Who Wins In A Lender Vs. Title Company Negligence Dispute?
For now, the answer is the title company.
Three weeks ago, when I first sat down to write this post, my intent was to discuss when a security interest in real property is created and perfected, and what happens to that lien in the absence of perfection or if the recorded instrument evidencing that lien has been released. I was thinking about old memories of me, my brother and my parents playing Monopoly on a rainy day at the beach at Vermilion Ohio, where I spent a lot of summers as a kid. In that game, the way my family played it, we didn’t have to worry about perfection when a property was mortgaged—although I know others played it with a rule that when a property was mortgaged, the card had to be turned over, which could be understood as a type of perfection—and that was the point I was hoping to illustrate: that a lien on real property may exist absent perfection; it just has no priority compared to third parties, who lack notice due to the lack of perfection.
Then, just like that, an opinion in one of our cases came back from the Middle District; a case in which our client, a lender, accidentally released its deed of trust, and years later, the title company closing a short sale of the subject property distributed sale proceeds to the property seller, not the lender, despite actual knowledge of the lender’s claim to said proceeds. Lender sued under a negligence theory: the title company had actual knowledge of the mortgagee’s lien, and ignored that lien in paying the seller. The defendant title company filed a motion to dismiss almost six months ago, and I had been anxiously awaiting the Court’s ruling. The Court ended up skipping the foundational notions that I just mentioned regarding lien creation, attachment and perfection. Instead, the Court took a completely different analytical route from any argued by the parties, and these are the ideas that I want to discuss today. The Court’s opinion is technical and I even agree with a lot of it, although I obviously still think that title companies owe, at least, something resembling an equitable duty of care to those it actually knows to have a legitimate claim on sale proceeds. The Court’s ruling in this case is likely to be cited a lot in coming months in two overlapping legal circles: amongst counsel for lenders and those in the real estate/title community, both of which audiences are represented in our e-mail blasts.
The main lesson for lenders is that, generally, a mortgagee cannot establish a duty of care—a necessary element of any negligence claim—owed by a title company or anyone else when the mortgagee’s only injury is economic. The Court relied on Tennessee’s adoption of the “economic loss doctrine,” which “prohibits the recovery of purely economic damages for negligence when the plaintiff lacks privity of contract with the defendant.” That is, as in this case, where the lender’s sole injury was economic, it could not pursue a negligence claim because there was no privity with the title company. The next branch on this particular judicial tree will probably be whether a mortgagee being paid off at closing is (or can be) an intended third party beneficiary of the escrow agreement between seller, buyer and escrow holder. I could argue it both ways. Another branch is what, exactly, should be alleged to characterize this kind of case as a negligent misrepresentation claim, which the Court said was not subject to the “economic loss doctrine.” (Factually, in this case, the title company requested a payoff from the mortgagee, but never affirmatively told anyone that it would pay the sale proceeds to the mortgagee.)
The other immediate takeaways for lenders from this one, for now, are: First, most obviously, keep careful track of your lien release instruments. Second, if the matter is headed for litigation, get very creative re-characterizing negligence claims seeking only economic damages as negligent misrepresentation claims (which require justifiable reliance) and in asserting the existence of a third party beneficiary relationship. And, third, that it may be advisable in the future for mortgagees to insist on a contract relationship with the title company when closing short sales of real property.
As an attorney who represents lenders, I have some serious apprehensions about the consequences of this opinion.
FOR TITLE COMPANIES:
This is a great holding for title companies, because the Court specifically declared that, “a title company/escrow holder owes no duty of care to a third party to the transaction, absent special circumstances.” An escrow holder is an agent and fiduciary of the parties to the escrow, and absent evidence of fraud or collusion, the escrow holder’s obligations are limited to compliance with the parties’ instructions. This is now the black-letter law in Tennessee.
The Court also acknowledged policy considerations supporting its ruling: allowing a duty of care between an escrow holder and an existing mortgagee would subject an escrow holder “to conflicting obligations [and] undermine a valuable business procedure.” Personally, I think the Court’s implied fear of opening the floodgates to litigation between escrow holders and third parties is overwrought; but the concern that forcing title companies to constantly look over their shoulders for potential third party claims, and the attendant chill on commerce this would entail, especially in such an important sector of the economy, is probably warranted.
If I were an attorney who only closes consumer and commercial real estate transactions through a title company, this would have been a more welcome opinion.
Ernie, Lisa and I love talking about this stuff. If you would like to pick the spots off the peppercorns of this case (for example, the Court’s use of a six part test for a duty of care, which I skipped, above), we encourage you to drop us a line using the contact info, below, or send us an email at email@example.com, firstname.lastname@example.org and email@example.com. If you need to close a loan, look into litigation or install processes so that your business doesn’t end up in a lawsuit like this, likewise give us a call or shoot us an email.
Next week, we will discuss recent changes to the Tennessee Thrift Act. In the meantime, check out our website: www.mbslawtn.com.