General Description

A title examination is a study of the records related to the ownership history of property and sometimes of other matters related to ownership interests in the property. A title report is a collection of public records relating to the ownership of a parcel of real estate. During the examination a title company reviews the applicable title information to determine who owns the lands, whether there are any defects in or claims against the ownership and whether any action is needed to make sure the purchaser obtains good record title to the property at closing.

Marketable title vs. Insurable Title and Permitted Exceptions

Marketable title means that the title (ownership) of a property is free and clear from defects in a manner that a prudent buyer would accept in the reasonable course of business. Essentially title is considered unmarketable if there are encumbrances on the land. The buyer can obtain marketable title to the property once all of the defects are identified and cleared prior to the closing. On the other hand, insurable title has or may have a known defect or defects in the chain of title but a title insurance company has agreed in advance to provide insurance against such defects. Marketable title is a much higher threshold to reach when compared to insurable title. A buyer would want to have its contract state that the seller has to deliver marketable title and a seller would want to have its contract state that the seller has to deliver insurable title. In New York the best approach is for both sides to agree to insurable title – if a reputable title company is willing to insure the risks, then the buyer is protected and the seller can transfer its property. Contract language that is fair to both parties typically reads as follows: Seller shall give and Purchaser shall accept such title as any reputable and licensed title company, doing business in New York State shall be willing to approve and insure, subject to only to the permitted exceptions more particularly set forth on Exhibit A. This language is broad enough that it protects both parties – if the buyer’s title company refuses to insure certain defects, the seller has the chance to find another reputable licensed title company who may be willing to insure the defects. An example list of permitted exceptions for Exhibit A is here. The list is blacklined to show the changes a buyer should always make to any list of permitted exceptions.

Municipal Searches and Violations in Title Reports

Not everything in a title report is a “title defect”. For example, municipal searches which often constitute a large portion of the pages of a title report (such as certificate of occupancy searches, open building permits, housing, building and fire violations) are not true title defects – they are not matters for which a title company will provide insurance. Those parts of a title report are provided “for information purposes only” – in other words, information that the buyer (and the buyer’s lender) should consider when purchasing the property. This means that a title company can issue a buyer a “clean” policy at a closing yet the property could be still subject to tens of thousands of dollars in violations or the property could have several open building permits that will involve significant time and costs to have closed. There are two driving forces behind what will be done with the results of these “for your information” searches: (1) the buyer’s lender; and (2) the contract between the parties. If there is a lender on the deal, the lender will require the non-title defect issues to be addressed, i.e. all open building permits to be closed, violations to be paid etc. Then the buyer should have appropriate language in the contract requiring the seller to address these issues (i.e. pay all violations, close open building permits, obtain the correct certificate of occupancy for the current use etc.). The key thing to understand here is that in an all-cash deal with no lender, as long as the title company is willing to deliver a title policy subject only to the permitted exceptions, if the buyer does not have appropriate protective language, the buyer could be forced to close and accept the property with all of the problems that, unfortunately, were listed as “for information purposes only.” It should be noted there are occasions when violations can become title defects– this happens when a violation has remained unpaid for long enough or is a large enough monetary violation that the municipality converts it into a judgment – at that point the violation becomes a lien and therefore a title defect. In this case in order for the seller to deliver “clean” title at the closing the seller must prove to the title company that the lien has been paid off or alternatively the seller must put up enough money in escrow.

What to look for in a Title Report:

Schedule A

Verify that title is vested in the exact same entity as the seller in the contract.
Verify legal and physical address of the property.
Confirm the date of the title report and whether an update is needed.
Determine the type of policy – Owner’s Policy for buyer and Lender’s Policy for bank.
Confirm that the policy amount is equal to the purchase price.

Legal Description

Review the vesting deed into the seller – confirm the block, lot and section and make sure the deed does not reference any specific covenants and restrictions.
Confirm that the metes and bounds description in the vesting deed is the same as Schedule A in the title report.
Compare the metes and bounds in the legal description to the survey and make sure they exactly match (down to the inch).

Schedule B

If there are existing mortgages review the mortgage schedule to understand who the lenders are and the total borrowed by seller; if the title company has identified any defects in the mortgage schedule quickly bring it to the sellers’ attention.
Confirm whether there are liens other than mortgages recorded against the property – mortgage liens are typical and banks have quick procedures in place to issue payoff letters – however any other lien may involve complicated steps to terminate so they should be quickly brought to sellers’ attention. For example, a judgment arising out of litigation will involve the seller having to negotiate with plaintiff’s attorney to have an original warrant of satisfaction delivered to the closing; or if there is a tax lien or tax sale certificates the seller will have to reach out to the municipality for the tax lien or to the purchasers of the tax sale to have them removed at the closing. These types of liens will take time and effort for the seller to get removed so do not leave them until just before the closing.
Confirm that the property has legal and physical access to a public road – ALTA policies insure only legal access not physical access; however legal and physical access at specified location may be insured by endorsement.
Carefully review any covenants and restrictions of record to make sure they do not prevent the buyer’s intended use or development of the property.
Carefully review any easements and have them plotted on the survey to make sure: (a) they do not interfere with the current improvements (e.g., under buildings); (b) they do not prevent the buyer’s intended use or development of the property; and (c) that the buyer is aware of any obligations it will take on once it owns the property (e.g. driveway easements).

Municipal Searches

Unless violations are converted to judgments and recorded against the property they are not title defects that are insured by the title company – carefully review all open violations and obtain a payoff letter from the title company.
Open violations are a good indicator of how the seller has cared for the condition of the building – carefully review the type and reason for the violations (i.e. not just the amount of the penalty) to make sure there are no major building issues.
Review Certificate of Occupancy Search to confirm that the building has a valid CO for the use represented by the seller; make sure that each tenant has a valid CO for its use.
Review both open and closed building permits to understand what the work has been done to the building – have the seller either close out open permits for work that will not be completed or obtain valid certificates of occupancy for the completed work.
Confirm the amount of real estate taxes paid or open and at the closing make sure seller pays for any late fees and penalties.

Contract Protections

Contract Protections for the Seller

Limit amount of money that the Seller is required to spend in order to fix title issues or pay/fix open violations (“Seller’s Maximum Expense”). If the cost to fix the problem is greater than the Seller’s Maximum Expense, then either: (a) the seller can terminate the contract or (b) the buyer can decide to take the property subject to the title defect or subject to the open violations with a credit only equal to Seller’s Maximum Expense.
Limit Seller’s responsibility for violations to monetary only – i.e. seller will pay for the penalties and interest for all open violations, but will not be obligated to actually fix the underlying physical issue with the building or property.
Obtain seller’s existing title policy and include the Schedule B in the list of permitted exceptions.

Contract Protections for the Buyer

Do not accept language that the buyer must provide written notification to seller of its objections to title – instead include language that buyer’s (or the title company’s) delivery of the title report to seller constitutes buyer’s objection of all items therein.
Negotiate a reasonable number for Seller’s Maximum Expense (for example 5 to 10% of the purchase price). Buyer’s attorney’s often give in too easily on this issue – it is especially important if the contract states that Seller only has to give the buyer a credit equal to the Maximum Expense – Seller will inform Buyer that it is terminating the contract and the buyer will be forced to either walk away from the deal or acquire a property with a title defect or open violations that will cost much more to fix than the credit.
Include contract language as to how the parties will agree on the estimated cost to fix a title defect or the total amount of open violations – for example, a private third party company’s report is binding on both parties.
Carefully modify and narrow permitted exceptions in the Contract, do not accept any broad descriptions. A fair list of permitted exceptions for both seller and buyer is here. The list is blacklined to show the changes a buyer should always make to any list of permitted exceptions.
Include a seller representation as to the current use of the property (i.e. four (4) residential units and one (1) commercial unit; retail etc.)
Require delivery of a valid certificate of occupancy as a condition to buyer’s obligation to close.
Require closure of all open building permits as a condition to buyer’s obligation to close.
Have seller represent that it is not aware of any pending litigation or pending foreclosure proceedings as depending on the state of those actions they may not yet show up on the title report.

Buyer Tips

Order a title search, ideally before entering into the contract – a good practice is to order the title report at the time that a non-binding term sheet is fully executed or during contract negotiations.
Order a detailed violations search, ideally before entering into the contract – a good practice is to order the violations search at the time that a non-binding term sheet is fully executed or during contract negotiations – request that your title company provide not only a list of open violations but a payoff letter showing the total amount due for the property.
Review the title report and municipal searches as soon as possible after they are received. Do not wait until just before the closing to review the searches.
Include appurtenant easements in the legal description that benefit the property and try to get the title company to provide affirmative insurance.
As soon as a lender’s attorney is assigned to the deal request a copy of the lender’s title search requirements including required endorsements to the lender’s policy – a typical title report and municipal search may not automatically include all of the searches that a bank attorney may want – requesting those searches late in the game can delay the closing.
If buyer is obtaining financing, make sure that the lender’s attorney receives a copy of the title report as early as possible and is copied on all title updates – when a buyer is getting a loan the lender is in the driver seat with respect to title defects and open municipal issues.
Hold money back from the seller at closing in escrow to fix identified problems that can’t be done by closing – use a carefully drafted escrow agreement with narrowly defined conditions for release of the escrow.
Obtain “affirmative insurance” from the title company that easements, restrictions, and covenants are not violated by the existing improvements or that existing improvements can remain as they currently stand.
Have seller promise to assist buyer with making all necessary municipal searches, including providing written authorization if necessary.
Request the title company provide a “proforma” policy prior to closing.

In the Concrete Jungle

In New York City most building have open violations. It is good practice to review the NYC Department of Buildings website and ACRIS before entering into any contract. Municipal violations in the Concrete Jungle can amount to hundreds of thousands of dollars – the open violations are not often title defects and so they will not be insured under a title policy. It is therefore very important that the contract spell out in detail the parties agreement as to municipal violations. In commercial deals in NYC the seller will typically agree to only pay for the actual dollar amount of violations on record, but not actually fix the physical problem (i.e. the seller will pay for the $1,000 open violation for a faulty exit sign, but will not actually fix the exit sign) – a buyer of property in NYC should carefully decide whether or not to accept this concept, especially in light of the buyer’s intended use of the building.

Good Resources

Disclaimer

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Part 3: Title Insurance Due Diligence In Commercial Real Estate