American Sav. and Loan Ass'n v. Lawyers Title Ins. Corp.

• Decision Date: 19 June 1986
• Docket Number: No. 84-5892,84-5892
• Parties: AMERICAN SAVINGS AND LOAN ASSOCIATION, Plaintiff-Appellant, v. LAWYERS TITLE INSURANCE CORPORATION, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 780

793 F.2d 780

AMERICAN SAVINGS AND LOAN ASSOCIATION, Plaintiff-Appellant, v. LAWYERS TITLE INSURANCE CORPORATION, Defendant-Appellee.

No. 84-5892.

United States Court of Appeals Sixth Circuit.

Argued Aug. 8, 1985.

Decided June 19, 1986.

Geoffrey D. Kressin, Knoxville, Tenn., Robert Craddock, Memphis, Tenn. (argued), for plaintiff-appellant.

James A. Ridley, III (argued), Kramer, Johnson, Rayson, McVeigh and Leake, Knoxville, Tenn., for defendant-appellee.

Before ENGEL and MERRITT, Circuit Judges; and GIBBONS, District Judge. ^*

ENGEL, Circuit Judge.

Appellant American Savings and Loan Association appeals a judgment of the United States District Court for the Eastern District of Tennessee in favor of defendant Lawyers Title Insurance Corporation. Tennessee law governs in this diversity action for breach of a contract of title insurance. We conclude that the losses incurred by American were covered by the insurance policy and not excluded as a risk "created, suffered, assumed or agreed to" by American.

I.

In 1982 American loaned $1,000,000 to a group engaged in the construction of a housing complex whose previous arrangements for financial backing had failed midway through the construction project. This sum was estimated to be the completion cost of the project, but in any event the borrowers guaranteed the commitment of any additional funding. To secure the loan American received a deed of trust executed by the borrowers. At the recording of this deed it was superior to any other recorded lien. At the same time, American acquired title insurance, policy No. 82-79-007065, from Lawyers Title Insurance Corporation. Both American and Lawyers Title were aware at the time the policy was issued that American's lien, under Tennessee law, could become subordinate to liens subsequently recorded by subcontractors, material furnishers and laborers.

The construction project subsequently encountered further difficulties with the result that it could not pay in full its debts to subcontractors, material furnishers and laborers who then filed notices of liens. These liens gained priority to American's lien under Tenn.Code Ann. Sec. 66-11-104 (1982). American ultimately settled these lien claims and consequently acquired title to the development property, which it then sold to a third party.

American sought recovery from Lawyers Title, and following Lawyers Title's refusal, brought suit for breach of the title insurance policy seeking damages in the sum of $105,943.00. This sum represented the difference of American's liabilities, including the loan principal and interest and the amount expended by American in paying off the mechanics' liens, less the amount received by American from its sale of the construction site. The case was tried before a magistrate on stipulated facts. Relying on Brown v. St. Paul Insurance Corp., 634 F.2d 1103 (8th Cir.1980), and Bankers Trust Co. v. Transamerica Title Ins. Co., 594 F.2d 231 (10th Cir.1979), the magistrate found that, by loaning funds for a construction project that it knew might be underfunded, American suffered, assumed or agreed to the priority of the liens within the meaning of the exclusionary clause of the insurance contract. He therefore held that the insurance policy did not cover losses due to the underfunding. On appeal, American contends that Brown and Bankers Trust are inapposite because of differences in the facts and law relevant to those cases.

The policy issued by Lawyers Title provided:

Lawyer's Title Insurance Corporation ... insures ... against loss or damage ... sustained or incurred by the insured by reason of:

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6. The priority of any lien or encumberance over the lien of the insured mortgage;

7. Any statutory lien for labor or material which now has gained or hereafter may gain priority over the lien of the insured mortgage, except any such lien arising from an improvement on the land contracted for and commenced subsequent to Date of Policy not financed in whole or in art by proceeds of the indebtedness secured by the insured mortgage which at Date of Policy the insured has advanced or is obligated to advance....

The policy expressly excluded coverage for:

3. Defects, liens, encumbrances, adverse claims, or other matters (a) created, suffered, assumed or agreed to by the insured claimant....

Lawyers Title contends, and the magistrate agreed, that the mechanics' liens in this case were excluded from coverage under the policy by this latter exclusion in paragraph 3.

It is generally recognized that title insurance does not insure against prospective risks.

[T]itle insurance operates to protect a purchaser or mortgagee against defects in or encumbrances on title which are in existence at the time the insured takes his title. Mayers v. Van Schaick, 197 N.E. 296 (1935); Trenton Potteries Co. v. Title Guarantee & Trust Co., 176 N.Y. 65, 68 N.E. 132 (1903); Strass v. District-Realty Title Insurance Corp., 31 Md.App. 690, 358 A.2d 251, cert. denied, 278 Md. 736 (1976); Butcher v. Burton Abstract Title Co., 52 Mich.App. 98, 216 N.W.2d 434, cert. denied, 419 U.S. 998 [95 S.Ct. 314, 42 L.Ed.2d 273] (1974); 9 Appleman, Insurance Law and Practice, p 5208 at 9 (1943). "It is not prospective in its operation and has no relation to liens or requirements arising thereafter." Mayers v. Van Schaick, supra. "The risks of title insurance end where the risks of other kinds begin. Title insurance, instead of protecting the insured against matters that may arise during a stated period after the issuance of the policy is designed to save him harmless from any loss through defects, liens, or encumbrances that may affect or burden his title when he takes it." Trenton Potteries v. Title Guarantee & Trust Co., supra.

National Mortgage Corp. v. American Title Insurance Co., 299 N.C. 369, 261 S.E.2d 844 (1980).

Additionally, it is often appropriate to assume that business people experienced in the transactions in which they are engaged intend to accept the risks that can be reasonably expected to arise from those transactions. Accordingly, it may not be improper to assume that American, a relatively sophisticated commercial lending concern, intended to accept the risk that the developer would not obtain the additional financing, and that mechanics' liens, which would gain priority over American's deed of trust, could arise against the property. Nevertheless, the general rules of insurance contract construction, as well as the extreme breadth of the exclusion under Lawyers Title's interpretation, militate against the construction offered by Lawyers Title and accepted by the magistrate.

Tennessee law holds that an insurance contract must be construed as a whole, English v. Virginia Surety Co., 196 Tenn. 426, 268 S.W.2d 338 (1954), and specifically directs that "the insuring clause and exceptions thereto should not be considered separately, but as parts of a whole...." White v. State Farm Mut. Auto Ins. Co., 59 Tenn.App. 707, 443 S.W.2d 661, 666 (1979). Further, under Tennessee law, exclusionary clauses are to be strictly construed against the insurer. Palmer v. State Farm Mut. Auto Ins. Co., 614 S.W.2d 788 (Tenn.1981). Guided by these rules of construction, we do not believe that the risk that service, labor or materials liens would arise because of underfunding on the project, was a risk excluded from coverage as a risk which American "suffered, assumed or agreed to."

The magistrate appears to have assumed that, but for the exclusionary clause, losses due to service, labor, or materials liens would have been covered by the policy. Accordingly, he construed only the exclusionary clause and applied the rule that a claimant has the initial burden of proving that he comes within the insuring terms of an insurance policy and conversely, the insurer carries the burden if it claims that one of the policy exclusions prevents recovery. Farmers Bank & Trust Co. v. Transamerica Ins. Co., 674 F.2d 548 (6th Cir.1982). Tennessee law, however, forbids a construction of the exclusionary clause in isolation from the rest of the contract.

A review of the insuring clause reveals that the parties insured against the possibility that under Tennessee law liens for service, labor and materials, although recorded after American's lien, could become senior to American's lien by relating back to the time that the construction project commenced. That clause expressly insures against "[a]ny statutory liens for labor or materials which ... hereafter may gain priority over [American's lien]." (Emphasis added). True, that clause excepts from its coverage "any such lien arising from an improvement on the land contracted for and commenced subsequent to Date of Policy not financed in whole or in part by proceeds of the indebtedness secured by the insured mortgage which at Date of Policy the insured has advanced or is obligated to advance...." But the liens which ultimately encumbered the construction site did not fall within this exception for they resulted from work which was a part of the project for which American's loan was advanced.

The parties' negotiations over contract terms further support the conclusion that the insuring clause was intended to cover the losses suffered here. The stipulation of facts states that when it approached Lawyers Title's agent, American sought a title insurance policy without a lien exception and Lawyers Title's agent responded that such a policy could be issued if the borrowers indemnified Lawyers Title. The initial commitment for title insurance issued by Lawyers Title excluded from coverage liens arising out of services, labor or materials provided unless the borrowers agreed to indemnify Lawyers Title against losses arising from such liens.

The policy or policies to be issued will contain exceptions to the following unless the same are disposed of to the satisfaction of the Company:

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5. Any lien, or right to a lien, for services, labor or...