Court Limits Duty of Escrow Companies

            Potential causes of action against escrow companies include those for breach of a contract such as escrow instructions, or a tort such as negligence, breach of fiduciary duty, and fraud.  As a general matter, the escrow holder's obligations are limited to compliance with the parties' instructions.  But as with most legal issues, the devil is in the details, and the outcome depends upon the facts in a particular case.

            In the recent decision of Alereza v. Chicago Title Company, the appellate court found that Chicago Title, handling an escrow for the sale of a gas station business, owed no legal duty of care to Alereza under a negligence cause of action, because he was not a party to the escrow (i.e., he was not the seller or buyer of the gas station), and he was not mentioned as a third party beneficiary in the escrow instructions. 

            Because Alereza formed a limited liability company (LLC) to purchase the business, even though he personally provided the initial deposit and a $100,000 promissory note secured by his residence, he was not personally a party to the escrow.  He did not sign the escrow instructions as an individual. As a result, he personally had no contractual relationship with Chicago Title, and he could not recover for breach of contract.

            However, Alereza also claimed that Chicago Title breached its duty to him under a tort cause of action for negligence.  The three essential elements of negligence are (1) legal duty of care, (2) breach of the duty, and (3) damages resulting from the breach.  The threshold element is whether the defendant owed a duty to use care toward an interest of another that enjoys legal protection against unintentional invasion. 

            The test for determining the existence of a duty of care was articulated in the California Supreme Court case of Biakanja v. Irving, an action for negligence by the sole beneficiary of a will against a notary public who prepared a will that turned out to be ineffective for lack of proper attestation, and it is a matter of "policy" and involves the balancing of various factors, including:

            a.         The extent to which the escrow transaction was intended to affect the plaintiff;

            b.         The foreseeability of harm to the plaintiff by the escrow holder;

            c.          The degree of certainty that the plaintiff suffered injury;

            d.         The closeness of the connection between the defendant's conduct and the injury suffered;

            e.         The moral blame attached to the defendant's conduct; and

            f.          The policy of preventing future harm.

            There was no dispute that Chicago Title was negligent in listing the wrong name of the insured when securing a new certificate of insurance for the business, requiring Alereza to give a personal guarantee that he claimed caused him losses when the business lost money.  However, the appellate court found no duty was owed by Chicago Title to Alereza because:

            a.         Alereza was not a party to the escrow that involved only the transfer of membership interests to the LLC, not Alereza personally;

            b.         At the close of escrow, Alereza had no personally liability for any business losses, and his subsequent decision to provide a personal guarantee was not something Chicago Title could reasonably foresee;

            c.          Chicago Title's mistake, while negligent, was not potentially fatal, and it was the "cascade of errors" by several different individuals in not checking on the insurance coverage that created the problem for Alereza;

            d.         There was only a remote connection between the misidentification of the insured and Alereza's eventual financial losses when the business declined;

            e.         Chicago Title's negligence was not morally blameworthy because the escrow officer did not act fraudulently, illegally, or with any intent to cause anyone disadvantage; and

            f.          No new legal duty on Chicago Title was necessary to prevent future harm because escrow companies already owe a fiduciary duty to parties to an escrow to properly carry out escrow instructions, and they already have both duties and incentives to faithfully execute the escrow instructions.

            This case illustrates how even experienced professionals, such as escrow officers, can make mistakes, and it is incumbent upon all persons involved in an escrow to carefully examine all documents and check on all aspects of the transaction as standard due diligence.  In other words, if you rely upon others to protect your interests, you create the opportunity for others to act negligently, and possibly cause you a disadvantage and lost funds or opportunity in the transaction, that you may not be able to recover in a lawsuit.

            It also illustrates how the details of the facts, including whether the claimant gave notice of its involvement in the transaction sufficient to give the escrow holder information of the role of the claimant, may determine the outcome of the dispute. 

            A hard money lender is in a similar role in an escrow as was Alereza, and it is essential that a hard money lender make a conditional delivery of the funds into the escrow, in a written document, to put the escrow holder on notice of the lender's role and exposure to harm if the escrow holder is negligent. 

            Often, a consultation with an experienced real estate attorney can be a valuable step in preventing the unfortunate outcome experienced by Alereza, who claimed he paid and borrowed more than $400,000 to keep the gas station business from defaulting on its lease.   Adding insult to injury, because he lost the appeal, he also had to pay Chicago Title its costs on the appeal.