A LAYPERSON’S GUIDE TO A COLORADO REAL ESTATE TITLE INSURANCE COMMITMENT
Real Estate Law is a complicated subject with many ins and outs to understand. Our Real Estate Law experts are here to help provide you with a basic understanding of the law and how it can affect your business and real estate dealings. Today we are going to examine Title Insurance Commitments: what they mean, how they relate to your ownership of real property and what you need to know about it.
PART I – A Short History Of Real Property Ownership
To understand the value of title insurance, one must first understand what ownership of real property means. My law school professor likened real estate ownership to the proprietorship of a bundle of sticks. Should the property be free and clear of any lien or encumbrance, the possessor owns all of the sticks in the bundle meaning that the person owns the property (defined by the square footage of all of the property within and up to the perimeter lines of the property) from the surface to the center of the earth and from the surface to the farthest reaches of the universe.
Sometimes, especially in the eastern part of the country where land ownership goes back centuries, owners may own the entire bundle of sticks. Usually however, and especially in the west where real estate development began relatively late in our country’s history, owners purchase real property with some of the sticks missing or with the value of some sticks being diminished.
The upshot is that the owner of real property most often receives a title that gives others the right to use the property. Restrictions on an owner’s use may include the consequences of: the lien of a lender (which lien requires the loan be paid in full before title can transfer); the lien of a creditor (who can place a “judgment lien” on the property and who can then foreclose the property as payment of the judgment); and easements including utility easements, rights-of-way easements, equestrian easements and the like. For example, if the owner has obtained a loan to purchase the property, the lender will lien the property through a deed of trust (DOT). The DOT limits the owner’s right to further encumber the property or to sell the property until the loan has been satisfied and the lien has been removed. Should the owner fail to timely pay, the lender can foreclose and take the property in full (or partial) payment of the debt. With easements, a prior or current owner does not give away title to the property but instead gives others the legal right to use the property. Easements typically “run with the land” meaning that the rights granted under the easement benefit (or burden) the property and subsequent owners far into the future. While the owner may use the easement property in conjunction with the easement holder, the easement may restrict the owner’s right to use the property in any other manner.
One may ask: “How would a prospective owner learn of the existence of matters that reduce or hamper ownership of his or her bundle of sticks?” The short answer to this complex question is that the buyer will have to search the public records to identify any document that affects ownership. This is a complex process that can take significant time and effort and that can be accomplished only if the buyer has intimate knowledge of the workings of the office of a clerk and recorder. Though the records are public in the sense that anyone can look at them, finding the documents that apply to a specific piece of property takes a skill that few have. If the buyer is able to collect all of the recorded documents that affect the title to the property, the prospective owner will have compiled an “abstract of title”. Often, and especially in the east, an abstract is maintained by the then-current owner (or his or her attorney or agent) and is passed from owner to another as part of the sale of the property.
The problem with a prospective owner’s abstract is that he or she may have missed a document or may have misconstrued the burden that a document places on the property. In such a case, the prospective owner is without recourse since his or her negligence caused the mistake. This is where title insurance comes in.
Title Insurance – What is it?
Like any other insurance, title insurance insures against certain losses. Unlike most insurance however, that insures against a future event, title insurance covers the policy owner (called the “insured”) against losses resulting from events that occurred before he or she took title to the property. To do this, the title insurance company (the “insurer”) takes on the burden of combing the public records to create an abstract for the property and then, in exchange for the payment of an insurance premium, will insure that the title delivered to the new owner is free and clear of the claims of others, EXCEPT for those matters that the title searched revealed. Title insurance is a form of “indemnity” insurance that protects the insured should a previously undiscovered defect in the title cause a loss to the owner or lender. “Indemnification” is a legal term of art that means the insurer that made the promise that the title was free and clear of liens or encumbrances (except those disclosed prior to the purchase in what is usually called a “title commitment”), will pay for any loss suffered by the insured because of the failure of the insurer to find a recorded lien or encumbrance. Note that the insurance will NOT usually cover any loss that resulted from a lien or encumbrance disclosed in the title commitment. This is fair and reasonable since the insured had notice of the matter before the closing and agreed by taking title to assume the risk that such lien or encumbrance posed.
Virtually all residential, farm/ranch, and commercial real estate transactions in Colorado call for the delivery to the buyer (called the “owner” in title-insurance speak) of title insurance. If there is a lender involved then it too will obtain such insurance usually at the owner’s cost.
Next week, we will cover Part II – Title Insurance Commitments. If you have any questions about what we’ve covered this week or would like to speak with a real estate law expert, please give us a call at 303-790-4103.