By Charles Ward, Esq.

Wilson and Associates, PLLC*

USFN Member (AR, MS, TN)

The Arkansas Court of Appeals recent opinion in First National Bank of Izard County v. Old Republic National Title Insurance Company, No. 33CV-18-69, 2022 Ark. App. 440 (2022), is a good lesson to lenders. The case concerned a mortgage lender’s claim that its mortgage, which was insured under a loan policy issued by Old Republic Title Insurance Company, was subordinate to a property interest not excepted to by the policy. In its decision, the Court of Appeals affirmed the trial court’s grant of summary judgment in favor of Old Republic and dismissed the lender’s complaint by applying the policy exclusion for title defects “created, suffered, assumed, or agreed to” by the lender.

The background circumstances of the case begin with one business partner buying out another partner. Both partners were represented by counsel and various agreements and documents were drawn-up to effectuate the buyout. Part of the transaction involved a transfer of real estate from the departing partner to the remaining partner, with the bank financing the remaining partner’s buyout with a mortgage on the property.

The bank’s CEO had “received and been copied on most, if not all, correspondence prior to the closing.” The terms and documentation of the transaction were also shared with the bank before closing. But, according to the court, the bank’s CEO “made a conscious decision not to read” the documents. One of the documents, a memorandum, provided for a reversionary interest that would be created in favor of the departing partner.

The court described the negotiations of the terms of the buyout as “prolonged and protracted.” Because of “animus” between the parties, the bank agreed to close the transaction itself at its office. The bank’s CEO handled the closing, and the parties executed the various agreements, notes, mortgages, and memoranda in his presence. The memorandum containing the reversionary interest was one of these documents. A bank employee was also present at the closing and notarized the documents. That same employee also handled the recording of the documents. When the documents were sent to the county clerk’s office for recording, a note was included instructing the recording office to record them in a certain order. When the recorded documents were returned to the bank, they were not reviewed to confirm they had been recorded in the right order. As it turned out, the documents were not recorded in the right order. The memorandum creating the reversionary interest was recorded before the bank’s mortgage, thereby creating an interest superior to the mortgage. After the documents were recorded, a local title agent for Old Republic issued the policy insuring the bank’s mortgage and first lien priority. Inexplicably, the policy did not take exception to the memorandum being recorded before the mortgage.

 Subsequently, the loan went into default, and the bank filed a foreclosure action. The holder of the reversionary interest asserted priority over the mortgage. The bank filed a claim against Old Republic and requested a defense against the reversioner’s claim. Old Republic denied the claim and refused to provide a defense. The bank proceeded with the foreclosure and settled with the reversioner. In the settlement, the bank conceded the priority of the reversionary interest over the insured mortgage. The bank also released the property from the mortgage. Then the bank sued Old Republic under its title policy. The parties filed competing motions for summary judgment. Old Republic argued that Exclusion 3(a) of the policy excepted the bank’s claim from coverage because the bank “created, suffered, assumed, or agreed to” the title defect. The trial court agreed and granted Old Republic’s motion.

In its opinion issued Nov. 2, 2022, the Court of Appeals relied on Bourland v. Title Ins. Co. of Minn., 4 Ark. App. 68, 627 S.W.2d 567 (1982), which had interpreted the “created, suffered, assumed, or agreed to” language of Exclusion 3(a) to apply to an insured that permits or has the power to prohibit the act giving rise to the title defect. The court rejected the bank’s argument that the exclusion requires that the insured have a “willful intent.” Instead, the court focused on the fact that the bank submitted the documents for recording and had the opportunity to review the recorded documents for errors, but did not do so. The court also noted the bank could have inquired into the terms of the memorandum that created the superior interest, but did not do so. The bank “could have prohibited and prevented the claim from arising” and “had within it the power to prohibit the memorandum from having priority over its mortgages,” but it did not protect itself. Consequently, the Court of Appeals held the bank’s claim was properly denied by Old Republic.

Although the court based its ruling on the bank’s failure to protect itself by recording the documents in the correct order, its opinion paints a broader picture of a lender that may have had a too casual attitude about the transaction. The lender had been in receipt of the transaction documents, including the one that created the superior interest, before closing, but purposely chose not to read them. The lender closed the loan itself instead of the local title agent and assumed the responsibility of recording the documents, but did not confirm they were recorded correctly.

The Court of Appeals briefly addressed the bank’s argument regarding “knowledge.” It rejected the argument about knowledge - who had it and when did they have it - as irrelevant. The court held that “knowledge, either actual or constructive, is immaterial” to Exclusion 3(a).

This case holds a useful reminder for lenders. Choosing to close a loan in-house instead of at the local title company may impose duties and risks on a lender that it is not aware of. Its actions as closer may adversely affect its rights as lender against other parties, in this case its title insurer.

Copyright @2022

USFNews - March 8

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