Escrow Holder Has No Duty to a Non-Party to the Escrow to Prevent Negligent Disbursement of Funds

An escrow holder in a refinancing transaction owes a duty of care only to the parties to, and participants in, the escrow, and cannot be liable to a stranger to the escrow for negligence in the way funds were disbursed, the California Court of Appeal held in Summit Financial Holdings, Ltd. v. Continental Lawyers Title Company, 105 Cal. Rptr. 2d 352 (Cal. App. 4th Dist., 2001).

Continental Lawyers Title Company (CLTC) was the escrow holder in the1995 refinancing of a 1994 loan by Talbert Financial (Talbert) to Dr. Furnish (Maker). The 1994 loan was secured by a deed of trust, which Talbert later assigned to Summit Financial Holdings (Summit). Though the assignment was recorded, neither Talbert nor Summit gave notice of the assignment to Maker as required by Civil Code section 2937.

In 1995, Maker refinanced the loan through another lender. Maker and the new lender employed Beverly Hills Escrow (BHE) to handle the transaction and CLTC as escrow holder in connection with issuing title insurance for a new deed of trust. CLTC’s preliminary title report noted the1994 assignment to Summit, but Summit was not a party to either the BHE or CLTC escrow. BHE obtained a payoff demand from Talbert and forwarded it to CLTC, who paid Talbert per BHE’s instructions. Several months later Maker filed for bankruptcy, and Summit’s lien claim was disallowed. Summit then sued CLTC for negligence, and the trial court, finding that under existing case law CLTC had breached its duty of care to Summit, entered judgment against CLTC. CLTC appealed.

The Court of Appeal began by rejecting and disapproving the case on which the trial court had relied, Kirby v. Palos Verdes Escrow Company, Inc., 183 Cal.App.3d 57 (1986), which held that an escrow holder may be liable for negligence to a stranger to the escrow agreement. Noting an escrow holder is a dual agent of the parties to the escrow, the Court stated the escrow holder has a “primary duty” to “strictly and faithfully” perform instructions given by the parties to the escrow, as well as ancillary duties that include disclosure to its principal of information discovered in the course of the agency which might affect the principal’s decision-making. The Court noted Kirby appears to be alone in holding an escrow holder may be liable to non-parties “for injuries allegedly caused by the escrow holder following its principals’ instructions.” The Court found the reasoning of Kirby seriously flawed, and declined to follow it.

The Court also rejected Summit’s argument that CLTC owed a general duty of care to Summit, based on the following factors:

    1. The transaction undertaken by CLTC was not intended to directly affect Summit, as CLTC was hired for the primary purpose of assisting in closing the new loan;
    1. There was no evidence CLTC could have foreseen that Talbert would default on its obligation to disburse funds to Summit;
    1. No “moral blame” could be assigned to CLTC for paying Talbert where the payment simply fulfilled CLTC’s duty to perform instructions given to it by the parties to the escrow; and
    1. The causal connection between CLTC’s payment to Talbert and Summit’s injury was too remote: Summit’s injury resulted from its own non-compliance with section 2937 and by Talbert’s breach of its contract with Summit.

Finally, the Court noted that imposing liability on CLTC in this case would have the incongruous and undesirable effect of exonerating the original debtor from liability by his agent’s payment to Talbert, but at the same time imposing liability on the agent for making the payment as directed by its principal.

This case serves as an important reminder of the dangers from failing to strictly comply with legal requirements. If you have any questions about this Legal Alert, please contact <!- Begin Link ->Kevin Dollison<!- End Link -> in our Business practice.