Real Estate Buyers Beware: Supreme Court opinion demonstrates importance for investors and developers to perform due dilligence before closing

14 Dec

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We’ve all heard the old adage: An ounce of prevention is worth a pound of cure. It surprises me how frequently I learn that clients or other savvy investors or businesspeople proceed to purchase real estate without receiving critical advice or performing adequate due diligence.

The Minnesota Supreme Court’s decision in Mattson Ridge, LLC v. Clear Rock Title, LLP, et al. demonstrates why, when purchasing land for investment, development, or even for personal enjoyment, due diligence is so important. The case involves Mattson Ridge, a real estate firm seeking investment opportunities in real estate, and presumably a savvy real estate investor in its own right. The company purchased 64 acres of farmland with the intent to hold it as an investment to sell to another party for future development.

Mattson Ridge read the market perfectly. It closed on its purchase of the property in September 2005 for $1.286 million and by the end of October 2005 had a purchase agreement in place to sell the property for $2.9 million. The sale was scheduled to close in May 2006, but a problem with the legal description of the property prevented the sale because it constituted a defect in the title to the property. In real estate terms, the seller was unable to provide “marketable title” to the property as of the date the buyer was ready, willing and able to close.

Mattson Ridge did take one step to protect itself that a surprising number of parties fail to do, which was to secure title insurance to protect against any title issues that might arise based on defects existing at the time it purchased the property. Unfortunately, that wasn’t enough to completely protect it. The limits under the title insurance policy were set at Mattson Ridge’s purchase price ($1.286 million), rather than at a higher figure that would have covered the full market value of the property (which the evidence suggests was $2.9 million, in light of the purchase agreement it entered into to sell the property).

In its opinion in the Mattson Ridge case, the Supreme Court held that the title to the property was defective, but that Mattson Ridge was not permitted to recover more on its insurance than the policy limits. This means Mattson Ridge is entitled to recovery $1.286 million, plus about $11,000 of out-of-pocket expenses, but it will not recover the profits it lost as a result of the failed closing; more than $1.6 million beyond those policy limits. An ounce of legal advice and assistance with due diligence in this matter would have prevented the need to seek more than a pound of cure -a cure that the buyer was denied because just buying title insurance was not enough.

What’s even more alarming than the $1.6 loss that wasn’t covered by insurance was that the case could have turned out even worse for Mattson Ridge. The Supreme Court declined to decide certain additional issues, which included whether a clause in the insurance policy called a “coinsurance provision” or “coinsurance clause” should reduce the coverage available to Mattson Ridge. A coinsurance provision in an insurance policy states that, if the insured purchases a policy with limits that are more than a certain percentage below the actual extent of potential loss that may arise (often 80 percent), the insured’s recovery may be reduced significantly. This issue did not affect Mattson Ridge because the title insurer did not raise it before the case reached the Supreme Court, but it certainly could have done so and if it had, the buyer could have lost even more money. This represents yet another reason to get advice and assistance when performing the proper due diligence required to make a sound real estate purchase.

Mattson Ridge ultimately was able to remedy the title defect, meaning it could be sold with a title that is now marketable (i.e., without the title defect that prevented its sale under the October 2005 purchase agreement). But the delays and defects that existed because the problem was not discovered prior to its own purchase means Mattson lost its opportunity to obtain a profit of more than $1.6 million in less than a year, and that kind of opportunity may not present itself again.

If you’re considering buying or selling real estate, or have a potential problem with providing or obtaining marketable title, consider taking a heavy dose of prevention and contact an attorney with Thomsen Nybeck. We have been assisting parties with real estate transactions and disputes for 40 years, and we can help you avoid the need for a painful cure that may never come. And, if need be, we can help administer the cure as well.

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Matt Drewes contributed this post.  Matt is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s nine-member Community Association Representation Group and the firm’s Creditors’ Remedies Group. and practices in the areas of business and real estate litigation and transactions, employment law, construction litigation, community association law, debtor/creditor law and insurance. He has been included in the annual list of Minnesota’s Rising Stars for several years, and has been quoted on issues involving construction litigation, community associations and real property issues in the Minneapolis StarTribune, Minnesota Lawyer, Habitat Magazine, Yahoo!Finance.com, Bankrate.com, MSN.com, HOALeader.com, and elsewhere. He can be reached at mdrewes@tn-law.com or by phone at 952.835.7000.

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