Posting for

Tuesday, October 20, 1998

by: Bert Rush

brush@firstam.com

TAX SALES/UNFAIR COMPETITION LAW/TITLE UNDERWRITING

The California Supreme Court has ruled that tax sale purchasers and investors may sue title companies who conspire to refuse to sell title insurance covering properties acquired at tax sales--under California's Unfair Competition Law ("UCL") and under the common law tort of interference with contractual relations.

The case is Quelimane Co. v. Stewart Title Guaranty Co.,19 Cal.4th 26, 77 Cal.Rptr.2d 709 (Aug. 1998).

The case arises from the title industry's historic aversion to insuring out of recent tax sales because of the risk that taxing authorities have not complied with statutory and/or constitutional requirements in conducting these sales or, even where compliance has been achieved, taxing authorities keep such poor records that proof of compliance is almost impossible if a tax sale is later challenged in court.

Over the years speculators hoping to make money on properties acquired at tax sales have complained that title company unwillingness to insure these titles has hurt their ability to sell these properties for maximum profit. Having failed in efforts to lobby title industry managers and state legislators, these interests have taken their case to court.

In Quelimane several companies who purchased properties at tax sales in El Dorado County, CA, and in some cases saw contracts for re-sale of their properties cancelled because buyers couldn't obtain title insurance, joined forces to sue all title companies doing business in that county: Stewart Title, First American, and Placer Title Company (an agent).

Mainly, plaintiffs alleged that the title company defendants interfered with the contractual relations of plaintiffs and their prospective buyers by refusing to insure even though the defendants were aware that ability to obtain title insurance is "an important part of any real estate transaction in California," and plaintiffs had represented to the public that they would insure "any real estate that had good title."

Second, plaintiffs alleged defendants conspired to deny title insurance to prospective purchasers of properties acquired at tax sales in a manner akin to "redlining," without "economic, actuarial, or other justification," in violation of California's Unfair Competition Law (California Business and Professions Code sections 17200, et seq.).

Third, plaintiffs alleged that defendants had a legal duty to not discriminate against plaintiffs--which duty was breached by defendants' refusal to sell title insurance for plaintiffs' properties.

Stewart Title and Placer Title were dismissed from the action, by stipulation, after successful demurrers based on the period of limitations.

First American demurred generally on grounds that the complaint failed to state a cause of action--which demurrer was sustained. The plaintiffs appealed, and the court of appeal affirmed the judgment for First American.

But the Supreme Court reversed, applying the familiar principle that upon hearing of a demurrer (at the earliest stage of the lawsuit) all well-pled allegations of a plaintiff should be regarded as true for purposes of weighing plaintiff's ability to state a legal cause of action. In other words, give the plaintiffs the benefit of the doubt.

The Court first put the case in context by describing California laws governing tax sales of real property. The law permits the tax collector to declare property in default for non-payment of property taxes. This is an in-rem procedure--with statutory requirements for giving notice prior to the sale. Five years after a default the owner's right to redeem the property--by paying all amounts past due--terminates, and the tax collector may sell the property to the highest bidder (for a minimum purchase price of all amounts past due) to anyone. The purchaser receives a "tax sale deed" for recording.

California statutes have also been written to give tax sale purchasers conditional assurances of good title. Thus, it's provided that, except as against fraud, a tax deed is conclusive evidence that the tax sale was duly and regularly performed. (California Revenue and Taxation Code section 3711.) With what the Court describes as "minor exceptions"the tax sale deed conveys title free of all encumbrances--but the list of "minor exceptions" includes liens for taxes levied by a government agency that has not consented to the sale and federal tax liens. (Revenue and Taxation Code section 3712.) Actions or proceedings to challenge a tax sale must be brought within one year of execution of the tax sale deed. (Revenue and Taxation Code sections 3735 and 3726.)

With this as background plaintiffs alleged that title companies have no "economic justification" for refusal to insure titles acquired at tax sale. The Court accepted this allegation as true for purposes of deciding whether the complaint was sufficient to state a cause of action--but in doing so it commented that First American might be able to prove otherwise at trial.

Next the Court turned to plaintiffs' allegations based on the UCL, which it described as follows:

The Court continues to conclude that the complaint's allegations that defendant title companies conspired to refuse to sell title insurance--engaging in an unlawful conspiracy in restraint of trade (California's Cartrwright Act--Business and Professions Code, sections 16700, et seq.)--are sufficient to state a cause of action under the UCL.

In other words, "(t)he UCL cause of action is based on a theory that this conspiracy was unlawful and that the conspiracy is a basis for a UCL action."

In passing the Court also said that the fact that insurance companies are regulated by state agencies does not give them a general exemption from antitrust and unfair competition statutes. Instead, the Insurance Code bars unfair competition suits based on rate-making (a/k/a price-fixing).

The Court next considered whether the allegations of the complaint would be sufficienct to state a cause of action under the Cartwright Act. The Cartwright Act makes it unlawful for two or more persons to agree "to create or carry out restrictions in trade or commerce" (a/k/a restraint of trade). Here, the Court found, an agreement between title companies not to offer title insurance under certain circumstances might constitute a violation, saying:

Giving the "conclusory allegations" of plaintiffs' complaint a "liberal" reading, the Court found the allegations sufficient to state a cause of action under the Cartwright Act. On the other hand, the Court acknowledged, "an insurer may lawfully and individually conclude that the risks inherent in insuring a title to property conveyed by tax deed outweigh the potential benefit and decline to issue title insurance to purchasers of tax-deeded property."

In addition to the Cartwright Act, the Court found potential violation of the UCL by false advertising. Specifically, it was alleged that First American (and the other title companies) have undertaken marketing efforts "stressing to consumers the necessity of title insurance in a real estate transaction,"and that the title companies have "represented...that they would insure any and all real estate which had good title." Despite this advertising, and despite the (alleged) safety of doing so, defendant title companies refuse to insure after tax deeds.

This, the Court held, is sufficient to state a cause of action:

Next the Court considered plaintiffs' cause of action for interference with contractual relations. Despite the fact there was no allegation that First American intended to cause cancellation of plaintiffs' pending sale contract, the Court found the allegations sufficient, saying:

Finally, the Court considered plaintiffs' negligence claims and found them insufficient to state a cause of action. In so holding, the Court said there was no duty on the part of First American to make its business decisions based on their affect on the financial interests of others. There is no standard of care to be legally imposed on one making the decision of whether or not to enter into a contract.

Comment: So now the case is remanded for further proceedings and, possibly, trial. But here are some thoughts:

Even though plaintiffs have rescued their case from dismissal, proof-wise they still have a tough row to hoe. In fact, in a strong dissent to the decision above, Justice Brown accused the plaintiffs of filing a sham lawsuit which, she said, the Court should "put out of its misery."

First, title companies don't conspire to turn away business. We want business--and, with all due respect to the majority here, we have a good track record of underwriting titles and taking risks when appropriate.

Second, insuring after tax deeds remains extraordinarily risky. In fact, there are at least two horror stories involving tax sales in Claims Chronicles on the First American website ("Tax Sale Saga" from Reno, NV, and "The Opportunist" from Fort Washington, MD, come to mind). So who says we advertise willingness to insure out of tax sales???

Third, there may be internal inconsistency in saying on the one hand that insuring property acquired at tax sale is safe, while saying on the other that no one in their right mind would buy such a property without title insurance because of the very same risks and concerns which cause title companies to refuse to insure.

Anyway, another case to watch.

Questions, comments, argument? Just press the "reply" button....

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Following Wednesday's posting Keith Pearson (Glendale/L.A.) writes:

Aside from the implications of the Qualimane decision on everyday underwriting practices, the court contradicted itself in its own opinion. The court talks about the refusal of First American to issue a title insurance policy on a tax sale later in the opinion but on the fourth page of the opinion, when reciting the facts of the case, they state that "First American issued a commitment for title insurance on the property, but conditioned it on commencement of a quiet title action" while Stewart and Placer Title has refused to issue a policy.

This fact apparently constitutes a refusal to issue in the Supreme Court's eyes instead of what it really is, which is nothing more than a requirement to issue title (either that or the California Supreme Court didn't want something as insignificant as the facts to interfere with what they considered a really great opinion). This is especially incredible in light of Section 12340.11 of the Insurance Code which states that a commitment is a offer to issue a insurance policy.

Apparently we are not allowed to impose any conditions on our offers to issue title insurance policies in the California Supreme Court's opinion. The court seemed to think that our justification for requiring a quiet title suit could be brought up at trial, but never addressed the fact that a conditioned offer to issue is still a offer to issue and not a refusal.

Thankfully the lower court has this case again on remand and can do what it correctly did the first time, chuck it out in the trash where it belongs.

Reply: Thanks for pointing this out. By trying to understand this case by focusing on the facts we'll only confuse ourselves. Once Stewart and Placer Title are out of the picture it's a one-shot deal in which First American asks for a quiet title action--but instead we get sued. The case has to be seen against a long-standing policy we've adopted not to insure after tax deeds in some areas. Tax-sale opportunists have truly lobbied everyone from Don Kennedy on down to change this policy--without success. So when plaintiffs allege this case is about more than one (or three) deals, we have to agree.

On the other hand, in other areas other underwriters have agreed to insure after tax deeds--based on passage of time, use of land and/or local practice--and our experience has been OK. Read on.

Cathy LaMont (Troy/Detroit Commercial) writes:

I find it ironic that First American is the only remaining defendant in the Quelimane case since, in Michigan anyway, we are virtually the only underwriter willing to look at tax reverted parcels on a case by case basis.

In Michigan, our statutory scheme was held unconstitutional under the due process clause of our state Constitution. The statute was amended in accordance with the court's dicta of what a constitutional clause should look like but this amendment has never been approved by our Supreme Court, notwithstanding that the initial opinion and amendatory legislation were written in 1976. As a result, many title insurers have taken the opinion that it is not cost-effective to insure tax reverted parcels until the state Supreme Court has given its blessing to the current statute. Our statutory scheme is also a bit of a maze - some might call it incomprehensible - and I suspect many agents feel it is not worth working through all the various twists and turns to determine insurability, even assuming constitutionality.

We have been actively involved in various task forces looking at legislation to make the statute a little less burdensome and also, to address the concerns of title insurers as to the constitutionality of the act. One proposal is a particular favorite of mine: The idea is to create a fund to indemnify a title insurer for the costs of litigating a constitutional challenge. Fannie Mae has been working with us and is eager to put together a partnership of private entities who might fund such a venture. Hopefully, the need for the fund would dwindle once we achieve Supreme Court approval of our statutory scheme. Coupled with amendatory legislation making the statute easier to understand and follow, I think tax reverted parcels will no longer be the fearsome bottomless pits that they currently are. In Detroit, we have a huge inventory of tax reverted parcels and productive development is all but stopped cold because of the risks inherent in these lands.

I suspect we don't have the same environment that led to the Quelimane lawsuit particularly given our willingness to look at the facts of any specific tax reversion. In fact, it is specifically this approach that has gotten us some huge deals ($500,000,000 stadiums, major residential developments, etc.). Fortunately, in these transactions, we often have recourse to the condemnation laws for those parcels that are too risky to insure. I'm curious though, if any statutory schemes are sufficiently palatable to go forward with comfort on tax reverted parcels? What, if anything, has worked in other jurisdictions?

Reply: Good question...we do underwrite the tax deed issue on commericial properties. The stricter policy not to insure them prevails in areas where property values relatively low. El Dorado County--involved in the Quelimane case--is Gold Rush territory, very rural. Of course, if we started to insure tax-deeded lots in such areas without thinking about it, one owner would sell to another, and the next thing you know you've insured a Wal-Mart or a Burger King.

Paul Trefz (PA) writes:

In Pennsylvania, tax sale procedures are often similarly suspect as to statutory compliance; many title examiners (and the title companies/agents they represent/work for) take the intellectual shortcut and conclude that because some tax sales may be invalid, no title deriving from a tax sale is insurable. I'm sure the Land Sakes savants would agree that better practice is to actually examine each tax sale, and if it meets statutory and constitutional mustard, then put that hot dog in the bun and insure the title. Such individual case analysis could be a defense against these restraint of trade/conspiracy attacks.

Reply: I know I sound like a weinie, but in some of these rural areas where there are many tax-deeded vacant lots--and the local tax assessor's records are in shambles or missing, it just doesn't make sense for a title company to try to fix everyone's problem. I'm a customer-service person (I hope)--but we have to be productive and maintain service levels for all our customers, which can be tough when extraordinary demands are made on your time by speculators trying to buy low and sell high. Speculators who wouldn't offer a warranty deed worth a nickle--if it was on them.

But in the end, it's your call. If you can make it work within reasonable limits of title underwriting--then I agree it's absolutely what we should be doing. Or, if in your area there's some extraordinary opportunity--as Cathy LaMont reports there is throughout downtown Detroit--then definitely go after it and find some way to make it work. It's appropriate to our role as the industry leader--remember the EAGLE policy--but don't let's start on that today.

Robbie Dimon (Atlanta) writes:

What if we did not refuse to insure out of tax sales but required a quiet title action before insuring. Then we are not "conspiring" but are merely imposing a requirement before we would insure. I think it might make a difference to the courts. The public policy arguments on the other side are that the Counties want to maximize revenue and move properties off the tax rolls but cannot do that if tax sales are not insurable. We will insure them but you have to successfully conclude the quiet title action which then makes insuring the PIQ an acceptable risk.

Reply: I agree. If we can determine who all should be noticed then a quiet title action can make tax-deeded property insurable. As you can see (above) we did require a tax sale in the Quelimane case--but that case has its own dynamics. In most cases of doubt a quiet title action is a reasonable requirement.

And, Don Schenker (WI) writes:

In Wisconsin, First American, unlike some of our competitors, will insure some titles derived from tax deeds. Wisconsin has a 3 year statute of limitations for any party to bring an action to have a tax deed set aside. We invariably will require that anyone reselling within the 3 years convey by general warranty deed.

In many counties our agents do the title searches that the county clerks use to send out the notices before the county takes a tax deed. Wisconsin has a closed sale in which the county is the only purchaser of deliquent taxes.

Reply: And in Wisconsin our claims experience has been excellent--so our approach at insuring after tax deeds has proven to be reasonable.

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Following up on Tuesday's (or was it Wednesday's?) posting, Mike Berey (Manhattan) writes:

Tax sales in New York City have until recently been In Rem proceedings in which a judgment of foreclosure was entered after the purpoted service of notice with a deed issued by the Commissioner of Finance to the City of New York. The proceedings were (and are when the process is used) deemed conclusive and binding after two years from the date of the recording of the deed.

After the Mennonite case and similar holdings on the issue of notice in tax sales in New York, title companies in New York City were reluctant to insure even a bona fide purchaser from the City absent satisfactory proof of at least mailed notice on all parties in interest. In many instances they refused to insure.

In Rem notice procedures have since been improved, and after the passage of time and with written confirmation at closing that there has been no notice to redeem, the companies will generally (after reviewing certain other factors) insure even if there is a question of whether notice was mailed.

It was never alleged that the title insurers had an obligation to insure these titles. Hopefully, this theory will not prevail or at worst it will stay on the west coast.

Reply: I'm glad we aired this. Those of you who have replied have given the rest of us a great survey of current attitudes and practices. And I wouldn't worry much about Quelimane--the more I hear from you the more I think it's a freak situation unlikely to be repeated on your planet.