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Real Estate Development Endorsements in Owners’ Policies

July 6, 1998


[Reprinted with permission from The Connecticut Law Tribune Magazine Title Insurance July 6, 1998]
A snapshot of endorsements that may be available to owners in connection with commercial development projects, ranging from the familiar to the obscure.

The basic insurance coverage afforded by an owner’s title insurance policy includes, of course, numerous exclusions from coverage. Typically, lenders in commercial real estate transactions have sought to expand coverage through the use of additional provisions known as endorsements. Title companies offer a panoply of standard lender endorsements to provide coverage relating to the creation of common interest communities, the enforceability of variable rates in the loan documents, the absence of environmental liens on the public record, and so on. Many of these endorsements have been available only to lenders.

Over the past several years, we have been involved in large commercial development projects in which the financing derives substantially from equity investors who, as members of a limited liability company or limited partners in a limited partnership, are part of the ownership entity. These investors desire the kind of full title insurance coverage that was once the domain of lending institutions. In addition, in the current acquisition mania in the senior-living and healthcare arenas, the sophisticated owners with substantial equity involved also look to wide-ranging title insurance coverage.

Without attempting to provide a complete list of all available endorsements, our purpose is to provide a snapshot of endorsements that may be available to owners in connection with commercial development projects, ranging from the familiar to the more obscure, the latter requiring direct negotiation with the title companies.

Comprehensive Endorsement

The familiar comprehensive endorsement has long been available to lenders, but a variation on that coverage may be available for an owner’s policy. The coverage seeks to protect the insured from any loss resulting from violations of covenants, conditions and restrictions that encumber the insured property. Typically, it protects against loss or damage resulting from any of the following:

  1. present violations of any enforceable covenants, conditions, restrictions or plat building lines;
  2. any recorded documents containing covenants conditions or restrictions that establish an easement, or provide for a lien, money damages, an option to purchase or prior approval of a future purchaser or occupant;
  3. encroachments of existing improvements onto adjoining land or encroachments of improvements situated on adjoining property onto the insured land; and
  4. encroachments of existing improvements located on the insured land onto any portion of the insured land subject to an easement.

In addition, the endorsement insures against loss resulting from the entry of a court order or judgment denying the right to maintain existing improvements on the insured land because of the failure of the above-stated conditions.

Zoning Endorsement

The language of the zoning endorsement varies depending on whether the land is improved or unimproved. In both instances, the endorsement insures against loss resulting from the failure of the insured property being situated within a particular zone permitting specific uses (subject to securing necessary approvals). For an improved parcel, the endorsement further provides coverage against loss arising from judicial decree prohibiting the use of the land for the insured’s use, or requiring removal or alteration of the structure on the basis that the setback and/or bulk requirements in the zoning regulations had been violated. It is also possible to obtain coverage relating to the required number of parking spaces and loading docks and their locations.

Typically, these endorsements offer no protection against the invalidity of ordinances or zoning amendments until after a final decree prohibiting the use or uses is issued, thereby absolving the insurer of liability for the cost of defending the validity of the ordinance. In addition, the standard policy does not cover losses sustained as a result of the refusal of a party to purchase, lease or lend money based on the interest covered by the policy.

To issue zoning endorsements, title insurers may require copies of the applicable zoning regulations, a certificate of zoning compliance from the local building or zoning official, an adequate survey, an opinion of counsel, and certifications or opinions from an architect or engineer. The title agent should take care to review all potentially applicable zoning/land use ordinances, including those of inland wetland agencies that may affect the issuance of zoning approvals and permits.

Nonimputation Endorsement and Fairway Endorsement

The following two endorsements are of particular interest in commercial transactions involving the transfer of interests in the insured owner entity, rather than transfers of title to the real estate itself. A typical transaction in our office involves the transfer of a limited partner interest to one or more investors. In such a case, the client, a developer, creates essentially a shell limited partnership, establishing an affiliated entity to act as general partner. The limited partnership acquires the property prior to the syndication, at which time the investor (or an affiliated entity) is admitted as a limited partner. The development process sometimes involves taking options on various parcels of land in order to assist the developer in securing parcels at a minimum cost.

A standard provision in an owner’s title insurance policy excludes from coverage damage or loss arising from unrecorded defects, liens, encumbrances, adverse claims or other matters known to the insured but not disclosed in writing to the insurer. Since interests in real property are created whether or not they are recorded, a limited partner in the circumstances we have described could be bound by the acts or knowledge of the general partner or its officers or employees. In order to protect against this “imputation of knowledge,” a “nonimputation endorsement” may be obtained, pursuant to which the title insurer will agree not to deny liability on the grounds that the insured had knowledge of any matter solely by reason of notice, imputed to it through a special party.

In our example, the nonimputation excludes matters known to the general partner, the original limited partner and the officers and employees of each. The endorsement specifically excludes, however, the company’s liability to the general partner and limits the loss payable to the limited partner to its percentage of partnership interest. Because this coverage is somewhat risky to the title insurer, the insurer may require a complete written description of the structure of the transaction, satisfactory financial statements of a party who may act as indemnitor, and satisfactory affidavits from knowledgeable officers, employees or directors.

A “Fairway endorsement” addresses another exclusion that could defeat a claim under an owner’s policy in the situation described above. An owner’s policy, by its terms, continues in effect for only as long as the insured retains an estate or an interest in the land or retains liability by virtue of warranty covenants made in the deed to the property. In the case of Fairway Development Co. v. Title Insurance Co. of Minnesota, 621 F.Supp. 120 (N.D. Ohio, 1985), an owner’s policy had been issued to a partnership and thereafter two of the three partners sold their interests to the remaining partner and a third party. The court held that the transfer of interest caused a dissolution of the insured partnership and the creation of a new partnership, thereby defeating a claim by the partnership under the policy. In a Fairway endorsement, the insured agrees that coverage will-not be deemed to have lapsed, been forfeited or terminated solely by virtue of the admission or withdrawal of a partner or change in a partner’s interest, provided that the insured entity has not been dissolved or discontinued by virtue of state law. This type of endorsement requires providing the insurer with verification that dissolution of the partnership would not occur by virtue of the admission or withdrawal of partners or change in a partnership interest.

The same goal may be achieved through other forms of endorsement that would include, within the definition of “insured,” the first successor partnership following a dissolution without the winding up of the business of the partnership. Alternatively, an endorsement may specifically agree not to deny liability to the insured or a successor insured solely by reason of certain permitted transfers or permitted transactions. These are tailored to specific transactions, but all are addressed to solving the problem of coverage being terminated by virtue of transfers of interest.

Assignment of Policy Endorsement

As noted, the owner’s insurance policy terminates with conveyance of the ownership interest to another owner. In the development process, however, it may be contemplated from the beginning that a separate entity will subsequently take ownership of the project for purposes of doing the development. The developer will not want to pay essentially twice for the owner’s policy. An assignment of policy endorsement may be available pursuant to which the insurer consents at the outset to the assignment of the policy to a successor under certain specified circumstances.

Option Endorsement

The development process sometimes involves taking options on various parcels of land in order to assist the developer in securing parcels at a minimum cost. The “option endorsement” is designed to assure the insured/optionee that its option to purchase is valid and that the rights of the insured/optionee under such option are vested in the insured. As one would expect, the coverage afforded by such endorsement terminates upon the earlier of the exercise of such option or on the date the option expires by its own terms. Although in some states options are not an interest in real estate, but rather contract rights, in Connecticut an option is deemed to be an interest in land, and title insurance may be obtained through the option endorsement. In some instances, an option to purchase may arise in connection with the issuance of a leasehold where both the option and the lease are created by the same contract.

Typical exceptions to such coverage may include the following:

  1. the disaffirmance of the option under the provisions of the U.S. Bankruptcy Code;
  2. the effect of any condemnation proceedings;
  3. mechanics’ liens recorded before or after the date of the policy; and
  4. the failure of the insured to have fulfilled any of its obligations under the option agreement.

Negotiated Endorsements

Particularly in the current competitive market among title companies (but of course within the statutory constraints on title companies), it is possible to negotiate endorsements specifically addressing concerns related to the particularities of a given transaction. In seeking to negotiate endorsements, it is important to bear in mind that title companies are subject to statutory and regulatory limitation and that title insurance is an indemnity policy premised upon underwriting that verifies that there is close to no risk in the undertaking.

Maximum Actual Loss Endorsement

Under a standard owner’s policy, loss is determined based on the diminution and the value of the subject land as it exists at the time the title defect is discovered. The tax credit endorsements and the maximum loss endorsement both bind the insurer to recognize certain principles relating to value in terms of measuring any loss under the policy.

We represent developers in connection with many transactions involving investors who are essentially the purchasers of the benefits of low-income housing tax credits. In these transactions, the value of the property is considerably enhanced by the availability of the credits to the owner of the project.

The negotiated tax credit endorsement provides that in the event of a successful claim under the policy, the damage sustained would be measured with reference to the value of the estate, taking into consideration the fact that the owner of the property was the beneficiary of tax credits pursuant to the Internal Revenue Code.

Similarly, it may be possible to obtain a “maximum actual loss endorsement” pursuant to which the insurer recognizes that the insured’s loss under the policy shall include all funds paid for the development of land and related soft costs. As with the tax credit endorsement, the purpose is to obtain insurer commitment that, for purposes of measuring loss or damage to the insured, the land will be valued taking into consideration the actual development costs, notwithstanding the fact that a standard appraisal might not recognize that value.

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