In commercial transactions, it is common for the insured party’s counsel to request some type of creditors’ rights coverage for their client from the title insurance company. This is typically done through an endorsement to the policy which either gives affirmative coverage for creditors’ rights issues or eliminates the creditors’ rights language from the policy jacket. Title insurance companies regard creditors’ rights coverage as an extra-hazardous risk and will usually require title attorney approval and/or analysis of the transaction before giving such coverage.
Before the advent of the ALTA 1992 Policies, specific creditors’ rights exclusion language was not present in the ALTA 1970 policy. When drafting the ALTA 1992 Policies, the ALTA Forms Committee decided to explicitly exclude coverage for creditors’ rights issues from the policies. This new exclusion from coverage led people to believe that coverage for creditors’ rights issues was implied in the ALTA 1970 policy; thus, title insurance companies began getting requests for removal of the exclusion or affirmative coverage over the exclusion. Please note that creditors’ rights coverage is prohibited in New York, New Mexico, Texas and Florida by their respective Departments of Insurance.
The 1992 loan policy exclusion language reads as follows:
Any claim, which arises out of the transaction creating the interest of the mortgagee insured by this policy, by reason of the operation of federal bankruptcy, state insolvency, or similar creditors’ rights laws, that is based on: (a) the transaction creating the interest of the insured mortgagee being deemed a fraudulent conveyance or fraudulent transfer; or
(b) the subordination of the interest of the insured mortgagee as a result of the application of the doctrine of equitable subordination; or
(c) the transaction creating the interest of the insured mortgagee being deemed a preferential transfer except where the preferential transfer results from the failure: (a) to timely record the instrument or transfer; or (b) of such recordation to impact notice to a purchaser for value or a judgment or lien creditor.
The 1992 owner’s policy contains similar language for creditors’ rights issues.
The risk for the title insurance company is substantial; in effect, the title insurance company must determine the solvency of the borrower and the structure of the transaction to give creditors’ rights coverage. In order to analyze this issue, the title insurance company will want to know details of the transaction and if the borrower is getting money back at the closing table. If the transaction is a purchase and all funds are being used to purchase the property, then there is no creditors’ rights issue, and the endorsement may be readily given. If the transaction is a refinance and all the funds are being used to pay off existing debt of the property, then the endorsement may be given. Creditors’ rights coverage may also be given for construction loans if all the funds are being used to construct improvements upon the property. On the other hand, a title insurance company may be reluctant to give the creditors’ rights endorsement if the borrower is getting money back at the closing. In addition, if the borrower is borrowing at a loan to value ratio greater than 80/20, the title insurance company may require additional information in the form of audited financial statements that attest to the financial stability and solvency of the borrower. The more information that the insured party requesting the creditors’ rights coverage can give to the title insurance company, the greater the likelihood that the creditors’ rights endorsement can be given.
The ALTA Forms Committee decided to give a limited form of creditors’ rights coverage in their new 2006 policy forms for both the lender and the owner’s policies. The coverage provides for insurance against the invalidity or unenforceability of the insured mortgage due from any transfer of any or all of the title to or interest in the land because of a fraudulent transfer under bankruptcy or other any other creditors’ rights laws occurring before the current insured transaction. Therefore, the insured party is covered for creditors’ rights issues for all transactions in the chain of title before the currently insured transaction. If coverage is desired for the current transaction, then the insured party must continue to request a creditors’ rights endorsement.
Two approaches to requests for coverage for creditors’ rights are issuance of either the ALTA 21 endorsement or an endorsement which deletes in its entirety the reference to creditors’ rights in the exclusions section of the policy. Title insurance companies usually prefer to give the ALTA 21 endorsement in lieu of omitting language from the policy jacket. Basically, the ALTA 21 endorsement provides affirmative assurances to the insured for creditors’ rights issues; however, the ALTA 21 endorsement does not provide coverage if the insured party has knowledge at the time of the transfer that the transaction was meant to defraud creditors or if the insured party does not conduct the transaction in good faith.
Even with the introduction of the ALTA 2006 Policies which contain limited creditors’ rights coverage, the issue of obtaining coverage for creditors’ rights issues is still an underwriting concern for the title insurance industry. When asking for this coverage, please be prepared to provide the title insurance company with as much information as to both the financial structure of the transaction as well as information about the solvency of the borrower as possible. Giving the title insurance company the needed information in advance will help facilitate the issuance of the endorsement and expedite the closing of the transaction.