In First American Title Insurance Company v. Action Acquisitions, LLC, Case No. CV-07-0412-PR (July 25, 2008) (“Action Acquisitions II”), the Supreme Court of Arizona defined the scope of two common exclusions to coverage found in most title insurance policies: (1) the “failure to pay value” exclusion and (2) exclusion for losses “created, allowed, or agreed to by” the insured. The Supreme Court of Arizona held that the term “value” in the “failure to pay value” exclusion is synonymous with the “valuable consideration” required for protection as a bona fide purchaser under the recording statutes. Further, the Court held that a purchaser need only have intended to commit the act that caused a title defect, not the creation of the defect, for the “created by” exclusion to prohibit recovery under a title insurance policy. In so holding, the Supreme Court of Arizona vacated a prior opinion of the Court of Appeals and affirmed the judgment of the trial court.
The case involved the purchase of a home at a sheriff’s sale for $3,500.00. Id. at ¶ 2. At the time, the property was estimated to be worth between $300,000 and $400,000 and was subject to a $162,000 deed of trust. Id. After the six month redemption period, the purchasers bought a $400,000 owner’s title insurance policy from First American Title Insurance Company (“First American”). Id. at ¶ 3. The policy excluded coverage for certain losses, including those resulting from the insured’s “failure to pay value” for the title and from risks “created” by the insured. Id.
The prior homeowner successfully moved to set aside the sheriff’s sale on the ground that the $3,500 purchase price was grossly inadequate. Action Acquisitions II, ¶ 4. Rather than appeal the court’s judgment setting aside the sale, the purchasers made a claim against the title insurance policy, and First American sought a declaratory judgment that it was not liable. Id. at ¶ 4.
The trial court agreed with the First American and found that coverage was properly denied under the “created” risk exclusion but did not address the “failure to pay value” exclusion. Id. The Court of Appeals affirmed the trial court’s judgment but relied instead upon the “failure to pay value” exclusion and did not address the “created” risk exception. First Am. Title Ins. Co. v. Action Acquisitions, LLC, 216 Ariz. 537, 539-40 ¶ 8, 169 P.3d 127, 129-30 (Ariz. App. 2007) (“Action Acquisitions I”). In so holding, the Court of Appeals concluded that the “failure to pay value” exclusion applies if the insured is not a bona fide purchaser for value under the recording statutes and that a purchaser whose sale is set aside for a grossly inadequate price is not a bona fide purchaser. Action Acquisitions I, 216 Ariz. at 540-41 ¶¶ 12-13, 169 P.3d at 130-31.
On appeal to the Supreme Court of Arizona, the purchasers argued that neither the “failure to pay value” exclusions relied upon by the Court of Appeals nor the “created by” exclusion relied upon by the trial court applied and that, even if one of the exclusions did apply, coverage should not be denied because they had a reasonable expectation of coverage. Action Acquisitions II, ¶ 7.
The purchasers presented two arguments regarding the “failure to pay value” exclusion: (1) because the property was subject to a substantial first mortgage and a statutory right to redeem the foreclosure, the payment of $3,500 was a payment of value for the property and, (2) alternatively, that the Court of Appeals erred in equating the term “value” with the “valuable consideration” required for protection by the recording statutes. Id. at ¶ 9.
Although the Court agreed with the purchasers that the term “value,” “when considered alone, is somewhat unclear,” the Court found guidance in the general nature of title insurance and the general provisions found in title insurance policies. Id.at ¶ 10. Specifically, the Court observed that “[t]itle insurance exists against the backdrop of the recording statutes” and the “circumstances in which a purchaser will not be protected by the recording statutes have evident counterparts in the policy exclusions.” Id. at ¶¶ 12 and 14. Guided by these observations, the Court held that “[g]iven the policy language and the nature of title insurance, the exclusion for ‘failure to pay value’ is most reasonably understood as applying when an insured is not a bona fide purchaser protected by the recording statutes.” Id. at ¶ 15.
Rejecting the purchasers’ arguments, the Court agreed with the Court of Appeals and held that “the policy’s exclusion for loss resulting from the insured’s ‘failure to pay value’ for the title means a loss resulting because the insured has not paid ‘valuable consideration’ and therefore is not protected under the recording statutes.” Id. at ¶ 16. Nevertheless, although the Supreme Court agreed that the exclusion applies when an insured does not pay valuable consideration, the Supreme Court disagreed with the Court of Appeals’ finding that the purchasers had not paid valuable consideration. Id. at ¶ 17.
Under the recording statutes, “valuable consideration” does not require fair market value or even a fair or adequate price; valuable consideration “exists if the purchaser surrenders a right or detrimentally changes a legal position ‘so that if the claim of title fails the purchaser is left in a worse position than he was before.’” Id. at ¶ 18, quoting Alexander v. O’Neil, 77 Ariz. 91, 99, 267 P.2d 730, 735 (1954). The recording statutes only require consideration sufficient to distinguish transactions in which the purchaser has surrendered a significant right or incurred some legal detriment from the transactions in which the person has received a gift. Id. at ¶ 19. Thus, a nominal payment would not qualify as “valuable consideration” because it does not demonstrate that a purchase ever occurred. Id.
First American argued that, as the Court of Appeals had held, “one whose purchase is later set aside for a grossly inadequate price has, by definition, not paid valuable consideration.” Id. at ¶ 21. However, the Supreme Court found First American’s argument unpersuasive in light of the decision in Krohn v. Sweetheart Props., Ltd., 203 Ariz. 205, 52 P.3d 774 (2002), where the Court “acknowledged that the purchaser was a bona fide purchaser for value, but concluded that this status did not insulate the sale from being set aside for a grossly inadequate price.” Action Acquisitions II, ¶ 22.
Because $3,500 was more than a nominal amount and, although it was a bargain, the property was purchased at arm’s length at a sheriff’s sale, thus minimizing the danger of bad faith, the Court found that the purchasers had paid valuable consideration for the property. Id. at ¶ 20. Therefore, “although the ‘failure to pay value’ exclusion applies if the purchaser’s loss is caused by failure to pay valuable consideration under the recording statutes, . . . the $3,500 payment here was sufficient to secure recording act protection” and, as a result, the “failure to pay value” exclusion does not preclude recovery. Id. at ¶ 24.
The Court then turned its attention to the trial court’s finding that the coverage exclusion for loss resulting from risks “created, allowed, or agreed to by” the purchasers precluded recovery. The purchasers argued that this exclusion could not apply because First American knew of the $3,500 bid prior to issuing the policy and First American argued that the exclusion applied because the bid was an intentional, affirmative act by the purchasers. Id. at ¶ 25.
Noting a split of opinion as to the intent required to trigger the exclusion, the Court held that “[c]onsidering the nature of title insurance, we conclude that the exclusion is not ambiguous and that it applies whenever the insured intended the act causing the defect, not only when the insured intended the defect or when the insured engaged in misconduct.” Id. at ¶ 28. Thus, “by bidding $3,500, the purchasers created the risk that resulted in the loss. Their bid was an intentional, affirmative act that resulted in the sale being set aside.” Id. at ¶ 29. Therefore, the “created” risk exclusion precluded recovery under the policy.
Finally, the purchasers argued that, even if the exclusions applied, they are entitled to coverage under the “reasonable expectations doctrine” under Arizona law. Id. at ¶ 31. Despite the evidence of First American’s investigation into the foreclosure, its suggestion that they purchase a premium policy, its knowledge that the purchasers bought the property at a foreclosure sale, and its knowledge that doing so was part of their business, the Court rejected the purchasers’ contention that they had a reasonable expectation of coverage. Id. at ¶ 35. The Court stated that, although the purchasers might have subjectively expected coverage, “this expectation is simply the ‘fervent hope usually engendered by loss.’” Id.
Although the “failure to pay value” exclusion did not preclude recovery, having rejected the purchasers’ reasonable expectations claim, the Court held that the “created” risk exclusion was enforceable and First American properly denied coverage.
J. Ben Vitale is an associate in the firm’s Insurance and Commercial Litigation Practices. Mr. Vitale has extensive knowledge of class action litigation, especially, “The Class Action Fairness Act of 2005,” and the use of back-end opt-outs in class action settlements. Ben received his bachelor’s degree from the University of Florida and his law degree from Vanderbilt University.