## Facts

- Max and Abe Karnowsky operated a plumbing and heating business and were overdue on notes totaling about \$4,575 owed to First National Bank & Trust Co. of Port Chester (First National).
- In August 1935, the Karnowskys conveyed Port Chester, New York real property to Ike Nathan; the property was already subject to a \$2,800 mortgage held by a third party.
- After learning of the conveyance and seeking additional security for the overdue debt, First National and the Karnowskys (through counsel) arranged a restructuring:
  - Nathan would deed the property back to the Karnowskys.
  - First National would take an assignment of the existing \$2,800 mortgage.
  - The Karnowskys would execute a new \$5,600 mortgage to First National.
  - The \$2,800 and \$5,600 mortgages would be consolidated into a single lien for \$8,400.

- First National applied to New York Title Insurance Co. (New York Title) for a policy insuring the consolidated mortgage.
- New York Title knew the transaction involved consolidation, examined title, approved the arrangement, and issued a policy insuring First National against loss or damage up to \$8,400; the policy acknowledged the consolidation and contained no express bankruptcy exception.
- In January 1936, an involuntary bankruptcy petition was filed against the Karnowskys; in February 1936, they were adjudicated bankrupt.
- The property was sold in the bankruptcy for \$5,650; at trial, First National offered testimony valuing it at about \$9,000.
- The bankruptcy trustee attacked the new \$5,600 mortgage as a voidable preference; the bankruptcy court set it aside, leaving only the \$2,800 mortgage (plus interest) enforceable.
- In the title-policy dispute, it was shown that First National had made misstatements and failed to disclose information to New York Title concerning the Karnowskys’ financial condition and the extent of their indebtedness.
- New York Title declined to indemnify First National for the loss tied to cancellation of the \$5,600 portion and tendered only the amount corresponding to the valid \$2,800 mortgage interest.

## Issues

1. Whether a title insurance policy insuring a consolidated mortgage covers loss when the later-created portion of the mortgage is avoided in the mortgagors’ bankruptcy as a voidable preference.
2. Whether First National’s misstatements and nondisclosures about the mortgagors’ finances and debts barred or limited recovery under the policy.
3. Whether the insurer’s payment obligation, if any, was limited to the amount of the enforceable preexisting \$2,800 mortgage (plus interest), rather than the full consolidated amount.

## Decision

- The court ruled for New York Title on First National’s claim for the avoided \$5,600 portion of the consolidated mortgage.
- The court treated the bankruptcy cancellation of the \$5,600 mortgage as outside the loss the policy was intended to cover and refused to make the insurer responsible as if the full \$8,400 lien remained valid.
- The court concluded that, at most, First National could recover only on the valid \$2,800 mortgage (plus interest), not on the portion set aside as a preference.
- The court relied as well on First National’s misstatements and concealment of facts bearing on the risk, which supported denying recovery for the loss tied to the preference mortgage.

## Legal Principles

- Title insurance is aimed at loss from defects, liens, or encumbrances affecting title as insured, not at loss arising from later invalidation of the insured mortgage because the transaction is avoided in bankruptcy as a preference.
- An insurer’s recognition of a mortgage consolidation does not amount to a guarantee that the added mortgage debt will be immune from bankruptcy avoidance.
- Material misstatements or concealment by the insured in procuring coverage can defeat or restrict recovery where the withheld or misstated facts relate to the risk that produced the claimed loss.
- A lender generally cannot shift to a title insurer the consequences of a security transaction that is set aside in bankruptcy based on the lender’s own preferential position and related nondisclosure.

## Conclusion

In First National Bank & Trust Co. of Port Chester v. New York Title Insurance Co., the court held that New York Title was not required to pay First National for the part of the consolidated mortgage that the bankruptcy trustee avoided as a voidable preference, and it limited any payment to the enforceable \$2,800 mortgage (plus interest), with First National’s misstatements and nondisclosures providing an added ground to deny recovery on the canceled portion.


First National Bank & Trust Co. of Port Chester v. New York Title Insurance Co., 12 N.Y.S. 2d 703, 171 Misc. 854 (1939)