Bank Cannot Sue Title Company Over Escrow Construction Loans

by James R. Keller

A bank cannot sue one of two title insurance companies over a construction escrow account, according to Missouri's Eastern District Court of Appeals in The Business Bank of Saint Louis v. Old Republic National Title Insurance Co., 2010 WL 1794396 (Mo. App. E.D.), decided May 4. This decision left the bank with construction loans that allegedly were not covered by sufficient collateral.

The project was the construction of houses. In 2004 Hillsboro Title Company entered into a construction escrow agreement. This agreement provided that Hillsboro agreed to act as the escrow agent and disburse money provided by the bank to fund the construction project.

The other parties to the escrow agreement were Beaker LLC, the project's owner, Lawless Homes, Inc., the contractor and The Business Bank of Saint Louis, the lender.

Most importantly, as it turns out, Old Republic was not a signatory to the escrow agreement. This fact was pivotal to the appellate court's decision that Old Republic was not subject to the bank's lawsuit.

The bank deposited $4.2 million with Hillsboro, of which about $2.4 million the parties had allocated for construction costs. Hillsboro received $12,430 as its fee for disbursing the money.

Hillsboro also issued a title insurance commitment for the project. The commitment showed Hillsboro's name at the top and stated: "Agent for: Old Republic National Title Insurance Company." Hillsboro never issued a title insurance policy on the project because the construction process never reached that point.

In 2007, the bank filed a four-count lawsuit against Hillsboro and Old Republic based on the escrow agreement (not the title insurance that clearly would have involved Old Republic). The allegations were negligence, breach of fiduciary duty, breach of contract and suit on a note.

The bank alleged that Hillsboro had disbursed funds from the escrow account in violation of the escrow agreement. Thus, the bank contended that the contractor, Lawless Homes, and others received money from the escrow account for work that was never done. The bank further asserted that its collateral in the project was worth less than its construction loans.

The bank based its case against Old Republic on the legal principle of agency. The bank contended that Hillsboro was the agent of Old Republic.

The bank alleged that Hillsboro had express authority to disburse the escrow funds and that Old Republic knowingly caused or permitted Hillsboro to hold itself out to the public as Old Republic's agent when disbursing money from the escrow account.

Thus, if Hillsboro disbursed money that should not have been disbursed, this was as much the fault of Old Republic as it was of Hillsboro, for Hillsboro was working for Old Republic when doing this, according to the bank's way of thinking.

The trial court saw things differently. It dismissed Old Republic from the case before trial by granting Old Republic's motion for summary judgment.

The bank challenged this decision on appeal. The appellate court noted that disputes over whether there is an agency relationship generally involve factual issues that are best sorted out at trial rather than a preliminary motion for summary judgment. Why did the bank not even advance that far with its theory?

An agency relationship requires proof of three elements: (1) the agent holds the power to alter legal relations between the principal and third parties, (2) the agent is a fiduciary with respect to matters within the scope of the agency and (3) the principal has the right to control the conduct of the agent with respect to matters entrusted to the agent.

Old Republic and Hillsboro both acknowledged that Hillsboro was Old Republic's agent for the purpose of issuing title insurance commitments and policies. They had entered into a written agency agreement between themselves to confirm this relationship.

This agency agreement, however, was separate from and different from the escrow agreement that was the subject of the bank's lawsuit. While this agency agreement allowed Hillsboro to perform escrow duties in connection with issuing title insurance commitments, this function was separate from Hillsboro's role as the escrow agent for the bank on the construction project.

The appellate court concluded that Hillsboro's duties under the escrow agreement were "on the side" from its agency agreement with Old Republic. The agency agreement expressly stated that Hillsboro is Old Republic's agent for the limited purpose of issuing title commitments and policies.

The appellate court also rejected that Old Republic's ability to periodically audit Hillsboro's escrow records, including the construction disbursement escrows, was sufficient control for an agency relationship.

And the court rejected that Hillsboro showed "apparent authority" to act on Old Republic's behalf. Apparent authority exists where a principal's actions to a third party create a reasonable belief in the third party that an agent is acting for the principal. The court found: "Old Republic did nothing to convey the impression to the Bank that Hillsboro had authority to act on its behalf."

James R. Keller is a partner at Herzog Crebs LLP where he concentrates his practice on construction law, complex business disputes, real estate and ADR. He also is an arbitrator and a mediator.

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