All lenders in California that provide financing against real property
have one thing in common – title insurance. Title insurance provides
protection for homeowners and lenders against defects and encumbrances
on a property’s title. Defects can come in the form of fraudulent
claims of ownership, improperly recorded documents, forgery, unlawful
liens, and encroachments. Unlike other insurance policies that protect
the holder against unforeseen future events, title insurance offers protection
against problems with the title that may have occurred in the past.
A title insurance policy is typically opened by a lender or escrow agent
at the beginning of the lending due diligence process. The first function
performed by a title company is the title search. The search provides
lenders with a preliminary report (“prelim”) that allows them
to review all liens, easements, and other covenants recorded against the
property. The actual title policy protects both the seller and the lender
during a transaction and is issued after all loan documents or contracts
have been signed and recorded.
There are two primary title policy types: Owner’s Policy and Lender’s
Policy. Each title policy is issued with specific terms, conditions, and
exclusions. Title insurance is codified under California Insurance Code
section 104 and defined as:
“Title insurance means insuring, guaranteeing or indemnifying owners
of real or personal property or the holders of liens or encumbrances thereon
or others interested therein against loss or damage suffered by reason of:
(a) Liens or encumbrances on, or defects in the title to said property;
(b) Invalidity or unenforceability of any liens or encumbrances thereon; or
(c) Incorrectness of searches relating to the title to real or personal property.
This basic definition under California code seems simple enough, but unfortunately
many times a title company will miss some of these items when performing
a title search. Keep in mind that the title searcher has to sort through
records that may be recorded by APN, property address, or by the grantor
or grantee’s name. This search can combine older paper records with
newer electronically recorded information, making it harder to catch everything.
The title policy will also protect the owner (lien holder) against errors
or mistakes that may have been made by the searcher. Because of this risk
to the title company, most title searchers provide a very thorough and
detailed report, but they are only human, and mistakes still occur. This
possibility is a reminder of how important a title policy is for protecting
the investor or lender from unforeseen title issues.
The primary reason lenders obtain a title policy is to protect against
liens on the property that may supersede a new lien or hamper the enforcement
of their lien. Under California Civil Code section 2872, a lien is described
as “a charge imposed upon specific property by which the property
is made security for the performance of an act.” So based on this
definition, a lien can be any instrument issued against a property that
provides a security interest to help enforce the repayment of debt. Standard
liens are deeds of trust, property tax liens, or judgment liens, but you
may also see mechanic’s liens, child support liens, or bail bond
liens on a property’s title.
The broadness of the lien definition under California code allows attorneys
to redefine the statutory definition to fit their specific issue and get
it covered under the title policy. It is imperative to understand what
liens and encumbrances are affecting the property to ensure they are covered
under title insurance.
The term “encumbrance” is regarded to mean a lien. However,
the concept of encumbrances is a much broader definition. Under the California
Civil Code, the definition of an encumbrance is limited to taxes, liens,
and assessments. However, recent court cases have redefined the definition
to include any restrictions on real property that limit the use or transfer
of the land. To that point, most, if not all encumbrances will be covered
under a title policy.
If done correctly, title insurance is the most comprehensive way for a
lender to protect his investor’s capital. Carefully reviewing each
preliminary report and discussing any questionable information with the
title officer and/or borrower is an essential duty that can help protect
the transaction and ensure you stop small problems before they become critical.