During the real estate boom of the mid-2000s, many novel financial products made their debuts. While some of the era's more complicated mortgage-backed securities and derivatives ended up creating serious headaches for banks, mortgage issuers and regular investors, others appeared to offer useful benefits for creditors that provided the boom's financial "juice." Unfortunately, the heady boom times didn't last. The creditors' rights insurance on which so many lenders and title insurers relied was one of the many casualties of the bust. In the more restrained lending environment of the present day, it's crucial for borrowers and lenders to understand the potential effects of recent and ongoing changes to the country's title insurance system.
A Brief Look at Creditors' Rights Insurance
Creditors' rights insurance covers a specific and slightly obscure area of the law. Before the housing bust and the subsequent deluge of foreclosures and bankruptcy filings, it was rarely invoked and even more rarely granted. However, it has become a major concern for mortgage lenders and home-buyers.
In effect, creditors' rights insurance insulates lenders and buyers from "fraudulent conveyance" charges. "Fraudulent conveyance" is often invoked by creditors who wish to set aside real estate transactions that work against their interests. Prior to the housing market's collapse, most judges would only accept charges that:
- Occurred while the creditor or seller was insolvent
- Resulted in insolvency for the creditor or seller
- Rendered the creditor unable to continue its operations
However, the practice was frequently used during the post-bust period to set aside transactions that didn't meet these strict criteria. This exposed the title insurers that issued creditors' rights insurance policies to steep and potentially ruinous losses.
Then and Now: Changes as a Result of the Housing Bust
Over time, this situation has proven untenable. Many title insurers have been forced out of business or into unfavorable mergers with larger firms. Others have had no choice but to lay off employees and scale back their operations. Most have reduced the rates at which they issue creditors' rights policies or eliminated the practice altogether. Even relatively healthy insurers have strengthened the requirements for these policies.
The History of Endorsement 21
Endorsement 21 is central to the creditors' rights issue. In the early 1990s, lenders began to demand some form of protection against fraudulent conveyance claims. As more title insurers began to oblige these demands, the American Land Title Association spearheaded a drive to codify such protections in a bylaw that became known as Endorsement 21. Enacted in 2004, this rule provided the framework for creditors' rights coverage in 46 states.
Only New York, New Mexico, Florida and Texas saw the problems inherent in the widespread use of creditors' rights insurance and voted against its adoption. Stung by the financial cascade of the housing bust, ALTA withdrew the amendment in 2010 and advised state-specific organizations to do the same. However, title insurers are still permitted to issue creditors' rights insurance on their own terms in states that have not yet prohibited the practice.
The entire creditors' rights framework is under siege in state legislatures across the country. A number of legislative bodies have already banned it outright, and more are mulling their options for doing so. While ALTA has not completely given up on the practice, it now advocates for its continued elimination through legislative action. The organization argues that title insurers operate with a dearth of important information that could influence their protocols for issuing his type of insurance. As such, it argues for the wholesale replacement of creditors' rights insurance with a more equitable framework.
Looking Ahead: Likely Outcomes of the Fight Over Creditors' Rights Insurance
Overall, this is a positive development for title insurance creditors that suffered through the housing crisis. Unfortunately, a significant amount of uncertainty remains. Going forward, creditors will need to pay attention to the specific policies of the states in which they do business to ensure that they remain compliant with the law and insulated from unnecessary risk.