From time to time, a loan that appeared straightforward will throw lenders for a loop at the last minute. Loan documents have been signed, the settlement statement is approved, and the clear to close is about to be issued. But then, the title company will pop in and say that they have some last-minute exception items they need to add to your title policy. This can be frustrating, confusing, and stressful especially when funding deadlines are rapidly approaching.
The best way to approach these late arrivals is to simply take a deep breath, relax, and investigate what they are. Review the exception item to see the underlying issue. If it’s not clear on its face, ask the title company why the item is being added, and ask if there are any potential ways to remove the item pre- or post-closing. Depending on how extreme the item is, you may decide to proceed, rewrite loan terms to address the item (using holdbacks or other incentives to get your borrower to clean up the item), or in a worst-case scenario, cancel the loan.
There are two common scenarios where last-minute exception items arise that may seem overwhelming at first, but ultimately are okay to remain on your policy. This article will shed some light on those items, and why they are okay to stay.
Cannabis-Related Exception Items
Since cannabis is still considered an illegal substance under federal law, many nationwide title companies tend to avoid issuing policies for cannabis loans. Fortunately, smaller, regional title companies have stepped up to fill the need for cannabis lenders. Regardless of the title company a lender chooses for their cannabis loan, cannabis-related exceptions are difficult to be removed. Lenders must prepare to live with those exceptions on their policy. For some peace of mind, here is a breakdown of a few of the cannabis exceptions lenders can expect to see, and how lenders can prepare to keep them on their policies.
Licensing issues are extremely common when lending on a cannabis loan. Typically, a state that has legalized cannabis leaves the permitting of cannabis-related businesses to local governments. Since local governments may be slow in issuing permits, title companies will try to include an exception like this:
Any failure to obtain a use permit, resolution, or exemption issued by the appropriate municipality that would preclude the property from being used for the use intended by the insured.
Like most cannabis exceptions, lenders should request this one to be removed; however, if a title company will not back down, a well-prepared lender should be okay leaving this exception on their policy. Before accepting a licensing exception, lenders should make sure the borrower has all their necessary licenses or permits. Local governments may require multiple permits to operate a cannabis business, including a standard business permit, so it is best to consult with an attorney with experience in this area before making a final decision. Finally, always make sure your loan documents also have proper event of default language requiring permits, licenses, and other state requirements.
It is not uncommon for cannabis borrowers to grow, store, and distribute cannabis on their properties. In this case, title companies will push for a broader variant of the licensing exception that may look something like this:
The company requires a copy of the permit or county ordinance authorizing the cultivation, storage, and/or distribution of Cannabis (Marijuana).
With this exception, not only must the borrower obtain necessary cannabis and business permits, but they may need agricultural permits as well. If the title company is adamant that this exception be included, Lenders should ensure all permits are in order before leaving this exception on their policy.
Borrowers often face delays while obtaining necessary cannabis permits. Because of these delays, a borrower may not have all the necessary permits at the time the loan closes; thus, a lender may be forced to move forward with a licensing exception on their title policy without all the necessary permits in place. Lenders can generally prepare for this by adding an event of default to their loan documents if the license is not obtained.
Violation of Law Exceptions
Another common exception title companies like to throw in for cannabis loans is:
. . . the Policy to be issued will not insure . . . any violation or alleged violation of any United States federal, state, county, municipal or local laws . . . relating to or governing the use, processing, manufacture, growth, possession, distribution, sale or any other activity . . . of any Schedule I drug as defined by the United States Controlled Substances Act, including, without limitation, marijuana and/or cannabis . . ..
This exception often functions as a “catch-all” for cannabis loans, so it is difficult to get a title company to remove this exception from a policy. The exception expressly states that the policy will not insure illegal activity related to the use of cannabis on the property. The important thing to remember when facing this exception is that title companies do not tend to insure illegal activity whether it is cannabis-related or not. So, having this exception on the policy does not change much for a lender and lenders can generally allow this to stay on the policy if the title company refuses to remove it. However, lenders should always check cannabis laws at the city, county, state, and federal levels to make sure the borrower and property are in compliance. Since many cannabis laws are relatively new, we recommend reaching out to an attorney with cannabis experience.
A similar exception title companies like to squeeze into their cannabis policies is:
Any Seizure or forfeiture as the result of an action by the State or the United States of America by virtue of cultivation of any substance determined to be violation of State or Federal Law.
This exception serves the same function as the previously discussed “catch-all,” but this exception is more specifically aimed at agricultural properties used for growing cannabis. Again, title companies do not tend to insure illegal activity whether cannabis-related or not, so this exception does little to change the title policy. If a title company refuses to remove this exception, lenders should review all relevant city, county, state, and federal agricultural and cannabis laws to make sure the borrower is in compliance. Since this exception also covers agricultural-related violations, there will be a much broader spectrum of applicable laws; therefore, we highly recommend consulting an attorney with experience in this area.
Title companies will generally be hesitant to remove cannabis exceptions due to the variety of laws surrounding cannabis. Lenders should be prepared to allow a few cannabis exceptions to remain on their title policies. The best way to prepare for these exceptions is to have an experienced attorney verify that borrowers are complying with all relevant laws.
Multi-Beneficiary Exception Items
Multi-beneficiary loans may also pose issues at the closing table, with title companies often requesting last-minute exception items be added to the title policy. Most frequently, we see this exception showing as:
Any impairment, loss or failure of title to the beneficial interest of the insured in the mortgage insured by this policy resulting from: (a) lack of possession of the original promissory note secured by the insured mortgage, or (b) the absence from the original promissory note of a property endorsement to the insured assignee (c) any claim, allegation, or determination that the beneficial interest insured herein, or the underlying transaction involves the sale of a Security and/or is in violation of State or Federal Security Laws (d) Any interest or claim of interest by the mortgage company, servicing agent, or broker under the Insured Mortgage or Indebtedness
This exception can be broken down into its parts, each of which title companies frequently want to except from coverage for various reasons. With the right loan structure and documentation, these items can generally remain on title without an issue for lenders.
Lack of possession
First is lack of possession of the original note which is secured by the insured mortgage. Typically, the title company wants to add this exception because they do not have access to the original documents and thus have no control over how they may be handled, or if they are revised or lost. This is also a challenge for co-lenders since not every lender will be able to hold original documents. To ensure you are still covered when this exception remains, you should consider working with a loan servicer on your multi-beneficiary deals. Not only do loan servicers collect payments and handle other important aspects of a loan, but they also keep the original documents. Having a loan servicer hold your documents will help ensure that the original note is not lost or damaged and that it is not revised in any way that would be detrimental.
Absence of a property endorsement
Next is the absence of a property endorsement to an assignee contained in the original promissory note. This only becomes an issue when a loan is assigned to another lender. The title company will not want to provide coverage in this situation where it may be difficult for them to verify proper process is followed at the time of the assignment. The simplest solution to ensure no issues arise is to properly document any assignments you may be involved in. You and your co-lenders should consult with counsel to advise on the requirements for each individual deal.
Securities laws and registration
The third item focuses on the securities aspect of a multi-beneficiary loan. Like the reasoning above, title companies may have a difficult time verifying that all securities laws and registration requirements are followed, especially when a loan is sold or assigned after closing has occurred. The solution here to avoid any issues is to follow all applicable securities laws throughout the life of a loan. In California, for example, multi-beneficiary loans are exempt from securities registration issues under California Business & Professions Code § 10238 or California Corporations Code § 25102f, depending on the needs of the deal. Deals where the lenders are located in more than one state generally must comply with federal securities laws as well. Consulting with your counsel regarding securities compliance is the best way to keep this item on title without creating issues for yourself or your co-lenders down the line.
Last is an exception for any claims made by a mortgage company, loan servicer, or broker, where one of these third parties claim they have an interest in the property or lien. Again, title companies do not directly deal with these parties and do not have much control over this part of the transaction, leading them to add this item to the title policy. This item can be added without issue when the proper agreements between the parties are in place. Specifically, your agreements should address the interests that these third parties may or may not have in the loan. With the proper agreements in place, this exception may remain on title without creating problems for you and your co-lenders.
These are just a few examples of common problems that arise at the finish line of a deal. It is essential to analyze any additional exception items your title company may request and determine the associated risks and impact on closing. For these items, and any others that may arise, you should consider reaching out to counsel to assist with determining whether the deal is able to move forward with the new exception items and how to mitigate any associated risks.
Geraci Law Firm is your partner through the entirety of your loan. Contact us today for counsel on questions relating to title.