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Captiva Lake Investments, LLC v. Fidelity National Title Insurance Co.

United States Court of Appeals, Eighth Circuit

February 28, 2018

Captiva Lake Investments, LLC Plaintiff- Appellee
Fidelity National Title Insurance Company, successor-by-merger to Lawyers Title Insurance Corporation Defendant-Appellant American Land Title Association; Missouri Land Title Association Amid on Behalf of Appellant (s) Captiva Lake Investments, LLC Plaintiff- Appellant
Fidelity National Title Insurance Company, successor-by-merger to Lawyers Title Insurance Corporation Defendant-Appellee

          Submitted: April 5, 2017

         Appeals from United States District Court for the Eastern District of Missouri - St. Louis

          Before WOLLMAN and LOKEN, Circuit Judges, and ROSSITER, District Judge. [1]

          WOLLMAN, Circuit Judge.

         National City Bank of the Midwest (National City) loaned Majestic Pointe Development Company, L.L.C. (Majestic Pointe), $21, 280, 000 in March 2006. Majestic Pointe planned to build a condominium development on the Lake of the Ozarks in Sunrise Beach, Missouri. To protect its security interest, National City purchased a title insurance policy (the policy) from Fidelity National Title Insurance Company (Fidelity).[2] Midway through construction, Majestic Pointe defaulted on the construction loan agreement and thereafter went bankrupt. National City sold its interest in the condominium development to Captiva Lake Investments, LLC (Captiva), which became the successor-in-interest under the policy.

         Captiva filed a claim with Fidelity in August 2009, seeking coverage for mechanics' liens that had been filed against the property. Fidelity agreed to defend Captiva, subject to a reservation of Fidelity's rights under the policy, and hired attorneys to defend Captiva in the mechanics' lien litigation. Fidelity specifically reserved the right to deny coverage based on Exclusion 3(a), which excludes from coverage loss or damage that arose by reason of liens "created, suffered, assumed or agreed to by the insured claimant." Fidelity did not resolve the liens as quickly as Captiva would have liked, and so in August 2010, Captiva filed an additional claim under the policy's unmarketability-of-title provision, alleging that Fidelity had rendered the title unmarketable by failing to resolve or insure over the pending mechanics' lien claims.

         Fidelity filed suit in federal district court in October 2010, seeking a declaration that the title insurance policy did not cover the mechanics' liens. Captiva filed counterclaims, which sought a declaration that the policy covered the mechanics' liens and which asserted claims against Fidelity for failing to diligently defend and resolve the mechanics' liens claims and for tortiously interfering with Captiva's relationship with the attorneys Fidelity had hired to defend Captiva. Before trial, Fidelity decided not to seek reimbursement from Captiva for the liens that it had resolved on Captiva's behalf. The parties thereafter stipulated to the dismissal of Fidelity's complaint and were realigned for trial, with Captiva as the plaintiff and Fidelity as the defendant.

         The district court did not allow Fidelity to present its Exclusion 3(a) defense that National City "created, suffered, assumed or agreed to" the mechanics' liens. The court determined that evidence of intentional misconduct or inequitable dealings by National City was required to sustain the defense and that Fidelity had failed to present such evidence. The court dismissed the tortious interference claim. The jury found that Fidelity had breached the title insurance policy and, as is more fully discussed below, awarded more than $6 million in damages to Captiva.

          We conclude that the district court did not apply the correct legal standard in deciding that Exclusion 3(a) did not apply to the mechanics' liens at issue in this case. Under the appropriate standard, Fidelity was entitled to present to the jury its defense that National City had "created, suffered, assumed or agreed to" the mechanics' liens. We further conclude that Captiva failed to show that the title was unmarketable on or before the effective date of the policy and thus failed to prove its claim that Fidelity breached the policy's unmarketability-of-title provision.

         We affirm the district court's dismissal of the tortious interference claim. We vacate the judgment and remand the case for further proceedings. We also vacate the order awarding attorneys' fees and costs.

         I. Background

         A construction loan provides funds for the construction of improvements on land. The developer and the lender enter into a construction loan agreement, which sets forth the terms of the loan and "generally incorporates by reference the project's plans and specifications, includes a budget that the developer must follow, and specifies the project completion date." 1 Grant S. Nelson et al., Real Estate Finance Law § 12.1 (6th ed.), Westlaw (database updated Dec. 2014). The developer's obligation to repay is set forth in a promissory note and the loan is secured by a mortgage or deed of trust, meaning that the loan is "secured by the construction project itself-the land and the building in progress." BB Syndication Servs., Inc. v. First Am. Title Ins. Co., 780 F.3d 825, 826-27 (7th Cir. 2015).

         Construction lending can be risky. "If the construction project fails and puts the developer into bankruptcy, the lender's loan is protected only by the unfinished project, which is often worth far less than the money put into it." Id. at 827. Accordingly, construction lending requires careful underwriting and monitoring. Michael F. Jones & Rebecca R. Messall, Mechanic's Lien Title Insurance Coverage for Construction Projects: Lenders & Insurers Beware, 16 Real Est. L.J. 291, 292-93 (1988). During underwriting, the lender will conduct a detailed analysis of the project to determine its risk. Id. at 292. Critical to the underwriting analysis is whether the construction loan, together with the developer's investment, provides sufficient funds to complete the project. Id. Many lenders require the developer to invest a substantial amount of its own money in the construction project. Nelson et al., supra, at § 12.1. If there is a shortfall in the loan amount compared with the estimated cost to complete the project, the lender often will require the developer to cover the difference before any loan funds are disbursed. Jones & Messall, supra, at 293. After the lender decides to issue the loan, it disburses loan funds incrementally as work is completed.

         Incremental disbursement of loan proceeds allows the lender to monitor the construction project and ensure that the loan remains "in balance"-that is, that sufficient funds exist to complete the project. Id. After the developer requests a disbursement, the lender typically conducts a site inspection to ensure that the work has been completed. See Nelson et al., supra, at § 12.1. The lender also usually obtains lien waivers from the subcontractors that have been paid and then disburses funds, often holding back five to ten percent of the requested amount to be paid upon completion. Id. The construction loan agreement typically requires that the loan account remain in balance, that suppliers and subcontractors be paid promptly, that the project be constructed in accordance with the approved plans and specifications, and that the developer meet the approved timetable for completion. Id.

         In the event of default, the lender may cease making disbursements and may foreclose on the deed of trust. Id. "When the lender cuts off funding, there will always be some outstanding unpaid work; contractors request payment as work is completed, but there is inevitable delay from the time when work is completed to the time when bills are submitted." BB Syndication Servs., 780 F.3d at 827. The lender typically will look to its title insurer for indemnification.

          Title insurance policies are important to construction lenders. Such policies typically provide that the insurer will indemnify the insured lender for loss or damage caused by defects in title or in lien priority that existed on the date of the policy, unless the defect is excluded from policy coverage. See Jones & Messall, supra, at 294-95. The lender pays only one premium, and the policy term continues as long as the insured can suffer loss from any defect that is covered by the policy and which existed at the time the policy went into effect. See BB Syndication Servs., 780 F.3d at 827. "This model works because title insurance is retrospective rather than prospective; it generally protects against defects in title that arose prior to the issuance of the policy, allowing the insurer to reduce or eliminate risk by conducting a careful title search to identify defects." Id.

         The American Land Title Association (ALTA) writes title insurance policy forms that are used nationwide. The title insurance policy at issue in this case is a standard 1992 ALTA lender's title policy. Fidelity issued the policy after work on the condominium development had begun. Fidelity agreed to the lender's deletion of the standard policy language that excepted coverage for mechanics' liens. The policy thus covered the risk of loss resulting from mechanics' liens being given priority over the insured's deed of trust. This type of coverage is significant because Missouri gives priority to the mechanics' liens of unpaid contractors and suppliers, with the result that even if the deed of trust is recorded before any mechanics' liens, the mechanics' liens nonetheless will be deemed first in priority. See Mo. Rev. Stat. § 429.060. Fidelity also deleted the policy language that required the loan to be fully funded.

         The policy insured "as of [the] Date of Policy . . ., against loss or damage . . . sustained or incurred by the insured by reason of:"

         3. Unmarketability of title; . . .

          7. Lack of priority of the lien of the insured mortgage over any statutory lien for services, labor or material.

         II. Exclusion 3(a)

         Exclusion 3(a) excludes from coverage any loss or damage that arose by reason of:

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

         Fidelity argues that Exclusion 3(a) of the policy excluded from coverage any loss or damage related to the liens that were filed against the Majestic Pointe development because National City "created, suffered, assumed or agreed to" the liens.

         National City agreed to lend Majestic Pointe $21, 280, 000 pursuant to a construction loan agreement. As a condition to the loan opening, the agreement required that a title insurance policy be purchased in the full amount of the loan and with coverage for claims related to mechanics' liens. It further required that Majestic Pointe submit detailed plans and specifications, as well as a construction schedule that set forth the dates for commencement and completion of each phase of the project.

         The construction loan agreement set forth a list of conditions precedent to disbursement of loan proceeds, including that the loan be in balance and that the lender be satisfied that the project budget remained accurate. To receive loan funds, Majestic Pointe was required to submit disbursement requests to National City. Those requests were to be accompanied by a certificate of completion signed by the architect, lien waivers covering the work for which disbursement was to be made, and endorsements to the title insurance policy. No disbursements of loan proceeds were to be made if the conditions precedent were not met. The agreement reiterated that Majestic Pointe was not entitled to disbursement "any time that the Loan [was] not In Balance or for payment of the Project Costs other than in strict accordance with the Project Budget." The agreement emphasized that "it is expressly understood and agreed that the Loan at all times shall be In Balance." Majestic Pointe also agreed to contribute funds, should the loan fall out of balance. Its failure to do so would constitute an event of default.

         Before entering into the agreement with Majestic Pointe, National City hired the consulting firm Landmark Contract Management, Inc. (Landmark), to review the project's budget and scope of work. Landmark's December 2005 initial feasibility report warned that the general contractor, Kidwell Construction, Inc. (Kidwell Construction), had not prepared plans or project specifications, a detailed budget, or a formal construction schedule.[3] The architectural drawings that Kidwell Construction had provided "[were] not, in [Landmark's] opinion, to the level of completeness that we would typically expect to see for the purposes of bidding." Based on the information provided, Landmark could not develop a detailed cost estimate, but it believed that Kidwell's estimate understated the overall cost by $3.79 to $4.75 million.

         Despite the shortcomings set forth in the initial feasibility report, National City and Majestic Pointe entered into the construction loan agreement on March 13, 2006. Majestic Pointe signed two promissory notes to obtain the earlier agreed-upon $21, 280, 000 from National City. The notes were secured by a construction deed of trust, a security agreement, an assignment of leases and rents, and a fixture filing (collectively, deed of trust).

         Fidelity issued the title insurance policy to National City on March 15, 2006, which provided $21, 280, 000 in coverage. Fidelity later issued an endorsement that changed the effective date of the policy to October 25, 2007, and which increased the amount of ...

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