Legal indemnity insurance is used more and more in conveyancing as a way of getting a transaction to the point of completion more quickly than would be possible if whatever defect is being insured against were actually resolved.
There are different types of policies for different risks but they all operate on the same principle. This is very broadly the same principle as any other type of insurance, i.e. a premium is paid in return for cover by the insurer against a given risk, but there are some important differences too. A purchaser ought to be fully aware of the implications before accepting insurance, however unfortunately it is often not fully explained by conveyancers and can leave clients feeling bewildered and more seriously, at greater risk. This article aims to demystify legal indemnity insurance.
What is Legal Indemnity Insurance?
Legal indemnity insurance is a specific type of insurance policy used in conveyancing transactions where there is some sort of legal defect (a missing landlord, lack of planning permission or building regulations approval, a lack of a right of way etc.) which cannot be quickly resolved (or in some cases cannot be resolved at all) and which is reasonably unlikely to cause any actual loss but does have the potential to cause a significant loss.
Unlike other types of policy, for which regular premiums have to be paid and which need to be renewed periodically (usually annually), only one premium will need to paid and the cover will last forever in most cases. Where a mortgage is being used for the purchase the lender will generally be insured jointly with the purchaser.
A legal indemnity insurance policy provides cover against any loss suffered by the insured as a result of any lawful action taken against him in respect of the defect, including for example any resulting loss of value to the property or any legal costs incurred in defending an action. As an illustration, if the defect is a lack of planning permission for an extension and the local authority serves an enforcement notice then any legal costs incurred in challenging the enforcement action, as well as any reduction in value if the local authority is successful. If the removal of the extension leads to the loss of a bedroom and if the insured has children and is under an obligation because of their age and gender to provide separate bedrooms for them, then the costs associated with moving to a larger property may also be covered.
If the defect is an absence of a right of way to access the property then the cost of purchasing an easement, if this is possible and is the cheapest effective solution, should be insured.
Do I Have To Take Out Indemnity Insurance?
If you are buying the property with cash then it is for your conveyancer to advise and for you to instruct, so you can go against your conveyancer’s advice and choose to do nothing about a defect, though you will almost certainly not be able to make a claim on the conveyancer’s professional indemnity insurance in the event you suffer a loss.
You could insist, if the seller is prepared to cooperate and if it is practically possible, that the defect is corrected.
If you are buying with the aid of a mortgage, it is likely that your lender will insist either that the defect is corrected or that indemnity insurance is put in place. The lender will not bear the cost of the premium.
Who Should Pay For Indemnity Insurance?
Although there is no legal obligation to do so, the seller will generally be expected to pay for indemnity insurance.
The rationale behind this is that a legal defect, unlike a physical one, cannot usually be seen by a purchaser when he views the property and makes his offer. In fact it will generally only be revealed once the conveyancing process is under way.
For this reason the purchaser could and should argue that, had he known of the defect and the need to purchase insurance when he viewed the property he would have reduced his offer accordingly, just as he would if his inspection had revealed physical damage which required repair.
The seller on the hand may argue that he does not believe the defect represents a significant risk therefore in his opinion insurance is not necessary and if the purchaser insists on having it, it must be at his own expense.
How Much Does Legal Indemnity Insurance Cost?
This depends on the value of the property – The more valuable the property, the more expensive the policy. It all depends on the type of cover. Generally though it will be anywhere between £50 – £200 for a standard policy. Sometimes a bespoke policy will be required, which will be more expensive but it is a similar application process as when applying for a home insurance quote.
What Happens to the Indemnity Insurance Policy When I Sell
Most policies will remain in force in perpetuity (forever) and when you sell, will protect the purchaser without the need for the policy to be formally assigned. It is important to note however that the limit of cover may not be index linked and may be limited to the value stated when the policy was taken out. If therefore when the policy was purchased the property was worth £100,000 but it is subsequently sold for say £250,000 then the limit of cover may need to be increased, in which case a premium will be payable.
What are My Obligations as an Insured Party?
Like any insurance policy, you must take reasonable steps to ensure that a circumstance does nor arise which would give rise to the need for a claim and you must certainly not do anything to significantly increase the likelihood of a claim being necessary.
In particular, you should not disclose the existence of the policy to anyone other than your own solicitor, your mortgage lender or a potential purchaser (or his solicitor). This is because a person who has a right to take action against you in respect of the insured defect may be more likely to do so if he believed that he will not be harming you because you are insured. An unauthorised disclosure may lead to the policy being invalidated.
If the cover is for lack of a right of way and you subsequently approached the owner of the land with a view to purchasing an easement then this would invalidate the policy since the owner might otherwise have allowed you to use the access indefinitely.
You will be asked to confirm certain presumptions before the policy issued, such as that the property has been used for residential purposes for at least 12 months; that no objections have been raised in respect of the defect etc. Giving a false statement will render the policy invalid and may constitute an offence.
What Types of Risks Can Be Covered?
There are too many to list, but basically almost all legal defects can be insured against depending on the precise circumstances. Some common examples are lack of planning permission or building regulations approval, missing easements, good leasehold title, absent/insolvent landlord or no search indemnity.
What are the Risks of Accepting Indemnity Insurance?
If you accept indemnity insurance then you accept that you will be purchasing a property with a legal defect. Indemnity insurance providers, like any insurers, will always try to avoid paying large claims if they think they have grounds so there is always the risk that you will have what you assumed would be a valid claim rejected.
You also have to think about what will happen when you come to sell. Opinions on what is and is not an acceptable risk do change in property conveyancing from time to time, usually as a result of case law. What may be considered a relatively minor risk which can be covered by insurance when you buy may be considered much more serious when you sell if there has been a headline case which has resulted in a large loss for a purchaser (or their solicitor), so you may find yourself having to deal with the defect when you sell.
In addition, whilst insurance may prevent you from suffering financial loss, it cannot compensate for the stress and inconvenience (or indeed to the emotional suffering, after all the value of a family home cannot always be measured in cash in the eyes of the owner) of losing your home.
Does It Cure The Defect?
Insurance certainly does not cure the defect. In fact, it effectively prevents this since any attempt to correct would most likely invalidate the cover.
Will Everybody Accept Indemnity Insurance?
Whether or not a particular individual or mortgage lender is likely to accept indemnity insurance depends on the severity of the defect, on the state of the market and of course, on the individual. At the time of writing the housing market is just emerging from a major slump which has seen many lenders and their solicitors suffer massive losses as a result of practices which, in the boom years, seemed perfectly acceptable. As such lender and solicitors are being much more cautious.
At some point there will be another boom and people will become more relaxed again. Then there will be a slump and the cycle will continue. Also, there will always be the occasional over-cautious solicitor or buyer who won’t accept anything less than a perfect title.
Are There Any Situations Where Insurance Is Not Appropriate?
If you intend doing something after completion of your purchase which is likely to alert a person who may have a right to make a claim in respect of it to the breach then insurance is not appropriate since your action may invalidate the cover.
An example of this might that if the insurance is for lack of planning permission for, say, an extension, and you intend doing some further work for which a planning application will be needed. By making an application you are inviting the planning inspector to inspect the property and upon doing so he is likely to discover the insured work and may then commence enforcement action. Since you have caused the planning inspector to visit you have breached the terms of the policy and could not make a claim under it.
Why Do Sellers Prefer Indemnity Insurance to Correcting a Defect?
It is almost always cheaper and quicker to purchase a policy than it is to correct the problem. The seller is disposing the property and so is bound to prefer the quick and cheap solution. In addition, by making enquiries in respect of the defect the seller may “open a can of worms” for himself. For example, say he approaches a land owner to ask for a legal easement to be granted over an accessway. The land owner may decide to hold the seller to ransom and prevent him from using the access unless he pays an exorbitant premium. The buyer would most likely walk away from the purchase at this point leaving the seller with major, and potentially very expensive problem, and still no sale.
I’m Doing My Own Conveyancing, Can I Arrange an Indemnity Policy Myself?
Indemnity insurance providers will generally deal only with solicitors or licensed conveyancers, not members of the public, however if you are not represented but your buyer/seller is, you could always ask his solicitor to arrange the cover on your behalf.