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Sears Mortgage Revisited: Liability For Theft of Seller's Funds

Under what circumstances is a title insurer liable for an attorney’s theft of funds related to a real estate closing? In Sears Mortgage v. Rose, 134 N.J. 326 (1993), and its companion case, Clients’ Security Fund v. Security Title, 134 N.J. 358 (1993), our Supreme Court adopted the theory that in a “North Jersey” style closing the attorney representing the purchaser or borrower is the common-law agent of the title insurer.

Thus, the title insurer (as “principal”) is liable to the purchaser or borrower for the theft of his money. But more recently, in N.J. Lawyers’ Fund for Client Protection v. Stewart Title & Guaranty Co., 203 N.J.208 (2010), the court declined to apply the Sears Mortgage holding where the theft occurred before the “agency” relationship had been established. Nevertheless, the Lawyers’ Fund for Client Protection [NJLFCP] continues to subscribe to an expansive reading of the Sears Mortgage decision, as illustrated by N.J. Lawyers’ Fund for Client Protection v. Flanagan, __ N.J. Super. __, 2014 WL 2459626 (Law Div. 2014) (not officially reported).

The case arose from a defalcation by [former] attorney Nancy Flanagan. As part of real estate closing in which she represented the purchaser (Goncalves), Flanagan insisted that $40,000 of the proceeds of sale be placed in an escrow held by her in order to satisfy undischarged mortgages. Flanagan subsequently converted the funds to her own use. The seller (Crawford) attempted unsuccessfully to recover the money from Flanagan. Crawford eventually filed a claim for reimbursement with NJLFCP, which paid the claim in exchange for an assignment of his rights. NJLFCP thereafter filed suit in the Law Division, Mercer County, against Flanagan, Tri-State (the title agent which insured the transaction), and its underwriter, First American Title Insurance Co. [FATICo]. The fund alleged that Tri-State and FATICo were liable under Sears Mortgage, even though Flana- gan had converted funds belonging to the seller, rather than the purchaser.

NJLFCP and FATICo filed cross-motions for summary judgment. Anthony J. Massi, J.S.C., in an unreported decision, framed the principal issue in the case as follows: “Whether a title insurance company can be held liable for a buyer’s attorney’s theft of seller’s proceeds, which are alleged to have been deposited into an escrow account a closing”. The court found that under Sears a defalcation committed by the buyer’s attorney remains a risk covered under the title insurance policy. However, the seller (Crawford) is not a party to the insurance contract. Furthermore, the “agency” relationship which forms the basis of the Sears decision exists to protect the buyer from the theft of his funds by his own attorney. In sum, the title insurer is not liable for loss suffered by the seller, a non-insured. Accordingly, the court granted FATICo’s motion, and denied NJLFCP’s motion. Judgment was entered dismissing the complaint against FATICo

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