RPLR November 2017

Secured Lenders and Sloppy Title Insurers: Hohvannisian v First American Title
Roger Bernhardt

Hovannisian v First Am. Title Ins. Co. (2017) 14 CA5th 420, reported at 40 CEB RPLR 122 (Sept. 2017), concerned the liability of a title company under a lender’s title insurance policy that had failed to mention an existing mortgage [133] on the property securing the loan—an omission apparently not discovered until after the property had been sold to third parties (the Hovannisians, whom I sometimes refer to as the Buyers) at the lender’s trustee sale. The Buyers had been forced to pay off that lien, apparently not having acquired title insurance themselves; had previously sued Wells Fargo Bank (WFB), the foreclosing successor to the original lender, claiming fraud and breach of warranty; and had settled that litigation by taking an assignment of any claims that WFB might have against First American under that policy. (Their claims looked doubtful, at best, because WFB apparently had not known of the mortgage, and its foreclosure notices and its trustee’s deed upon sale to them disclaimed any warranties of title.) Thereafter, the Buyers brought this action against First American as WFB’s assignee.
This second round of litigation by the Buyers against First American turned on a “proxy” issue: Could WFB have recovered from First American under the policy for the undisclosed mortgage? The court’s answer to that question was “No,” because WFB itself had no claim under the policy after it had sold the property to the Buyers, and the Buyers, as WFB’s assignees, were no better off than WFB. The language of the policy provided that coverage would terminate once the lender disposed of its title (absent any special circumstances such as a warranty deed or purchase money mortgage, neither of which had existed in this case), and that ended the matter.
This holding—that coverage had terminated on WFB’s foreclosure sale to a stranger—is what title policies generally recite (thereby giving the carriers more business by forcing successor owners to purchase new policies). This meant that the Buyers’ claim against First American failed because any claim by their assignor (WFB) would have failed because it was asserted after WFB had disposed of the property. “At the point of conveyance to the Hovannisians, any preexisting defect in title became the Hovannisians’ problem” (14 CA5th at 432)—a proposition that might have been somewhat arguable had WFB discovered the defect before it sold the property to the Hovannisians, and taken a loss, before going against First American, all of which didn’t seem to have happened, but have provoked this column.
The Timing and Strategy of a Claim
Would WFB’s claim against First American have been viable if it had been presented at a different time or under different circumstances, before WFB had foreclosed or sold the property to the Buyers? In general, when must an insured lender make a claim to its insurer after it has discovered a defect impairing the priority that it thought its lien had? How should it behave so as not to jeopardize or impair that claim? The fact or measure of such insurer liability is obvious when the policy insures an owner, but is much more complicated when the insured party is a lender, holding a security interest rather than title to the property.
An insured lender who turns out to be in third rather than second position is probably less likely to have its lien paid, but that is not absolutely certain. The policy it holds does not ipso facto cover nonpriority liens over other liens, insuring only against any loss or damage that the insured suffers from the absence of such priority. A lender must therefore show not only that its lien has less priority than it was promised, but also that it has suffered a loss because of that fact. A title insurance policy is one only of indemnity, not a guaranty of title. (“This policy insures against loss or damage due to....”) The question for the Buyers would have been: How great was the loss or damage to WFB because of the existence of the other mortgage?
The policy first issued in 2006 insured a loan of $120,000 that was ostensibly secured by a second mortgage. (The amount of the first mortgage was surely known by all but is not mentioned in the opinion.) That policy also failed to disclose an existing $38,000 mortgage (the Long mortgage, probably in actual second position), so that the mortgage actually held by WFB and its predecessor was in fact a third rather than a second, and was behind $38,000 of more debt than anticipated.
These facts do not tell us that WFB had a $38,000 loss, or how much of one it did suffer, although they have a spurious appeal in that direction. If a title policy omits a $38,000 mortgage, we may be inclined to say that its insured has lost that much, but what the insured has really lost is $38,000 of priority, which is not the same as $38,000 of money. If property values rose after the loan was made, there might be sufficient equity in the property to pay off all of the prior liens (including the omitted ones), as well the one insured by the policy even if it had less priority than promised. Thus, a lender’s loan loss may be affected, but is not directly controlled, by the extent of its loss of priority.
A second, but equally noncontrolling, mathematical consideration is the price garnered at a trustee sale of the property. In this case, WFB sold the land to the Buyers for only $29,000 at a time when $139,000 remained unpaid on its loan. That meant it had suffered a loan loss of $110,000 (because any deficiency was uncollectible), but that $110,000 was not the measure of its insured loss, since even a high-ranking deed of trust can decline in value for reasons other than a change in priority. (In this case, the original loan of $120,000 was made in 2006, when values were quite much inflated, whereas the $29,000-producing trustee’s sale had occurred in 2012, after the Great Recession had substantially reduced prices, which circumstances alone may have accounted for the changes in value, even if the priorities had not been altered by the omission of a prior mortgage.)
The Cale and Karl Decisions
Measures of loss are suggested by our case law, although not very persuasively. In 1990, the Third District Court of Appeal decided Cale v Transamerica Title Ins. (1990) 225 CA3d 422, reported at 14 CEB RPLR 85 (Feb. 1991), in which Cale, holding an $8000 mortgage that had been [134] insured as a second (behind a $25,000 first), discovered that it was also behind $5000 of other liens. Cale’s carrier, Transamerica, originally declined to compensate him, saying that his “loss (if any), cannot be determined until he has completed nonjudicial foreclosure proceedings.” 225 CA3d at 424. That led Cale to complete a trustee sale, successfully bidding $1 at it, and then claiming an insured loss (of $7999, presumably). But those circumstances, according to the court’s majority opinion written by Judge Puglia, were not enough to determine Cale’s loss.
[T]he value of the property in the hands of the foreclosing insured lender is not the measure of loss under the terms of the policy.... If one of the senior lienors were to foreclose, or if Cale were to sell the property on the open market, he might then suffer an indemnifiable loss under the policy, but only to the extent the proceeds of sale otherwise available to discharge Cale’s lien are required instead to discharge any of the undisclosed senior liens.
225 CA3d at 428. Under Judge Puglia’s logic, an insured lender must not only wait until after its trustee sale; it must apparently hold off until senior lienors have acted, wiping its lien out or producing a surplus to satisfy. (I’ll call this the Puglia view; perhaps under that view, WFB could have made some claim against First American despite its previous sale to the Buyers—or might even that have been too soon, rather than too late?)
The Puglia view was not shared by Judge Sims, who in his dissent contended that the foreclosure sale price itself had “made out a prima facie case of damage and loss to Cale,” there being no other evidence of the value of the property at that time other than the $1 Cale paid. Under the Sims view, a loss (of apparently $7999) arose when the hammer fell at the trustee sale.
The Sims view was partly endorsed by the Fourth District three years later in Karl v Commonwealth Land Title Ins. Co. (1993) 20 CA4th 972, reported at 17 CEB RPLR 79 (Feb. 1994). Karl had held a $150,000 mortgage, ostensibly in second position, but that turned out also to fall behind a $26,000 undisclosed tax lien. He paid it off (as part of reinstating the first deed of trust), foreclosed, and acquired title to the property with a successful full credit bid (of $219,000) at that sale. But Karl then resold the property for $1000 more than that ($220,000) before filing suit against Commonwealth (his title insurer), which profitable resale led the trial court’s Judge O’Neill to hold that he had suffered no collectible loss under his policy.
One could characterize this position (the O’Neill view) as an offspring of the Puglia view, determining loss (or nonloss) by an event that occurred after the trustee sale, but that rule was rejected by the appellate court in Karl, where Judge Froehlich ruled that it was incorrect because the relevant consideration was the “fair market value as of the date of foreclosure, not the price realized at a later sale” (the Froehlich rule). 20 CA4th at 983 (emphasis in original).
The Froehlich rule is like the Sims rule in preferring the moment of the foreclosure sale over subsequent events, but Froehlich’s view does not accept the amount bid at that foreclosure sale (as did Sims) as the measure of the insured lender’s recovery, because for Froehlich, “by focusing on the fair market value of the property rather than on the amount of the lender’s credit bid, a lender cannot manipulate the bidding process at the foreclosure sale artificially to increase his loss.” 20 CA4th at 985. He preferred the fair market value at the time of the trustee sale, rather than the amount bid at it.
Froehlich’s rejection of the Sims approach inevitably required more litigation, as was illustrated by the subsequent history of Karl. The Karls had held a second mortgage for $150,000 (although they paid only $128,000 for it) and had thereafter advanced $51,000 to reinstate the first mortgage and cure the omitted tax liens. They had then trustee-sold the property, making a full credit bid of $219,000 at it (a bid that should have, under the Sims rule, eliminated any right to recover from the title insurer, since it would have demonstrated that they suffered no loss). However, in Karl II (Karl v Commonwealth Land Title Ins. Co. (1997) 60 CA4th 858, reported at 21 CEB RPLR 111 (May 1998)), Judge Nares, speaking for an entirely different panel of that District, held that the Karls could not recover in light of a jury finding that the fair market value of the property on the date of the sale was $715,000, compared to debts of only $695,000 at that time, so that they had suffered no compensable loss on the foreclosure sale date. 60 CA4th at 870.
Comparing the Rules
How should secured creditors behave when they cannot know which approach the judges will take? The following observations about these positions probably do not offer much help.
On the issue of whether a loss is calculated at the time of foreclosure sale or at the time of some later event instead, the Puglia/Sims/Nares position has apparently appealed to the majority of judges considering that matter (including, perhaps, those deciding Hovannisian). However, Judge O’Neill’s original superior court opinion that a profitable resale eliminates any claim of loss appears also endorsed by Justice Traynor, who had held, in Freedman v Rector, Wardens & Vestrymen of St. Matthias Parish (1951) 37 C2d 16, that a vendor who profitably resold its property after a breach by its purchaser could not thereafter retain the deposit it had originally received—a position later adopted by CC §1675, our real estate liquidated damages statute.
Freedman had said (37 C2d at 19):
Since defendant resold the property for $2,000 more than plaintiff had agreed to pay for it, it is clear that defendant suffered no damage as a result of plaintiff’s breach. If defendant is allowed to retain the amount of the down payment in excess of its expenses in connection with the contract it will be enriched and plaintiff–will suffer a penalty in excess of any damages he caused.
Civil Code §1675(e) provides that “the reasonableness of an amount actually paid as liquidated damages shall be determined by taking into account ... (2) The price and other [135] terms and circumstances of any subsequent sale or contract to sell ... made within six months of the buyer’s default [emphasis added].” Whether there are sufficient similarities between (1) a vendor trying to retain her purchaser’s deposit after a breach and resale and (2) a mortgagee trying to recover from his title insurer after a foreclosure and profitable resale is up for grabs. (Even if this principle does apply, we don’t know how it will operate when the resale was for a loss rather than a profit.) Perhaps that risk can be entirely averted by holding on to the property past the “deadline”—but perhaps not, if favorable offers were rejected in the meantime. As noted above, the effect of an unprofitable resale is unknown. Bidding behavior probably should be irrelevant under this rule, but a lower bid might be less dangerous than a high one (maybe).
As to the other issue of whether the fair market value of the property or the amount bid at the trustee sale measures a lender’s loss, the Sims position appears to me to have the major advantage of simplicity: The amount bid at the trustee sale is a much easier calculation than what a jury later decides was the fair market value at that time. (The retrial in Karl required the parties to produce testimony not only from the lenders, but also from an intervening owner, an economist, and rival appraisers—expenses that bidders are not likely to incur.) But economy does not always prevail over what is perceived as perfect justice.
The Puglia/Froehlich requirement of an independent determination of value may have been influenced by the fact that Cale had successfully bid only $1 at his trustee sale—which fact probably generated the fear in Karl about “manipulat[ing] the bidding process.” It is certainly legitimate to worry about bidding behavior at foreclosure sales, but the prospect of underbidding and bid-chilling at those sales is unlikely to be as material if a title insurer knows that that amount can determine its liability. That insurer is also eligible to bid at lender’s trustee sale, certainly has the wherewithal to do so, and under the Sims rule would have the incentive to do so. Transamerica was not likely to have allowed Cale’s $1 bid to prevail had it known that the measure of its liability would depend on it. (Cale is not likely to have allowed the property to get away by failing to increase his own credit bid to $2, in order to reduce his own liability and give him the prospect of a profitable resale.) Self-interest by these two parties should offset the danger of “manipulative” bidding.
But this is only me, not the courts, talking. As to what rule they choose, it is still anybody’s guess.

40 Real Property Law Reporter 132 (Cal CEB Nov. 2017), © The Regents of the University of California, reprinted with permission of CEB.