Montana Big Sky Review Newsletter

- A M O N TA N A A G E N C Y N E W S L E T T E R -

2020 | ISSUE 11

BIG SKY Review

THE UNDERWRITING EDITION Page

This issue of the newsletter contains underwriting articles, resources and tools to assist agents in their operations. We are pleased to include three new Underwriting Challenges from the Corporate Underwriting Department which address a common underwriting challenge, why it is important to us and how to address the challenge and move to resolution.

In This Issue

The Underwriting Edition

Underwriting Mechanics’ Lien Risk in a Weakened Economy

Bankruptcy: 363(f) vs. 365 (h)

Native American Lands

AgentNet ID

How to Combat Zoom Fatigue Montana Agency Team

The information contained in this document was prepared by First American Title Insurance Company (“FATICO”) for informational purposes only and does not constitute legal advice. FATICO is not a law firm and this information is not intended to be legal advice. Readers should not act upon this without seeking advice from professional advisers. First American Title Insurance Company makes no express or implied warranty respecting the information presented and assumes no responsibility for errors or omissions. First American, the eagle logo, First American Title, and firstam.com are registered trademarks or trademarks of First American Financial Corporation and/or its affiliates. AMD: 08/2020

UNDERWRITING CHALLENGE

UNDERWRITING MECHANICS’ LIEN RISK IN A WEAKENED ECONOMY You have underwritten many construction projects and understand the risks involved and how to evaluate them. Your best customer has brought you a new construction transaction, but the economy has taken a serious turn for the worse. Mechanics’ liens. In a previous Underwriting Challenge titled Construction Project with Broken Priority, we discussed the challenges inherent in underwriting mechanics’ lien risk where there is broken priority. Now we turn to the challenges in underwriting construction projects where economic and market conditions may present increased risk. Increased risk in a stressed economy. Even in a strong economy, underwriting mechanics’ lien risk involves careful consideration of various factors. You may need to consider these factors differently and obtain additional information if the economy is stressed. For example, a weakened economy may result in project delays and cost overruns due to labor or materials shortages and delays, all of which may affect project viability. Depending on the nature of the project, an economic downturn may even result in the project being abandoned mid-construction. Any of these scenarios could result in increased policy risk. What should you do? In all situations, you are required to to obtain approval from an underwriter with the requisite authority limit for mechanics’ lien risk. Gather as much of the following information as possible and discuss how you should proceed with the underwriter. u Determine the requested form of mechanics’ lien coverage (unmodified Covered Risk 11(a), i.e. “full up-front coverage”, ALTA 32, etc.). u Identify the mechanics’ lien laws in your state and determine the extent of your risk. Determine if there are any First American-approved statutory “safe harbors” or processes for re-establishing or setting priority. u Determine the extent of the work done to date and who did the work. If a site inspection was performed, obtain photographs and reports. Determine whether the contractors, subcontractors, and suppliers who did work have been paid and/or have unconditionally waived or subordinated their lien rights to the Insured Mortgage (if legally enforceable under state law). u Determine the method and degree of fund control, and planned disbursement documentation (lien waivers, invoices, sworn statements, inspection reports, etc.). u Determine whether you can obtain mechanics’ lien indemnities and, if so, the sufficiency of the financial strength of the project participants to support the amount of our risk. Keep in mind that a sudden economic downturn

could have a negative impact on a potential indemnitor’s liquidity and net worth which may not be reflected in the last set of financials that the indemnitor has provided. You will need to obtain the most recent and reliable information to reflect the actual, current financial strength of a potential indemnitor. Determine whether the project is viable. An as-built appraisal may help with this analysis. Also consider whether the type of improvement to be constructed seems to make sense during an economic downturn. Review the budget and sources of funds. Consider whether the sources are reliable and the funds adequate to complete the project. Consider cost increases and shortage of materials and whether the developer has set aside a contingency fund. Determine how much equity the borrower will put into the project and when. Consider the experience of the owner/developer and general contractor with this type of project and the extent of our successful (i.e. no mechanics’ lien claims) experience with those parties. Conduct an internet search to find any relevant information about the project, its construction, owner/developer and general contractor. Confirm that there are no impediments to being able to record the instruments to be insured in a timely fashion or affecting the ability to search for mechanics’ lien filings in the public records. Consider the impact of any state or local governmental orders that may curtail or prohibit construction activities on the project and any contingency plan that the project participants have in place.

Key takeaways for future transactions. Establish open lines of communication with your customer and underwriter, and try to obtain the information outlined above as early in the process as possible. This approach will help you to get to know your deal and obtain adequate information to underwrite the mechanics’ lien risk.

800.854.3643 q www.firstam.com First American Title Insurance Company makes no express or implied warranty respecting the information presented and assumes no responsibility for errors or omissions. First American, the eagle logo, and firstam.com are registered trademarks or trademarks of First American Financial Corporation and/or its affiliates.

First American Title | Big Sky Review | 2020 - Issue 11

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UNDERWRITING CHALLENGE

BANKRUPTCY: 363(f) VS. 365(h) Can a Lease be Extinguished in a Bankruptcy §363(f) “Free and Clear” Sale?

The Issue. §363(f) seems to authorize the Bankruptcy Court to eliminate a valid lease of the debtor’s real estate, but this power seems to be in direct conflict with the protections afforded a lessee under §365(h). This conflict has caused a split in the federal circuits, with some permitting the lease to be extinguished and some not. §365(h). §365(h) grants lessees a right of “use, possession, quiet enjoyment, subletting, assignment, or hypothecation … for the balance of the term of such lease and for any renewal or extension of such rights to the extent that such rights are enforceable under applicable nonbankruptcy law.” In other words, regardless of whether the debtor or the Bankruptcy Trustee has rejected an unexpired lease as an executory contract, the lessee is allowed to “pay and stay” – i.e. to remain in possession of the property as long as there is no default. §363(f). §363(f) provides that a Debtor-in-Possession or a Bankruptcy Trustee may sell the debtor’s real property free and clear of “any interest” in the property, provided the Bankruptcy Court finds that at least one of the five grounds enumerated in subsection 1-5 apply. Unfortunately, the word “interest” is not defined, and an interpretation broad enough to include a leasehold interest seems to conflict with the protections afforded in §365(h). Majority Interpretation. Most federal courts have held that the phrase “any interest” does not include a leasehold interest. (Most jurisdictions also exclude covenants or rights of first refusal from the definition of “any interest” as well.) In the majority’s view, allowing §363(f) to trump §365(h) renders §365(h) meaningless from the standpoint of a compliant lessee who wishes to remain in possession. Some courts further reason that §365(h) is more specific than, and should therefore prevail over the more general, §363(f) under statutory construction rules. Minority Interpretation. The minority view, first espoused in the 7th Circuit’s 2003 Precision Industries, Inc. v. Qualitech Steel SBQ decision, holds that, despite other cross references in each statute, “the statutory provisions themselves do not suggest that one supersedes or limits the other.” The Qualitech court reasoned that the lessee’s §365(h) right to continued possession only comes into play if the lease is rejected. If the lease is not rejected, the lessee’s rights are protected in a §363(f) sale by the provisions of §363(e), which allow a lessee to request that

the sale either be prohibited or conditioned so as to provide “adequate protection” for its interest, which may include continued possession. Finally, it also found that a lessee could be financially compensated for the value of its leasehold. Consequently, the Qualitech court concluded that a sale free and clear under §363(f) may not conflict with the protections afforded lessees under §365(h). A number of lower courts came to the same conclusion, and the 9th Circuit did too in 2017 in In re Spanish Peaks Holdings II, LLC. In addition to relying on the Qualitech reasoning, the Spanish Peaks court also distinguished the everyday definition of “rejection” from its more specific meaning in §365, defining it as one requiring an affirmative declaration that the estate will not take on the lease obligations. Key takeaways for future transactions. Until this issue is definitively resolved by Congress or the Supreme Court, the decision to insure a transaction in which the property has been sold free and clear of a lease must be considered carefully. The Company’s default position is that a §363(f) sale cannot prematurely terminate a leasehold interest, but you should consider the following factors before making a final determination: u Was the interest listed in the debtor’s bankruptcy schedules; u Did the lessee receive notice of the §363(f) motion; u Did the lessee file an objection to the planned §363(f) sale or otherwise appear in the bankruptcy proceedings; u Was the lease accepted or rejected by the trustee; u Did the lessee request “adequate protection” of its interest under §363(e); and u Has the 14-day appeal period passed with no appeals having been filed? You must consult with a Senior Underwriter who has the requisite level of authority and responsibility for the geographic area where the land is located. As with other bankruptcy matters, an overall understanding of the transaction and early discussions with the customer of the issues involved are important to avoiding later conflicts and enhancing customer relationships.

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UNDERWRITING CHALLENGE

NATIVE AMERICAN LANDS You are expecting to receive an application for title insurance involving a Native American tribe, an affiliate of a Native American tribe, or land owned by an individual Native American, or land lying within the boundary of a tribal reservation. What should you consider before proceeding with the transaction? What is the Underwriting Challenge? Transactions involving tribal lands, individual Native Americans, Native American tribes, bands, pueblos, Native Alaskans, and related entities created under federal, state or tribal law are unique and complex due to issues such as confusion over applicable law, sovereign immunity, authority of the parties, access, where and how to obtain an appropriate title search, and other concerns described below. These complications pose an “Unusual Risk” to the Company and are outside of the typical expertise of most title personnel unless they have been sufficiently trained to identify and properly solve these complicated issues. The underwriting process can be much more taxing than usual and may even require retaining outside experts to reach an appropriate conclusion. Please keep this in mind as you review the details below. Proactive Transaction Management Unusual Risks commonly generate requirements and special exceptions that must be thoroughly communicated to the proposed Insured. If the requirements and exceptions are not acceptable to the principals, the Company may not be able to issue a title insurance policy. Therefore, as with any Unusual Risk, we must carefully and proactively manage customer expectations. The Company’s history and experience with a tribe can be influential when underwriting a Native American transaction. However, the fact that we may have insured a transaction involving the same land or parties should not cause you to forego the analysis described below. Before issuing any form of title evidence or title commitment involving this Unusual Risk, you must thoroughly analyze the issues discussed herein, and conclude that there is a sufficient legal, underwriting and practical basis to properly insure. Economic Feasibility Evaluation Many transactions involving an Unusual Risk require timeconsuming, careful analysis and research. A Native American component often necessitates extensive research and possibly the retention of outside experts. If this additional expense is not absorbed by the customer, it may reduce or eliminate the Company’s profitability. It is also important to consider the indirect costs associated with the consumption of Company resources (including the impact on servicing other profitable business opportunities). If these collective costs exceed the anticipated premium, the expense associated with the transaction may outweigh the benefit of participating in the transaction. This analysis requires collaboration with management and senior underwriting leadership.

Applicable Law Native American tribes are self-governing political entities that establish their own distinct body of law. In addition to state and federal law, tribal law impacts land within the boundaries of a reservation. In other words, just because the tribe’s reservation lies within a state, that state’s laws may not be controlling or even applicable to the tribal land or transaction. That differentiating factor creates an Unusual Risk that requires greater scrutiny. We must have an opportunity to review and understand the tribal law that affects title to real property. If the tribe’s laws are applicable and clear, we may have a predictable legal framework in which to underwrite title insurance risk, but that determination must be carefully underwritten by qualified underwriters with an expertise in Native American issues. In addition to statutes established by tribal code, it may be necessary to review treaties, the tribal constitution and bylaws, tribal “common law,” (tribal court opinions, customs and traditions) and administrative law. That law must support each coverage determination we make when issuing policies and endorsements. Be mindful that tribal law may not recognize many or any of the legal principles that serve as foundation for our normal day-to-day underwriting. If state law does not apply, then we must understand and become comfortable with the tribal law applicable to: u the concepts of “Title” u the transfer and leasing of real property u creation of valid and enforceable encumbrances, such as mortgages and rights of way and their relative priority u what constitutes “Public Records” u the concept of “constructive notice” and protection of a “bona fide purchaser” u adverse possession u prescriptive rights u foreclosure u construction/mechanics’ liens u mineral rights u access u zoning, subdivision of land, and other restrictions regulating use u choice of law, choice of forum, and jurisdiction u and many other legal concepts foundational to title insurance coverage.

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COMING IN OCTOBER 2020

AgentNet ID Upgraded Security | New Look | Easier Navigation An extra layer of security, called AgentNet ID, which requires a phone number and creation of new AgentNet credentials, will soon be added to the AgentNet website. This change will enable two-factor authentication and create a single sign-on experience across multiple First American applications.

TWO-FACTOR AUTHENTICATION Two-factor authentication is an extra layer of security for your AgentNet account designed to ensure that you are the only person who can access your account, even if someone knows your password. This added security measure requires

IMPORTANT

ONE-TIME ACTION REQUIRED Soon, you will receive an email asking you to: 1. Update your AgentNet credentials 2. Verify your phone number, email address, and other contact details 3. Create new AgentNet ID and password Once you have updated or added your contact information, you will be asked to authenticate with a code. You will then choose your new login and password credential for AgentNet.

you to verify your identity by phone, via text or voice call.

Actions Requiring Two-Factor Authentication: » Email, phone or mailing address

change » Establishing username and

password » Requesting lost username or

password

Questions: Contact the First American Agency Service Center at 866-701-3361

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H O W T O C O M B AT

ZOOM FATIGUE Over the past few weeks, mentions of “Zoom fatigue” have popped up more and more on social media, and Google searches for the same phrase have steadily increased since early March. By: Liz Fosslien and Mollie West Duffy, Harvard Business Review, April 29, 2020

To read the article, visit: https://hbr.org/2020/04/how-to-combat-zoom-fatigue

Amie Voss VP, Agency State Manager D: 303.305.3358 abvoss@firstam.com

Cindy Guanell Regional Underwriter D: 208.321.5184 cguanell@firstam.com

FIRST A ME RICA N T IT L E Lance Lewis Area Underwriter D: 208.321.5157 lancelewis@firstam.com

First American Title | Big Sky Review | 2020 - Issue 11

MONTANA AGENCY TEAM

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