Summary:  A title insurer’s failure to except a defect does not constitute negligence or defeat an equitable claim.

United Community Bank v Prairie State Bank & Trust, 2012 IL App (4^th) 110973, 972 NE2d 324, 361 Ill Dec 839 (4^th D, 2012).

Facts: On May 12, 2005, Santarelli and Sons, Inc. (Santarelli) signed and recorded a mortgage in favor of Illinois National Bank in securing a construction loan on real estate it owned in Springfield.  On April 5, 2007, Santarelli signed a contract to sell the land to James G. McDonough (McDonough). The sales contract was not recorded at that time. On June 27, 2007, United Community Bank told McDonough that it would lend money for the purchase if he obtained a title commitment showing no liens or encumbrances for the amount of the purchase price.

In the meantime, on July 24, 2007, Prairie State bank obtained a judgment against Santarelli and recoded a memorandum of the judgment on July 26, 2007. Later, on September 6, 2007, Commonwealth Title Insurance Company (Commonwealth) issued a commitment, which failed to except Prairie State Bank’s judgment from coverage. Then Commonwealth issued a policy to McDonough and to United Community Bank and the deed and mortgage were recorded along with a release of the construction mortgage in favor of Illinois National Bank. 

United Community Bank and McDonough filed a complaint for declaratory judgment against Prairie State Bank and Santarelli seeking a judgment that conventional subrogation voided Prairie State Bank’s judgment lien, or in the alternative, that it made United Community Bank’s lien superior. Furthermore, United Community Bank claimed that equitable subrogation made McDonough’s ownership of the property free and clear of Prairie State Bank’s judgment lien. The trial court rejected these arguments and granted summary judgment in favor of Prairie State Bank. The court based this on an Indiana decision which held that equitable subrogation should not be used to benefit a negligent insurer.  McDonough and United Community Bank filed a motion for reconsideration arguing that they were innocent of any negligence. The trial court rejected this argument finding that a buyer and lender’s delegation of a responsibility to a third party does not relieve them of responsibility. 

Holding: Affirmed in part and reversed in part. Equitable conversion occurs where a vendee enjoys “all the incidents of a real ownership” before there is a “confirmation of legal title for the purposes of security against third persons.” The appellate court found that this argument did not apply because, at common law, equitable conversion is effective only against people with notice of the executory contract.  In this case there was no evidence that Prairie State Bank had notice of the contract. This reasoning defeated the argument that, because the judgment lien attached to Santarelli’s property after the contract was signed, there was already an effective transfer and Prairie State Bank had an interest only in the money paid and not the property. For those reasons equitable conversion did not apply.

The appellate court found equitable subrogation applicable. Equitable subrogation exists when a “party involuntarily pays a debt of another and succeeds to the right of the other with respect to the debt paid.” In this instance, the money from United Community Bank’s mortgage loan was used to satisfy Illinois National Bank’s mortgage. Because no prejudice results to Prairie State Bank when equitable subrogation is applied, the appellate court held it applicable in the amount that it was used to pay the construction loan. That holding gave United Community Bank’s mortgage priority as to the amount of the payoff over Prairie State Bank’s judgment lien.

The court further held that the lower court’s finding of “misfeasance” or “negligence” was inappropriate. Commonwealth owed no duty to discover the judgment lien. This is where it’s important to distinguish between the contract for title insurance and a title search. Commonwealth’s freedom of contract would have allowed it to discover the judgment and not except it for the purposes of title insurance. The title search that Commonwealth conducted was for its own purposes and not for anyone else’s business. The title insurance policy is a contract for insurance, not a title search or a title opinion.