Brothers Charles and Henry Shotmeyer took their $900,000 title insurance claim all the way to the New Jersey Supreme Court... and lost.  The brothers purchased 24.7 acres in 1981 for $260,000.  In 2001, Sussex County reduced the acreage shown on his tax bill to 12.68 acres after judgments were filed declaring that the missing 12.02 acres belonged to a neighboring lot.  An appraisal valued the land at $900,000.

The Shotmeyers filed a claim on their title insurance policy and New Jersey Realty Title Insurance Company offered a settlement of $43,000.  The settlement was rejected and litigation began.  The focus, however, was not on whether there was a title defect that was covered, but rather whether the brothers were insureds under the policy with standing to file a claim.

The brothers purchased the property as "Henry J. Shotmeyer and Charles P. Shotmeyer, Partners trading as Beaver Run Farms, a General Partnership." In 1992, the general partnership conveyed the property to Beaver Run Farms, L.P., a limited partnership.  The Shotmeyers remained the only partners and apparently the change to the limited partnership was done to facilitate their estate planning.

The title company's position was that the "voluntary and intentional" conveyance to the new entity caused the owner's policy to lapse.  The trial court granted summary judgment in favor of the title company finding that the limited partnership did not have standing to sue. 

The appeals court reversed, finding that brothers had retained "beneficial interest" in the property and that the general and limited partnerships were but "alter egos" of the Shotmeyers who retained control of the property at all times.  The court found that the partnerships should be disregarded in the interest of justice.

There were several interesting arguments addressed by the NJ Supreme Court.  (Shotmeyer v. NJ Realty Title Ins. Co.)  They first addressed the "named insured," and whether the brothers as individuals were insured under the policy.

[T]he property belonged to the general partnership and not the brothers as individuals. Similarly, the 1992 transfer involved a conveyance from the general partnership to the limited partnership and, by statute, the property belonged to the limited partnership, not the individual brothers.

...

The Court is not persuaded by the argument that the brothers did nothing to affect the defect in the property’s title or the risk to the insurer through their conveyances. One-time title insurance premiums are based in part on the time of exposure to risk. Allowing coverage to continue when a tract of land is conveyed to a different legal entity extends the time of exposure and the risk to the insurer. Nor does the alter ego doctrine provide relief to the Shotmeyers. The Shotmeyers set up the different, legitimate business structures to further their personal and business plans. They did not use the partnerships to commit fraud or defeat the ends of justice, requiring the application of the doctrine to pierce the corporate veil.

Next the court addressed the issue of whether the conveyance to the limited partnership was a covered as an entity that succeeded the named insured "by operation of law." 

[T]he general partnership voluntarily transferred the property to a newly formed limited partnership in exchange for nominal consideration. All obligations relating to the land were transferred from the general partnership, in which the individual members were personally liable, to the limited partnership, which shielded them from liability. Thereafter, the general partnership continued to exist and carried on unrelated business activities. The Court finds, therefore, that the property was not transferred by operation of law.

Then, there was discussion about reliance on the "Continuation of Insurance after Conveyance of Title" that provides that coverage continues "so long as such insured shall have liability by reason of covenants of warranty made by such insured in any transfer of conveyance."  Unfortunately, they did not grant general warranty covenants when they conveyed the title.  The only covenant was "the grantor promises that the Grantor has done no act to encumber the property."  Because the general partnership did not cause the defect in title, it had no liability under this limited warranty, known as a "covenant as to grantor's acts'" in New Jersey.  Otherwise, the limited partnership could have sought to enforce the warranties against the general partnership and the general partnership, in turn, could have filed a claim under the owner's policy.

Lastly, the court addressed the issue of whether the title company waived its policy defenses by offering the settlement.  The court found it did not.

This policy was issued in 1981.  Today, a policy issued on the ALTA Owner's Policy form, adopted 6/17/06, would be much more generous by providing a more expansive definition of "Insured."

 (d) “Insured": The Insured named in Schedule A.
      (i) the term "Insured" also includes
            (A) successors to the Title of the Insured by operation of law as
                  distinguished from purchase, including heirs, devisees,
                  survivors, personal representatives, or next of kin;
            (B) successors to an Insured by dissolution, merger, consolidation,
                  distribution, or reorganization;
            (C) successors to an Insured by its conversion to another kind of
                  Entity;
            (D) a grantee of an Insured under a deed delivered without
                  payment of actual valuable consideration conveying the Title
                  (1) if the stock, shares, memberships, or other equity interests
                       of the grantee are wholly-owned by the named Insured,
                  (2) if the grantee wholly owns the named Insured,
                  (3) if the grantee is wholly-owned by an affiliated Entity of the
                        named Insured, provided the affiliated Entity and the named
                        Insured are both wholly-owned by the same person or Entity,
                        or
                  (4) if the grantee is a trustee or beneficiary of a trust created by
                       a written instrument established by the Insured named in
                       Schedule A for estate planning purposes.
      (ii) with regard to (A), (B), (C), and (D) reserving, however, all rights and
           defenses as to any successor that the Company would have had
           against any predecessor Insured.

Depending on the circumstance, the Shotmeyers may have had a much better chance under this new language.  At the very least, the new policy form provides more flexibility for crafting these types of estate planning transactions.  Still, it is very important to consider the effects that conveying property will have on the rights of the insured under an owner's policy and balance them along with the tax savings that might be gained.  Losing $900,000 worth of valuable real estate may just net out any tax savings that the estate planning was created to take advantage of. 

I have read a few cases where conveyances have caused the loss of coverage under a title policy that were not intended or expected. The title company usually wins.

As the NJ Supreme Court stated in conclusion:

This case highlights the need for special care when transferring assets as part of an estate plan. Particular attention must be given to title insurance policies when real property is transferred.

Though we are often told that title insurance claims are rare, they do happen.  It is unfortunate when a claim arises and an insured finds out that his estate planning inadvertently caused a termination of his coverage.  Tax advisers and attorneys need to be mindful of the potential hazards of their estate planning that might otherwise be sound from a tax perspective.

Robert A. Franco
SOURCE OF TITLE