The Appellate Division of the Supreme Court of New York, Second Department recently heard an appeal in the case of Countrywide Home Loans v. United General Title Insurance. This interesting appeal touches on a situation made much more meaningful by the recent historical background of the so-called subprime mortgage crisis (or scandal, depending on who you ask).
The plaintiff, Countrywide, issued a mortgage loan to one Fayyaz Ahmed in 2005, for approximately $300,000. However, there was a serious problem: Ahmed had stolen the identity of Munir Lodhi, and took out the mortgage under the name of Munir Lodhi! As is routinely done, Countrywide took out a mortgage Title Insurance policy (or contract) with the defendant, United General Title Insurance (“United.”)
In December 2005, the plaintiff found out about the fraud and identity theft involved in this particular mortgage. Plaintiff issued a satisfaction to the real Mr. Lodhi, releasing its lien or legal claim upon his property. Plaintiff then filed a claim under its Title Insurance policy. Three and a half years later, defendant announced that it would not pay out the claim, alleging various theories. Plaintiff sued, and a trial court dismissed the case. Plaintiff appeals to the appellate division.
We do not know if the loan issued in this case was indeed a subprime mortgage. However, the case follows the general broad strokes of a typical case in the subprime crisis. The crisis was brought on by the issuance of mortgages, during the real estate boom (or bubble) of the early 2000’s. A staggering number of mortgages were issued to people who should not have received them… people who could not afford them (the true subprime situation), people who lied about their income, and as in this case, people who committed outright fraud.
The net result was that in 2008 the real estate bubble crashed. One of the root causes was that many mortgages (which had been securitized and insured with other worthless mortgages) were completely worthless. Title insurance companies were then put into an impossible situation. They could not possibly pay out for ALL of these claims. Instead, they turned to the courts – they sued the original mortgage issuers under a theory that they had turned a blind eye to fraud and not lived up to their responsibility to check the credit of people they actually issued mortgages to.
Here the defendant’s first reason for not paying was just that – that the plaintiff had not checked the identity of the borrower. There is language in the policy that excludes coverage for defects ‘created by’ the insured, and the lower court agreed with the defendant that plaintiff’s failure to detect the identity theft was a valid grounds for exclusion.
The appellate division disagreed with this reasoning. There was a record of a checklist that plaintiff’s underwriter followed, with Identity Theft prevention and Fraud Detection components. Because the supreme court had dismissed this case via summary judgment, the appellate division felt that this was an error b/c this record at least raised some kind of a factual error. Reading between the lines, it is likely that the underwriting documentation was more akin to a rubber stamp than a thorough investigation, and the appellate division felt that the supreme court had jumped the gun a little bit by deeming it worthless… which is inappropriate when ruling on a motion for summary judgement.
The defendant’s second argument, which the appellate division again rejected, was that by issuing a satisfaction to the real Mr. Lodhi, the plaintiff had created its own loss, again grounds for contractual exclusion. The court, applying contract interpretation, stated that there was no specific exclusion for cases of fraud or identity theft. Furthermore, the title obtained was fraudulent from the start – thus the loss occurred the minute it was received. The subsequent satisfaction issued to the innocent party was irrelevant, because the loss had already occurred.
If you have any concerns related to mortgages or title insurance, especially relating to the 2008 crisis, please don’t hesitate to contact our office for a consultation.