By JAMES R. KELLER
The Eighth Circuit Court of Appeals recently vacated a jury verdict of $6 million in favor of a lender and against the title insurance company on a construction loan. The parties face a new trial with a different jury in federal court in St. Louis on this 13-year-old project.
The case is Captiva Lake Investments, LLC v. Fidelity National Title Insurance Co., 883 F.3d 1038 (8th Cir. 2018). This is a significant opinion about Missouri law from the nation’s second-highest court on construction lending, insurance coverage and mechanics’ liens.
The construction project was a condominium development at the Lake of the Ozarks in Sunrise Beach, MO that started in 2005.
National City Bank of the Midwest had loaned Majestic Pointe Development Co., LLC $21,280,000. National purchased title insurance for the project from Fidelity National Title Insurance Co.
Partway through construction, Majestic defaulted on the construction loan and went bankrupt. Captiva Lake Investments, LLC bought National City’s ownership interest in the project. Various contractors and subcontractors filed mechanics’ liens against the property.
Captiva (the lender) sued Fidelity (the title company) in 2009 asking Fidelity to protect Captiva on the mechanics’ liens. Fidelity agreed to defend Captiva under a reservation of rights. In turn, Fidelity sued Captiva alleging there was no coverage for the mechanics’ liens.
A reservation of rights is not unusual in the insurance industry. In this case, it meant that Fidelity would provide and pay for the defense of the lawsuit; it reserved the right to later disclaim there was insurance coverage.
Fidelity based its reservation on a specific exclusion contained in the title policy it had issued. The exclusion excluded from coverage claims based on liens that were “created, suffered, assumed or agreed to by the insured claimant.” In this case, that was Captiva.
After some procedural maneuvering in court, Captiva became the plaintiff in its claim against Fidelity for insurance coverage. The facts and claims are complicated.
The trial court judge did not allow Fidelity to present its exclusion defense to the jury. The judge determined that there had to be evidence of intentional misconduct or inequitable dealings by National City (the original lender) to advance that defense, and there was no such evidence.
The Eighth Circuit noted “construction lending can be risky.” In case of bankruptcy, the lender’s loan is only protected by the unfinished project, “which is often worth far less than the money put into it.”
Title insurance protects the owner and insurer against defects in title that already existed before the date of the policy. It generally does not protect from events that occur after the date of the policy.
In this case, the title insurance policy was a standard 1992 American Land Title Association (ALTA) lender’s title policy. ALTA writes industry-standard policy forms that are used nationwide.
Fidelity issued the policy after the work had begun. Fidelity agreed to the lender’s deletion of standard policy language that excluded from coverage mechanics’ liens.
This created a risk to the title company that mechanics’ liens might be covered by its policy and that the liens might be given priority over Captiva’s deed of trust for the construction loan.
Missouri law gives priority to mechanics’ liens to protect unpaid contractors, subcontractors and material suppliers. These project partners may be the first in line to be paid before others, including the lender – even a lender whose loan predated any recorded mechanics’ lien. This depends in part on when the work first started in relation to the date of the construction loan.
This priority encourages those trades farther down the food chain to work. Otherwise, some would argue that nothing would get done on a construction project without up-front payment.
Since at least 1855, Missouri has followed the first-spade rule. This rule provides that the first day of work by any contractor, subcontractor or supplier is the operative first date of work for all of them as far as mechanics’ liens are concerned. The liens of all of them – no matter when filed (as long as timely filed) – revert for priority purposes to that first date.
If that date is before the date of the filing of the construction loan, all mechanics’ liens have priority over that lender. In this case, mechanics’ liens were filed after the date of the loan – but at least some of the work apparently preceded that date.
The Eighth Circuit stated that evidence was not presented to show that any work done before the policy date became part of a later lien.
Captiva did not provide any legal authority that applying the first-spade rule was determinative of whether unresolved mechanics’ liens rendered a title unmarketable. Coverage for a title that is unmarketable allows the insured to be indemnified when there is a title defect that existed prior to the date of the policy.
There was another consideration in this case, however, besides mechanics’ lien priority and the first-spade rule.
The Eighth Circuit concluded that the jury should have been allowed to consider the lien exclusion contained in the policy without needing to find intentional misconduct or inequitable dealings by National City.
National City may have “allowed” or “suffered” the liens when it stopped funding the project. The general contractor – Kidwell Construction, Inc. – paid itself about $681,000 of a $1 million fee. This money was supposed to be deferred until the construction loan was repaid.
The schedule of values revealed there were insufficient funds to pay for finishes and site improvements. These events caused National City to stop funding the loan, leaving $1.2 million unpaid from the original loan.
Such evidence could persuade a jury that the “allowed” and “suffered” exclusion should apply, thereby releasing the title company from coverage even though the general exclusion for mechanics’ liens was not in the policy.
James R. Keller is counsel with Sandberg Phoenix & von Gontard P.C. where he concentrates his practice on construction law, complex business disputes, real estate and ADR. He also is an arbitrator and a mediator. Keller can be reached at (314) 446-4285 or firstname.lastname@example.org.