Lien On Me
It's Not in Its Nature
Okay, the basics: when you purchase shares in a co-op you are actually purchasing personal property and not real estate. Although ownership of a cooperative apartment has many of the characteristics of owning real estate, when it comes to things like "title insurance", a co-op just isn't considered real estate. As a result, when you close on your purchase of a co-op, the "title" that you are acquiring is very different. Your ownership interest will be evidenced by shares of stock in the cooperative that owns the building you will be living in and by a proprietary lease which gives you a "leasehold interest" in the unit to which your shares are allocated. When you purchase a condominium apartment, you actually receive a deed to the condo unit just like you would if you purchased a house in the burbs. In essence, there is not a real estate "fee interest" to insure with title insurance when buying a co-op. So how do you protect yourself?
The Lien Search
The cooperative corporation owns the "fee interest" to the building in which your co-operative apartment is located. Since that title must have been cleared when the co-operative acquired title to the building, everyone assumes that the title to the building is okay and there's nothing to worry about. That’s a somewhat exaggerated interpretation, but basically, that's actually the premise that folks rely on. Accordingly, everyone (purchaser, bank and managing agent) goes along with the program of clearing "title" to a seller’s interest in a particular cooperative apartment by ordering a "lien search"from a title insurance company or other company engaged in the business of performing cooperative lien searches. What actually happens when a lien search is conducted? The title company or lien search company will search many of the same records that are searched when a title report for a condo purchase is generated. Tax records, litigation filings, UCC filings and bankruptcy filings are checked to insure that the seller has the unencumbered right to transfer his or her shares to the purchaser. When the search process is completed, the search company generates a lien search report that is an abbreviated version of the title report. The purchaser, the purchaser's bank (if there is financing) and the managing agent, as representative of the cooperative, rely on this search to determine the status of the seller's ownership of his or her shares. But that's it. After the search is generated, except as discussed below, there is no cooperative insurance policy issued by the search company at closing. The parties just rely on that search to make the decision as to whether or not to go ahead with the closing. The Managing Agent's representative will issue a stock certificate and a proprietary lease in the name of the purchaser and the purchaser will be reflected as the owner of the shares on the books and records of the cooperative. But what happens if there is a mistake in the lien search?
Oops, We Missed that Tax Lien
Here's the tricky part about purchasing a co-op. Most search companies limit their liability for making a mistake. Limitations on liability can be as low as $1,000 and run as high as $100,000 (if the purchaser's bank demands a higher limitation). So if the search company accidentally missed a $150,000 tax lien or judgment, and the search company's liability is limited to $20,000, there's a big problem. Of course there would he recourse against the seller, but that is always a difficult remedy once the seller is long gone. The truth is, there's not much that can be done when an undisclosed lien surfaces after closing. Although this scenario rarely occurs, it can happen. Everyone accepts that the lien search is accurate and relies on whatever representations the seller has made in the contract (some of which representations survive closing and most of which do not). There is a "trust me"component to co-op purchases that has always been a part of the process. That being said, once the stock and lease are issued to the purchaser, except in the extremely rare case of a voidable transaction as a result of fraud (which I have never seen happen), once the new stock and lease are issued, the purchaser is without question the owner of the shares. However, that does not guaranty that the shares have been transferred to the purchaser free and clear of all liens and encumbrances. Is there anything else you can do to protect yourself?
Although not used very often, a purchaser can obtained something called a "leasehold insurance"policy from a title insurance company. Leasehold insurance insures that the "leasehold" created by the proprietary lease between the co-op and the tenant-shareholder (the purchaser of the shares), is free and clear of all liens and encumbrances. The search that a title insurance company conducts when it will be issuing a leasehold insurance report is very similar to a title report generated with a condo purchase. Similarly, a "leasehold insurance policy" will be issued at closing just like a title insurance policy. What does it cost? For a $1,000,000 co-op, the leasehold policy premium would be $3,155. A standard cooperative lien search costs about $300, so you can see the difference in the liability assumed by the title company by the higher premiums charged for the leasehold insurance policy. You would think that the protection of a leasehold insurance policy, would be as important as obtaining title insurance. Surprisingly, leasehold insurance is rarely obtained in co-op purchases. A leasehold policy is never requested by the purchaser’s bank and most purchasers don't even know it exists.
The Eagle 9 Policy
A number of years ago, First American Title Insurance Company of New York, recognizing the minimal title insurance protection afforded to purchasers of co-ops, introduced a new insurance product called the “Eagle 9 Cooperative Insurance Policy for Buyers”. This new type of insurance coverage specifically addresses many of the liability concerns that arise in connection with the purchase of cooperative shares and protects the insured against claims arising under the Uniform Commercial Code (affectionately call the “UCC”), which is the body of law that deals with security interests filed against personal property (shares in a co-op), among many other things. Here are just a few items covered under the policy:
Someone other than the purchaser claims an interest in the shares.
A lender attempts to enforce a wrongfully terminated UCC-1 filing.
A tax lien filed in another jurisdiction is being enforced against the unit.
- A proceeding is commenced to enforce a judgment or a claim.
There are a number of other areas of coverage, but you get the idea. In order to make the product interesting to purchasers and to the industry, First American priced the title product at a lower premium. The same coverage for a $1,000,000 cooperative apartment would be $1,257, instead of $3,155 for a leasehold title insurance policy. Despite the reasonable cost (taking the average price of a co-op into consideration), most co-op purchasers do not purchase Eagle 9 policy coverage.
Which is the More Effective Policy?
As with any type of insurance, the value of the insurance is determined by the insurance company’s willingness to cover a loss once a claim that is made under the policy. Based on my conversations with a number of title companies, I could not find an instance where a claim had been made either under a leasehold title insurance policy or under the Eagle 9 policy. Accordingly, until a claim is made, no on really knows exactly how a title company will respond to the claim and whether the particular claim will be covered under the insurance policy. Further, I have asked a number of title professionals which policy has better coverage and I have not gotten a definitive answer. The Eagle 9 is less expensive, but not necessarily a better product. Until a claim is made and a title company reacts, I don’t think that question can get answered.
Uncertainty Aside, When Should A Leasehold or Eagle 9 Policy be Purchased?
Despite the unquantifiable value of leasehold insurance or UCC-related insurance at the moment, when should you consider obtaining leasehold or Eagle 9 UCC insurance policy, even though such policies are used infrequently? Here are a few cases when incurring the cost makes sense.
If you happen to be purchasing shares from a bank that has foreclosed on its cooperative lien.
If you’re purchasing shares from a bankruptcy trustee.
When purchasing cooperative shares from an estate (that is, the entity through which shares are sold after the shareholder has died), particularly if there is any concern about the ability of the estate to transfer the shares and to insure that all estate tax has been paid and all federal and state estate tax lien waivers have been obtained.
If you are purchasing from a divorced couple who have just completed a hostile divorce and only one party is actively participating the closing (as the other party has given his or her former spouse a power of attorney to complete the transaction pursuant to the terms of the divorce decree or separation agreement).
When the seller is currently a party to material litigation.
When a lien search discloses significant liens and judgments against your seller, to insure that all such liens and judgments are disposed of prior to closing,
Again, even in these situations, as odd as it sounds, leasehold or UCC-related insurance is rarely obtained.
What Happens at Closing
With most co-ops closings, unlike a condo closing, there is no "title closer" at the closing. The bank's attorney or the purchaser's attorney will order a "continuation search" to be conducted by the search company on the morning of the closing. This search is performed to insure that no new liens have come of record since the date of the original lien search. If leasehold or UCC-related insurance is being obtained, a title closer will attend the closing to “mark up” the title report initially prepared by the title company in order to issue the policy. As a part of the process of clearing title, at closing, the seller will provide the title closer with whatever documentation the title company has requested, such as federal or state tax releases, satisfactions of judgments or UCC lien terminations.
Residential Reality: Go Ahead and Close
Some of you may be thinking, how can I buy a co-op with such uncertainty about the status of the seller’s title? There is definitely a leap of faith taken by the purchaser when purchasing a co-op because of the holes in liability protection. That being said, co-ops represent about 80% of the ownership-based housing stock in New York City and thousands of people are buying and selling cooperatives every year. Although it can happen, there are very few cases where bad title is transferred when a co-op is sold, resulting in the seller’s problem becoming the buyer’s problem. Obviously, due diligence is very important. In the vast majority of cases, the professionals take the appropriate action to insure that the purchaser is getting “lien free” title. Attorneys know all of the above and now you do as well.
For more about title insurance, see “What Exactly is Title Insurance.”
For more about closings, see “The Closing—Time to Wrap Things Up.”