In our December 2000 issue we took a fly-on-the-wall look at how title insurance professionals solved some of the most vexing issues they faced during recent transactions. In this issue, five more creative problem solvers share the secrets of their greatest successes.
Just as impressive as their ability to overcome seemingly insurmountable challenges were the myriad ways in which those problems were solved. In one instance, a team of title insurance professionals created an entirely new vehicle for insuring a mezzanine lender; in another, a title company's new, proprietary technology enabled all parties of 54 different offices to operate at their own pace by creating a virtual conference room. Still another tells a cautionary take of a new business structure that offers an opportunity for greater profits, but also is a potential breeding ground for abuse.
We are pleased to again present the war stories of real estate's unsung heroes. We hope you continue to enjoy these case studies, and to marvel at the hard work, the pressures, the under-the-gun creativity and the teamwork that occurs between contract and closing.
If there's no solution in sight, then invent one!
There's creativity, and then there's creativity. In one recent transaction, the Los Angeles office of Chicago Title Insurance created an entirely new title insurance concept to make the deal happen.
The deal, in excess of $300 million, involved the refinancing of a mix of retail and office properties that the borrower had owned for a considerable period of time. The borrower actually procured two loans: a “pure vanilla” real estate loan secured by first mortgages, and some mezzanine financing that was not secured by the real estate. The mezzanine lender took a pledge of the membership interest of the sole member of the owning limited liability corporation as collateral.
“Ordinarily with mezzanine financing, if the borrower doesn't pay the mezzanine loan, the lender forecloses and obtains the ownership of some or all of the real estate owning entity,” explained Sharon Yarber, vice president and senior counsel for Chicago Title. “The first mortgage is unaffected. So, a mezzanine lender wants to get protection to ensure that it will be entitled to all the benefits of an owner's policy when and if it becomes the beneficial owner.
“Normally in a transaction such as this, we issue an owner's policy to an owner and attach a special mezzanine lender endorsement to that policy. This endorsement assigns the owner's title insurance policy proceeds to the mezzanine lender; it also provides the mezzanine lender fairway (an agreement that the policy will remain in effect notwithstanding changes in the identity of the constituent members of the owner) and non-imputation coverage,” she said.
“It is a title industry practice to always write an owner's policy for the full, fair-market value of the property at the time it is issued. In this case, the fair-market value was well over the total of the two indebtednesses.”
— Sharon Yarber Chicago Title Insurance
In a partnership situation, Yarber explained, the knowledge of each partner is imputed to the partnership by operation of law. Non-imputation coverage for a mezzanine lender insures the lender that, after succeeding to the ownership of the partnership following a default, coverage will not be denied to said lender on the basis that the title holding entity had knowledge imputed to it from the former partners.
“It is a title industry practice to always write an owner's policy for the full, fair-market value of the property at the time it is issued,” Yarber said. “In this case, the fair-market value was well over the total of the two indebtednesses. The borrower did not want to spend the money required to get an owner's policy for current value, but the mezzanine lender would then not have an owner's policy to which the endorsement that would give it protection could be attached.” The owner had to get a new loan policy for the secured lender, but that just insured the amount of the loan for that lender, Yarber added.
So this was the challenge: How do you insure a mezzanine lender when there is no mortgage (a loan policy doesn't make sense), and when there is no owner's policy to which the mezzanine endorsement can be attached?
The resolution devised by Chicago Title was to issue a new owner's policy for the amount of the mezzanine loan (the reasoning was that in any event the most the lender can collect with a loss is the amount of the loan). The insured was the mezzanine lender; the vestee under the policy was the borrower. “Then, we added a special provision that said that notwithstanding anything else in the policy, the lender would only be entitled to recover under that policy what it would have been entitled to recover if the policy had been a loan policy insuring a second mortgage,” Yarber noted.
The bottom line? “Everybody was happy; it was a great resolution, and a ‘killer’ deal was closed,” Yarber said.
Bankruptcy proceeding creates complex challenges
Many times the parties in a closing misunderstand the role of title insurance; they may be under the impression that the underwriter will assume liability for things that have nothing at all to do with title law.
Some fancy footwork was required by the Dallas office of Chicago Title, and more specifically, by Lamar Tims, assistant vice president and commercial escrow officer, to close a deal this past October. “The deal initially had to do with the sale of 11 properties, and ultimately eight or nine, out of a Chapter 11 bankruptcy proceeding,” Tims said. “The uniqueness of the transaction was not necessarily that it had come out of a bankruptcy, but as is true of all bankruptcies, it brought into play so many different facets and elements of the law, particularly as it applies to real estate creditor's rights.”
Perhaps the most outstanding challenge Tims faced was how to accomplish a closing when you are basically dealing with delinquent or currently due taxes and with parties who don't want to face up to the fact that they themselves are subject to bankruptcy laws. “For example, taxing authorities think that bankruptcy laws don't apply to them,” he said. Tims had to resolve with these authorities the extent to which penalties and interest that normally accrue might or might not apply in a given jurisdiction.
“If you're dealing with a growing concern, matters are further complicated because you have taxes on real estate that are a concern of the title company.”
— Lamar Tims Chicago Title Insurance
“If you're dealing with a growing concern, matters are further complicated because you have taxes on real estate that are a concern of the title company,” Tims said. “You also have taxes on personal property that technically may not be your concern. But as a settlement agent, you could be charged with that responsibility and asked to assume the responsibility for it all to be taken care of in a timely manner — and in a manner that will not leave you open to potential trouble down the road.”
To further complicate matters, this was a multi-jurisdictional transaction. From a practical standpoint Tims was not only dealing with delinquent taxes, but also with taxes that were collected in advance in some jurisdictions, in arrears in others, with some on a calendar-year basis and others on a fiscal-year basis.
How did Tims handle it? “You crank up your Excel spreadsheet,” he replied. “It also required a tremendous amount of coordination with numbers of people in the bankrupt party. You have to be in tune with what they do internally, with what's paid and what's not paid, and reach a level of confidence in what they say. The main challenge is to keep an open mind and not get thrown by the next punch. But you must reach that comfort level,” Tims said.
It also was important to keep in contact with the proposed insured, Tims added, because some of this year's taxes were to be paid out of the transaction. “So they had to be comfortable with some of the decisions we made; conversely, if we decided certain matters did not need to be taken care of, we wanted the proposed insured to be in agreement.” Many of these issues are not black and white, Tims said. “You just have to keep talking to the parties, making sure they are as informed as you are. You want them to have confidence in you, and in the fact that you're not making a decision just to get the deal closed. In the event that a claim does arise, at least it arises in what possibly could be characterized as a friendly environment.”
Technology streamlines 54-office title clearance
Chicago-based Near North National Title Corp. used new, proprietary technology to facilitate the year-end closing of a joint venture involving 54 office and industrial properties in the Las Vegas area. The technology dramatically sped up the process not only for Near North's staff, but also for the multiple lenders and the major Maryland and Atlanta law firms who represented the parties in the transaction.
“Due to the nature of the transaction, it was actually a three-phase closing with multiple bank accounts and multiple escrows,” said Cindy O'Donohue, executive vice president with Near North. “Our technology, which is unique in the industry, allows for the entire title clearance process to be handled over the Internet in a secure environment.”
During the process there were 350 title comments and responses logged in through Near North's Commercial Transaction Management System. “We also used another unique product — a CD that stores all the title commitments and Schedule-B documents,” O'Donohue said. That product, the Commercial Document Management System, employs proprietary software with search features, so parties can search for a specific document and effect instant retrievals. “We had more than 300 Schedule-B questions; whenever one would come up, instead of having to go through our files, we simply put in the CD and searched,” she said.
Near North also was able to use the software in preparation for and during closing. “Instead of having boxes of documents shipped to the closing, we just took our CD and we were there,” O'Donohue said. “What we're trying to do through these products is create a virtual conference room. The process is greatly enhanced, and everyone can work at their own pace.”
“Our technology, which is unique in the industry, allows for the entire title clearance process to be handled over the Internet in a secure environment.”
— Cindy O'Donohue Near North National Title Corp.
This new technology also results in a significant reduction in transaction costs, noted Dennis Kasper, also an executive vice president with Near North. “It enables people to make more efficient use of their time,” he said. “Faxes are not being lost; it eliminates the sole reliance on physical documents, or on phone calls that are only sometimes being returned.”
“It also means greater accountability for the title company,” O'Donohue added. “Every communication is time-stamped and recorded, so you must respond. It also allows our clients to follow the progress of the transaction. On this particular deal, all the title commitments, the pro forma policies and the final policies were delivered electronically. Obviously, they also were sent on paper, but the client likes to see the product instantly. Then, we put the paper product in our file. This new technology is something we are really excited about,” she said.
National offices ensure success of 106-site deal
Sometimes the parameters of a deal virtually dictate that it be handled through offices of national title services to ensure success, said Sally French Tyler, vice president of national business development at Fidelity National Title Insurance Co., Irvine, Calif.
“One deal we closed in 2000 involved 106 sites in 23 states,” she recalled. The $600 million deal entailed the use of 32 field offices, six law firms and a national survey company. “I had to coordinate it all, but we had a phenomenal support team of eight individuals,” Tyler said.
The deal was a refinancing involving the healthcare industry, with Fidelity National representing the borrower. “We got the green light in late May and it had to close in August, which placed significant time constraints on us,” Tyler said. “Since it was a refinancing, we also were dealing with the termination side; there were a lot of mortgages and UCCs (universal commercial codes) to release.”
The structure of the deal also was complicated, she added. It was a Wall Street transaction, which required the team to spend a significant amount of time problem-solving. “It certainly produced some complications with respect to title underwriting,” Tyler said.
As with many of these large transactions, the deal closed in New York City. Half the Fidelity team spent a week there working on the closing. “The deal was so significant that for a short period of time, it virtually threatened to shut down the rest of our production efforts,” Tyler recalled. “During times like that, it really helps matters when you have a strong relationship with the companies you work with.”
There were a number of keys to the success of this deal, Tyler said. “Not only was the pricing dealt with up front — nobody likes closing surprises — but our office centralized and coordinated all of the underwriting. Title insurance is virtually different in every state; there are often different laws and different pricing,” Tyler continued. “A national office allows everything to be coordinated under one roof; the borrower only has to deal with one group of people and one contact.”
Being centralized also enabled Fidelity National to respond quickly to client requests. “Once the file offices produced the product, we were able to take it and revise it as requested by the borrower and their counsel,” Tyler said. “Everyone had their own version of what the product should look like. Instead of requesting revision upon revision from different field offices, we could do it all in-house. And, being centralized, we could look at all of the issues on a global basis, taking both the business risk and the big picture into account.”
Finally, Tyler said being a member of Commercial Real Estate Women (CREW) made the deal a little easier for her personally. “I found out that an attorney representing the lender being paid off was also a CREW member. Once we realized we had that in common, it really helped facilitate the transaction. Since then we've had the opportunity through other CREW events to discuss and work on other transactions,” she said.
AFBAs: a new source of potential profits — or abuses
In recent years the growth of Affiliated Businesses Arrangements (AFBAs) have led to new opportunities for growth and profit in the title insurance industry. It has also led to abuses, and presents a new challenge to the ongoing success of title firms.
“Title agencies have traditionally enjoyed a separated market, with realtors and mortgage companies providing referrals,” explained Tina Dickey, president of Baltimore-based Affiliated Title Management LLC. “If a realtor refers business to a title company in which he has ownership, that would be considered an affiliated business. The ability to refer includes the ability to reap dividends. Under the Real Estate Settlement Procedures Act (RESPA), referrals are illegal, so in order for the realtor to benefit financially from the referral, there should be ownership.”
Unfortunately, as these doors have closed for realtors and mortgage bankers, many title providers have created sham organizations or entities, Dickey said. “There are 10 points that must be followed by an affiliated business for it to be legitimate.”
“The deal was so significant that for a short period of time, it virtually threatened to shut down the rest of our production efforts.”
— Sally French Tyler Fidelity National Title Insurance Co.
According to Dickey, those 10 points include:
paying fair-market rent for the space it occupies;
the title firm has to provide core title services;
the entity has to be sufficiently capitalized;
capitalization has to be in direct correlation to ownership percentage;
the entity has to manage its own affairs;
it has to have real employees who receive W-2s; and
it has to compete in the marketplace beyond the referrals it receives from the owning realtor or mortgage banker.
Currently, many businesses in operation do not meet these criteria, Dickey said, and this flurry of sham organizations has led to a number of U.S. Housing and Urban Development Dept. (HUD) investigations and even fines.
“There is a case currently under investigation that involves a title agency owner and a mortgage broker,” Dickey explained. “What we believe happened was the title agency owner had an ownership interest in the mortgage brokerage, albeit slight. The mortgage banker's lines of credit were being funded on certain transactions. Even if the settlement was with another company, the money was being funneled through the title agency's escrow account. This meant they had access to all that money. By getting access to the lines of credit they were ‘showing’ credit support with commitments on properties that never closed. The lenders were funding on those very commitments, believing these settlements were taking place.
“We believe the agent funneled up to $6 million out of the country. If there had been proper oversight — for example, sharing of books — this situation could have been avoided,” Dickey said.
In addition to bringing parties together, Dickey's organization also makes sure their business partners are alerted to these potential problems. “One of the things we try to do is avoid all these sham issues and set up legitimate organizations,” she said.
Setting up and running an AFBA properly will not only keep participants out of trouble, but it can also enhance profitability. “In sham organizations, there is a relatively low return on investment — about 50%,” Dickey said. “But if you structure these organizations properly, there's going to be an ROI (return on investment) somewhere above 200%, just using the average model. One of our clients is realizing more than 350%.”
Potential customers for AFBAs now include banks, as well as realtors and mortgage bankers, Dickey said. “Under the Gramm-Leach-Bliley Act, banks can now own title agencies,” Dickey explained.
All of this makes title insurance companies targets for takeovers, Dickey said. “If your title company doesn't get involved in AFBAs, someone else is going to. If you don't embrace them and figure out a way to make money with them, then you're putting yourself at risk.”
Steve Lewis is an Alpharetta, Ga.-based writer.