posting for

Monday, April 19, 2004

 

by:  Lillian E. Eyrich

leyrich@steeglaw.com

 

and:  Cliff Morgan

cmorgan@firstam.com

 

LEASEHOLD TITLE INSURANCE/COMMERCIAL PROPERTIES/TITLE UNDERWRITING

 

Intro by Bert Rush:  Lillian "Lillie" Eyrich (The Steeg Law Firm/New Orleans, LA) writes:

 

Bert, you were kind enough to help us get a better understanding of the coinsurance provisions in a fee owner's policy.  Now we're asking for input on a leasehold owner's policy.

 

 

Under both Texas and Louisiana premium structures, a leasehold policy can be issued either for the value of the property, or the amount of the rent over the term of the lease.  Assume that: (i) the value of the land is $1,600,000; (ii) the insured will build a building worth $3,000,000; and (iii) the amount of the rent over the 20-year primary term of the lease (at $100,000 per year) is $2,000,000.  Further assume that the lease provides that the tenant owns any improvements built on the land during the term of the lease, and that the ownership of the improvements goes to the landlord at the termination of the lease.

 

 

As I see it, the policy can be issued for $1,600,000 (land value), $2,000,000 (rent value), $4,600,000 (land plus building value), or $5,000,000 (rent plus building value).

 

 

The recent ALTA owner's leasehold endorsement provides in Section 2:  "The provisions of subsection (b) of Section 7 of the Conditions and Stipulations shall not apply to any Leasehold Estate covered by this policy."

 

 

Our question is: Remember that the tenant owns the buildings.  Does Sect. 2 mean that the coinsurance provisions do not apply at all? Or would there be a sort of hybrid result; i.e., would the leasehold endorsement measure of damages in Sect. 3 apply to the rent/ground lease, and the co-insurance provisions apply to the value of the buildings as a fee estate in those buildings?  If so, how would the two different items be measured?

 

If you could provide an example, as you did before, it would be helpful.  If there is a $1,000,000 loss in Year Five of the lease (because a mortgage was missed, for example), how would the measure of damages be calculated?

 

 

Reply by Cliff Morgan:

 

In a deal like Lillie has described I would totally endorse out the coinsurance provision of the policy. It would be confusing otherwise and probably not enforceable anyway under those circumstances. I am sorry to be so "summary" in my approach but to otherwise try to analyze when, if and to what part the coinsurance provision might apply would not be productive in my view. This is because I think for Lillie's deal our endorsement is ambiguous at best. Just to try to contemplate the outcome of the various arguments and issues will twist one's mind and put them into a continuing intellectual downward spiral. Certainly the coinsurance provisions of Section 7b of the policy do not apply to any leasehold estate, but what is the leasehold estate in Lillie's example? Is it the land only or both the land and improvements? Keep in mind the improvements do not exist at Date of Policy. However, if in the policy we describe the estate or interest as being a leasehold as to the land and a fee as to the improvements does the coinsurance provision apply to the fee estate in the improvements portion? I don't think so. This is because the coinsurance provision itself talks only about improvements being "erected on the land". If it does not apply to the leasehold estate and it is the land the improvements are being constructed upon, then how can it apply to the fee estate in the improvements that don't yet exist, but when they come into existence on the land to which the coinsurance provision does not apply are owned in fee? Is our insured making "improvements" to the fee estate which is not the physical land? We may have some claims lawyers that would probably want to say yes in a claims posture, but our insured would say no. The insured would say the improvements were made to the leasehold (land) and upon termination of the lease are in fact owned by the landlord. Therefore the coinsurance provision does not apply to either the leasehold or improvements fee estate. I agree with the insured. I have bottomed out on the continuing intellectual downward spiral at this point. That is why I say we should just make it easy on our claims attorneys and our insureds and endorse the coinsurance provision of the policy totally out as to both the leasehold and the fee estates in this type of deal. At the very minimum if one wants to maintain such a provision as to some portion of the deal they would have to do a special endorsement anyway just to accomplish that. If that is the case just do an endorsement that takes the provision out of the policy and be done with it. I have never liked the coinsurance provision anyway and don't believe it serves any real purpose in reducing claims or claims payments. The leasehold endorsement (ALTA endorsement form 13 and 13.1) was designed for simple leasehold transactions and does not contemplate the more complicated "severance" arrangements like the one described by Lillie. Those deals must be dealt with by special endorsement in most situations. That is not unlike many fee simple transactions we are asked to insure that have special or unusual facts and provisions.

 

Response by Lillie:

 

Cliff: Thanks for input.  I didn't think this was that unusual a fact scenario, because it's so common for a tenant under a ground lease to own the buildings [that it builds] during the term of the lease, and then ownership of the buildings to go to landlord at termination of the lease.  In Louisiana, we could endorse out the co-insurance provision if that is what you recommend. But what about Texas?  Can they do that?

 

 

Alternative:  is it advisable to insure this in one policy as two separate estates?  That is, call Parcel I the ground lease, and call Parcel II the buildings situated on the land described in Parcel I, and insure that the estate in Parcel I is leasehold, and that the estate in Parcel II is fee?  Then add an exception to Parcel I about the servitude/easement of support for and access to the buildings?  If we do that, do we have to add an exception to Parcel II regarding the separate ownership of the land on which the buildings are situated?

 

Or am I making a mountain out of a molehill here?  I just want to be sure we structure the insurance correctly and advise our client.  I guess part of this is a question about what the leasehold endorsements were designed for.  In the case where the buildings are more valuable than the land (often), is it better to issue an owner's policy, describing the estate as a leasehold, but not issuing the leasehold endorsement?

 

Reply by Cliff:

 

Lillie: I agree these deals are not unusual in terms of their frequency. They are very common. The way I advise to do these deals is to use the legal one would use to convey the fee to the entire interest had "severance" of the improvements not occurred and use it twice in the policy. Once for a Parcel One  and once for a Parcel Two.  Therefore the legal description for each parcel is the same except at the end of the Parcel One legal you add: "excepting therefrom all buildings and improvements now or hereafter constructed thereon.".  For the Parcel Two legal insert the following phrase in the beginning of the legal: " All buildings and improvements now or hereafter constructed on the following land:".

 

For the description of the estate or interest covered by the policy  in paragraph 2 of Schedule A, you would say "a leasehold estate created by that certain lease by________as lessor and ___________as lessee dated______ and recorded________________ as to Parcel One; and a fee as to Parcel Two".

 

In paragraph 3 of Schedule A you would show the title being vested in the name of the person or entity that owns the leasehold and the improvements when built.

 

In schedule B you should take an exception for implied easements for ingress and egress, utilities, and support of buildings and improvements over Parcel One and in favor of Parcel Two.

 

I would attach the ALTA Form 13 or 13.1 Leasehold endorsement to the policy depending upon whether it is an owner's or lender's. I would endorse out all of Section 7(b) of the policy in those states where that can be done. For Texas and the few other states where you cannot do special endorsements I simply would not worry about it. Should a claim arise in any of those states we will just have to work with our claims attorneys to make sure our insured gets what we thought we were insuring in the first place; and that is that the coinsurance provision doesn't apply under these circumstances.

 

Response by Lillie:

 

Thanks, Cliff.  We appreciate the fast response.  This puts us in a better position to advise our client, which builds bank branches in both LA and TX, and some of the properties are leaseholds.   We've been trying to explain to them the dangers of under-insuring.