United States: Defalcation Is A Dirty Word, But Not The End Of The World

Last Updated: September 13 2016
Article by Marty J. Solomon

The word "defalcation" remains one of the more frightening terms in the title insurers' lexicon. But with the proper training, preparation, and response, defalcations can be managed, and the title insurers' exposure controlled. A defalcation occurs when a title insurance agent misdirects or misappropriates funds held in trust for the parties to real estate transactions. They can cause liability for title insurers under statutes, common law, title policies, or closing protection letters. But because of that liability, the law gives title insurers all the tools they need to respond. It is just a matter of learning how to use the tools.

Because real estate transactions typically involve hundreds of thousands of dollars in deposits and loan proceeds, even small title agencies can have millions of dollars flowing through their escrow accounts at any given time. Sometimes, the temptation to dip into those funds for improper purposes can prove irresistible. Sometimes, title agents simply cannot manage proper accounting, and negligent defalcation occurs. Either way, the title insurers' response should secure the remaining escrow funds to cap defalcation liability, then turn to the process of resolving all potential liabilities to the parties to the escrow, then to salvage against those responsible for the defalcation.

Intentional defalcation usually results when a title agent finds itself short of operating funds, or when a third party persuades the title agent to misdirect funds. Typically, a struggling title agency may find itself unable to cover its own operating expenses, such as payroll, payroll tax liabilities, or liabilities to vendors. A title agent may try to "borrow" money from escrow to cover these shortfalls by moving money to the title agent's operating account. These title agents usually intend to "repay" the escrow account when they become able. But a failing business is a failing business, and they rarely find themselves able to do so. Instead, they become emboldened when the escrow shortage does not immediately come to light. They may move more and more money from escrow to operating until they find themselves in completely over their heads and the title insurer discovers the shortage.

Title agents also sometimes find themselves bent to the will of unscrupulous clients such as mortgage brokers or developers who pressure them to move escrow funds improperly. For example, a developer may demand that the title agent distribute loan payoff funds directly to the developer, rather than to the developer's mortgage lender, promising to "take care of" making the payoff and obtaining the mortgage loan release. When a large portion of a title agent's business comes from a small number of significant clients, those clients can often wield tremendous influence over the title agent. Developers, real estate agents, and mortgage brokers have many times used a title agent's escrow account as a "piggy bank," leaving the title agent and title insurer to clean up the mess.

Consider the "give the developer the loan payoff scenario."  In such a transaction, the developer sells its property to a buyer, who gets an owner's title policy.  The buyer's lender gets a closing protection letter and a lender's title policy.  The developer does not, of course, secure the lien release from the developer's mortgage lender.  As a result, the developer's mortgage lien remains on the property.  The buyer has a cloud on title not excepted from the owner's title policy.  The buyer's lender's closing instructions required the title agent to make payoffs and secure the lender a first priority lien.  As a result, the closing protection letter may give rise to an immediate claim.  And since the buyer's lender's lien is inferior to the developer's lender's lien, the buyer's lender may wind up with a policy claim as well, if the matter impairs the value of the buyer's lender's security and results in an actual loss.  In addition to this potential liability under its policies and closing protection letter, in some states, so-called "defalcation statutes" may make the title insurer directly liable to the parties for the misdirected escrow funds.  Finally, parties who suffer a defalcation loss can sometimes assert common law claims under theories of actual or apparent agency, respondeat superior, or negligent supervision.  A title insurer may learn about a defalcation when it receives a claim from the buyer or the buyer's lender in this situation. 

A title insurer can also learn of a defalcation through an audit of the title agency's escrow accounts.  When an agent's accounts will not reconcile, or when a title agent maintains multiple escrow accounts, some hidden from the underwriter, red flags should pop up in the auditor's mind and tougher scrutiny must apply.   

Business interruptions, such as a natural disaster or economic disruption (like the 2008 bubble burst) also bring defalcations to light.  When a title agent is "playing the float" in their escrow account, keeping a defalcation under wraps depends upon a steady flow of new funds into the escrow account.  When the flow contracts, the agent loses the ability to continue to play the diminishing float, and the defalcation emerges into view. 

When a title insurer discovers a defalcation, the most urgent response is to secure the escrow account to prevent further defalcation.  Many title insurance agency agreements give title insurers a contract right to do this.  Even if the agency agreement does not provide this right, a title insurer will usually have a solid argument to obtain an immediate injunction or the appointment of a receiver from a court.  When the title insurer suspects intentional defalcation, and has already obtained evidence of missing funds, that relief can sometimes be obtained ex parte in order to prevent a fraudster title agent from making off with the remaining escrow money before it can be secured. 

After securing the escrow funds, the title insurer should try to minimize disruption of the title agent's business in order to minimize reputational risk.  The title insurer or the receiver should continue to close transactions that are "in the pipeline," or should farm those transactions out to other title agents who can handle them smoothly, with a minimum of fuss and inconvenience for the parties. 

The title insurer should then work to determine the exact amount of the escrow shortage, so that the title insurer can pin down its maximum potential liability.  Tracing the escrow shortage back to its original source can help identify all of the title insurer's potential liabilities from the defalcation.  That exercise can also help identify potential sources of salvage recovery, such as the identity of those who benefitted from the defalcation, or other title insurance underwriters who may have liability. 

The title insurer should coordinate claims on the title agent's errors and omissions policy, fidelity bonds, or other insurance or bonds that may be in place.  Some bonds are designed to cover losses from intentional defalcation.  Other bonds exclude criminal acts, escrow liabilities, or liabilities caused by an agency's principals.  For these reasons, the title insurer should be extremely careful with the language used in these claims until all the facts are known. 

Once the escrows have been secured and the liability reduced to a certainty, the title insurer should pursue salvage.  Contract claims under the agency agreement typically survive cancellation of the agent, and can provide for recovery not only of the missing escrow money, but the title insurer's cost of response and cleanup.   Title insurers may also have unjust enrichment or similar equitable or quasi-contractual remedies.  If third parties have benefited from the defalcation, the title insurer may have either direct or subrogated claims against those parties. 

In addition, the title insurer may alert law enforcement to the defalcation.  In most jurisdiction, misdirection or misappropriate of trust funds is a serious criminal offense.  Prior to the 2008 recession, criminal prosecution could be difficult to obtain, since law enforcement was focused more on terrorism than on financial crimes – but in the wake of the bursting of the real estate bubble, prosecutors and law enforcement agencies focused far more on economic crime and became adept at prosecuting these types of offenses.  When a title agent is prosecuted, a title insurer can typically obtain a restitution order that can result in a stream of payments from the perpetrator.  Restitution is typically non-dischargeable in bankruptcy, ensuring that payments may go on for years, no matter what the guilty try to do to evade making them. 

Finally, title insurers have become far more proactive in recent years in taking a prophylactic approach.  Title insurers now train title agents on the seriousness of defalcations, and sometimes require better insurance and bonding than in the past.  In the world of defalcations, a dollar of prevention can be worth a pound of cure.  Carlton Fields offers training and prevention programs for title insurers and agents, as well as rapid defalcation response.  Once the title insurer understands the tools at its disposal, title agent defalcations, while still costly, need not be nearly as frightening.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.