The recent economic downturn has had a dramatic impact on the real estate market, both nationally and locally. Many people are considering seizing the opportunity to invest in real estate while the prices are low and tax credits are available. While most people understand the importance of a physical inspection of the property prior to purchasing, a large percentage of purchasers do not properly inspect title to the property or understand the importance of obtaining an owner’s policy of title insurance (note: a discussion of the differences between owner’s and lender’s policies and standard and extended coverage are beyond the scope of this article). The worst case scenario is that a purchaser could lose the property and money as a result of a title matter. The good news is that purchasers have the ability to protect their investments by performing adequate title review and obtaining a policy of title insurance. The following is a brief explanation of the title review process and title insurance along with some practical tips and suggestions to help purchasers with this important due diligence work.
“Title” is the bundle of rights associated with real property ownership, as evidenced by a deed or other appropriate documentation recorded in the public records in the county where the property is located. A sale of real property involves transferring title to the property from the seller to the purchaser. The seller is only able to transfer what he owns to the purchaser, which is why the purchaser should carefully review the title, i.e. what the purchaser will receive from the seller. Title review is possible without using the services of a title company; however, the process is time consuming and complicated. A policy of title insurance is a contract between the purchaser and the title insurance company which protects the purchaser against claims and losses (including legal fees) that the purchaser may suffer as a result of certain title defects or other title matters, such as fraud and omissions or mistakes in the public records, subject to certain stated exceptions in the title insurance policy. Upon request of the purchaser or seller, the title insurance company chosen by the parties will issue a title commitment, which is essentially a commitment of the title insurance company to issue the title insurance policy to the purchaser upon closing of the purchase and sale transaction, and which sets forth certain title matters disclosed by the title insurance company’s search of the title documents recorded in the public records. A purchase and sale agreement should include a title review provision that provides adequate time for the purchaser to review the title commitment, object to matters listed on the title commitment, and terminate the contract and receive a refund of the earnest money if the seller is unable or unwilling to cure any objectionable title matters. If the purchase and sale agreement does not include the foregoing provisions, the purchaser should attempt to negotiate those items before executing the agreement. The seller customarily pays the one-time premium for the title insurance policy at closing, which should be included in the terms of the purchase and sale agreement.
During the title review period specified in the purchase and sale agreement, the prospective purchaser should, at a minimum, review the title commitment and the documents referenced in the special exception section of the title commitment (which will be provided by the title insurance company upon request) and look for the matters described below. The special exception documents should be reviewed very carefully because matters disclosed in those documents are excluded from coverage under the title insurance policy. First, the seller listed in the purchase and sale agreement should be the person or persons identified in the title commitment as the owner of the property. Second, the title commitment should show that the seller has fee simple title to the property, meaning the seller has the right to transfer absolute ownership of the property to the purchaser (for further discussion on types of property ownership, please see my article entitled “Types of Property Ownership and the Impact on Purchase and Sale Transactions”). Third, the purchaser should verify whether the real property taxes have been paid because delinquent taxes may become a lien on the property. Fourth, if the property is subject to liens and other monetary encumbrances (such as mortgages and deeds of trust), the purchaser should verify that the seller will remove those monetary liens and encumbrances at closing. Fifth, the purchaser should determine whether the property owner is required to pay any fees or other costs under any document recorded against the property (such as covenants, conditions or restrictions), and if so, the seller should verify that such fees have been paid because delinquent fees may become a lien on the property. Sixth, if the property is subject to easements or other use restrictions (such as covenants, conditions and restrictions), the purchaser should verify whether the purchaser’s intended use of the property will be limited by the terms of those documents. Seventh, the purchaser should review the legal description in the title commitment and verify that it matches the description of the property being purchased pursuant to the purchase and sale agreement. Finally, the purchaser should verify whether any third parties have a right to possess or use the property, although some possessory interests, such as leases, are not always recorded in the public records, do not always show up on the title commitment, and should be discussed separately between the purchaser, the seller and the title company.
The suggested title review items listed above are not intended to be an exhaustive list; rather, they are intended to provide a starting point for a purchaser’s title review. The purchaser should carefully review all aspects of the title commitment and each document provided by the title company and ask questions that result from a complete review. If the purchaser is not satisfied with matters disclosed by the title commitment and title documents, the purchaser should inform the seller and the title insurance company. If the seller is unable to cure the objectionable title matters prior to the time period allotted in the purchase and sale agreement, the purchaser should consider renegotiating the purchase price (if the purchaser is willing to own the property subject to the objectionable matters) or terminating the purchase and sale agreement.
The title review process is a critical aspect of a purchaser’s due diligence review in both commercial and residential transactions. A prospective purchaser of real property should obtain a title insurance policy for the property, and the purchaser should review the title commitment and underlying documents thoroughly. Title review helps a purchaser ensure that he will own fee simple title to the property, and that he may use and enjoy the property as he intended. A title insurance policy can prevent a property owner from losing his investment and having to pay substantial amounts of money to defend title claims. Furthermore, undiscovered title issues can affect the owner’s ability to sell the property in the future, and adequate title review informs the purchaser that the property is marketable and will likely remain marketable if the purchaser elects to sell it in the future. If you are unsure about the status of a seller’s title, need assistance reviewing title to real estate, or would like to discuss the matters addressed in this article, please feel free to contact April Anderson.
Lukins & Annis, P.S. // OFFICES IN: SPOKANE, COEUR D'ALENE, MOSES LAKE
Telephone: (509) 455-9555 or (208) 667-0517