TRW Title Ins. Co. v. Security Union Title Ins. Co., s. 97-2226

Citation153 F.3d 822
Decision Date13 October 1998
Docket NumberNos. 97-2226,97-3155,s. 97-2226
PartiesTRW TITLE INSURANCE COMPANY, a corporation, on its own behalf and as a subrogee of its insureds, Plaintiff-Appellant, v. SECURITY UNION TITLE INSURANCE COMPANY, a corporation, Defendant-Appellee. and TRW TITLE INSURANCE COMPANY, Plaintiff, v. SECURITY UNION TITLE INSURANCE COMPANY, Defendant, Third-Party Plaintiff-Appellee, v. LIBERTY NATIONAL TITLE INSURANCE COMPANY, d/b/a Liberty Title Insurance Company, a corporation, Third-Party Defendant-Appellant.
CourtUnited States Courts of Appeals. United States Court of Appeals (7th Circuit)

Joshua G. Vincent, William J. Holloway (argued), Michael J. Leech, Hinshaw & Culbertson, Chicago, IL, for Plaintiff-Appellant.

Thomas A. Doyle (argued), Barrie L. Brejcha, Adriane W. Buckland, Baker & McKenzie, Chicago, IL, for Defendant-Appellee.

William J. Holloway (argued), Hinshaw & Culbertson, Chicago, IL, for Plaintiff.

Gerald Haberkorn (argued), Lowis & Gellen, Chicago, IL, for Defendant-Appellant.

Thomas A. Doyle (argued), Baker & McKenzie, Chicago, IL, for Defendant-Appellee.

Before COFFEY, KANNE, and EVANS, Circuit Judges.

TERENCE T. EVANS, Circuit Judge.

During the 1980's some said greed was good. If so, then title insurance agent Ed Wells was a saint, for beginning in 1986 he stole upwards of $3 million from the closing escrow accounts he administered. The 1990's find Wells in prison (apparently for other, unrelated crimes) and the two title insurers he represented during his thievery--Security Union Title Insurance Company and TRW Title Insurance Company, who, at different times, insured the escrow deposits that Wells stole--fighting over who should pick up the tab for Wells' misdeeds.

Originally, Wells was a lawyer who had several law offices in the Chicago area. Because he handled a lot of real estate transactions he started Liberty National Title Insurance Company as a title insurance and closing escrow agent and then referred all his clients to it. He increased his business by reducing his legal fees, knowing that he would recoup them through Liberty.

A title insurance policy, which is issued at the time of the closing of a real estate transaction, is essentially a promise that the insured party will not suffer a loss if the title turns out to be less secure than it appears to be. While title insurers can sell insurance on their own, they often enlist the services of retail title insurance agents like Liberty. Many of these agents, like Liberty, also offer themselves as escrow agents in order to provide the parties to real estate transactions with a one-stop closing service.

An escrow agent serves as a neutral depository for the monies and documents involved in a real estate deal. The legal relationship between the parties to the real estate deal and the escrowee is detailed in the closing escrow agreement in which the parties give the escrowee specific written instructions on how the transaction is to be done-the escrowee is accountable to and acts for the mutual benefit of all parties to the deal. In the best of all possible worlds, after all of the monies and documents are handed over to the escrowee, it follows the instructions about the preconditions to the closing--title searches, etc.--and then disburses the funds to the seller, his mortgagee(s), and also the surveyors, appraisers, lawyers, and the tax man. And, as title insurance is issued at the time of the closing, escrowees also disburse premiums to the title insurer.

The best of all possible worlds, as we just described it, is not always the norm. Because closing is often a slow process, funds often stay in the escrow account for a long time, and that creates an opportunity for embezzlement. So long as new deposits keep rolling in, a crooked escrowee can use the "float" created by new money coming in to keep early deposits for himself by using the later deposits to pay earlier disbursements. Unless new money stops coming in, the escrowee can keep repeating the process and, theoretically, nobody would be the wiser.

Because of this ever-present risk and the market power of mortgage lenders, title insurers are often forced to insure the lenders' escrow deposits if they want the lenders' business. In so-called escrow protection letters the insurers promise they will indemnify the lender/depositor for losses caused by a title agent/escrowee's fraud or failure to follow disbursement instructions.

Because of this potential insurer liability, title insurers keep a close eye on their agents. They do this primarily by auditing the escrow account. Suspicious signs include withdrawals in even dollar amounts and overdrafts--disbursements should always match deposits, so there should never be a negative balance. However, because the float masks any shortage and disguises the true balance of the account, title insurers require their agents to reconcile the account--match the disbursements up with the deposits.

Back on January 1, 1984, Security--at the time called Safeco; its name was changed to Security after Chicago Title Insurance Company acquired it in 1988--signed Liberty to an exclusive agency contract. Security, of course, had to issue escrow protection letters as an incentive to lenders to deal with Wells and buy Security's title insurance policies.

Because it would be on the hook for any of Wells' escrow hijinks, the contract featured several safeguards. It required Liberty to keep all escrowed funds in a segregated bank account--segregated, that is, from non-escrow monies; it didn't require individually segregated accounts for each deposit. In case of a shortage, it gave Security the right to cancel the contract and place a lien on Liberty's assets. And it gave Security the right to audit Liberty at any time.

Security followed a practice of annual audits. Its first audit was in October of 1985. By that time Liberty had not yet reconciled its account, but it promised to do so. In May of 1986, the second audit, the auditor noted that Liberty was "[j]ust beginning to reconcile." However, in the 1987 audit the auditor stated that Liberty hadn't been reconciling the escrow account.

Despite this, the Liberty/Security arrangement was lucrative for both parties. Liberty averaged around 250 closings per month, and roughly $15 million went through the escrow account every 30 days. Between 1986 and 1989 Security earned between $300,000 to $500,000 a month in title insurance premiums. But, starting in 1986, Wells began using the float created by this high volume business to pay Liberty's operating costs, creating a shortage in the escrow account--and leaving Security liable on its letters if all disbursements suddenly became due.

While Security didn't catch the embezzlement, it did catch some of Wells' other shenanigans. The Liberty/Security contract required Liberty to do its title research in Liberty's title plant--a database of land titles. Liberty was supposed to pay a certain amount per search. However, Wells rigged up a way of avoiding the search costs while still using the plant, and this trick saved Liberty significant money.

Security discovered Wells' antics in 1988 so it sued Liberty, seeking damages for breach of contract, fraud, and RICO violations and also a declaration that it could cancel the whole agency agreement because of Liberty's title plant abuse. A court dismissed the declaratory suit, ruling that Security couldn't cancel the whole agency agreement because fraud occurred in the title plant.

The parties tried to settle the remainder of the suit and eventually struck a bargain. On November 13, 1989, Security sent Liberty a draft of the settlement agreement. The draft called for Liberty to allow Security out of the contract, pay $235,000 in back title plant fees, and permit an audit of the escrow account. In addition, the draft agreement obligated Liberty to "immediately and in good faith undertake with all due diligence, to obtain a new underwriter for Liberty's title insurance agency services."

A week after getting the draft Wells contacted Eric Alejos, an agency recruiter for TRW Title Insurance Company. Wells said that Security was dissolving its relationships with Illinois agents and had given him leave to find another insurer. This was not the truth, the whole truth, and nothing but the truth. During the application process Wells also made two other misrepresentations; he said that Liberty was solvent and, on the agency application, he failed to list Security's lawsuit in the blank reserved for pending legal actions.

While a pre-signing audit would seem sensible-TRW now has a policy requiring such an audit for any title agent handling the volume of deposits Liberty handled--TRW blew it off. While it checked Wells' personal references, it didn't do any credit check on Liberty's banking, leasing, or money handling activities. Concerning the escrow account, TRW failed to contact the bank that held the account, investigate Liberty's escrow practices, talk to the other Liberty employees, or contact state licensing authorities. And, finally, TRW did no public records check, which would have turned up the title plant lawsuit and exposed one of Wells' misrepresentations. The reason behind this shoddy investigation was TRW's fear of alerting Security that it was courting Liberty.

On December 4, 1989, TRW signed Liberty up as a TRW title insurance agent. After the signing, Liberty dealt with all new--post-December 4, 1989-depositors on TRW's behalf, and TRW issued escrow protection letters to all of them. However, instead of setting up a new account for the TRW depositors' money, Liberty and TRW used the same old escrow account that still held Security's depositors' money--violating the provision of Security's agency agreement (which was still viable at this point) requiring segregation of Security depositors' funds.

Not knowing what was going on between Liberty and TRW, on ...

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