California Escrows and Liability to Third Party Strangers to Escrow – The Difficult Challenge to Finding Liability

In the ordinary real estate or business sale escrow, the escrow officer owes duties to the parties to only the parties to the escrow, and not to third parties. There are a few exceptions, such as when the parties real estate sale escrow instructions require following a third party’s instructions, such as lender’s instructions for closing a loan. But it is generally difficult to prove that an escrow holder owes a duty to a third party, the breach of which would result in a finding of negligence. Such was the case in a recent decision which resulted from a misguided and tangled effort to avoid the “no assignment” clause in a commercial lease; parties concerned with suck lease provisions should consult with a real estate attorney.

In Alereza v. Chicago Title, the plaintiff Bobby wanted to buy a gas station which was on leased property, which would require assignment of the lease to the buyer. Escrow #1 was opened, but the landlord required a personal guaranty to allow assignment and the plaintiff did not want to do that. The plaintiff formed an LLC and assigned the purchase contract to the LLC, but the landlord still wanted a personal guaranty. Escrow #1 was cancelled.

The parties had a new idea – plaintiff would buy the interest in the seller’s LLC, thus the tenant would not change, and there would be no assignment. They opened escrow #2. The landlord found out, and said he would consider it a breach of the lease. Escrow #2 closed, and the plaintiff was not a party to the escrow. The escrow officer obtained an insurance certificate for the purchased business, but incorrectly got it in the name of the plaintiff’s LLC (created for escrow #1), not the Seller’s LLC. The parties were not speaking at the time, and nobody knew what was happening. The insurer sent a notice of cancellation of the original policy, and the landlord demanded a personal guaranty. It was not given, and there was an eviction action. The plaintiff gave the personal guaranty, and sued the escrow company for negligence. The court found that, as the individual plaintiff Bobby was not a party to the escrow, there was no liability.

Proving negligence requires showing three elements: a legal duty of care, breach of the duty, and damages resulting from the breach. The threshold element for negligence is the existence of a duty to use due care toward an interest of another that enjoys legal protection against unintentional invasion.

The Supreme Court has considered how to determine whether there is such a legal duty to a third person not in privity (having a relationship that is recognized by law, such as a contract) and found that it is a matter of policy and involves the balancing of various factors, among which are:

a. the extent to which the transaction was intended to affect the plaintiff,
b. the foreseeability of harm to him [or her],
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.” (The Biakanja factors, 49 Cal.2d at p. 650)

In considering escrows, courts have ruled that an escrow holder is an agent and fiduciary of the parties to the escrow. The agency created by the escrow is limited — limited to the obligation of the escrow holder to carry out the instructions of each of the parties to the escrow. If the escrow holder fails to carry out an instruction it has contracted to perform, the injured party has a cause of action for breach of contract. Without clear evidence of fraud, an escrow holder’s obligations are limited to complying with the parties’ instructions.

The court compaired the facts with the Kiakanja factors, and found no liability-
First, Alereza was not a party to Escrow 2, which involved only the transfer of membership interests in Bains to TANL.

Second, there was insufficient foreseeability of harm. Alereza had no personal liability for any gas station business losses. His subsequent decision to provide a personal guarantee was not something Chicago Title could reasonably foresee.

Third, there is a low degree of certainty that Alereza suffered harm as a result of Chicago Title’s negligence. Chicago Title’s mistakes, “while negligent, were not potentially fatal, as a correction to the name on the certificates later showed.”

Fourth, there was only a remote connection between the misidentification of the insured by Pearson and Alereza’s eventual financial losses when the gas station business declined. Several independent errors cascaded into the eventual liability.
Fifth, Chicago Title’s negligence is not morally blameworthy. Although negligent, the mistake in providing the name of the Escrow 1 purchaser of the gas station business to the insurer instead of the Escrow 2 purchaser does not constitute moral blame. We reject Alereza’s contention negligence is inherently morally blameworthy. Here, the escrow officer did not act fraudulently, illegally, or with any intent to cause anyone disadvantage.

Finally, the policy of preventing future harm does not require imposition of a new legal duty on Chicago Title in this case. Escrow companies already owe a fiduciary duty to parties to an escrow to properly carry out all escrow instructions.

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