in construction and substantial additional expenses.    Borrower eventually obtained a loan modification from Failed Bank that increased the principal amount of the loan by over $2 million and which supposedly provided that Failed Bank would supply any additional funds Borrower needed to complete the construction project.

 

Almost two years following the loan modification, Failed Bank was placed into receivership.  As its receiver, the FDIC executed a so-called "purchase and assumption" agreement (the "P&A") with another financial institution ("Assuming Bank") allowing Assuming Bank to acquire certain of Failed Bank's assets, including all loans and loan commitments.  The P&A also provided in part that Assuming Bank would "assume no liabilities associated with borrower claims arising out of [Failed Bank's] lending activities," and also that "Assuming Bank specifically assumes all mortgage servicing rights and obligations of Failed Bank." 

 

Several months after Assuming Bank's acquisition of Failed Bank's assets, Borrower, who had not yet completed construction, defaulted on his loan.   Nevertheless, Borrower tried to secure a loan modification from Assuming Bank in order to complete construction.  Borrower also sought enforcement of a so-called "rollover" provision whereby the loan would convert to an amortizing loan.  Assuming Bank allegedly declined to honor the rollover provision because Borrower defaulted and construction had not been completed.  Accordingly, Assuming Bank demanded payment in full and initiated foreclosure proceedings against Borrower's property. 

 

Shortly thereafter, however, an employee of Assuming Bank allegedly kept Borrower's hopes for a loan modification alive by supposedly repeatedly assuring Borrower that Assuming Bank would not pursue the foreclosure as long as there was still the potential for a loan modification.  Despite these alleged assurances from the employee, Assuming Bank went ahead with the planned foreclosure.

 

Two days before the scheduled foreclosure sale of the collateral, Borrower, asserting in part that Assuming Bank had "stepped into the shoes" of Failed Bank, filed a lawsuit against Assuming Bank and others, alleging various causes of action, including fraud, breach of contract, negligence, violation of California's unfair competition law.  Borrower also sought declaratory relief, accounting, and contract reformation.

 

Assuming Bank moved in part for summary judgment, claiming that it was not liable for Failed Bank's conduct prior to failure and that, moreover, the P&A specifically provided that Assuming Bank had acquired only the assets of Failed Bank and not its liabilities.  Along with its motion, Assuming Bank requested that the lower court take judicial notice of the P&A it submitted to the court.

 

In response, Borrower argued that Assuming Bank failed to provide the complete P&A agreement.  Borrower included a declaration from an expert stating that the actual full-length P&A was never made public, and that the complete P&A contained additional provisions related to Assuming Bank's assumption of Failed Bank's liabilities that could affect the outcome of this case.  In addition, Borrower unsuccessfully sought the full-length P&A from the FDIC, which was allegedly willing to produce it provided all parties to the litigation signed a confidentiality agreement.  Assuming Bank allegedly did not agree to do so.

 

Following Borrower's unsuccessful attempts at procuring a copy of the full-length version of the P&A and at keeping discovery open, the lower court, taking judicial notice of the P&A documentation Assuming Bank submitted, granted summary judgment in favor of Assuming Bank.  The lower court reasoned in part that Assuming Bank never assumed liability for claims related to Failed Bank's lending activities.  The lower court also concluded that, because the assurances from Assuming Bank's employee were mere "opinions," rather than statements of fact, Assuming Bank never agreed to a modification of Borrower's loan.  The lower court also ruled in part that according to the typical lender-borrower relationship, Assuming Bank owed Borrower no duty of care that would support a negligence claim.  

 

The Court of Appeal affirmed in part and reversed in part, ruling that there were triable issues of material fact as to the causes of action for misrepresentation, breach of contract/promissory estoppel, negligence, unfair or fraudulent business practices, and reformation.  However, the Appellate Court affirmed the lower court's rulings as to Borrower's requests for declaratory relief and an accounting.

 

First addressing the lower court's taking judicial notice of the P&A and noting that the full-length P&A was available had the parties signed a confidentiality agreement, the Appellate Court ruled that it was error to use judicial notice as a vehicle for determining the content and legal effect of the P&A.  In so ruling, the Court noted that Assuming Bank's request for judicial notice specifically related to the P&A provision according to which Assuming Bank acquired "certain assets of [Failed Bank], including all loan and loan commitments of [Failed Bank]" but that the lower court used the P&A more broadly to prove that Assuming Bank did not in fact assume liability for Failed Bank's alleged improper acts or omissions with respect to Borrower's loan.   See Cal. Code Civ. Proc. § 437c, subd. (b)((1)(use of judicial notice on a motion for summary judgment); Cal. Evidence Code §§450-460 (referring to permissive judicial notice of court records and official acts). 

 

Turning specifically to the lower court's rulings on Borrower's various causes of action, the Appellate Court noted among other things that triable issues of fact existed as to whether: (1) the P&A submitted by Assuming Bank represented the full extent of its liabilities; (2) representations by Assuming Bank's employee regarding a possible loan modification were actionable; (3)  Assuming Bank had an obligation to continue disbursing funds; (4) Assuming Bank owed a duty of care to Borrower to support a negligence cause of action; and (5) Assuming Bank was liable for alleged "fraudulent" or "unfair" conduct in violation of California's unfair completion law, Cal. Bus. & Prof. Code § 17200 et seq.

 

In its analysis of Borrower's negligence claim and in particular on the issue whether Assuming Bank owed Borrower any duty of care, the Appellate Court primarily focused on the practice of "dual tracking" a loan in danger of default and on the lender-borrower relationship created by a construction loan. See Connor v. Great Western Sav. & Loan Assoc., 69 Cal.2d 850, 856-58 (1968)(as an "active participant  in a home construction enterprise," lender owed duty of ordinary car to homebuyers); Biakanja v. Irving, 49 Cal.2d 647,  650 (1958)(identifying six non-exhaustive factors for determining whether lender owed duty to borrower:  (1) extent to which transaction was intended to affect plaintiff; (2) foreseeability of harm to the plaintiff; (3) degree of certainty that plaintiff suffered injury; (4) connection between defendants' conduct and injury suffered; (5) moral blame attached to defendant's conduct; and (6) risk of future harm).

 

In so doing, the Court rejected Assuming Bank's assertion that it owed Borrower no duty of care in this case, referencing evidence of an ongoing dispute between the parties as to their respective rights and obligations.  See Newson v. Countrywide Home Loans, Inc. (N.D.Cal. Nov. 30, 2010, 2010 No. C 09-5288) 2010 U.S. Dist. Lexis 126383, at 15; Ottolini v. Bank of America (N.D. Cal. Aug. 19, 2011 No. C-11-0477) 2011 U.S. Dist. Lexis 92900 at 16). 

 

Moreover, citing state and federal government efforts to encourage loan modifications, the Court referred to the recently enacted "California Homeowner Bill of Rights" legislation aimed at requiring lenders and loan servicers to deal "reasonably" with borrowers in default by eventually prohibiting the practice of dual-tracking.   While noting that the legislative provisions did not apply to this case, the Court concluded that the policy considerations set forth in the legislation bore on the determination as to whether Assuming Bank owed Borrower a duty of care and that summary adjudication of the negligence cause of action was thus reversible error.  See, e.g., Ansanelli v. JP Morgan Chase Bank, N.A. (N.D. Cal. Mar. 28, 2011 No. C. 10-03892) 2011 U.S. Dist. Lexis 32350, p. *21 (finding that duty of care had been properly pleaded in negligence action after bank reneged on promise to modify loan and reported loan as past due even though borrowers had made all payments under their trial modification plan); Robinson v. Bank of America, (N.D. Cal. May 29, 2012 No. 12-CV-00494-RMW) 2012 U.S. Dist. Lexis 74212, p. *21.

 

With respect to Borrower's claim that Assuming Bank violated California's unfair competition law due to its employee's statements as to the possibility of a loan modification, the Court held that triable issues existed as to what constituted "fraudulent" or "unfair" practices in light of the recent legislative changes, among other things.  

 

The Court also reasoned that, given Borrower's allegations of fraud or mutual mistake as to the issue of reimbursement of pre-paid construction costs and their impact on the terms of the original loan agreement, triable issues of fact similarly existed so as to render summary adjudication of the reformation cause of action improper. 

 

Finally, the Appellate Court affirmed the lower court's rulings denying declaratory relief and an accounting, concluding that: (1) because Borrower had a fully matured cause of action for money damages, declaratory relief was not proper; and (2) there was no fiduciary or other "special relationship" that would give rise to an accounting remedy, nor were the accounts so complicated that an ordinary legal action demanding damages would be impracticable. 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mtwllp.com

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FYI: Cal App Ct Rules Assignee Liable Under FTC's Holder Rule Even When Transaction Not "Practically Worthless," Credit Defamation Allegations Preempted Under FCRA

The California Court of Appeal, Third District, recently ruled that the FTC's "holder rule" allows consumers to assert causes of action against the owner of their consumer installment sale contract for alleged violations of California's Consumer Legal Remedies Act, as well as for negligence stemming from improper repair of the vehicle, even though these allegations would not render the transaction "practically worthless."  

 

The Court also concluded, however, that the purchasers' state-law cause of action for negligent credit defamation was preempted by the federal Fair Credit Reporting Act, and that they lacked standing as third-party beneficiaries under a dealer agreement which provided protective warranties benefiting only the holder of the debt and not the consumers.
 
A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/C067812.PDF.

 

Plaintiffs-consumers ("Consumers") purchased a motor home from defendant dealer ("Dealer") that they financed with an installment agreement.  Consumers also paid Dealer for an extended service contract.  Shortly after selling the motor home to Consumers, Dealer assigned the installment contract to defendant bank ("Bank") pursuant to an agreement whereby Dealer promised to defend Bank against any legal action arising out of the sale of the motor home.  The agreement further indicated that Bank's failure to exercise any rights or to require Dealer's performance of any duties under the agreement would not operate as a waiver of rights under the agreement.

 

Due to alleged ongoing electrical problems with the motor home that were never repaired despite Consumers' efforts, Consumers wrote to the manufacturer of the motor home explaining their plight, as well as to Bank stating that they would stop payments on the loan until repairs were made.  Further, their attorney later notified Dealer, Bank, and the manufacturer, among others, that Consumers had relinquished their ownership interest in the vehicle, indicating that Consumers would be seeking compensation for their troubles.

 

After Consumers stopped making the payments on the motor home and disclaimed their ownership in the vehicle, Bank re-possessed the motor home.  However, while taking no action to collect on the loan, Bank also reported to various consumer credit reporting agencies that Consumers had defaulted on the installment agreement.

 

On the theory that both California law and the Federal Trade Commission's ("FTC's") so-called "Holder Rule" allowed them to assert against Bank the same claims they had against Dealer or the manufacturer, Consumers then sued Dealer, Bank, and others, asserting various causes of action, including breach of warranty, breach of contract, breach of the covenant of good faith and fair dealing, violation of California's Consumer Legal Remedies Act ("CLRA"), negligence for improper repair of the motor home, and negligent defamation of credit for Bank's supposedly improper reporting of incorrect credit information to credit bureaus.
 
Further, asserting that they were third-party beneficiaries of the dealer agreement between Bank and Dealer, Consumers also sought declaratory and injunctive relief as to Bank's liability under that agreement and on whether the return of the motor home nullified any potential claim of Bank to a security interest in the motor home. 

 

Bank demurred as to the causes of action relating to the CLRA, negligence, negligent credit defamation, and declaratory and injunctive relief.  Bank also moved for summary adjudication on the remaining causes of action.
 
The lower court sustained the demurer without leave to amend and entered summary judgment in favor of Bank, reasoning in part that the Holder Rule did not permit Consumers to assert claims against Bank that related only to Dealer's duties under the installment contract.  The lower court further ruled that Consumers' cause of action for disparagement of credit was preempted by the federal Fair Credit Reporting Act, 15 U.S.C. § 1681, et seq.  Noting that Consumers' affirmative relief was "limited to no more than what they have already paid on the contract, the lower court also awarded attorney's fees to Bank.  Consumers appealed.

 

The Appellate Court reversed, concluding among other things that the Holder Rule applied to allow Consumers to assert against Bank the claims they otherwise had against Dealer, but limited Consumers' recovery to no more than what they already paid under the installment contract.  The court also reversed the award of attorney's fees.

 

As you may recall, the "Holder Rule" requires that the following language, set in all capital letters of at least 10-point typeface, prominently appear in every consumer installment contract that is assigned to a subsequent creditor:  "Notice: Any holder of this consumer credit contract is subject to all claims and defenses which services obtained pursuant to or hereto or with the proceeds hereof.  Recovery hereunder by the debtor shall not exceed amounts paid by the debtor hereunder."  16 C.F.R. § 433.2.

 

In addition, California's CLRA makes unlawful various "unfair methods of competition and unfair or deceptive acts or practices" in sales transactions and requires that a plaintiff who intends to assert a damages claim under the CLRA provide at least 30 days' notice to prospective defendants of the alleged violations and "[d]emand that such person correct, repair, replace or otherwise rectify the goods or services alleged to be in violation" of the CLRA.  See Cal. Civ. Code §§ 1770, subd. (a), 1780, 1782, subd.(a)(2).

 

Finally, the federal Fair Credit Reporting Act ("FCRA") concerns issues related to credit reporting and completely preempts all state common law tort claims against furnishers of credit information arising from conduct regulated by the FCRA.  See 15 U.S.C. § 1681t(b)(1)(F).  See also, e.g., Riegel v. Medtronic, Inc., 552 U.S. 312, 324 (2008)(holding '[a]bsent other indication, reference to a State's "requirements" includes its common-law duties"); Sanai v. Saltz, 170 Cal. App. 4th 746, 773 (2009).

 

Noting a split of authority interpreting the Holder Rule, but analyzing the Holder Rule according to what the Court saw as the plain meaning of its language, the Court of Appeal ruled that the Holder Rule allows a consumer to assert against the holder of a consumer credit contract "all claims and defenses" that the consumer could assert against the seller, including claims based on negligence and the CLRA.  See Music Acceptance Corp. v. Lofing, 32 Cal. App.4th 610, 627-28 (1995)(noting in part that in abrogating the holder in due course doctrine in consumer credit transactions, the FTC shifted the burden of seller misconduct to the creditor); Oxford Fin. Companies, Inc. v. Velez, 807 S.W.2d 460, 463 (Tex. App. 1991).   In so ruling, the Court rejected Bank's assertion that the Holder Rule was ambiguous and limited to those situations where a seller's breach of contract rendered the transaction "practically worthless."  See, e.g., Ford Motor Credit Co. v. Morgan, 536 N.E.2d 587 (1989)(avoiding "plain meaning"  interpretation of Holder Rule). 

 

With respect to damages, the Court also ruled that, as expressly stated in the Holder Rule, Consumers' recovery against Dealer and Bank was limited to the amount they already paid under the installment contract.

 

Turning to the lower court's dismissal of the causes of action based on alleged CLRA violations, and negligence, the appellate court concluded that Consumers were not barred from asserting those causes of action.  Among other things in so doing, the court determined that, contrary to Bank's assertion, Consumers had satisfied the CLRA's notice requirements by their various letters to Bank, Dealer and the manufacturer.  Second, clarifying the distinction between the causes of action for negligence and negligent credit defamation, the court ruled that to the extent the negligence claim was based on the alleged failure to repair the motor home and not on derogatory remarks on Consumers' credit reports, the negligence cause of action against Bank remained viable.  However, with respect to Consumers' claim that Bank negligently reported inaccurate credit information to credit agencies, the court ruled that, pursuant to the express preemption provision in the FCRA, their state-law cause of action for negligent credit defamation was preempted.

 

Finally, ruling that Consumers were not third-party beneficiaries of the dealer agreement between Bank and Dealer because Dealer made warranties under that agreement specifically to benefit Bank and not Consumers, the Court concluded that Consumers lacked standing to seek declaratory and injunctive relief under the dealer agreement.  The Court also ruled that Consumers had forfeited their remaining causes of action for failure to present sufficient legal arguments.
 
Accordingly, the Court reversed the judgment in Bank's favor on the CLRA and negligence causes of action and also reversed the lower court's order awarding attorney's fees and costs to Bank.

 

 

Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mtwllp.com

 

 

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