The Art Of Reviewing A Leasehold Title Insurance Commitment

  • Published: January 17, 2010
  • By Mark Morfopoulos

A little time spent at the beginning can save the tenant an awful lot of grief later on.

WHEN A TENANT leases property, it typically focuses on the lease, and perhaps a guaranty that they may be asked to sign. They may also seek to have the landlord’s lender execute a non-disturbance agreement to make sure that its leasehold interests are secure in the event the landlord defaults on its loan. Savvy tenants realize that it may be equally important to protect their interests in the event that the landlord is not holding clear title to its property. If the landlord does not have valid title, the non-disturbance protection the tenant just received from the landlord’s lender will not be worth very much. Just like when a tenant purchases property, the interest in the underlying property could actually be held by an unrelated third-party. Many tenants do not look at a leasehold transaction in the same way as they do when they are purchasing property, however. This could lead to unintended results. Especially if costly improvements are constructed within the leased premises, or if the lease has value because of locational goodwill or because it is a favorable lease, a tenant will not be happy if it learns that it must vacate the premises due to a title defect. That is why many tenants obtain leasehold insurance. It may also be impossible to obtain financing for leasehold improvements unless a tenant procures such insurance. Carefully scrutinizing the initial title insurance commitment, including Schedules A, B, and any endorsements that will be attached to the final policy, will maximize a tenant’s protection against title defects.

For the purposes of this article, I am analyzing the American Land Title Association’s (ALTA) forms, as these are the forms that are used by the vast majority of States around the county. As an initial comment, before reviewing either Schedule A or B of a title insurance commitment, make sure that the American Land Title Association’s (ALTA) policy form that you are reviewing is the “2006 ALTA Owner’s Policy” adopted June 17, 2006. The “Covered Risks” section included in this form provides significantly more favorable language benefiting the insured than prior versions of the same document. (For a very detailed discussion as to how such revisions provide additional protection to the insured’s coverage, see 2006 ALTA Policy and Endorsement Forms, Paul L. Hammann).

Once you have determined that you have the right form, there are two schedules attached to the commitment where the information inserted into each such schedule is specific to your transaction; Schedules A and B. Schedule A attached to a title insurance commitment sets forth the baseline as to: policy limits; who is insured; what is insured; and the effective date of the insurance. Practitioners may have a tendency to gloss over this section of the leasehold title commitment thinking that the “important” policy provisions are only contained in Schedule B relating to policy exceptions. This would be a big mistake. Identifying and reviewing the exceptions to your coverage may have little relevance if you do not make sure that what you intend to insure is, in fact, covered by the insurance.

Schedule B lists the exceptions to a policy’s insurance coverage. In other words, the restrictions, conditions, covenants, liens, or other title defects on this schedule are conditions that the insured takes “subject to” and losses or damages resulting therefrom are not covered by the title insurance policy. It is similar to the “Permitted Exceptions” exhibit found in many commercial leases. Schedule B exceptions are items that a tenant must be comfortable accepting as part of the risk of leasing its premises.

Title endorsements amend the coverage provided by the policy. They are specifically tailored to meet the needs of an insured where the factual circumstances of a particular property warrant or demand additional coverage. Each transaction is different. The available and desired endorsements will vary with each leasehold title policy. Knowing which endorsements are available is important when it comes to maximizing protection against title defects.

SCHEDULE A • The relevant sections of Schedule A of a title insurance commitment are as follows.

Amount Of Insurance

Most landlords are formed as single-purpose entities with little or no assets backing them up. Thus, leasehold title insurance is utilized to guaranty that tenants will be adequately compensated for any damages they incur if their landlord has defective title. These damages can be substantial and determining the appropriate amount of insurance is a vital element in protecting a tenant’s business interests.

It is therefore not surprising that the first section in Schedule A of a title commitment is the amount of insurance. This section may, in and of itself, be the most important portion of a title policy. The amount sets the limits the insurance company will pay if title is defective. Even if the damage is greater than this amount, the insured can only recover up to the amount stated in this section. A quick review of the 2006 ALTA Form 13 Leasehold Owner’s Endorsement discloses that the value of the leasehold estate and of tenant improvements built at the tenant’s expense are both included in the valuation of the insured estate. Additional items of loss covered by the policy include:

The reasonable cost of removing and relocating any personal property;

Rent or damages the tenant would have to pay to any person having paramount title;

The fair market value of any sublease in place; and

The reasonable costs to secure a replacement leasehold equivalent to the leasehold estate.

Unlike an owner’s or lender’s policy, in which the value of the insured interest is typically the purchase price or the amount of the loan, the amount of insurance for a leasehold owner’s policy is not as easily determined. First, the ALTA Form 13 Endorsement does not provide a specific method for valuing tenant leasehold improvements or other expenses. Second, the value of the remaining portion of the leasehold estate is a moving target since it changes from day to day, i.e. the length of the term diminishes over time and what may be below-market rent today may be above market rent tomorrow (or visa versa). Nevertheless, if a tenant reasonably determines the amount of insurance it needs based on the considerations above, its chances of finding itself in a disagreement with the insurer as to the policy limit is greatly diminished.

Date of Policy

The date of a leasehold title insurance policy is its effective date. Since the insured is not covered before that date, it is imperative that the policy become effective as soon as possible once you have an existing insurable risk, i.e., once the lease is in place and costly improvements have been constructed. The effective date of a leasehold title policy is the date that the lease or, more typically, a memorandum of lease, is properly recorded in the land records. So, recording this document should not be delayed. The recording of the memorandum (or short form of lease) provides notice to third parties that your lease is in existence. Title examiners conduct their searches to this date. This is why the insurance companies require the document to be recorded. Typically, it sets the date when the lease has priority over later-recorded documents. When reviewing a commitment, it is important to check that the proposed policy date is the same as the recording date of the document evidencing the leasehold interest. Note, however, in some jurisdictions, there is a significant cost associated with recording leases and memoranda of leases. When obtaining insurance in such states, title insurers commonly examine title to the date of the lease. In such jurisdictions, the instrument creating the leasehold interest is not recorded to avoid the high recording charges. In such instances, the lease will need to be submitted to the title examiner to determine when the lease was executed.

Name Of Insured

If, the wrong entity is named in this section, there may be no coverage at all! After the 2006 revisions to the ALTA policy, the definition of “Insured” was expanded to include transfers between certain related entities such as subsidiaries, parent or affiliates, even when no actual consideration was given with respect to the transfer. Nevertheless, be careful to check that the name of the tenant in the lease matches the name of the insured in the title commitment. Note also that an additional insured endorsement may be offered in some jurisdictions. Check with the title company as to the availability of this endorsement, if needed.

Interest In The Land Covered By The Policy

The words “Leasehold Estate” should be inserted in this section. Careless title companies have sometimes referred to “insured mortgages” or state that the “mortgage will be insured as a lien” in this section. Although a title company may be hard pressed to argue that it never issued you a leasehold policy, the insured tenant will not be pleased with the quality of its attorney’s work if it sees such obvious errors in its policy. They may also wonder how carefully the rest of the policy was examined.

Be aware that the policy’s coverage is only effective during the term of the lease as extended by the terms of the lease in effect when the policy was issued. If lease term extensions are negotiated after the date the insured lease was executed, the original coverage may not extend to the longer term.

Title To The Estate In The Land

This section should be thought of as two sections, the Fee Owner section and the Leasehold Owner section.

Fee Owner Section

Make sure that the exact name of the landlord is here. Be conscious of the fact that the original owner may have changed into another type of entity (for example, from a limited partnership to a limited liability company) and additional documentation may need to be provided to the title company to account for this transformation. Also check to see if the jurisdiction where the landlord entity was created is properly recited. If the fee owner is not the same as the landlord named in the lease, it may be evidence that there is a ground lease superior to the insured leasehold interest. In such a case, the superior (ground) landlord and its ground tenant who is the landlord under the insured lease should execute a recognition agreement. A careful review of the ground lease is always wise to determine how it could impact the insured lease.

Leasehold Owner Section

The following should be inserted in this section of the commitment:

“Tenant, a [insert type of entity and the jurisdiction where the entity was formed], by virtue of an unrecorded Lease Agreement dated ________, 20__, as evidenced by a Memorandum of Lease dated ________, 20__ by and between [insert name of landlord], a [insert type of entity and the jurisdiction where the entity was formed], as Landlord, and [insert name of Tenant], a [insert type of entity and the jurisdiction where the entity was formed], as Tenant, recorded on _______, 20__ in [insert name of recording office].”

Reviewing this provision is a good way of double-checking that the names of the parties and the date on which the memorandum of lease was executed and recorded are correct.

Description of Land Referred to in Policy. In this section of the commitment, check that the description of the demised premises set forth in the title commitment matches the description contained in the lease. If there are discrepancies, make sure the title company reconciles them to the insured tenant’s satisfaction. Remember, in a shopping center lease, the insured’s rights extend to all areas of the shopping center owned by landlord, including but not limited to, parking, loading docks, pylon signs, access points to a mall, and common areas. Therefore, there is no reason to amend the Memorandum of Lease or Lease to revise and limit the legal descriptions in such documents to a depiction of only the “leased premises,” as some title company’s may request. Moreover, language should also be added to the insured description to provide that the insured premises include “the benefits of such easements appurtenant to the leasehold estate” as set forth in the lease agreement. This will ensure that the insured tenant will be covered for loss if such loss occurs because of a loss of tenant’s right to use a part of the shopping center outside of the demised premises. For example, the insured tenant might have a contractual right to utilize portions of the shopping center, such as a parking spaces or common areas, and those rights are diminished or lost because of a title defect.

If there are Reciprocal Easement Agreements (REA) that confer rights on the tenant, they should also be recited as part of the insured description. For example, the legal description would add, “together with, and subject to” and then add the description of the REA together with the recording information relating to the REA.

As mentioned earlier, leasehold title insurance policy is designed to protect a tenant’s valuable leasehold interests, including among other things: “locational goodwill,” the value of a tenant’s improvements, and the possible remaining below market rent value of a tenant’s lease. Carefully reviewing Schedule A of a leasehold title insurance commitment is the first step in ensuring that such interests are adequately safeguarded.

Examining Schedule B of the leasehold title insurance commitment together with any endorsements that will be attached is very important, as well, to protect a tenant’s leasehold interest.

SCHEDULE B • The title exceptions listed in Schedule B of a leasehold title insurance commitment generally fall under one of two categories; those that may immediately disrupt a tenant’s business operations, and those that may result in future liability once a tenant takes possession of the premises. Prior recorded liens, leases, easements, and declarations are examples of conditions that can unfavorably affect a tenant’s right to possess the premises and properly operate its business. Listed environmental liens may be a clue that there are adverse environmental conditions related to the property. Knowledge of these conditions could warn a tenant of potential exposure to environmental liability at some later date. Most of the exceptions set forth in a typical leasehold title insurance commitment’s Schedule B relate to the first category of exceptions — restrictions that may directly affect a tenant’s business operations in an unfavorable manner.

What follows is intended to briefly discuss a selected number of leasehold title exceptions in a commitment’s Schedule B typically found, as follows.

Taxes Or Assessments

The tax search attached to the commitment must be scrutinized to see if all taxes, assessments, and governmental utility charges that are due and payable have been paid. This is a good opportunity to match the parcels in the tax search against the insured property’s description in Schedule A. Only taxes not yet due and payable should be accepted as exceptions. If other taxes are open, the landlord should either pay them or make some other arrangements with the title company to delete this exception.

Survey Exceptions

The leasehold title insurance commitment will typically list these exceptions from coverage where no current survey is submitted to the title insurer:
Any facts, rights, interests or claims that are not shown by the Public Records but that could be ascertained by an inspection of the land or that may be asserted by persons in possession of the land;

Easements, liens or encumbrances, or claims thereof, not shown by the Public Records; and

Any encroachment, encumbrance, violation, variation or adverse circumstances affecting title that would be disclosed by an accurate and complete land survey of the land and not shown by the Public Records.

All three of these exceptions should be omitted if an accurate, complete, and relatively contemporaneous land survey has been provided to the title company. This is called, “deleting the survey exception.”

If a current survey is not available, many insurers will delete the survey exception upon furnishing an older survey coupled with an affidavit stating that there is nothing about the property that would change the older survey.

If a survey is given to the title insurance company, any easements, liens or other encumbrances shown on the survey will be “read into” the title policy and be noted as exceptions to coverage. Make sure none of these encumbrances adversely affect the tenant’s interests. Also, if a survey is in the process of being prepared or updated, the landlord should be asked to have the surveyor add tenant’s name to the list of certified parties on the survey. This will give the tenant a direct right against the surveyor in the event the survey is incorrect. Moreover, if a survey is provided, the title company can then issue a “survey endorsement.” This states that the insurance company insures against loss or damage the tenant may sustain if the land described in Schedule A of the policy is not the same as that on a survey made by the surveyor.

Without a survey or survey affidavit, title coverage is subject to whatever defects a survey would have revealed at the time a policy becomes effective. That is what the exceptions listed above are about. A shopping center tenant might assume that its premises fall within the boundaries of the landlord’s property, but important shopping center improvements, such as parking areas and signage, may be adversely affected if the property lines are incorrect. In addition, a survey can disclose unrecorded easements or other agreements that may adversely affect a tenant.

Mortgages And Other Security Agreements/U.C.C. Financing Statements

If any liens not securing the indebtedness of the landlord or other party having a superior interest to tenant are listed as exceptions in the commitment they should be omitted. In the event there are liens relating to the landlord, it will alert a tenant that a non-disturbance agreement may be required from the lender. Further, if a non-disturbance agreement in a tenant’s favor is executed, it should be recorded. The mortgage listed as an exception should then be subject to the insured’s non-disturbance agreement. In extreme cases, excessive liens against a landlord can tip off a tenant that the landlord is experiencing financial difficulties and the property may be headed to foreclosure.

The Terms And Conditions Of A Tenant’s Unrecorded Lease Agreement As Evidenced By The Recorded Memorandum Of Lease

Despite the vigorous attempts of many title insurance companies to include such an exception in a commitment, it should always be omitted. A title company should not be “excepting” from coverage what it is insuring. In addition, a written statement from the tenant stating that the “conditions contained within the lease have been satisfied and that there are no outstanding obligations by the landlord,” should not be required.

“Leasehold Estate,” as described in the most recent version of the ALTA 13 Leasehold Endorsement, is defined as “the right of possession for the Lease Term.” As John C. Murray stated in Benefits of the New Leasehold Endorsements for Owner’s and Loan Policies (2005):

“[This definition] has deleted the (often contentious) language in the 1975 Leasehold Policy Forms that made the coverage subject to lease provisions that limited the tenant’s right of possession. The ALTA Forms Committee also decided not to raise a specific Schedule B exception for duties and obligations of the tenant under the lease. The ALTA Forms Committee reasoned that no specific Schedule B exception was necessary because of Exclusion 3(a) of the ALTA Owner’s and Loan Policies, which excludes from coverage those matters ‘created, suffered, assumed or agreed to by the insured claimant.’” (emphasis added)

Title insurance companies are insuring a tenant’s possessory rights in the leasehold interest a tenant has created. It is not insuring that any of the contractual rights contained in the lease are valid or enforceable against the landlord. Many title examiners are unaware of the expanded coverage set forth in the 2006 ALTA 13 Endorsement. It is up to a tenant to educate a title insurance company as to this fact if a tenant desires to have this exception deleted.

Covenants, Restrictions, Easement Agreements, Declarations, Memorandum of Leases

Encroachment agreements, development agreements, and any other type of agreement that could adversely affect a tenant’s title can be considered as part of this category of exceptions. Any and all of these items may adversely impact upon a tenant’s use and continued possession of the premises. Many of these documents are old and barely legible. Reading these documents can be an extremely tedious endeavor. A tenant will be potentially placing itself at extreme risk if it does not carefully examine every page of these agreements. For example, it is not uncommon for many of these types of exceptions to contain rights of reverter or purchase options. As a retail tenant, the memorandum of lease of a prior tenant can alert it of use restrictions that can limit what may be sold at the premises. They can also provide for expansion options, and special rights to parking and signage areas that may be detrimental to a tenant’s interests. A prior recorded ground lease may provide evidence of a superior leasehold interest. A tenant may need to obtain a recognition agreement in such a circumstance. It may also find that the prior lease was subsequently terminated. Easements and declarations are among the various types of agreements that can adversely affect a tenant’s ability to access the premises. Be also aware that many of the agreements contain references to other agreements that may not be listed in the commitment. Do not let the sloppy work of a title company be an excuse not to investigate further. For example, an agreement which was listed as a title exception in one commitment’s Schedule B mentioned that it was subject to a ground lease. It turned out that this ground lease had not been terminated as of the date the commitment was issued. Unrelated third parties still had a potential interest in the leasehold premises for another 100 years! As a practical matter, making a request to the title company to expressly except the rights of such third parties from the particular “exception” could be a solution to this type of title issue because such action would specifically include those matters within the policy coverage.

Rights Of Tenants And Others In Possession Of The Premises

Title companies do not know who is currently in possession of the premises a tenant intends to lease. The “rights of tenants in possession” exception is added to account for any tenants or other parties that may be in possession of the premises either by virtue of a holdover or other situation. This exception can easily be deleted by asking the title company to obtain an affidavit from the owner/landlord that there are no such parties in possession. If a tenant neglects to ask for this exception to be deleted it cannot go back to the title company at a later date and ask that they defend and hold tenant harmless against any loss or damage caused by a holdover tenant.

LEASEHOLD TITLE ENDORSEMENTS • On June 17, 2006 ALTA adopted revised endorsements to the standard title insurance policy forms for owners and lenders. Each jurisdiction, however, is subject to different regulations, and may amend both the policy forms and the endorsements attached to them. Many jurisdictions have modified the ALTA forms, including the ALTA endorsements. Prime examples of this are Texas and California (see CLTA forms). The ALTA 13 Leasehold Endorsement (or same variation of this form depending on which jurisdiction you are in) will be attached to the standard owner’s policy if a tenant is purchasing leasehold title insurance. There are many other endorsements that can be made a part of a leasehold title policy. Among the possible endorsements that may be obtained are as follows:

Survey Endorsement;

Zoning Endorsement;

Restrictions, Encroachments; Minerals endorsement;

Access and Entry Endorsement;

Contiguity Endorsement;

Creditors’ Rights Endorsement;

Location Endorsement; and

Utility Availability Endorsement.

The availability of these and other endorsements varies from jurisdiction to jurisdiction. As mentioned earlier, a tenant’s need for a particular endorsement depends on the facts of its particular deal. Endorsements that may be required for one transaction may not necessarily be needed for the next transaction. When looking at a commitment, a careful review of the available endorsements in a tenant’s jurisdiction is required to ascertain which endorsements are affordable (or offered at no charge) and which ones apply.

CONCLUSION • Leasehold title insurance can be an important method of protecting a tenant’s valuable leasehold property interests. Unfortunately, most title agencies are not as familiar with such policies as they could be because the great majority of title insurance policies issued are owner’s and lender’s policies and not leasehold policies. It is up to a tenant to identify and be knowledgeable as to the important issues relating to leasehold policies and the applicable endorsements in order to adequately protect its interests and minimize exposure to damages caused by title defects. Once the policy is issued, a tenant is in a much worse position to ask that its policy be revised. Therefore, a thorough review of a commitment is critical to make sure that the final policy provides a tenant with the title insurance coverage it expects to receive.