The Third Circuit recently rejected an attempt to limit the scope of title insurance coverage. Nationwide Life Ins. Co. v. Commonwealth Land Title Ins. Co., 2009 WL 2710189 (3d Cir. Aug. 31, 2009). In a sharply worded and comprehensive opinion, the court held that a title insurer must expressly except exceptions from coverage in order to limit ALTA 9 Endorsement coverage.

The coverage claim has its origins in the exercise of a right to refuse approval of purchasers of property. In 1988, PMI Associates purchased real property from Liberty Mills Limited Partnership. PMI and Liberty Mills entered into a Declaration of Restriction (the “Declaration”), which vested Liberty Mills with the right to refuse approval of future purchasers of the property. In 2001, PMI borrowed $3.5 million from Nationwide, using the property as collateral. PMI defaulted in 2003 on the balance of its loan. In consequence, PMI conveyed the property to Nationwide by fee simple deed. Nationwide attempted to sell the property to Ironwood Real Estate. This sale was aborted, however, when Liberty Mills’s successor-in-interest, Franklin Mills Associates Limited Partnership, refused to approve Ironwood as a buyer in accordance with Franklin Mills’s rights conferred by the restrictions in the Declaration. 2009 WL 2710189, at *1.

Nationwide insured its lender’s interest in the property by purchasing a title insurance policy from Commonwealth. Commonwealth issued to Nationwide a 1992 ALTA Loan Policy with an ALTA 9 Endorsement. The standard form policy contained six sections: (1) the Insuring Provisions; (2) the Exclusions from Coverage, which set forth standard coverage exclusions; (3) the Conditions and Stipulations that defined relevant terms and the responsibilities of the parties; (4) Schedule A, which describes the property and the amount of insurance; (5) Schedule B, which listed in two parts the coverage exceptions specific to the property; and (6) the ALTA 9 Endorsement, which provided additional coverage over certain exceptions in Schedule B. The policy provided Nationwide with $3.5 million of insurance, obligating Commonwealth to insure Nationwide’s interest in the property against any loss from any restriction not stated in the Exclusions from Coverage where listed as an exception in Schedule B. 2009 WL 2710189, at *3.

Part I of Schedule B to the policy excluded coverage “against loss or damage” by reason of the “Declaration of Restrictions between Liberty Mills Limited Partnership and PMI Associates dated August 15, 1988.” 2009 WL 2710189, at *4. Paragraph 1(b)(2) of the ALTA 9 Endorsement extended coverage to certain losses excluded in Schedule B: “(b) Unless expressly excepted in Schedule B . . . any instrument referred to in Schedule B as containing covenants, conditions or restrictions on the land which . . . provides for an option to purchase a right of first refusal or the prior approval of a future purchaser or occupant.” Id.

Following Franklin Mills’s rejection of Ironwood, Nationwide submitted a claim for coverage from Commonwealth. Commonwealth denied the claim on the basis that its policy expressly excepted coverage for loss resulting from Franklin Mills’s exercise of its rights under the Declaration.

Nationwide responded by filing suit in the United States District Court for the Eastern District of Pennsylvania. Nationwide argued that the ALTA 9 Endorsement afforded it coverage for the loss resulting from Franklin Mills’s exercise of its right of refusal, because those rights were not expressly excepted in the policy’s scheduled exceptions. Commonwealth countered that the claim was excluded because the ALTA 9 Endorsement listed the Declaration in the policy’s schedule of exceptions. 2009 WL 2710189, at *2.

The district court granted Commonwealth’s motion to dismiss, holding that the general listing of the Declaration in the “Exceptions from Coverage” in the policy’s schedule of exceptions unambiguously eliminated coverage for the loss stemming from Franklin Mills’s exercise of its right of refusal. Id. The Third Circuit reversed.

The Third Circuit held that the policy afforded Nationwide coverage for the loss that arose from the exercise of the right of refusal contained in the Declaration:

 The text and purpose of the policy, along with custom and practice in the title insurance industry convince us that the ALTA 9 Endorsement covers loss stemming from rights of refusal, unless those rights are explicitly noted in the exceptions to the policy. Insurers may not except rights of refusal or other title restrictions from ALTA 9 Endorsement coverage simply by listing as exceptions the instruments in which they are embedded. Instead, the burden is on the title insurer to find and except them expressly.

2009 WL 2710189, at *3.

Commonwealth argued that a loss arising from the Declaration is “expressly excepted in Schedule B” and is therefore not covered by paragraph 1(b)(2) of the ALTA 9 Endorsement. Id. The court rejected this argument:

 We disagree with Commonwealth and the District Court. In our view, concluding that Schedule B, Part II, does not contain “exceptions from coverage,” and reading the caption and initial language of Schedule B, Part I to “expressly except” from ALTA 9 Endorsement coverage loss stemming from all matters and instruments listed therein runs roughshod over the policy’s language, purpose, and usage. We instead adopt Nationwide’s construction of the policy and hold that paragraph 1(b)(2) of the ALTA 9 Endorsement extends coverage to a loss from an instrument in either part of Schedule B unless the insured takes express exception to the specific restrictions stated in the instrument. This interpretation fits the textual scheme of the policy, and reflects the purpose and industry custom associated with the ALTA 9 Endorsement.

2009 WL 2710189, at *6.

The court concluded that “the placement of the line ‘EXCEPTIONS FROM COVERAGE’ above ‘PART I’ in the caption of Schedule B is evidence that both parts I and II contain ‘exceptions from coverage.’” Id. The ALTA 9 Endorsement “recognizes a difference between ‘excepted’ instruments and ‘expressly excepted’ restrictions.” 2009 WL 2710189, at *7. “The very term ‘expressly excepted’ implies as well that an insurer seeking to retract Endorsement coverage of a restriction must do so specifically.” Id.

In the court’s view, Commonwealth’s interpretation “flouts the purpose of the Endorsement.” Id. The court pointedly remarked:

Lenders seeking to insure their mortgage interest in a property pay an additional premium for an ALTA 9 Endorsement to cover, among other things, ‘any instrument referred to in Schedule B as containing covenants, conditions, or restrictions’ . . . we cannot conceive why . . . lenders would do so only to cover instruments in Schedule B, Part II, which already are insured as “subordinate to the lien or charge of the insured mortgage upon the estate or interest.’ More specifically, it surpasses strange to think that Nationwide would pay for an ALTA 9 Endorsement just to cover the matters already listed as subordinate to its interest in Schedule B, Part II . . . .

 Id.

What is more, the court concluded that “Commonwealth’s interpretation would thwart the purpose of the ALTA 9 Endorsement by eliminating the notice benefits it provides.” Id. That is, “through its requirement that insurers ‘expressly except’ the restrictions they do not want to cover under paragraph 1(b)(2), the Endorsement gives lenders crucial notice of the specific matters that may harm their mortgage interest.” Id. “By permitting insurers to except expressly all loss from an instrument simply by listing that interest in Schedule B, Part I, Commonwealth’s interpretation would strip away this notice benefit from the ALTA 9 Endorsement.” Id.

The court further found that industry custom and practice supported its interpretation of the ALTA 9 Endorsement. “Industry custom and practice show that both parts of Schedule B contain exceptions over which the ALTA 9 Endorsement insures.” 2009 WL 2710189, at *8. The court made the striking observation that “industry practice is so settled in favor of requiring insurers to state the specific matters they are excepting from ALTA 9 Endorsement coverage that one industry expert directly criticized the District Court’s decision in Commonwealth’s favor.” 2009 WL 2710189, at *10.

The court held that “to except expressly from ALTA 9 Endorsement coverage a right of refusal or other restrictions noted in paragraph 1(b)(2) of the Endorsement, an insurer must list those restrictions specifically in Schedule B.” Id. Nationwide had a duty to exercise diligence to ensure that the Declaration does not contain restrictions that were adverse to its interest in the property. The court enjoined that “Nationwide paid Commonwealth to review its interest in the title to property and either cover in the title descriptions or explicitly identify them as exceptions.” 2009 WL 2710189, at *12.

 The court concluded its opinion with a rather sharply worded remonstration:

 When Commonwealth issued its title insurance policy to Nationwide, it failed to except expressly the restrictions contained in the Declaration from coverage under paragraph 1(b)(2) of the policy’s ALTA 9 Endorsement. To avoid paying for this failure (and Nationwide’s claim), Commonwealth seeks to lead us down a path that would make title insurance a Barmecide feast. That is not the purpose of title insurance. It is not how the title insurance industry perceives what it does, and it is not how the text of and guidelines for title insurance read.

Id.