ASSURING MARKETABILITY OF TITLE

ASSURING MARKETABILITY OF TITLE

Casual reflection on the nature of title to real property and its use and transfer must lead to the conclusion that
establishing marketable title is often a complex and difficult undertaking. The term itself has no universally
accepted meaning. It does not mean a perfect title, but rather one that is free from plausible or reasonable
objections. In effect, the title is marketable (or merchantable) if there is reasonable assurance as to the extent of
the rights involved. The title must be such that a proper court would compel the buyer to accept it, if asked to
decree specific performance of the purchase and sale contract/agreement.

Establishing a marketable title is especially important whenever land/property is transferred for consideration,
and when, in connection with such transfer or otherwise, money is loaned with land as security. The
prospective buyer or lender would be reluctant to commit funds to the transaction without some assurance of

getting what was bargained for. Buyers of real property expect some assurance that there are no hidden interests
in the real property they propose to buy.

For example: One uses the surface, another extracts subsurface minerals, and a third controls the air space
above the surface. Interests in land/real property may be divided, distributed, and distinguished in many
different manners or ways. This occurs since much land/property is of comparatively high value, especially in
urban areas where the growth and concentration of population have placed a premium on such parcels.
Consequently, the land/property has been divided, subdivided and recombined into a patchwork measured in
feet and sometimes even in inches.

Since the persons who own or deal with land/property are themselves subject to a variety of laws which
determine the extent of their rights (e.g., probate, dissolution, guardianship, bankruptcy, business association
laws, among others), an understanding of how these laws affect ownership rights is necessary. Since creditors
and others may burden the real property with a variety of liens and encumbrances, an understanding of how
applicable law affects the rights of mortgagees and mortgagors (beneficiaries and trustors) and creditors and
debtors is also essential.

Who owns what? The issue is one of determining all the important facts with reference to who owns what
interests or rights in the title to a particular parcel of land. Actual possession of the land/property has always
been important and helpful in providing the answer. But possession may be by someone other than the owner,
and transfers may be made without taking possession. Hence, the documentary record of ownership in the
county recorder’s office of the county in which the parcel is located assumes great significance. Reliance on
recorded documents is encouraged by the official recording system under which deeds and other instruments
affecting title may be recorded with the recorder of the county in which the land/property is situated.

Thus, a “chain of paper title” could be traced back to the original conveyance from the government. However,
recordation is not generally compulsory, although there are fact situations were it is required. The “Race
Recording” or “Race-Notice Recording” systems were created to accomplish a “chain of paper title” and to
establish the priority of recorded instruments/documents. However, the record of the “chain of paper title” is
not always properly achieved or maintained. Records may be erroneous, or sometimes may even reflect
fraudulent and unenforceable transactions. When done thoroughly and conscientiously, the resulting records
over the years become a complicated history in themselves, yet they may be woefully incomplete for purposes
of determining the status of the title in question. This is so for a variety of reasons.

For example: In an intestate transfer, a qualified heir might have inadvertently been excluded; or a transfer,
valid on its face may have been made by a person incompetent because of age or mental condition. Then too,
other official records (e.g., tax records and records of court judgments) may profoundly affect the picture. In
short, title to land/property and marketability of that title depends not only on recorded facts of title transfer, but
also on a vast array of extraneous information outside of the documents recorded in the county recorder’s
office.

Abstract of Title

As might be expected under such complex circumstances, historically the individual buyer or lender was ill
equipped to make the necessary investigation of the status of the title to property. They soon came to rely on the
title specialist who made a business of studying the records and preparing summaries or abstracts of title of all
pertinent documents discovered in the search. An abstract of title is a summary statement of the successive
conveyances and other facts (appearing in the proper place in the public records) on which a person’s title to
real property rests. The abstract of title and a lawyer’s opinion of the documents appearing in the abstractor’s
“chain of title” were the basis of our earliest attempts to establish marketable title. This method still exists
today, with modern refinements.

Certificate of Title

In time, abstractors accumulated extensive files of abstracts and other useful data, including “lot books”
wherein references to recorded documents were systematically arranged according to the particular property
affected, and “general indices” wherein landowners were listed alphabetically together with information
concerning them and affecting titles (e.g., probates and property settlements).

These files came to be known as “title plants” and provided classified and summarized histories of real estate
transactions and of other activities that affect or might affect ownership of the land/property in the areas

covered. With the growth and improvement of title plants and increased proficiency of examiners employed by
the abstractors, the formal abstract of title for delivery to the customer and the related legal opinion were
sometimes dispensed with completely. The abstract company would simply study its records and furnish the
customer with a certificate of title in which it stated that it found the title properly vested in the present owner,
subject to noted encumbrances. The certificate plan has strictly limited use today, for it was a transitional
method of assuring not insuring titles.

Guarantee of Title

The next step was the guarantee of title under which the title insurance company did more than certify the
correctness of its research and examination.

Thus, the company provided written assurances (not insurance) about the title to real property. The coverage
was usually limited to a particular condition of title, a certain period of time, and a certain kind of information.
This meant it was engaged in the insurance business and generally was subject to regulation as such.

Title Insurance

As already noted, the public records may be incomplete or erroneous and do not necessarily disclose
shortcomings arising from forgery, incompetence, and failures to comply with legal requirements, among
others. Accordingly, the policy of title insurance was developed as the culmination of the quest for a reliable
and marketable title as well as compensation for incorrect assurances that cause a covered loss. Although still
covering most risks that are a matter of public record, it alone extends protection against many nonrecorded
types of risks, depending on the type of policy purchased. The title insurance company continues to utilize the
“title plant” to conduct as accurate a search of the records as possible and seeks to interpret correctly what it
finds in the records. Its unique contribution is the protection it affords against risks that lie outside the public
records.

Preliminary report. In current practice, the title insurance industry typically issues a “preliminary report”
rather than a “search” or “abstract” that are intended to assure the status of title and for which there would be
liability, as defined in the document issued as a “search” or “abstract”. The Insurance Code defines
“preliminary report” as a “commitment” or “binder” furnished in connection with an application for title
insurance and such reports are offers to issue a title policy subject to the stated exceptions set forth therein and
such other matters as may be incorporated by reference. Preliminary reports are not abstracts of title, nor are
any of the rights, duties, or responsibilities applicable to the preparation and issuance of an abstract of title
applicable to the issuance of such reports. Preliminary reports are not to be construed as nor constitute a
representation as to the condition of title to real property (a “search” of the title). Preliminary reports are a
statement of the terms and conditions upon which the issuer is willing to issue its title policy, if such offer is
accepted. See Insurance Code Section 1234.11.

Standard policy. In addition to risks of record, the standard policy of title insurance protects against:

• off-record hazards such as forgery, impersonation, or lack of capacity of a party to any transaction
involving title to the land (e.g., a deed of an incompetent or an agent whose authority has terminated, or of
a corporation whose charter has expired);

• the possibility that a deed of record was not in fact delivered with intent to convey title (typically excluding
a fraudulent conveyance);

• the loss which might arise from the lien of federal estate taxes, which is effective without notice upon
death; and

• the expense, including attorneys’ fees, incurred in defending the title, whether the plaintiff prevails or not.

The standard policy of title insurance does not however protect the policyholder against defects in the title
known to the holder or to the agent of the holder to exist at the date of the policy and not previously disclosed
to the insurance company. Further, the standard policy neither protects against easements and liens which are
not shown by the public records; nor against rights or claims of persons in physical possession of the
land/property, yet which are not shown by the public records (since the insurer typically does not inspect the
property when offering such coverage); nor against rights or claims not shown in public records, yet which
could be ascertained by physical inspection of the land/property, or by appropriate inquiry of persons on the

land/property, or by a correct survey; nor against mining claims, reservations in patents, or water rights; nor
against zoning ordinances.

These limitations may not be as dangerous as they might appear to be. To a considerable degree, the limitations
can or may be eliminated by careful inspection of the land/property by the purchaser/buyer or his or her agents
(e.g., brokers/appraisers) and a routine inquiry as to the status of persons in possession. However, if desired,
most of these risks can be covered by special endorsement or use of extended coverage policies at added
premium cost.

ALTA Policy (for lenders). In California, many loans secured by real property have been made by out-of-state
financial institutions/licensed lenders that were not in a position to make personal inspection of the properties
involved except at disproportionate expense. For them and other nonresident lenders, the special ALTA
(American Land Title Association) Policy was developed. This policy expands the risks normally insured
against to include: rights of parties in physical possession, including tenants and buyers under unrecorded
instruments; reservations in patents; and, most importantly, unmarketable title. The new ALTA Loan Policy
(issued 10-17-92 and further revised 6-17-2006) also covers recorded notices of enforcement of excluded
matters (like zoning), as well as recorded notices of defects, liens or encumbrances affecting title that result
from a violation of matters excluded from policy coverage. A review by knowledgeable legal counsel of the
provisions of ALTA Loan Policies is recommended before purchasing coverage, including specific
endorsements.

Extended coverage. The American Land Title Association has adopted an owner’s extended coverage policy
(designated as ALTA Owner’s Policy [10-17-92]) that provides to buyers or owners much the same protection
that the ALTA policy gives lenders. The owner’s policy has been recently revised and the coverage expanded.
The California Land Title Association (“CLTA”) has also provided expanded protection for the owner’s
policies it issues under standard coverage.

However, reliance on the owner’s or the owner’s agent notice or knowledge of defects affecting the title and
not of record has also been expanded and enhanced. These policies offer no protection against defects or other
matters concerning the title that are known to exist by the insured (the owner or the agents of the owner) as of
the date of the policy that have not previously been communicated in writing to the insurer. These policies also
offer no protection regarding governmental regulations concerning occupancy and use. The former limitation is
self-explanatory; the latter exists because zoning regulations concern the condition of the land/property rather
than the condition of title.

For homeowner’s (1 to 4 residential units) a new CLTA/ALTA policy was developed in 1998; (ALTA
Homeowner’s Policy (10-17-98), and CLTA Homeowners Policy (6-2-98). As previously mentioned, these
polices have been revised again. Generally, the policies are the same with the exception: the CLTA policy
provides a form of Subdivision Map coverage, while the ALTA policy makes the Map Act coverage optional.
The idea of the new and revised policies is to provide homeowners with a form of extended coverage. The new
and revised policies contain maximums payable under certain categories of coverage and small deductibles
payable by the insured. Both policies incorporate protection against certain risks that conventionally were
available only to lenders and only by endorsement.

Domestic Title Insurance Companies in California

Section 12359 of the Insurance Code of California requires that a title insurance company organized under the
laws of this State have at least $500,000 paid-in capital represented by shares of stock. Section 12350 requires
that the insurer deposit with the Insurance Commissioner a “guarantee fund” of $100,000 in cash or approved
securities to secure protection for title insurance policy holders. A title insurer must also set apart annually, as a
title insurance surplus fund, a sum equal to 10 percent of its premiums collected during the year until this fund
equals the lesser of 25 percent of the paid-in capital of the company or $1,000,000. This fund acts as further
security to the holders and beneficiaries of policies of title insurance.

Policies of title insurance are now almost universally used in California, largely in the standardized forms
prepared by the California Land Title Association (“CLTA”), the trade organization of the title companies in
this State. Every title insurer must adopt and make available to the public a schedule of fees and charges for
title policies. Today, it is the general practice in California for buyers, sellers and lenders, as well as the

attorneys and real estate brokers who serve them, to rely on title insurance companies for title information, title
reports and policies of title insurance.

Rebate Law

Title insurance companies are required to charge for preliminary reports under the terms of legislation adopted
at the 1967 general session of the California Legislature. The rebate law requires title insurance companies to
not only charge for reports, but also to make sincere efforts to collect for them except in certain defined
circumstances.

Title insurance companies can still furnish “the name of the owner of record and the record description of any
parcel or real property” without charge. Such information may be referred to as a “property profile” or “subject
property history”.

The statute extends the anti-commission provisions of Section 12404 of the Insurance Code to prohibit direct or
indirect payments by a title insurance company to principals in a transaction as a consideration for title
business.

Thus, the law prohibits a title insurance company from paying, either directly or indirectly, any commission,
rebate, or other consideration as an inducement for or as compensation on any title insurance business, escrow
or other title business in connection with which a title policy is issued. Rebates are also precluded in the Real
Estate Law, as defined.

See Business and Professions Code Section 10177.4.

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