ROSEN v. NATIONAL TITLE INS. CO.
56 Cal.App.4th 1489 (1997)

Action for damages for breach of title insurance policy, and for bad faith denial of coverage.

Barrich, a real estate developer, borrowed money from Brentwood Bank of California (the "Bank") for construction of two luxury homes. There were two loans, each secured by a first trust deed on the parcel to be improved.
Barrich defaulted on both loans, and the Bank commenced foreclosure proceedings. Barrich then filed Chapter 11 bankruptcy, staying the foreclosures.

Barrich filed a motion for a "priming lien loan" [11 U.S.C. § 364(d)] in its Chapter 11. The Bank strenuously opposed the motion, but in July, 1992 the Bankruptcy Court authorized Barrich to obtain two loans of $165,000, each of which would be secured by trust deeds taking priority over the Bank's existing trust deeds. The Bankruptcy Court's order also directed that the loan funds be used only to complete construction of the homes, and to pay expenses essential to preserve the assets of Barrich's bankruptcy estate.

Plaintiff, Rosen, and several other physicians ("Plaintiffs") made the two $165,000 loans. The loans were secured by trust deeds which were insured as first trust deed liens by Defendant, Nations Title Insurance Company. In doing so, Nations relied on the priming order in Barrich's bankruptcy.

In 1993 the Bank obtained relief from the stay in the Chapter 11, and commenced foreclosure proceedings under its trust deeds. It then brought an action against Rosen and his co-beneficiaries for a declaratory judgment that their trust deeds had been subordinated to the Bank's liens, because (1) Barrich, in violation of the priming order, had used Plaintiffs' loan funds for purposes unrelated to construction of the homes, or preservation of its assets in the Chapter 11; and (2) Rosen and his co-beneficiaries had negligently permitted Barrich to squander the loan funds by failing to monitor the disbursements made to Barrich.

Rosen and his co-beneficiaries tendered defense of the Bank's action to Nations, but Nations denied the tender on grounds that (1) the defect in the beneficiaries' title was created by their own conduct -- their failure to monitor loan disbursements -- and (2) the Bank's litigation related to conduct which occurred after the policy was issued, and was therefore outside the scope of coverage. The beneficiaries paid for their own defense in the Bank's declaratory relief action, and ultimately prevailed, the trial court finding that there was no evidence of misuse of the loan funds by Barrich.

The beneficiaries then brought this action against Nations for breach of their loan policies of title insurance, and for bad faith. Both parties brought motions for summary judgment. The trial court granted Nations' motion, and denied Plaintiffs' motion, on the ground that the title defect alleged in the Bank's declaratory relief action arose from events occurring after the title policies were issued. On appeal by Plaintiffs, HELD, affirmed.

1. Title Insurance; Duty To Defend: Coverage For "Post-Policy" Matters.

The Court of Appeal (2nd Dist., Div. 5) agreed with the trial court's conclusion that the insurance under Nations' loan policies looked to one moment of time -- the "Date of Policy". The scope of coverage afforded by the term "Date of Policy" is "limited to defects which existed when the policy became effective. 56 Cal.App.4th at 1498.

According to the Court of Appeal, the trial court properly relied on two non-California decisions, National Mortgage Corp. v. American Title Ins. Co., 299 N.C. 369 (1980), and Mark Twain Kansas City Bank v. Lawyers Title Ins. Co., 807 F.Supp. 85 (E.D. Mo. 1992). The Court also discussed a leading California case regarding liability of a title insurer to defend litigation arising out of post-policy events, Safeco Title Ins. Co. v. Moskopoulos, 116 Cal.App.3d 658 (1981).

[N]ational Mortgage is therefore in accord with California law on the scope of coverage for title insurers and we adopt its reasoning. Such policies only insure against defects, liens or title challenges which exist when the policy took effect, not after. Combined with the decision in Safeco, supra, it is clear that the challenge to appellants' priming loan trust deeds which was raised in the bank's action was based on events occurring after Nations issued its title policy and that it therefore owed no duty to defend that action.

The complaint at issue in Safeco alleged intentionally tortious conduct by the insured which invalidated its title. The complaint at issue here alleged negligent conduct by appellants which supposedly invalidated the priority of their trust deeds. Such allegations do not constitute any title defect or lien or encumbrance on the property (Safeco, supra, 116 Cal.App.3d at p. 666, 172

Cal. Rptr. 248) and to the extent appellants' predicate their claim on that portion of the insuring clause. Safeco demonstrates that the bank's action fell outside the scope of coverage. Since the lis pendens in Safeco was filed after the title policy took effect, the insured's title was rendered unmarketable by events occurring outside the scope of coverage. The same is true of the bank's action, which was filed more than one year after the title policy took effect.Id., at 1501.

Rosen and his co-beneficiaries attempted to distinguish National Mortgage on the theory that in this case the title insurer knew that all of the loan funds would be distributed at once, and that the Bank -- in opposing the priming motion -- had complained that the circumstances of disbursement would virtually ensure misuse of the loan funds. In short, Plaintiffs argued that Nations knew, at the time the policy was issued, of the likelihood of occurrence of the very problems about which the Bank complained in its declaratory relief action, and that disputes arising from those circumstances were therefore part of Nations' coverage obligation.

[W]e believe the trial court adequately addressed these distinctions in its tentative decision: "[Appellants'] attempts to distinguish National Mortgage ... are unconvincing. The cases clearly hold that loan proceeds are not covered by the policy because the policies insure title only as of the date of the policy. It is not significant whether the insured lost control of his funds, the knowledge of the insured and insurer when the policy was issued or whether the funds were misappropriated or correctly disbursed. The critical fact is the time of the wrongful event in relation to the date of the policy.Id., at 1502.

Significantly, the Bank's declaratory relief complaint did not allege any defects or liens at the time Nations' policy took effect. "Instead, as in Safeco and National Mortgage, it alleged misconduct or legal actions which occurred after and which were therefore outside the scope of coverage. Id., at 1502.

COMMENT.

This case is a good illustration of the "freeze-frame" nature of title insurance -- the "camera" focuses on the condition of title at the instant the policy is issued, in order to determine whether there is coverage for an event which -- according to the insured -- has created a duty to defend or indemnify. See, Safeco Title Ins. Co. v. Moskopoulos, supra, at 666, Barczewski v. Commonwealth Land Title Insurance Company, 210 Cal.App.3d 406 (1989).

In this case the Court of Appeal was particularly mindful of the applicable instant of time: it specifically mentioned the time of day that Plaintiffs' trust deeds recorded (3:01 p.m., September 4, 1992). "The policies by their terms were effective at the same time and date that [Plaintiffs'] trust deeds recorded.")

This case also contains a helpful discussion of an insurer's duty to defend under a policy of title insurance. According to the Court, "Step 1" requires a comparison of the allegations of the complaint with the terms of the policy. Id., at 1497; Montrose Chemical Corp. v. Superior Court, 6 Cal.4th 287, 300 (1993). Is there a potential for coverage? In this case, the answer was "No," since the Bank's declaratory relief complaint alleged no title defect or problem at the time the policy took effect. The problem arose later when, according to the Bank's allegations, Rosen and his co-beneficiaries failed to properly monitor disbursements made under their loans to Barrich.