Title Review 101 for Commercial Real Estate Transactions
Title reviews are the heartbeat of the due diligence process. When a buyer is considering acquiring a commercial property, it is the title review process that confirms the seller actually owns the property and provides an overview of all rights affecting such property.
In order to review title, the buyer generally obtains a title commitment from a title company, which is a commitment that the title company will provide insurance, subject to a list of exceptions and requirements, on terms provided within the commitment at closing. The general information of the prospective policy is contained in Schedule A of the commitment, the requirements are contained in Schedule B, Part 1 of the commitment (commonly referred to as “Schedule B-I”), and the exceptions, often considered the most critical portion of a commitment, are contained in Schedule B-II of the commitment (commonly referred to as “Schedule B-II”).
In Schedule A, the commitment provides the terms on which it is committing to offer insurance. The most important item on Schedule A is the item that identifies who owns rights to the property. If the owner identified on the commitment does not match the seller in the purchase agreement, the buyer may not be obtaining any or all rights to the property. In addition, Schedule A states how much insurance is being provided, what type of insurance, and who the insurance would be provided to (commonly referred to as the “Proposed Insured”). For example, title insurance is commonly offered to both lenders and buyers. Consequently, buyers must assure that they are receiving an Owner’s Policy, which insures their fee interest in the property; whereas, lender’s must obtain a Lender’s Policy, which insures their mortgage to the property. This information is provided in Schedule A.
Schedule B-I provides a list of requirements that must be met before the title company will provide insurance. Often, in commercial transactions, the seller is required to satisfy these requirements before closing, except for the requirements that are specifically designated by the commitment to the buyer. Schedule B-I requirements, like Schedule B-II exceptions, can either be general or specific. General requirements include those requirements that are included in almost every policy. For example, the requirement that the insurance premium must be paid before the title company will provide insurance. Specific requirements include those specific to the property or the parties related thereto. For example, a common specific requirement is that the seller must pay all outstanding property taxes on the property before the policy is issued.
However, it is Schedule B-II that gives lawyers, and often their clients, the most pause. Schedule B-II sets out exceptions that the title company is refusing to cover. Buyers are very preoccupied with this list for two reasons. First, buyers want to maximize the coverage of their policy and often attempt to do this by removing as many exceptions as possible. Second, and just as important, Schedule B-II often reveals encumbrances affecting the property that were previously unknown to the buyer, which may cause the buyer to no longer wish to purchase the property.
There are a number of important standard exceptions. The vast majority of these exceptions may be and, from a buyer’s perspective, should be removed. A summary of three types of very common standard exceptions, and how to remove them, are provided below:
1. Gap Exception. This exception states that the title company will not cover any encumbrances that arise after the date of its search and before the policy is issued. Because the title company conducted a search on the commitment date, the title company would have no reason to know of any encumbrance created after that date. This exception is generally removable through a standard owner’s affidavit, which states that no such encumbrances exist.
2. Not on the Public Records Exceptions. Most commitments contain several exceptions for rights not on the public records. As with the gap exception, title companies do not want to be liable for encumbrances they were not aware of. Specifically, these exceptions often except, all to the extent not shown by the public records, (i) rights/claims of parties in possession, (ii) easements/claims of easements, (iii) taxes and special assessments, and (iv) liens for services or material.
3. Disclosed by Survey Exception. This exception excepts all encumbrances that would be disclosed by an accurate and complete land survey. Here, title companies are acknowledging the importance of a survey, which is capable of locating encumbrances not otherwise determinable. Consequently, this exception can only be removed by obtaining a survey.
In addition, most commitments list one or more specific exceptions. These exceptions include specific encumbrances affecting the property. Specific exceptions often identify access easements, utility easements, restrictions, covenants and more. For example, a specific exception may identify a stormwater declaration that will require the buyer to provide maintenance on the property after the closing. Additionally, a specific exception could identify an easement running through the property that may prevent the buyer from developing the property as desired.
In the above instances, the buyer often must decide whether to go forward with the transaction or not. However, in other instances, the buyer may seek to simply have the exceptions removed. In order to remove an exception, an attorney generally reviews a survey of the property to determine if the exception actually affects the subject property. If the surveyor was provided with the relevant title commitment, the survey should include a list of all specific exceptions and should plot these exceptions to the extent possible. If a surveyor finds that an exception does not actually affect the property (e.g., an easement that is outside the boundaries of the subject property), then the title company is likely to agree to remove the exception.
Overall, the title review process is extremely imperative to investors in commercial real estate. The title review process identifies who owns the subject property and helps a prospective buyer understand the full extent of real estate rights affecting the property. Although the title review process is generally left to attorneys, buyers and real estate professionals of all types are well served by understanding the important role of title review to commercial real estate.
Republished with permission. This article, "Title Review 101 for Commercial Real Estate Transactions," was originally published as a blog by CRE615 on March 8, 2021.