A defective title means that there is a problem with the title deed to real estate or with a title to negotiate instruments. Some of the reasons for a defective title in real estate include improper filing of public records, loss of the title without recording it, or an invalid prior claim of ownership by another title holder. The title is unmarketable as a result and may be the basis for voiding a purchase contract, or it can lead to the seller owing the buyer compensation for damages. Sellers often purchase defective tile insurance at the request of the lender or buyer to protect both from financial losses due to a defective title. For negotiable instruments, the title is often defective because the seller received it by fraud.
In a contract for the sale of real estate, the seller expressly or implicitly agrees to deliver a good title. A good title is one that is marketable and free of claims by other holders. The buyer can research the public records and see that there are no flaws in the transfer of title from the first owner to the seller. If the chain of title is incomplete or inadequate, the buyer is often going to receive a defective title. It’s also considered an unmarketable right of ownership, and the buyer can initiate a lawsuit against the seller for breach of contract and ask the court to award damages.
Signers of negotiable instruments are also required to transfer ownership that is marketable. A negotiable instrument is a signed legal document in which there’s a promise to pay the holder money, such as a check or promissory note, at a specified time. The title to those instruments should be free of defects, and when they are not, the buyer has the right to sue for damages. The cause of a defective title is often due to fraud, but duress and other illegal means are common causes as well. Courts may find that the new holder has a right to the instrument or is a holder in due course if the holder was not aware of any fraud or illegal activity.
Defective title insurance is one solution available to sellers and buyers to protect themselves against financial losses. A buyer may purchase defective title indemnity insurance as protection against original owners for breach of covenants and other issues. For example, if there is a covenant not to move a mobile home on the property, but the previous owner breaches that, then the insurance company can provide legal representation and pay for damages resulting from lawsuits.