Opinion ID: 1205077
Heading Depth: 1
Heading Rank: 4

Heading: Are the title companies' direct payments to policyholders to discharge the obligations of the insurers income to the insurers?

Text: As noted above, there is an alternative procedure set forth in three of the underwriting agreements at issue here. Under that procedure, when a claim is made by a policyholder, the title company, rather than compensating the insurer for the claims it has paid, simply pays the policyholder's claim directly. In my view, this procedure also results in income to the insurer. The conclusion that this alternate procedure produces income to the insurer is supported by both logic and case law. The case law is clear that substance, not form, determines whether a transaction gives rise to income. ( Diedrich v. Commissioner, supra, 457 U.S. at p. 195 [72 L.Ed.2d at pp. 781-782]; Metropolitan Life Ins. Co. v. State Bd. of Equalization, supra, 32 Cal.3d at pp. 656-657.) Here, the distinction between the contracts specifying that the insurers pay the claims directly and then seek compensation from the title companies, and the contracts that specify that the title companies pay the claims in the first instance, is one of form and not substance. If, as I have shown, contracts of the first type produce income to the insurers, then surely contracts of the second type do as well. Moreover, the conclusion that when a title company pays a claim on behalf of an insurer the insurer has received income is also compelled by the rule governing discharge of indebtedness. Under that rule, the discharge of liability by the [third party's] payment of the [first party's] indebtedness constitute[s] income to the [first party] and is to be treated as such. ( United States v. Hendler (1938) 303 U.S. 564, 566 [82 L.Ed. 1018, 1019-1020, 58 S.Ct. 655]; accord, e.g., Diedrich v. Commissioner, supra, 457 U.S. at p. 195 [72 L.Ed.2d at pp. 781-782].) An illustration of this principle is found in Old Colony Trust Co. v. Comm'r Int. Rev. (1929) 279 U.S. 716 [73 L.Ed. 918, 49 S.Ct. 499]. There, an employer agreed to pay an employee's income taxes. The high court held that payment of the employee's income tax indebtedness was income to the employee. ( Id. at p. 729 [73 L.Ed. at pp. 927-928].) This case is in substance no different. The insurer is legally obliged to pay all valid claims under its insurance policies. When a title company steps in and pays a policy claim on behalf of the insurer, it discharges a debt of the insurer. Accordingly, this discharge constitutes income to the insurer, and is to be treated as such. The majority attempts to distinguish Old Colony Trust Co. v. Comm'r Int. Rev., supra, 279 U.S. 716; Diedrich v. Commissioner, supra, 457 U.S. 191; and United States v. Boston & M.R. Co. (1929) 279 U.S. 732 [73 L.Ed. 929, 49 S.Ct. 505]. It writes that [i]n each of these cases, the taxpayer realized a gain by being relieved of a tax obligation for which the taxpayer alone was liable. Such is not the case here, where the insurers and the title companies contracted in advance to divide the premium, labor, risk and liability between themselves. (Maj. opn. ante, at p. 727.) According to the majority, this case presents a situation in which the taxpayer has reached an arm's-length agreement in advance with a third party by which that third party assumes certain risks in return for a consideration that reflects the value of those risks. ( Id. at p. 728.) The factor of risk assumption by the title companies somehow, in the majority's view, means that when the title companies pay claims on behalf of the insurers, the discharge of the insurers' indebtedness is not income to the insurers. The majority's reasoning is defective, for two reasons. First, it proves too much. An allocation of risk between contracting parties is certainly not unique to the insurer-title company relationship. Indeed, one court has stated that [a]ll commerce and all contracts allocate risks and benefits. ( Valley Bank of Nevada v. Plus System, Inc. (9th Cir.1990) 914 F.2d 1186, 1190.) To use a simple example, a private investor lends money to a manufacturer at a specified rate of interest for a fixed term. The loan contract by its nature allocates risks and benefits; the manufacturer bears the risk, among others, that deflation will occur and it will thereby be more costly, in real economic terms, to repay the loan. When the manufacturer repays the loan to the investor, we do not say that, because the manufacturer has borne the risk that the value of money will increase, the money it pays to the investor does not result in income to the investor. Similarly, the mere fact that the title company may assume some quantum of risk cannot mean that the money it pays to the insurer does not result in income to the insurer. [1] Second, the majority's reasoning ignores the fact that the insurers, not the title companies, are primarily and ultimately liable to the policyholders for the payment of claims. The insurer is the obligor under the insurance contract; the title company is not even a party to the contract. And the insurer remains ultimately liable under the policy. This is an indisputable proposition of law. A title insurance policy is a contract that insures the owner of property or another interested party against defects in title or liens and encumbrances that affect title, the invalidity of liens or encumbrances, or the incorrectness of title searches. (Ins. Code, §§ 12340.1, 12340.2.) Under California law, the function of title insurance can only be performed by an admitted insurer that had been issued a certificate of authority by the Insurance Commissioner to transact title insurance. (Ins. Code, §§ 700, 12360.) The functions of a title company are also precisely delineated by statute, and a title company has no statutory authority to become a party to a contract of title insurance. (Ins. Code, §§ 12340.5, 12389.) To the extent that a title company has any role in the title insurance function, it can only be as an agent of an admitted title insurer. Indeed, the stipulation executed by all the parties in this case, and the underwriting agreements between the insurers and the title companies on which that stipulation is based, all specifically refer to the title companies as agents of the insurers. Because title companies can, as a matter of law, assume none of the functions of title insurers, but can only act as the agents of such insurers, the conclusion is unavoidable that title companies cannot ultimately assume any portion of the risk that a claim will be made, and that the title companies are mere conduits for claims payments for which the insurers remain primarily and ultimately liable. And because the title companies cannot be ultimately responsible for payment of any claims made under the insurers' policies, it follows that, even under the majority's reasoning that the allocation of risk can defeat the conclusion that income was received, the insurers transferred no risk and thus cannot escape the conclusion that they received income when the title companies paid claims on their behalf.