Title Insurance in Central European Transactions
4 May 2011
The major title insurers operating in Central Europe are all affiliates of companies in the United States, where title insurance is used in almost every transaction because of the perceived benefit. Similar benefit is available in Central Europe, and purchasing title insurance is often appropriate in Central European transactions. Because title insurance is being used more in these markets and because of the varying level of understanding of title insurance issues by those in the real estate community operating in these markets, this article will review some of the basics of title insurance, discuss some items that need to be considered when purchasing title insurance and explain how your lawyer can help you in the process of purchasing title insurance.
Even though this discussion focuses on Central Europe, much of it applies to other jurisdictions in the region where title insurance has now become available (such as Turkey), as well as some of the more mature European markets where title insurance has never played a major role.
What is Title Insurance?
Title insurance for an owner of real estate covers losses incurred by the insured party in connection with defects in title to the covered real estate (which can in the most egregious case result in a decision that the real estate is actually owned by a party other then the owner stated in the title policy). Coverage includes such items as losses incurred from the existence of certain liens and other encumbrances which may have been registered against the property, but were not discovered by the title company.
Title insurance for a lender primarily covers losses arising from the lender's mortgage not being a valid lien or not having the stated priority. One common misconception is that the premium paid for a title policy is a reoccurring annual cost; but actually - unlike casualty insurance -the premium paid for title insurance is onetime upfront fee. The reason for this is that unlike casualty insurance (which covers future problems), title insurance deals with claims arising because of problems in the past, and the underwriting of the risk by the title insurance company for these problems is all done at the time that the policy is issued.
After payment of the initial premium, the policy remains in effect indefinitely in respect of the originally insured party. If the property is sold, the new owner is not necessarily covered, but the party that was originally insured by remains covered as toany claims made by the new owner with respect to any contractual or statutory title warranties given by an insured seller.
In addition to full coverage policies for owners and lenders, title companies offer"known risk" policies that may cover only one (or more) specific risks that were identified as part of the owner's (or lender's) due diligence. We advise our clients to avoid such policies for several reasons: because the cost is not much less then for a full policy; because, in our experience, when a claim is made under a title policy it is usually in connection with an unforeseen problem; and because there is a risk that if a title claim is made by some third party it might not be determinable whether the claim was made solely in connection with the "known risk".
Why Purchase Title Insurance?
Even though it is often argued that in most Central European jurisdictions sufficient comfort regarding title can be obtained by taking steps such as checking with cadastral offices, obtaining restitution certificates and examining documents in the chain of title, this is not necessarily the case.
For example, there are limits (varying by jurisdiction) to the degree of comfort that a buyer can have in relying on a cadastral excerpt or on a restitution certificate. Even protections that are sometimes given to "good faith" purchasers are often inadequate. Some jurisdictions require that the purchaser hold the real estate for a certain period before the "good faith"protection kicks in, and in some jurisdictions it is not even clear what "good faith" means in this context.
There are many issues that can give rise to a title problem. Defective compliance with conveyance laws, adverse possession matters, invalid powers of attorney, defects in documents, mistakes in registering documents, capacity issues, restitution claims and fraud are just some of the hitches that in various jurisdictions can cause title problems. Some jurisdictions are notorious for certain problems in respect of which one can never obtain complete protection, and it is often said that investors must accept a certain "country risk" when purchasing real estate in such jurisdictions. Title insurance can cover this "country risk"and give an additional level of assurance to a purchaser, alleviating some of the risk associated with an investment acquisition or development project.
Some risks are of course slight, but no one wants to be the investor in a real estate project that incurs a major loss when a problem that was unlikely to occur nevertheless materialises. Title insurers, like all insurers, evaluate the various risks and the potential loss and then spread the risk by collecting premiums on many properties where losses never occur to pay for large losses that may be incurred on a particular property.
Clients often ask why they should purchase title insurance when they are receiving warranties and/or indemnities from their seller. There are several reasons why such warranties/indemnities are often insufficient. Seller warranties/indemnities are often time-limited. In addition, they are often limited in respect of the amount that can be claimed. This limit is particularly problematic in a development deal in which even if the purchase price paid for the land is fully covered by the seller the future cost invested in improvements will be much greater. One of the greatest risks associated with relying on a seller warranty/indemnity is that the seller will not have the financial wherewithal to make good on its warranty/indemnity. The Seller might be a special purpose vehicle (SPV) and the purchase price paid may already be long gone by the time a claim is made.
Even having a financially solid seller or getting a guarantee in respect of the SPV's obligations from a financially solid affiliate may not suffice, as the financial worth of a company often changes and, as the recent financial crisis has shown, the financial health of reputable companies often changes quickly. In addition, a seller's warranty would not usually cover the cost of defending a claim (particularly a spurious claim), and such a warranty often might not cover defects that could have been uncovered by a complete examination of public records.
Clients also often ask why they should purchase title insurance when they are paying their lawyer to do legal title due diligence. There are several reasons why title due diligence cannot provide the, same comfort that title insurance can. For example, legal due diligence involves examining documents that are presented and are presumed to be accurate, that signatories had proper capacity and that there is no fraud involved. In addition, legal due diligence cannot predict the possibility that a spurious claim could be made that might cost a substantial amount to defend or might need to be settled because of the possibility that the claim may be successful. In connection with their title due diligence, competent law firms correctly warn their clients of potential title problems that may occur even if thorough due diligence is performed and lawyers often find "minor"title flaws that can't be fixed, but which title insurance covers. If title insurance is going to be purchased, the lawyer's role with respect to title may in some instances be limited as to the scope of the review being performed.
If title insurance was purchased when acquiring a property it often proves useful on exit for several reasons. For example, as previously mentioned, a seller's title policy covers any title warranties that such seller gives when selling the property. In addition, by taking certain steps at the time that the title insurance is purchased, assignment of the title insurance policy to a buyer might be possible at the time of a sale.
Exclusions to Title Coverage
Title policies, like all important contracts, should be carefully reviewed by experienced professionals. As part of the review, your lawyer should explain to you some of the intricacies of the policy, so as to avoid problems later.
There are certain "exclusions" to title coverage. For example, there is no coverage when there is a potential title problem that the insured knew about, but did not reveal to the title company. An experienced lawyer will always advise a client to reveal all knowledge that the client has regarding title to the property being purchased whether or not there seems to be a problem. While in many situations there is a natural tendency (often correct) to avoid disclosing potential problems in advance of their occurrence, with regard to disclosing things to a title company, it is better to err on the side of "over-disclosure."
In addition to "exclusions" which are generic, there are often "exceptions" to coverage which are specific to the property being insured (e.g., existing easements and existing mortgages).
Certain steps can be taken to deal with the various exclusions and exceptions to a title policy and an experienced practitioner can help their client deal with such items.
Tailoring Coverage
While coverage under a title policy is often said to be "standard", your lawyer should get the title policy tailored to your particular transaction. For example, there are different coverage concerns with respect to a share sale than with an asset sale and your lawyer can help you with issues such as determining whether the insured party should be the entity owning the property or its shareholders. Your lawyer should be informed of your policy that meets your needs. Some of the information that your lawyer will need to know are your exit plans and future financing plans. Discussion of your future plans not only helps your lawyer in negotiating the correct coverage with the title company, it can also help in making the decision as to which title insurer to use, as different title companies often handle things in different ways.
Development
When purchasing real estate that will be extensively developed, there are some special concerns. Careful consideration should be given to the amount of coverage purchased. Often, it makes sense to put into place at the time of a land acquisition an amount of title insurance coverage sufficient to cover project costs or the ultimate value of the improved property (not just the initial land costs). Consideration also needs to be given to the intention of the developer for example, is the intent that the project will be sold shortly after completion or is the project a joint venture, with the long term investor in place at the outset? There are different ways to put in place title insurance for development projects; these should be discussed with the lawyer representing you in connection with the title policy.
Lender's Policy
As previously mentioned, a lender's title insurance policy primarily covers losses arising from the lender's mortgage not being a valid lien or not having the stated priority. Sometimes, a lender requires title insurance because of some perceived problem. In such event, the investor/ developer should almost certainly also purchase an owner's title policy. The pricing of title insurance companies is such that an owner's and lender's policy can be purchased for not much more then for just the price of a lender's policy.
It should be noted that some lenders may give a reduction on the interest rate if they are to receive a title insurance policy. This is something that should be explored at the time a term sheet is being negotiated with a lender.
When a lender is receiving a title policy, there are specific concerns that should be addressed by the lender's lawyer. An experienced lawyer will always advise their lender client that it is preferable to receive a lender's policy then to receive an assignment of an owner's policy. The reasons for this include the fact that an assigned policy is subject to the title company's defences against the assignor of the policy - for example, if coverage for a claim is denied by the title company because an owner (assignor) knew about a problem and didn't reveal it to the title company, the lender would not be covered for such a claim.
Claims
A full discussion of the title insurance claims process is beyond the scope of this article, but a few things are worth mentioning. As soon as an insured party becomes aware of any title problem or claim they should immediately contact the title company that issued the policy and avoid a natural inclination to try to deal with the claim themselves. Delay in notification may serve to prejudice an insured party's rights under their policy.
It is worth noting that one of the most frequent payouts made by title insurers in connection with a policy claim is in connection with the costs of defending a title claim brought by a third party, even if there is no determination that the title claim had merit. Defence costs are covered under title insurance policies, but sometimes when a special risk is discovered by the title company at the time of policy issuance, the title company may offer to insure the risk, but require the insured to bear the cost of defending a claim with respect to that particular risk. In such instance a full discussion with your lawyer is warranted.
Summary
Title insurance is being used increasingly in Central Europe and other jurisdictions in the region and is a useful tool for minimising risk in connection with an investment or loan.
However, once a decision to use title insurance is made, that is not the end of the story. There are many issues that need to be considered and addressed in connection with the title policy. Purchasers of title insurance will find that an experienced lawyer will prove invaluable in helping them navigate the title insurance process.