Title Insurance and Neighborhood Revitalization

COMMUNITY DEVELOPMENT LAW CORNER

By Danny Schaffzin & Steve Barlow

Very often after a foreclosure auction, a property is so delinquent on taxes that it remains extremely difficult, if not impossible, for the tax sale purchaser to sell or resell, or even secure a loan to build or rehabilitate a property.

In the Community Development Law Corner, we try to explain in plain language some of the complicated legal issues that in our experience present the greatest challenges to community and neighborhood revitalization in Memphis. Previous editions of the Corner have focused on code enforcement, land banking, delinquent property tax auction sales, Environmental Court litigation, housing discrimination, and unfair evictions as just a few of the nuanced legal areas that can have a direct bearing on rebuilding quality neighborhoods.  

In this month’s Community Development Law Corner, we highlight one of the most pervasive challenges facing most Memphis neighborhoods—the lack of marketability and insurability of title to real estate once it has been through a tax sale auction. Very often, a property that is so delinquent on taxes that it is sold off at a foreclosure auction remains extremely difficult, if not impossible, for the tax sale purchaser to sell or resell after the auction. Likewise, the tax sale purchaser will commonly be unable to secure a loan to build or rehabilitate a property following the sale.

Under current laws, systems, and policies, the “tax sale” blemish on title, in case after case, is very difficult if not impossible to overcome.

In usual property conveyances, a title insurance policy guarantees that the person whose name is on the deed will be able to sell that property, occupy and use the property according to its zoning, and get a loan with the property as collateral. To get a title policy, the owner pays a one-time premium. That premium for a $100,000 residential property in Memphis today will likely be about $600. 

“Dead” Properties

Any person who buys real estate is advised to purchase an unqualified title insurance policy on that property. In fact, most real estate agreements require that title insurance be available to the buyer and, if it isn’t, provide the buyer with an absolute right to terminate the agreement and get back their earnest money. Lawyers routinely advise their clients NOT to purchase real estate that does not have marketable and insurable title. A real estate purchaser who is not concerned about whether they can get a title policy is an anomaly. Therefore, a property for which a title insurance policy is not available is essentially a “dead” property.

For far too many properties across Memphis, however, title insurance is not available. This is because so many of our City’s properties have fallen prey to tax foreclosure sales over the years. Under current laws, systems, and policies, the “tax sale” blemish on title, in case after case, is very difficult if not impossible to overcome.

It is understandable to then ask who might buy a dead property and, what they might do with it?

Who will buy a dead property? Usually someone who is only interested in getting cash flow from the property for a limited period of time.

The main question has to do with the property’s investment value, and that is closely related to development or use potential and the ability to borrow money against the property. A property that cannot get a title insurance policy has far less value than a property that can.

For example, if you buy a small piece of land (say 50 feet by 150 feet) in a residential community, it is likely that you will eventually want to build a house on it. And even if you want to live there for the time being, you will certainly want to know that when it is time to move you will be able to sell the property at the same or similar value you put into it. If you are able to get a title policy for the property, this is a likely outcome.

If you cannot get a title policy, however, it is very unlikely that you will ever build or otherwise invest any additional resources into developing the property. Most people need to borrow money to build or make improvements to a house. But banks do not lend if they cannot get their own title policy – called a lender’s title policy. And even if you have the cash you need without a loan to build what you like on the property and to live there without any trouble for as long as you like, the next person to come along with interest in buying your property will not be able to get a loan either.

There is also a risk that someone will show up and sue you to get the property back, claiming that since they were not notified of the tax sale (see due process discussion below) the property should be returned to them. 

This challenge plagues many thousands of parcels of real estate all across Memphis neighborhoods that have been through the tax sale auction process. 

Property & Due Process

How is it that property that has gone through a government-initiated tax sale auction may nonetheless be dead and uninsurable? The United States Constitution guarantees every citizen the right to due process before any property may be taken from them. Due process involves notice and a right to a hearing. For this reason, taking a property from someone for his or her failure to pay property taxes may only be done if the non-tax-paying citizen is given his or her right to due process. If they are not, the resulting “taking” by the government can be invalidated by a court—at any time in the future without limitation. This is a good thing to protect property owners.

In the case of tax sales, however, the matter of due process can become quite confusing. Tax collectors do not want to deprive property owners of their rights. But there is a difference between satisfying the right to due process and persuading the title insurance companies to insure due process rights have been satisfied. 

Another potential issue for tax sale properties is the fear of liens or other claims against the property by people other than the owner that might still be attached to the property after the tax sale. Potential buyers, title insurers, or lenders may believe the risk of future liability or loss is too high to justify any involvement with the property in question.

Tax sales are conducted at the city or county level, and there are many cities and counties in every state. In every instance, the government entity must carefully track what procedures were followed, by whom, and by when to provide notice and a right to a hearing on the taxes that are delinquent? Quickly, the issues can get sticky. And the title insurance company, once it insures a parcel, is obligated to defend any challenges to title, including claims asserting that a property tax sale was improperly noticed or conducted. Even an invalid challenge to title costs the title insurance company money in court costs and attorney’s fees to defend.  

National and international title insurance and lending industries have developed standards and expectations with regard to insurability of title. If they cannot be met easily and have proven to have been met, those companies will simply not issue a title insurance policy. For low-valued real estate, the incentive for the title industry to find a solution to this challenge is virtually non-existent since the profit per transaction is very low.

In the case of the residential property with a $600 title insurance premium, for example, the title company makes that money one time, with a portion also going to the underwriter. So, for about $200 in profit, the insurance company takes on the risk of defending a lawsuit likely to cost thousands of dollars even if meritless. The practical result is that almost no property that has been through a tax sale process in any city or state is insurable. The problem is particularly acute in urban areas like Memphis, which have a sprawling land area and multiple neighborhoods compromised by years of disinvestment. 

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Who will buy a dead property?

We return then to an earlier question – the one which underscores why we believe this is such an important community development law issue: who will buy a dead property? The simple answer is usually someone who buys it for very cheap and is only interested in getting cash flow from the property for a limited period of time. Commonly, this is a purchaser who knows they cannot get a title policy on the property but believes if they buy it cheap enough, they can make their money back along with some return before they walk away and abandon it. This is not the type of investor that any struggling Memphis neighborhood needs.  

Of course, there are ways to navigate through this complex challenge. Some title insurers have come up with solutions to small parts of the challenge in certain markets. One title insurer in Memphis will provide title insurance on tax sale auction property, for instance, if the government can show that all of the owners have been given notice by certified mail. But a large scale, national level solution is needed. At the state level in Tennessee, there has been a recent legislative push to improve the likelihood of insurable title following tax sale. Meanwhile, long abandoned land in the heart of Memphis lies fallow with little hope of high-quality revitalization until the title insurance challenge can be solved. <>

Barlow and Schaffzin (Barlow & Schaffzin PLC.) co-direct the University of Memphis School of Law’s Neighborhood Preservation Clinic where they supervise law students handling Environmental Court lawsuits on behalf of the City of Memphis. Schaffzin is an associate professor of law and director of experiential learning and Barlow is adjunct faculty and part time staff attorney for the City. Barlow serves as President of Neighborhood Preservation, Inc.

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