Short-Selling Homeowner Found Liable For Losses Arising From Blown Title Search That Failed To Reveal Existence Of 2nd Mortgage Lien

The following facts have been taken from a recent ruling from a U.S. Bankruptcy Court in Mobile, Alabama:

• Saddled with two mortgages on a home, said home being worth less than the amounts owed on the indebtedness it secured, homeowner David Young found it necessary to unload the home via a short sale.
• At the time of the sale, SouthTrust Bank held a first mortgage on the property, and AmSouth Bank held a second mortgage on the property.
• The homebuyers purchased title insurance from Stewart Title and Guaranty ("Stewart"), and Stewart hired RELI, Inc. to conduct the title search.
• Being that the sale price for the home was actually worth less than the balance of the first mortgage (the 2nd mortgage was completely underwater), Young signed a personal promissory note to SouthTrust for the deficiency.
• Young received no proceeds from the sale, which took place in June, 2004.
• Young conveyed the property to the homebuyers by warranty deed, and by signing the deed, Young represented that the property was "`free and clear of all encumbrances'" and "that he would `warrant and . . . forever defend the title to said property'".
• He also executed an Indemnity Affidavit in which he represented that no liens or encumbrances existed against the property and that he would indemnify RELI for any loss it may incur under its title policy.
• The title report did not reveal AmSouth's second mortgage on the property.
• In January 2005, the homebuyers received a letter from AmSouth indicating that the 2nd mortgage, undiscovered by the title search, was in default and subject to foreclosure.
• In February 2005, AmSouth advised Stewart (the title insurance underwriter) that the second mortgage was in default, and Stewart ultimately coughed up the cash to pay off the debt secured by said mortgage that went undiscovered by the blown title search.
• Stewart then sued RELI (the title searcher) over the blown title search.
• A settlement agreement was ultimately reached whereby RELI's liability insurer forked over $200,000 to Stewart because of RELI's blown title search.
• The liablity insurer, as subrogee of RELI, then decided to go after the broke homeowner, Young (who walked away from the sale of his home without a penny of the sale proceeds in his pocket), and filed suit against him to recover the funds paid to Stewart on account of the unpaid 2nd mortgage that was missed by RELI's blown title search.
• The basis for this lawsuit was the fact that Young signed the Indemnity Affidavit, in which he represented that no liens or encumbrances existed against the property and that he would indemnify RELI for any loss it may incur under its title policy.

Despite Young's arguments that:

1. the mortgage to AmSouth was properly recorded with the Probate Court of Mobile County and was easily searchable under the defendant's name;
2. RELI is a title agent in the business of real property title work and admittedly overlooked the recordation of AmSouth's mortgage;
3. Ala. Code §35-4-90 (1975) charges Zurich, as subrogee of RELI, with knowledge of the AmSouth mortgage, as a properly recorded instrument constitutes "conclusive knowledge to all the world of everything that appears on the face of the instrument." Boyce v. Cassese, 941 So.2d 932, 943 (Ala. 2006) citing Ala. Code §35-4-90 (1975); and
4. under Alabama law, RELI had notice of the mortgage and could not have reasonably relied upon the indemnity affidavit of the defendant,

the court found that Young, by reason of his signing the Indemnity Affidavit, was liable for the amount paid by RELI's insurer to Stewart that arose because of RELI's screw-up in failing to discover the properly recorded 2nd mortgage, and for reasons set forth in the court ruling, the court found that this liability was non-dischargeable in Young's bankruptcy proceeding.

For the ruling, see Zurich American Ins. Co. v. Young (In re Young), Case No. 05-11355-WSS, Adv. Proc. No. 10-00036 (Bankr. S.D. Ala. April 7, 2011).