Fidelity Nat’l Title Ins. Co. v. Osborn III Partners LLC, – 3/1/2023

March 10, 2023

Arizona Supreme Court holds that a title insurance policy exclusion applies whenever insured’s action creates the risk of a coverage-triggering event.

A developer hired a general contractor to begin work on a development project. To secure funding for that project, the developer obtained a loan from a lender secured by a deed of trust on the project. To ensure the validity and priority of the deed of trust, the lender obtained a title insurance policy from a title insurer. The developer often struggled to make payments on the loan and, around the time the contractor completed its work, the lender notified the developer that it would cease funding the project due to missed interest payments. The developer was ultimately unable to pay the contractor, who obtained a mechanic’s lien on the project. The contractor eventually sued to enforce that lien, which had priority over the lender’s deed of trust. As a result, the lender eventually settled with the contractor.

After settlement, the lender sought to recover the cost of the settlement from the title insurer under the terms of the lender’s title insurance policy. The insurer denied the claim, asserting it fell under Exclusion 3(a), which “expressly excluded from coverage” any “defects, liens, encumbrances, adverse claims, or other matters created, suffered, assumed or agreed to by the insured claimant.” The insurer argued that the developer’s failure to pay the contractor was a result of the lender’s cessation of funding, and so the lender’s actions were the cause of the mechanic’s lien.

The lender sued, and the trial court rejected the insurer’s argument. Relying on federal law, the trial court believed that, because the lender was within its contractual rights to stop funding the project, it could not have created the mechanic’s lien. In other words, as a matter of policy, title insurance policies should not require that an insured waive a contractual right. The insurer appealed, and the court of appeals reversed. In that court’s view, there was a bright-line rule, also based on federal law: where a lender cuts off funding, Exclusion 3(a) excludes coverage for liens that arise when completed work goes unpaid as a result of the lack of funds.

On review, the Arizona Supreme Court rejected both approaches. Instead, it focused on the causation analysis articulated in First American Title Insurance Co. v. Action Acquisitions, LLC, 218 Ariz. 394 (2008). Under that test, the question is whether the insured intentionally took an affirmative action that resulted in the risk of loss. Causality was the sole focus: the motive behind the action was irrelevant, so long as the action was taken intentionally.

As the Court explained, this differed from the trial court’s analysis because the trial court interpreted Exclusion 3(a) to only exclude risks created as a result of the insured’s misconduct. The relevant question was whether the insured’s action caused the mechanic’s lien, regardless of motive. On the other hand, the Court rejected the court of appeals’ approach because it conflated causation with correlation and would lead to policy exclusions whenever a funding shortfall resulted in a mechanic’s lien, regardless of whether the lender’s actions were the cause of that shortfall.

With this understanding in mind, the Court remanded the case for further proceedings because the factual record was underdeveloped. It was not clear whether the developer failed to pay the contractor because of the lender’s cessation of payment or the failure to pay proceeded the lender’s refusal to provide further funds.

Justice Lopez authored the opinion for the unanimous Court.

Posted by: Joshua J. Messer