Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

As noted in my posting this morning [link], the ALTA Board of Governors voted to withdraw and de-certify the use of the ALT 21endorsement form.  It removes creditors rights issues from certain title insurance policies.

So, what is the next step?

The title companies seize the opportunity, and stop issuing it.  (You're not surprised.)

Here's the list of title companies (by my count) that have done so since the ALTA announcement:

• Stewart Title
• Chicago Title*
• Fidelity National Title*
• Ticor Title*
• Lawyers Title*
• Commonwealth Land Title*
• Security Union Title*
• Alamo *

*= all part of the Fidelity National Title Group underwriters

More title insurance companies will follow, lenders will accept the change, and this endorsement will be fondly remembered - as a unique attribute of the "old economy."

If you can add to this list, please add it by posting a comment below.

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Last Tuesday (Feb 2), the ALTA Board of Governors met to review and discuss the creditor rights issue in light of various recent court rulings.

The outcome is no surprise: they voted (unanimously) to withdraw and de-certify the ALTA 21 endorsement (commonly referred to as creditors' rights coverage).  This change will be effective on March 8th.

Briefly, this endorsement removes creditors rights issues from coverage of the policy – such as fraudulent preferential transfers.

We've addressed the ALTA 21 as part of your file review process (link)

As you might suspect, money is the root of this decision.  The title insurance industry has been experiencing significant losses through this endorsement (although it is not available in all states - for example, it is not available in Texas).  Many underwriters had begun to decline to give this endorsement, or were imposing onerous conditions to issuing the endorsement.  And it was beginning to increase premium rates.

I agree with ALTA's decision.  The financial viability of the company covered by the endorsement is NOT a title record matter that the title insurer can protect itself against through examination.  Indeed, it was a business decision or risk, and of a nature that the lender should independently assess and address.  Why should a lender depend upon another party to assess the financial viability of a party to a transaction?  Isn't the lender ultimately responsible for this underwriting risk? Do we really want lenders to lay-off that assessment to a title company?  And if it is duplicate or "belts and suspenders" to the lender's process and assessment, it is an additional cost that we want to load up on to a transaction?

At least one very, very significant lending client of ours sees it the same way: one of the largest apartment lenders will NO longer require the ALTA 21.

• are other lenders taking this same approach?

No doubt, this approach will be adopted by non-ALTA jurisdictions.

Please post your information, questions or comments below.

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(WARNING: Do not "tune this one out" simply because you're NOT at a bank.  Every lender or servicer should have this same concern . . . .)

From one of my all-time favorite movies, and an all-time favorite scene:

[about the trackers following them]
Butch Cassidy:  "I couldn't do that.  Could you do that?  Why can they do it? 
Who are those guys"?

Borrowers and guarantors are NOT the only people stopping on the next hill, and then looking over their shoulder.  Our friends at FinCriAdvisor today focus on a seldom discussed topic [link]:

"The FDIC actively is investigating dozens of former bank directors and officers at failed banks across the country, sending out more and more civil demand letters in recent months, banking lawyers report.  In many cases, FDIC investigators first are subpoenaing bank officials and workers, hoping to gather evidence to use in potential litigation."

If you were around in the late 80s\early 90s, then this action on the part of the FDIC does not surprise you.

My bottom line is that yes, I expect the Feds to do their work.  I just don't expect shocking news on regulatory wrong-doing.

So, I do NOT see much coming from this.  Why?  Because this commercial real estate wreck is very, very different than the brazen scandals and thievery of the old days.

I'm sure that books will be written about the differences—so I won't launch off on the list, except to note several glaring differences:

• This time we have complicated debt, equity, co-lender AND investment structures (this point alone gives me a headache) (Did I say "complicated?").
• Our problems are systemic —this is not a "Texas" thing, nor an "S&L Crisis."
• Does the FDIC really have money to follow through on a large number of law suits?  (Recall that the FDIC is so short on funds that it has collected in advance premiums from its members).

However, just to be careful, take a look at FinCriAdvisor's preparation guidelines, which they label as "6 Ways Directors and Officers Can Get Ready for Potential FDIC Litigation."  Here's the short version of their list:

• Understand your D&O insurance policies before the bank closes.
• Be aware that the terms of D&O insurance policies vary widely.
• Inquire about "tail coverage" for claims brought after (but based on events before) the policy's expiration.
• Get copies of bank records that can document your role at the bank before it failed.
• Think twice before giving a free-wheeling deposition to FDIC investigators after the bank closes,
• Hire new legal counsel after the bank closes.

If you want to comment with your perspective or add to the list, please do so below.

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As many readers that follow the insurance industry know, the National Association of Insurance Commissioners ("NAIC") met this last summer and went through a series of sometimes heated discussions over what modifications should be made to NAIC Risk-Based Capital rules. Specifically, the current NAIC mortgage loan portfolio quality measure known as the "Mortgage Experience Adjustment Factor" ("MEAF") can and does cause a sudden and substantial increase in capital requirements for insurance companies. The "factor" could be a seven-fold multiplier for reserve purposes, if an insurance company's portfolio delinquency rate rises significantly above industry averages, creating a dramatic negative effect upon reserve requirements. It is conceivable that a company with modest delinquencies in its portfolio might be way above "industry averages," causing reserve requirements to be greatly increased for the entire portfolio (ranging from .5 to 3.5 times).

Last summer the NAIC agreed to a more tightly-bracketed multiplier (.75 to 1.25). They did that because they believed that too many companies were being forced to either sell problem loans at "artificially distressed" prices to avoid the application of the MEAF factor or simply transferring these loans to non-insurance based affiliates within a holding company so that the delinquent loan did not increase capital reserve requirements at the insurance company level.

Interestingly, the relief that the NAIC gave to Risk-Based Capital requirements only applies to 2009 financial statements. If no further action is taken, the 2010 financial statements will revert back to the old rules requiring artificially high level of reserves. Hopefully, the NAIC will proactively address the 2010 reporting requirements and avoid insurance companies having to make state by state exception requests to their principal regulators.

It is especially important for the NAIC to act, as the political pressure for federal regulation of the insurance industry seems to be abating. It's looking more and more likely that it will be left up to the NAIC to deal with Risk-Based Capital changes in a realistic, but still prudent way

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This is the second part of a two-part series laying out a quick checklist covering title insurance issues—and highlighting topics that should be investigated.  This is an important and often overlooked topic.

1. Was UCC insurance obtained (covering attachment, perfection and priority of lender’s security interest in personal property)?  Here are the types of transactions where UCC insurance is important:
   --Factoring credit facilities (where the collateral includes a right to payment or claim covered by a UCC filing).
   --Mezzanine loans (where the collateral is ownership interests in the borrower entity) covered by UCC filings.
   --Asset based credit facilities (for example, where collateral includes inventory and accounts receivable covered by UCC filings).
   --Mixed collateral structures (for example, where collateral includes both real and personal property—such as a hotel or a restaurant).
2. Title insurance polices can contain a long listing of “exclusions” from coverage.  There are items that are not covered by the policy.  These can include the following, each of which can limit the use and value of the collateral: easements; restrictions; use agreements; development agreements.
   --Do these exclusions impact the current use and physical attributes of the collateral?
3. Note that zoning compliance and building code restrictions typically are not included in the basic title insurance coverage.  Therefore:
   --Does the policy contain a zoning endorsement?
   --If “yes,” then what are the terms of the endorsement?
   --Has the current use and physical attributes of the property changed since the issuance of the endorsement?)
   
   Note that a zoning endorsement to a title insurance is a separate and distinct topic from ordinance or law casualty insurance.  Apples and oranges.
    
4. Does the title policy (and endorsements) in the file contain the terms requested at loan closing?
   --For example, if the removal of the “creditors’ rights” exclusion was requested at closing, was it removed (or endorsed “out”) of the policy? A “creditors’ rights exclusion” removes creditors rights issues from coverage of the policy – such as fraudulent preferential transfers.
   
   Note that creditor rights commonly present risks in these types of transactions:
   --Multi-collateral, with separate SPE or “single purpose entity” ownership entities
   --Leverage buyout transactions

If you have questions or a story to share, then post a comment
 

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No surprise at this statement:  When the real estate mortgage nears the ditch, the lien priority of the loan and the status of the title (such as easements, deed restrictions, access rights and lien priority) all come under scrutiny.

One important point of inquiry is the title policy covering the loan.  An “audit” or review of the title policy should be done. 

Here’s a quick (albeit incomplete) list of things that should be investigated (in no order of priority):
 

1. Is there a title policy? (Don’t be shocked if you don’t have a title policy—this is one of those “details” that can get “lost” during the post-closing\servicing process.)
2. If it is a construction loan, was a policy purchased or is a “binder” merely in place? (If a binder, can or should a policy be purchased? Is this possible or even desirable?)
   --What is the current coverage amount?
   --What is the date of the last down-date?
3. Do you need to put the title policy insurer on notice of a possible claim? (Read the title policy for “how” to do this.)
4. Do you have a complete copy of the title policy, the title policy exception documents and the title policy endorsements? (You’ll be amazed at how many loan files fail to contain all of this.)
5. Does the title policy:
   --Continue to cover an affiliate of the lender that takes the title at foreclosure or a transfer 
      in lieu of foreclosure?
   --Correctly describe the insured land?
   --Contain the correct amount?
   --Have the correct title policy form with all endorsements?

The next posting will cover UCC issues, zoning endorsements and creditors rights exclusions.

If you have any questions or some thing to add, please post a comment.
 

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More from our That Ticking Sound  series (use the search term "ticking" in the keyword search box on the right hand side for other postings on insurance issues) . . . .

Back in the "good old days" when foreclosed and REO property was promptly sold, it was all too easy for lenders and servicers to ignore problems with a borrower's insurance. Sadly, those days are gone, and to cope with today's new world, lenders and servicers now must understand how insurance works and how the coverage in the policies obtained by borrowers and by lenders or servicers themselves does – and sometimes doesn't – provide protection.

The focus on insurance coverages needs to start early in the surveillance process, and most certainly as the deal heads toward the ditch.

To assist lenders and servicers in understanding insurance, I attach (as a PDF) part one of "Insurance for Lenders and Servicers; Part One (Insurance Basics; Insurance for Property)."  In coming months, I'll post future portions (or parts) as I complete other parts of this new resource guide.

If you have specific insurance topics for me to cover, or questions based upon Part One, please post a comment below.

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Insurance issues often are overlooked in the context of a workout or a foreclosure. (Recall our other posting covering title insurance.) So, here's another topic from our "ticking sound" series covering insurance issues...

Chances are that foreclosed property is empty property.  No one is present to lock the doors, keep the heat on or make repairs.  The likelihood of broken pipes, vandalism or even the arrival of scavengers whose aim is to remove the copper pipes from the building goes up.  Sometimes it goes way up.

For lenders and servicers, vacant property is at least an annoyance.  For property insurers, it is a reason to terminate coverage.  The insurer’s justification is “increase in hazard,” shorthand for any change in conditions in an insured premises that increases the likelihood of an insured loss simply by its existence.  Just as public policy would not allow an insured to make an insurance claim on premises it had destroyed by fire, so too public policy does not permit coverage where the insured – in this case, the borrower – accomplishes the same end by allowing the premises to deteriorate.  Courts routinely  enforce “increase of hazard” as grounds for denying coverage. See, e.g., Washington Mutual Bank, F.A. v. Allstate Ins. Co., 48 A.D. 3d 554, 852 N.Y.S. 2d 201 (2d Dept. 2008).

So what does a lender/servicer do to avoid losing coverage for “increase of hazard?”  There are two approaches, and smart lenders and servicers should use them both.

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Here's another topic from our "ticking sound" series covering insurance issues and environmental issues:

The subject of insurance for foreclosed properties doesn't seem to come up very often, most likely because there are so many other more pressing problems to worry about. But failing to ensure that the property has adequate insurance – not just "trendy" coverage like environmental impairment insurance but also "old fashioned" property, liability and flood insurance – is absolutely vital to avoid problems that arise all too often.

A lender, servicer or foreclosure purchaser's analysis of insurance on foreclosed property should start with the working presumption that the borrower's insurance will not protect the lender, servicer or foreclosure purchaser after the property is transferred. This may no be so, particularly if care has been taken on the front end to ensure that the lender is included as a named insured on applicable policies, but it still is possible (if not quite likely) that the borrower quietly cancelled the policies to pick up any premium refunds that might be available. Even if the borrower did not resort to such a tactic, the transfer of title from borrower to lender may deprive the borrower of an insurable interest in the property, without which the policy may be void. Some policies also include exclusions or other provisions limiting or precluding coverage for abandoned property, and when the borrower walks away, these provisions may be triggered. The result can be a nasty surprise when a claim occurs later.

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Here's another topic from our "ticking sound" series covering insurance issues and environmental issues . . .

Most discussion of the environmental issues that can come with foreclosed property focuses on when the CERCLA lender safe harbor provisions and its state-law analogues apply. What doesn't get discussed often enough is how a lender goes about selling an environmentally challenged piece of property and its obligations during the sale process independent of CERCLA.

The problem for lenders or others who foreclose on property with environmental problems is that CERCLA requires them to try to sell it. This means listing the property, keeping control of any brokers or listing agents acting on seller's behalf, learning enough about the issues there to provide accurate disclosures and appropriately responding to the purchaser's efforts to make "all appropriate inquiries" as it tries to shoehorn itself into EPA's "innocent purchaser" safe harbor, while trying at the same time to maximize the sale price so as to satisfy security holders or regulators. There obviously can be real tension for a lender or servicer caught between these requirements.

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Environmental issues loom large in the context of a real estate workout or a foreclosure.  This was a lesson "learned" in the '80s. (A lesson that often even "glowed" in the dark.)  So, here's another topic from our "ticking sound" series covering insurance issues...and now, environmental issues . . .

Few acronyms have more power to raise a lender's blood pressure than CERCLA.  Since its passage in 1984, the specter of CERCLA or "Superfund" environmental liability probably has had more negative impact on lending transactions than any other single factor.  With the return of hard times and the likelihood of foreclosure on brownfields or other "environmentally challenged" properties going up . . . actually way up, it is past time to remind ourselves about CERCLA's lender safe harbor provisions and how they affect the foreclosure process.  In doing so, we also need to remember that most states now have CERCLA-like statutes, some of which contain safe harbor provisions, but others of which do not. CERCLA's lender safe harbor gives a good idea of how most of these work, but some are different, so caution should be used – and a professional consulted – before assuming that the overlap is complete.

CERCLA's lender safe harbor provision, a lender or its privies is considered an "owner or operator" of a plant for CERCLA purposes only if it "participates in management" of the facility.  "Participat[ing] in management" is at best an elastic clause, but received wisdom as well as the statute itself states that exercising a security interest or foreclosing on property does not constitute "participat[ing] in management" so as to subject the lender to liability.  Likewise, a lender does not "participate in management" so long as it makes commercially reasonable efforts to sell the property – i.e., asks a commercially reasonable price for the property, makes appropriate efforts to sell it given the nature of the property and market conditions – even if it is initially unsuccessful in doing so.  Taking steps during the foreclosure process to operate or maintain the property, up to and including cleaning up existing contamination (or compelling the borrower to do so, do not constitute "participat[ion] in management" so long as, but only so long as, those steps do not increase the environmental risks as the property.

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Insurance issues often are overlooked in the context of a workout or a foreclosure.  (Recall our other posting(s) covering title insurance.)  So, here's another topic from our "ticking sound" series covering insurance issues . . . .

Many real estate and construction contracts now include detailed alternative dispute resolution ["ADR"] clauses stipulating that the parties will attempt to resolve their differences short of litigation by submission of the dispute to mediation, arbitration or both. The impetus for such clauses is the parties' perception that these ADR procedures will lower litigation costs and speed resolution of disputes. The hasty invocation of ADR clauses may result in loss of available liability insurance proceeds through the insurer's invocation of two significant but overlooked requirements in virtually every insurance policy; (1) the provisions in virtually every policy stating that the insurer will "pay on behalf of the insured only those sums that the insured is legally obligated to pay as damages and that the insurer has no obligation to reimburse the insured for voluntary settlements it makes without the insurer's consent; and (2) the clause requiring the insured to give prompt notice to the insurer of all claims and demands.

The first pair of provisions – that portion of the basic insuring agreement obligating the insurer to pay sums its insured is "legally obligated to pay as damages" and the policy condition stating that the insurer has no obligation to reimburse the insured for settlements made without the insurers provision – implement the overarching principle in a standard liability policy that the insurer is allowed to control the defense and determine when to settle within policy limits. See, e.g., Judwin Properties, Inc. v. U.S. Fire Ins. Co., 973 F.2d 432, 435 (5th Cir 1992). The two provisions also express and even more basic idea, as succinctly stated by the Nebraska Supreme Court in City of Scottsbluff v. Employers Mut. Ins. Co., 265 Neb. 707, 658 N.W.2d 704, 710 (2003): "The parties to the insurance contract at the time the contract was made could not have reasonably intended it to cover the voluntary agreements of the insured to pay for damage it was not otherwise legally obligated to pay." In other words, the otherwise commendable instinct to "make things right" may have the unintended consequence of costing the Good Samaritan its insurance coverage.

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As noted in my earlier posting on Fidelity's acquisition of Commonwealth Land Title and Lawyers Title, the American College of Mortgage Attorneys furnishes its members with information on title insurance and escrow issues relating to the bankrupcty of LandAmerica Financial Group.

Here is a portion of the most recent announcement from ACMA:

A. Title Insurance Issues:  Bankrupcty Order, State Order, Rating Agency

As the dust starts to settle regarding the bankruptcy sale of Commonwealth Land Title Insurance Company and Lawyers Title Insurance Company to the Fidelity family of title companies, we are able to provide the following information regarding the status of the sale, the rehabilitation proceedings of the acquired companies and the acquiring and acquired companies.

1. Bankruptcy Court Order (PDF) entered in the LandAmerica Chapter 11 approving the sale of the stock of the subsidiary title companies to Fidelity family companies.
2. Here are links to the Nebraska Department of Insurance press release and orders releasing acquired companies from rehabilitation upon closing of sale and the recapitalization contemplated under the purchase agreement (the proceeding is not yet dismissed, however) (one; two; and three)
3. Reported Downgrade of Fidelity by Ratings Agency (PDF).

B. Information Relating to Treatment of Exchange Funds and Responsibility for Decisions on Deposits

1. Private Letter Ruling (Word doc) addressing status of an exchange where release of funds from exchange company is delayed by state insolvency proceeding.

2. Decisions (PDF) involving allegations of bank or attorney responsibility for choices relating to exchange accommodator or depositor:

a. Campbell v. Bank of America, United States District Court for the District of Kansas; Case No. 04 4108. Although this decision focuses specifically on whether personal jurisdiction existed over the defendant bank in question, the court’s discussion of the substantive claims at issue in the case may nevertheless be of interest.

b. See also, Bazinet v. Kluge, 196 Misc.2d 231, 764 N.Y.S.2d 320, 2003 WL 21361746,(N.Y.Sup.2003), overruled on appeal by Bazinet v. Kluge, 2005 WL 22693 (N.Y. App. 1/6/05). The lower court in this case found a valid cause of action existed against a lawyer, who in acting as escrow agent, chose a small bank (which later failed) as the depository for a substantial escrow deposit. However, the appellate court subsequently overruled the trial court in this case finding the attorney could not be held accountable for consequences arising from the insolvency in this situation.

I hope this is helpful to you or others. 

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Many real estate and construction contracts now include detailed alternative dispute resolution ["ADR"] clauses stipulating that the parties will attempt to resolve their differences short of litigation by submission of the dispute to mediation, arbitration or both. The impetus for such clauses is the parties' perception that these ADR procedures will lower litigation costs and speed resolution of disputes. This may be so, but the result of their use may be to cause a forfeiture of the allegedly liable party's liability insurance.

Virtually all liability policies contain provisions requiring the insured to give its liability insurer prompt notice of any claim or suit, as well as the opportunity to assume control of the defense of the claim. The policies also contain provisions that relieve the insurer of the obligation to reimburse its insured for any defense costs, attorney's fees or settlement sums made before the insurer has been given notice of the claim by its insured. Recent Texas Supreme Court cases, including National Union Fire Ins. Co. of Pittsburgh, Pa. v. Crocker, 246 S.W.3d 603 (Tex. 2008), make it clear that the Texas Supreme Court does not view these provisions as boilerplate; the Court will enforce these clauses as written and allow insurers to avoid policy obligations where they have been prejudiced by non-compliance.

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