Illinois Fed. Court Holds No ‘Bad Faith Denial Of Coverage’ Against Title Insurers in Illinois

The U.S. District Court for the Northern District of Illinois recently held that a title insurer may exclude coverage under the exception for defects “created, suffered, assumed, or agreed to by the insured claimant” without intentional or wrongful conduct by the insured.

In so ruling, the Court also held that the Illinois statute for bad faith denial of coverage by insurers did not apply to title insurers.

A copy of the opinion in Bank of America, NA v. Chicago Title Insurance Company is available at:  Link to Opinion.

In 2007, a developer sought to purchase real estate in Yorkville, Illinois, to build a shopping center.  The lending bank and the developer entered into a construction loan agreement, which was secured by a construction mortgage, security agreement, assignment of rights and leases and fixture filing on the property.

As part of the project, the developer sold land to an anchor tenant pursuant to a purchase agreement.  Under that purchase agreement, the developer agreed to reimburse the tenant for a portion of a special tax imposed on the property by Yorkville.  The purchase agreement also provided lien rights to the tenant should the developer fail to timely pay the reimbursement, and stated that the developer’s obligation shall be a covenant running with the land and binding the developer’s successors and assigns.

The purchase agreement, development agreement, and the mortgage were recorded in that order.  A title insurer provided title insurance to the bank for the transaction.

The developer defaulted under the construction loan agreement and the bank sued for foreclosure in state court.  With respect to the tenant, the foreclosure complaint alleged that the tenant’s rights were subordinate and inferior to the lien and interest of the bank.  The tenant counterclaimed for a declaration of its rights under the agreements that ran with the land and were binding on the developer’s successors and assigns.  The parties filed cross motions for summary judgment.

The state court in the foreclosure held that the bank’s mortgage had priority, the tenant’s tax reimbursement and lien rights were personal between the developer and tenant, did not run with the property, and would be foreclosed and terminated upon entry of final order of foreclosure.

The state appellate court affirmed in part and reversed in part, agreeing that the bank’s mortgage had priority over any lien of the tenant, but concluded that the tenant’s tax reimbursement and lien rights were covenants that ran with the land binding on the bank and its successors, and were not extinguished, because the bank had actual knowledge of the tax reimbursement and lien rights before the bank recorded the mortgage, and because the mortgage was recorded after the memorandum of agreement and memorandum of development agreement.

As a result of the state appellate court ruling, the bank filed a complaint in federal court against the title insurer.  The bank alleged that due to the state appellate court ruling, it sold the mortgaged property for $1,780,000 less than what it would have sold without the tax obligation.  The title insurer, which represented the bank in the state court action against the tenant, denied coverage and refused to indemnify the bank because it claimed that the bank’s loss was excluded from the policy.

The bank’s complaint asserted a claim for breach of contract (Count I) and a claim titled “bad faith” (Count II).  The title insurer answered Count I, moved to dismiss Count II, and raised a number of affirmative defenses, and filed a counterclaim for declaratory judgment and/or “reformation of the policy to reflect the bargained for coverage.”

The bank moved to strike and/or dismiss the title insurer’s counterclaim and first affirmative, both of which asserted that the underlying policy excluded the bank’s claims.

The title insurer’s motion to dismiss argued that § 155 of the Illinois Insurance Code, which provides a cause of action against insurers for bad faith denial of coverage, did not apply because the Insurance Code specifically exempted title insurance companies.  See 215 ILCS 5/451.  Moreover, the title insurer argued that Illinois law does not provide an independent tort claim for breach of good faith and fair dealing.  See Voyles v. Sandia Mortgage Corp., 196 Ill.2d 288, 297-98 (2001).

The Court granted the title insurer’s motion and dismissed Count II.

Next, the bank’s motion to strike and dismiss the counterclaim and first affirmative defense, argued that: (1) the counterclaim should be stricken because it was duplicative of the title insurer’s first two affirmative defenses, and (2) neither the first affirmative defense nor Count I of the counterclaim, both of which sought to avoid coverage based on an exclusion for encumbrances, stated a cause of action because the title insurer did not allege that the bank’s intentional misconduct or inequitable behavior created the tax encumbrances at issue.  The Court rejected both arguments.

First, the Court determined that the bank suffered no prejudice by having to respond to the counterclaim, even if the counterclaim was duplicative of the title insurer’s first two affirmative defenses.  The issue of whether the exclusion applied was the key issue in this case.  The Court held that striking the counterclaim as redundant will not remove the issue, and would not save the plaintiff any time or money.

Second, the Court held that the title insurance policy excluded from coverage “defects, liens, encumbrances, adverse claims or other matters (a) created, suffered, assumed, or agreed to by the insured claimant.”   The title insurer’s affirmative defense and counterclaim alleged that the bank was aware: (1) of the documents creating the tax encumbrance; (2) that the documents provided for the encumbrance to run with the land; and (3) the documents that created the encumbrance were intended to be and were recorded prior to the bank’s mortgage.

Because the tax encumbrance was recorded before the mortgage, the Court held that the foreclosure could not extinguish it.

The Court also held that the exclusion could be applied without intentional or wrongful conduct by the bank to create the encumbrance.  By agreeing to the order of recordation, the Court found that the bank implicitly agreed that the encumbrance for tax reimbursements would survive a foreclosure.

Accordingly, the Court granted the bank’s motion to dismiss Count I and denied its motion to strike and dismiss the title insurer’s counterclaim and first affirmative defense.

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Eric Tsai practices in Maurice Wutscher’s Commercial Litigation and Consumer Credit Litigation groups, and in its Regulatory Compliance group. He concentrates his practice primarily on the defense of consumer and commercial financial services companies, including mortgage lenders and servicers, mortgage loan investors, third party debt collectors, and other financial services providers. He also counsels clients on regulatory compliance, licensing, and other consumer protection matters. Eric earned his undergraduate degree from the University of California, Irvine. Prior to attending law school, he worked as a loan officer for national direct lenders. He earned his Juris Doctor from California Western School of Law and thereafter obtained a Master of Laws (LLM) in Taxation from the University of San Diego School of Law. Eric publishes extensively on various issues affecting consumer lending and litigation, including both federal and California-specific developments. He is licensed to practice law in California, Nevada, and Oregon, and is admitted in all United States District Courts in the State of California, the United States District Court for the District of Oregon, the United States District Court for the District of Nevada, the U.S. Tax Court, and the Ninth Circuit Court of Appeals. He is also a licensed real estate broker in the State of California.