In Fawn Second Ave., LLC v. First American Title Insurance, LEXIS 122021 (S.D.N.Y. July 11, 2022), the United States District Court for the Southern District of New York (“the Court”) found a title insurer was not liable for coverage in connection with a failure to inform property purchasers that the subject property had been designated as a “landmark” prior to purchase, thus restricting its use.

The matter involved a group of corporate entities including Fawn Second Avenue, LLC (“Plaintiffs”), who held a title insurance policy issued by Defendant First American Title Insurance Company (“First American”) in connection with Plaintiffs' November 17, 2015 purchase of real property located at 82 Second Avenue in New York City (“the Property”).  In early October 2017, Plaintiffs commenced performing a series of improvements to the Property–however, shortly after beginning construction, they received formal warning letters from the New York City Landmarks Preservation Commission informing them that in October 2012, the Property had been formally designated as a “landmark,” and thus Plaintiffs were not legally permitted to modify or improve the building.

On October 12, 2017, Plaintiffs submitted a notice of claim to First American under their title policy, seeking coverage for the diminution in value inflicted upon the Property due to its “landmark” designation.  The claim was subsequently denied.  Plaintiffs then brought suit, alleging that First American had breached its coverage obligations owed under the title policy, and had been negligent in failing to disclose the Property’s landmark status.  First American responded by moving to dismiss the suit pursuant to Federal Rule 12(b)(6), alleging that Plaintiffs’ claims were barred from coverage.

In doing so, First American argued that a landmark designation did not create a “defect, lien, or encumbrance” on title sufficient to qualify as a covered risk on a title policy, contending that because such designation is “an exercise of governmental power” meant to “regulate [a] [p]roperty’s use or development,” it was wholly distinct from standard title impairments.  The Court agreed, holding that the operative New York case law “ma[de] plain that local regulations that restrict the use or development of real property do not give rise to a defect in or encumbrance on title,” and reaffirming the essential principle that title insurance is concerned only with marketability of title itself and not impairments to the value or use of a property.

The Court further explained that zoning regulations cannot be construed as “impact[ing] the marketability of title” nor as creating a “defect, lien, or encumbrance” on title regardless of their impact on a property’s value, as these restrictions have no impact on the marketability of the title–i.e. the ownership–itself.  As the Property’s landmark status restricted “the manner” in which the Property could be used, but “in no way” impacted Plaintiffs’ right to ownership and possession of the Property, no coverage under the title policy was possible and Plaintiffs’ claim necessarily failed.

First American additionally contended that Plaintiffs’ claims were barred by the title policy’s standard 1(a) exclusion, which provided that First American was not required to provide coverage for any:

law, ordinance, permit, or governmental regulation (including those relating to building and zoning) restricting, regulating, prohibiting, or relating to ... the occupancy, use, or enjoyment of the Land; ... the character, dimensions, or location of any improvement erected on the Land; ... or the effect of any violation of these laws, ordinances, or governmental regulations.

The Court again agreed for the same “reasons just discussed,” holding that because the landmark designation was not a title defect, but instead an exercise of governmental power, the 1(a) exclusion was triggered and coverage was not owed.  In so holding the Court reaffirmed the general principle that when interpreting a title policy the “total scope of coverage . . . [is] the balance of the covered risks, less the exclusions”–i.e., there are no circumstances in which a covered risk within a policy can prevail over a triggered exclusion.

Finally, as to Plaintiffs’ negligence claim, the Court first observed that while it is “well-settled” that a “cause of action for negligence based on a deficient title search cannot be sustained under a title insurance policy,” such a claim is possible under “a certificate of title.”  However, when the certificate of title is provided prior to the issuance of the title policy itself, and subsequently merges with the policy at the time it is issued, “any action for damages arising out of the search–whether sounding in tort or contract–is foreclosed.”  Due to these settled principles Plaintiffs’ claim thus failed, as while First American did issue a pre-policy certificate of title, the language of the certificate clearly indicated that it was to merge with any later issued title policy.  Thus, “New York law clearly preclude[d] Plaintiffs from pursuing a claim for negligence under the Policy.”

Takeaways

This matter makes clear that policy coverage will not be triggered by a property’s designation as an official “landmark,” regardless of how restrictive such designation is upon the property’s use, unless the limitations imposed impact possession or ownership of the property itself.  It also clarifies that a policy’s 1(a) exclusion will serve to disclaim coverage wherever a restriction can be successfully characterized as an exercise of governmental regulatory authority, providing creative practitioners with a potentially broad basis to seek coverage denials.  Several essential title principles are also conveniently stated and reaffirmed, such as the inability of negligence to constitute a claim and the triggering of an exclusion always serving to bar coverage.

For a copy of the decision, please contact Michael O’Donnell at modonnell@riker.com, Kevin Hakansson at khakansson@riker.com, James Mazewski at jmazewski@riker.com or Kori Pruett at kpruett@riker.com.