The Fortuity Doctrine

            This is a bit complicated. But follow along until you see the words “The Fortuity Doctrine.” Доверяй, но проверяй.

Kernell and Stanley Thaw were married in 2001. In 2002 Stan Thaw and Leslie Schachar began operating a business together. When the business failed, Schachar paid business debts that were guaranteed by both Stanley and Schachar.

            Schachar sued Stanley in 2008 to recover Stanley’s share of the debt.

 

            While the lawsuit was pending, the Thaws contracted to purchase a home in Frisco Texas. In 2009 Schachar obtained a final judgment against Stanley, and Stanley appealed.

 

            While the appeal was in process, Schachar recorded an Abstract of Judgment in Collin County before any Deeds to the new home were recorded. Kernell and Stanley Thaw moved into their new home in 2010.

            In 2011 the Thaws paid off the mortgage debt and only then recorded a Deed in a transaction insured by Fidelity National Title. One month later the Texas Court of Appeals affirmed Schachar’s judgment, so Stanley countered by filing a bankruptcy petition near the end of 2011.

            Schachar filed a proof of claim in the bankruptcy for a $400,000 secured interest in the Frisco property. The bankruptcy court held that both the claim and lien were valid, finding that Schachar had recorded his Abstract of Judgment lien before the Thaws had made their new Frisco property their Texas homestead.

            As a consequence, when the Frisco property was sold in 2013 the Schachar lien attached to the net proceeds of the sale, approximately $500,000.

            In 2014 the bankruptcy Trustee as well as Stanley and Kernell Thaw made demand upon Fidelity for insurance benefits, as the title insurance policy insured title without exclusion for Schachar’s judgment. In 2016 the bankruptcy court approved a settlement in which Schachar received $444,000 from the net proceeds of the sale, in full satisfaction of his claim.

At that juncture the Trustee and Kernell Thaw determined they could recover the amount paid to Schachar from their title insurance carrier. As you likely guessed, Fidelity Title resisted and refused to pay.

            So Kernell and the Trustee sued Fidelity Title, arguing that Fidelity had breached its Policy by denying the claim. The bankruptcy court reviewed the policy and these unique facts, and issued an Order that coverage under Fidelity’s insurance policy was barred. The reasoning was partly due to application of the “Fortuity Doctrine.”

            The Trustee and Kernell Thaw appealed the bankruptcy court’s Order.

            The Fortuity Doctrine relieves insurers from covering some behaviors that the insured undertook prior to purchasing the insurance policy. Under this doctrine, the insured cannot obtain coverage for losses of which the insured had knowledge when the policy was bought, but failed to disclose to the insurance carrier.

            Kernell claimed that she had no actual knowledge that Schachar had recorded an Abstract of Judgment lien and further – she would not have understood the effect of such a filing if she had known of it.

            Evidently the Fortuity Doctrine covers this event, as it precludes insurance coverage when the insured is or should be aware of a known loss at the time the policy is purchased. Not understanding the legalities or process is not a great defense.

            The Court rationalized that even if Kernell had no knowledge of the recordation of the Abstract of Judgment, she knew or should have been aware that her husband’s failure to pay his debts resulted in a Judgment against him in 2009. And that due to appeals, the Judgment was uncollected at the time the Thaws purchased the Frisco property. And that the Judgment remained unpaid when the Thaws paid off the mortgage debt and purchased the title insurance policy in 2011.

            The Court reasoned that was a “loss in progress” and for that reason, Fidelity Title is not responsible for the claims asserted by Kernell Thaw and the Trustee.

            Fidelity Title wins; Kernell Thaw and the Trustee lose. See Christopher Moser and Kernell Thaw v. Fidelity National Title Insurance Company; US District Court; Eastern District of Texas; Case 4:17-CV-104; March 21, 2018; https://www.leagle.com/decision/infdco20180322h25

            Lessons Learned / Questions Asked:

1.      Now I know what the Fortuity Doctrine is!

2.      Insurance companies have abilities to defend that many of us (meaning: me) could never contemplate. This is one among many.

3.      This is my 99^th blog posting over a period of almost 10 years. Shouldn’t I get a watch, pen, or tuna sandwich? I mean, for the love of Pete it’s been fun but 99 blogs, really?

                                                                                                                            Stuart A. Lautin, Esq.*

 

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

Texas Board of Legal Specialization

 

Licensed in the States of Texas and New York

 

Reprinted with the permission of the North Texas Commercial Association of REALTORS®, Inc.

 

 

*

Doctrine of Merger

In the late 1980s Joseph and Genevieve Roche starting work on the Roche Family Winery outside the City of Sonoma on Highway 121. By 2005 the winery went bust, and the property was offered for sale.

On November 15, 2006, Ram’s Gate Winery LLC entered into a contract to buy the winery property. The Roches agreed to provide a full disclosure of all information known to them regarding the property condition within 10 days.

Ram’s Gate evidently approved the condition of the property, and the deal closed on December 14, 2006. Four years later Ram’s Gate sued the Roches and the brokers involved in the purchase, alleging that the Roches failed to provide information within their possession relating to earthquake issues.

Ram’s Gate alleges it learned in mid-2007 about an active fault line on the property, which had been documented in two reports available to the Roches, being a site plan prepared in 1987-1988 and a geological study of 1987. Both identified a fault trace on the land, which required the Roches to relocate the winery building to provide a 50-foot setback.

The Roches contend that Ram’s Gate either knew or should have known about the earthquake issues before closing, as the two reports were in the Sonoma County files.

The Roches filed a Motion for Summary Judgment, claiming that since the Purchase Agreement did not specifically provide that the warranty relating to disclosures would survive closing, those obligations “merged” into the deed and could not properly be the subject of a claim.

On March 1, 2013 the court granted the Roches’ Motion for Summary Judgment, stating that the representations and warranties made in the agreement are extinguished as of the closing date, unless the Contract specifically stated they would survive. Ram’s Gate appealed.

This Federal Appellate Court started by focusing on the intent of the parties. In doing so, the Court determined that the contractual terms were inconsistent with the Deed. And that the Deed was “. . . a rather pedestrian instrument addressing only ‘the mechanics of transferring title’ and containing a legal description of the property conveyed.”

From there, the Court analyzed the balance of the Contract. As in most commercial contracts, the Court found that some portions of the Contract specifically provided for post-closing survival, while many others were silent. However, from there the Court concluded that the fact that several paragraphs in the Contract provided for survival does not mean that no other provision could survive without a similar recital.

Although a basic legal doctrine of “merger” states that those matters excluded from the Deed and not continued within a “survival” recital in the Purchase Agreement are forever extinguished, this Appellate Court rejected the concept of integration. Instead, this Court concurred with Ram’s Gate that the Roches should have disclosed the existence of fault trace lines within the buyer’s due diligence period. The Roches could not now escape that obligation by using the “Doctrine of Merger” inherent in all commercial real estate closings.

See Ram’s Gate Winery, LLC v. Joseph G. Roche; Nos. A139189 and A141090; US Court of Appeals, 1^st Circuit, Division 4; April 9, 2015.

Lessons learned:

1.      I’ve been doing this a long time. A really long time. I was pretty sure I knew the doctrines of merger and integration, particularly as applied to commercial real estate. Maybe this is a rogue opinion (it’s from California after all), but still.

2.      And yet there’s another way to look at this that makes sense. Forget integration and merger. Instead, focus on the issues created where the Seller (could also be a Landlord) fails to disclose material conditions to the Buyer / Tenant in the period of time before the Buyer / Tenant becomes committed to do the deal. In that context, this outcome is logical.

3.      Practice Point: Disclose more, not less. Keep written records of your disclosures. Don’t assume that the buyer / tenant had knowledge of a defect or condition, and factored that into the decision to close or go forward with the deal, unless you furnished that intel to the buyer / tenant.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Jackin' with Effective Dates

Pursuant to a Lease of September 3, 2004, Sidney Wicks leased various commercial properties in Addison Texas to Transcontinental Realty Investors. On May 17, 2006, Sidney formed the Sidney Wicks Revocable Trust and assigned all of his properties to the Trust. The assignment was not made in the traditional form of Deed, but rather in a more general form of “Assignment and Declaration,” which presumably was not recorded with the Dallas County Clerk.

TRI began making rental payments to the Trust on receipt of the Assignment and Declaration.

On December 2, 2010, Sidney filed a lawsuit against TRI for breach of the Lease, then later amended it to substitute the Trust as the Plaintiff instead of Sidney. TRI answered the lawsuit by contending that the Trust lacked standing to assert claims, stating that Sidney should have been the correct party – not his Trust – as Sidney failed to convey his property interests by Deed.

TRI’s point was that the 2006 Assignment and Declaration is not effective in Texas to transfer ownership in real estate. Only Deeds in Texas would suffice for that purpose. And, if the Assignment and Declaration is ineffective, then the Trust lacked standing or capacity to sue TRI as only Sidney would have that right.

On July 1, 2011, the trial court granted the Trust’s Motion for Judgment, finding that there were no material issues of fact in controversy, and that the Trust was entitled to Judgment by operation of Texas law.

The trial court did not deal with damages though, and reserved that issue for a jury trial to be conducted more than one year later.

On September 6, 2011, Sidney executed and recorded a General Warranty Deed which transferred his real estate to the Trust. On the same date Sidney also executed an “Assignment and Assumption of Lease.” Both the Assignment and the Deed stated that although the documents were signed on September 6, 2011, they each had an “effective date” of May 17, 2006. Over five years prior to the date that each was executed and the Deed recorded.

Having already won Round One, the issue of damages owed by TRI to the Trust proceeded to a jury trial. In October 2012 the jury determined in Round Two that TRI owed the Trust $1 million plus interest, attorney’s fees and expenses.

The trial court converted the jury’s award to Final Judgment. TRI appealed.

TRI again claimed that the Trust lacked standing in Court. That Sidney failed to timely sign and record a Deed to the Trust. That using an artificial “effective date” was not lawful. And that Sidney would have been the proper party in interest at the time of the lawsuit. Not the Trust.

The Trust countered by arguing that there was no provision in Sidney’s Lease with TRI requiring that an assignment would only be effective upon execution. And, consequently, Sidney was not prevented from executing the docs in 2011, with a 2006 “effective date.”

The Appellate Court agreed with the Trust. Sidney’s Trust won and Transcontinental Realty Investors lost. See Transcontinental Realty Investors, Inc. v. Sidney Wicks, Trustee of the Sidney Wicks Revocable Trust; No. 05-13-00362-CV; Texas Court of Appeals; 5^th District; August 5, 2014.

Lessons learned:

1.  I see this issue often. Parties want to make documents “effective” as of a date that is not identical to the date the documents were actually signed, notarized and / or recorded. Title companies see this daily. In my world, the documents and the Settlement Statements very rarely line up 100% with the actual date of closing / funding / recording.

2.  This appellate decision makes clear that, at least in Texas and assuming there is no prohibition against it in documents already signed by the parties, using an artificial “effective date” can be lawful.

3.  Practice Point: Although using an “effective date” that does not exactly line up with the “execution date” may be Ok generally, I suspect it may not be acceptable for tax purposes, including federal income tax, Texas franchise / margin tax, Texas sales tax, and even local ad valorem tax. Be careful and get professional advice before you go jackin’ with effective dates.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Whoops! I May Have Made a Mistake

In August 2004 Hazel Berry, Evelyn Mebane and Rebecca Robinson entered into a contract to sell 176 acres in Scurry County, Texas to Cynthia Gail for $80,000. The contract reserved to the sellers all minerals and royalties. When the deal closed in September 2004, however, the deed did not contain a mineral reservation. It appeared to be an oversight as the attorney who prepared the contract and the deed did not compare the two.

One of the sellers sued Gail, claiming a legal theory of “mutual mistake,” and asked that the court reform the deed by adding the mineral reservation effective as of the date of closing. The trial court agreed. Cynthia Gail appealed.

Gail’s testimony was that: (a) this is not a case of mutual mistake; (b) contract negotiations continued after the contract was signed; (c) Gail believed that the contract would be later amended; (d) although the contract contained a mineral exception, in actuality there was no definitive agreement on that point; and (e) Gail believed the absence of a mineral reservation in the deed meant that the Sellers had agreed to amend the contract to remove the mineral reservation.

Gail also submitted an Affidavit, generally claiming that the absence of a mineral reservation in the deed was not a mistake, but rather reflected the intent of the parties.

The Texas Court of Appeals had little difficulty dismissing all of Gail’s arguments, relying instead on the legal principle that a party is entitled to reformation of a deed when it proves that it reached an agreement with the other party, but the deed does not reflect the true agreement due to mutual mistake. Unilateral mistake by one side (Berry and Mebane), and knowledge of that mistake by the other side (Gail), is equivalent to mutual mistake.

The contract contained a mineral reservation. The deed did not. The lawyer who failed to insert the reservation in the deed testified that it was an inadvertent failure. A scrivener’s failure to follow the precise terms of a contract equals a mutual mistake. Judgment affirmed for Mebane and Berry.

Gail v. Berry; 11-09-00299-CV (11th Texas Court of Appeals, decided April 16, 2011).

Lessons learned:

1. Everybody makes mistakes.

2. Lawyers make mistakes.

3. Mutual mistakes can be corrected. Unilateral mistakes cannot.


Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Buyer Beware: Always Check Vesting Deeds

In February 2006 Summit Electric Supply Co., Inc. agreed to sell a five-acre parcel of property located at Manana Drive and IH-35 in Dallas to Saeed Mahboubi. Those of us who live or work in Dallas might guess the highest and best use for that property just by the location. Nonetheless, the Contract of Purchase and Sale prohibited use of the property as a sexually oriented business.

Mahboubi assigned the Contract to Semira Rezaie. Rezaie then entered into a Contract to flip the parcel to Jerry Spencer, LP.

The first closing was on August 4, 2006. Summit signed a Deed conveying the property to Rezaie. The Deed contained a clause restricting use of the property as a SOB. Because the first Deed failed to contain a proper legal description, the corrected Deed was not recorded until August 25, 2006, three weeks after closing.

The second closing was also on August 4. At that closing, Rezaie conveyed the property to Spencer, without exceptions or restrictions. The second Deed was recorded on August 7, 2006 – 18 days before the first Deed.

Spencer leased the property to 2327 Manana, LLC, who posted a notice on the front door announcing its intent to operate a SOB. Then the litigation started.

Spencer and Manana argued in trial court that they could not be held responsible for compliance with the SOB restriction, because the Deed containing that restriction was not recorded in Dallas County until weeks after they had completed their purchase and lease. Since the Deed from Rezaie did not contain the restriction, they argued, then surely Texas law would not / could not stop them from operating a SOB at the site.

Spencer and Manana lost. They appealed.

On June 25, 2010, the Dallas Court of Appeals affirmed the trial court’s judgment. The Court of Appeals had little trouble concluding that a real estate purchaser is bound by every matter contained in or disclosed by any instrument which forms an essential link in the chain of title, even though Spencer and Manana had never read the documents. Essentially, if Spencer and Manana closed their transaction without reviewing the immediately preceding deed in the chain – the ‘vesting deed’ – then Spencer and Manana did so at their own peril.

Not addressed in the case due to procedural matters were the claims against the broker who represented all of the buyers, and possibly failed to disclose the inclusion of the restrictive clause in the first deed. Also not addressed were possible claims against the title company, who may have insured the secondary transaction without reference to the restrictive covenant contained in the Summit / Rezaie deed.

Bottom line:

1.  Demand to see the Vesting Deed. Check it for restrictions. Particularly in flip transactions where closings are occurring quickly.

2.  If possible, get representations and indemnities in Contracts and Leases, obligating the Seller / Landlord to certify that the property can be used as the Purchaser / Tenant requires.

3.  If you have actual knowledge about a latent defect or material condition, immediately disclose it to your principal in writing.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Commercial Foreclosures and Correction Deeds

It is rare that The Supremes review a real estate case. But in December 2009 the Texas Supreme Court decided Myrad Properties vs. LaSalle Bank. The case was about a timely subject – Texas foreclosure.

Myrad financed two apartment communities in Killeen with LaSalle Bank NA’s predecessor. Myrad signed a $1 million note and a deed of trust. The deed of trust was recorded in Bell County. The deed of trust contained separate property descriptions for both the Casa Grande Apartments and La Casa Apartments.

Myrad defaulted. LaSalle Bank posted a notice of foreclosure upon only the Casa Grande property. At the foreclosure auction in Bell County, the substitute trustee read only the property description for Casa Grande. LaSalle was the only bidder, offering almost $1 million.

LaSalle received and recorded a substitute trustee’s deed for the Casa Grande property.

Two days later Myrad sued LaSalle, to keep it from filing a correction deed covering the La Casa property. When LaSalle filed it anyway, Myrad asserted that LaSalle owned only the Casa Grande property, while Myrad retained ownership of La Casa free of LaSalle’s deed of trust lien.

Both the trial court and court of appeals held that LaSalle’s correction deed was effective to transfer ownership of both Casa Grande and La Casa to LaSalle.

The Texas Supreme Court reviewed the history of correction deeds and determined that such deeds can be used to correct minor defects and imperfections. However, correction deeds cannot be used to convey additional, separate properties. The correction deed filed by LaSalle was void.

Bottom line:
1. Foreclosures are risky business.
2. Purchasers at foreclosure auctions sometimes make mistakes. So do lenders. Trustees too.
3. Be wary of correction deeds.


Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.