Client Alert

Contact:
Arnold D. Litt, Esq., Chairperson
Real Estate Law Group
201-498-8520

Case: Dennis M. Sammarone vs.
James J. Bovino, et als.
Docket No.: A-6287-05T1
Decided July 23, 2007

SUPREME COURT RULES TRANSFER OF TITLE
FROM OWNER TO A RELATED ENTITY
TERMINATES TITLE INSURANCE COVERAGE

Dear Clients and Friends:

On June 5, 2008,in the case of Shotmeyer, et al v. New Jersey Realty Title Insurance Company, the Supreme Court of New Jersey reversed the Appellate Division (Supreme Court, A-125 Sept. Term 2006, decided June 5, 2008) agreeing with the trial court, that title insurance coverage provided by a policy terminated upon the transfer of title, notwithstanding the fact that the new entity had the same composition of membership as its predecessor.

The facts of the case are simply stated as follows:

Through a general partnership controlled by them, Shotmeyer, et al purchased a tract of land (the "property") in 1981 which was transferred to a new entity, a limited partnership also controlled by Shotmeyer, as part of an estate-planning program in 1991 and 1992. In 2001, Shotmeyer discovered the property was smaller than believed and filed a claim with the title company that insured the 1981 purchase. The title company declined coverage on the basis that the real party in interest, the insured, had transferred title, and therefore there were no further obligations on the part of the title company to provide coverage. The trial court agreed with the title company, but upon appeal, the Appellate Division reversed. The Appellate Division found that the Shotmeyers had never transferred their "beneficial interest" in the land and that both the general and limited partnerships were merely alter egos of the Shotmeyers. The Supreme Court noted that the limited partnership entity shielded the individual partners from personal liability as contrasted with the general partnership in which the general partners were personally liable. The Court also found significant the fact that the general partnership entity remained with respect to its business operations. It only conveyed the real estate in question to the limited partnership. The Court found "that this fact carries weight in analyzing whether the policy continues to offer coverage".

Unfortunately for the Shotmeyers, what started out as an estate planning tool, the conveyance to a limited partnership, resulted in the release of the title insurance company from any obligation to insure title relative to the successor entity. Its claim against the title company, therefore, was denied.

In this day and age when income taxes are substantial and ever-increasing, estate planning techniques are extremely important in attempting to preserve wealth and assets. Moreover, other tax deferral techniques such as Section 1031 tax free exchanges have enabled property owners to avoid the payment of taxes in a properly qualifying 1031 Exchange. However, these techniques in many instances have required transitioning of existing entities to new entities in order to maximize the estate planning and 1031 tax saving opportunities. As the Supreme Court has now held, this may jeopardize existing title insurance coverage, thereby relieving title companies of their title coverage obligations in the event of post-closing claims.

However, there are mechanisms including title insurance endorsements that can be procured that will prevent termination of coverage in the event of subsequent transfer of title:

  • As pointed out by the Supreme Court, a transfer by way of a warranty deed as opposed to a bargain and sale deed with covenant against grantor's acts will result in continuing coverage for the benefit of the insured. That is the case because with a warranty deed the grantor is warranting title to subsequent purchasers. This is contrasted with a bargain and sale deed in which the grantor only represents that it has not created a title defect. In the context of a warranty deed, the title policy coverage continues notwithstanding the transfer to another entity because the grantor remains liable for a breach of any covenants. However, in Shotmeyer the deed of conveyance was a bargain and sale deed. The Court noted that "the defect in title existed before the general partnership purchased the land", so the covenant in the bargain and sale deed did not control, since the grantor did not create the title defect. Simply stated, a warranty deed will protect against title insurance termination upon transfer to another entity. However, this exposes the grantor to continual liability to subsequent purchasers for title defects. Thus, one has to weigh possible liability exposure with the possible termination of title insurance.

  • For policies issued before 2007, there is an endorsement know as Successors and Transferees Coverage Endorsement ("S&TCE"), which expands the definition of insured to include related entity transferees for nominal consideration and has the effect of continuing coverage in favor of certain grantees who acquire title at a point in time after the policy is issued. The endorsement may be obtained at the time the policy is issued or at a subsequent date. The cost is 20% of the original premium if issued after closing and 10% of the original premium if issued simultaneously with the policy.

  • The new ALTA Owner's Policy (2006) expands the definition of insured to include certain related entity transferees, including the following:  

    1. successor to the title of the insured by operation of law as distinguished from purchase, including heirs, devisees, survivors, personal representatives, or next of kin;

    2.  successors to an insured by dissolution, merger, consolidation, distribution, or reorganization;

    3.  successors to an insured by its conversion to another kind of entity;

    4.  a grantee of an insured under a deed delivered without payment of actual valuable consideration conveying the title.

      1. if the stock, shares, memberships, or other equity interests of the grantee are wholly owned by the named insured,


      2.  if the grantee wholly owns the named insured,

      3.  if the grantee is wholly-owned by an affiliated entity of the named insured, provided the affiliated entity and the named insured are both wholly-owned by the same person or entity, or

      4.  if the grantee is a trustee or beneficiary of a trust created by a written instrument established by the insured named in Schedule A of that title policy for estate planning purposes.

  • The "Fairway" Endorsement. This endorsement is named after the Court's holding in Fairway Development Co. vs. Title Ins. Co. of Minn., 621F. Supp. 120 (N.D. Ohio 1985) (Court holding that a successor partnership had no insurable interest under title insurance policy with respect to an alleged defect in title to the property where two partners in an existing general partnership transferred their interest to the remaining partner who, in turn, entered into a new partnership bearing the same partnership name and where the original partnership was dissolved). If a Fairway Endorsement is in place, a general partnership or LLC is protected against lapse of title insurance coverage resulting from a change in the membership of the partnership or LLC, or from any resulting dissolution. Some title companies may insert strict limitations in the Fairway Endorsement that may vary from case-to-case and must be read closely by the insured. The cost is approximately $50.00 and the endorsement issues simultaneously with the title policy.

In conclusion, it is extremely important that sellers and buyers of real estate retain competent real estate counsel to analyze for them any potential pit falls of a discontinuation of title insurance based upon their post-closing conveyance plans, so as to provide them with the best continuity of coverage available.

In the meanwhile, let us hope that the New Jersey State Legislature will intervene to cure some of the potential inequities that may have arisen in connection with transfers for nominal consideration in the context of estate planning and tax free exchanges.

Should you have any questions with regard to the above in general or as specifically applied to your particular situation, please feel free to contact Arnold D. Litt, Esq. at 201-498-8520 (direct line), or via e-mail at Alitt@hertenburstein.com or Susan M. Marra, Esq. at 201-498-8521 (direct line) or via e-mail at Smarra@hertenburstein.com.