Understanding Defalcation: Risks, Implications, and Protection in Real Estate Transactions
What is defalcation and why should you care? Defalcation occurs when a title agent or agency misappropriates another person’s funds held in trust that are intended to be subsequently disbursed in connection with a real estate transaction involving title insurance.
A title agent is authorized by Florida law to engage in the business as an escrow agent as to funds received from others to be subsequently disbursed by the title insurance agent in connection with real estate closing transactions involving the issuance of title insurance binders, commitments, policies of title insurance, or guarantees of title. Title agents are authorized through contractual agreements with title insurers, such as Attorneys’ Title Insurance Fund, First American Title, Chicago Title or Fidelity National Title, to issue title commitments and policies for that insurer. Realtors sometimes refer their clients to title agents rather than real estate attorneys to handle the closing for real estate transactions. The title agent or agency receives all funds in connection with the real estate closing in a fiduciary capacity, and these funds are the property of the person or persons entitled to the funds. A title agent or agency misappropriates the funds held in escrow if they are used for any other purpose other than designated. A title agent or agency acts illegally if the funds are misappropriated. As with any transaction in which an escrow agent holds funds in trust there is always a risk that the title agent or employee of the title agency holding the funds in escrow misappropriates the funds for a purpose other than the intended use.
Why should you care? Imagine the following nightmare: After months of marketing a listing for your seller, the buyer you recently showed the listing to made an offer that was accepted by your seller. The buyer made all the necessary deposits. The property passed the home inspection with flying colors. You referred the seller to the same title agency that you have recommended dozen of times in the past. You attend the closing and the closing takes place without a hitch. You break out the champagne and celebrate. However, when you go to deposit your commission check, the check bounces!
Although the real estate market is currently trending downwards, many transactions in Palm Beach County still involve millions of dollars. A buyer could make a significant investment of several hundred thousand dollars just to make the initial deposit. A seller could stand to lose their entire investment. Although less frequent than years ago, commissions in excess of one hundred thousand dollars are still common. Acts of defalcation remain extremely rare, but one act is all it takes to wipe out an entire escrow account of millions of funds.
Florida law requires a title agent to maintain an errors and omissions policy in the amount not less than two hundred fifty thousand dollars. Florida law also requires a title agency to maintain a fidelity bond or employee dishonesty coverage in the amount not less than fifty thousand dollars. However, when an act of defalcation typically occurs all funds in the escrow account are at risk and the amount of the policy and fidelity bond is typically insufficient to cover the claims.
Fortunately, Florida law provides that the title insurer is liable for the defalcation, misappropriation, or conversion of funds held in trust by a licensed title agent or agency in connection with real estate transactions involving title insurance. If a title agent or agency is authorized to write policies for multiple title insurers, then the title insurer who issued the title commitment or policy for the transaction is liable. If no title commitment or policy was issued, then each title insurer represented by the agent or agency is liable based upon the proportion of the premiums it received during the year prior to the defalcation to the total premiums received by all title insurers from the agent or agency during the same period.
What should you do if you suspect defalcation? If you suspect problems, contact the proper authorities and the title insurer immediately. Each insurer typically has a fraud or an audit department where suspected acts of defalcation are investigated and resolved. Make sure you document everything, including the date, amount, and purpose of every check or wire received by the title agent or agency.
What can you do to protect yourself and your client? Title insurers may issue closing protection letters buyers or lenders that protect against defalcation. If you are representing a buyer, make sure that the buyer receives a closing protection letter as quickly as possible. You should verify that the title agent or agency is in good standing with the title insurer. You should verify with the Department of Financial Services that the title agent has a valid title insurance license. You should verify the errors and omissions coverage and amount of the fidelity bond.