First National Bank & Trust Co. of Port Chester v. New York Title Insurance Co.

Max and Abe Karnowsky owned a plumbing and heating business. The Karnowskys were overdue in repaying $4,575 in notes to First National Bank and Trust Co. of Port Chester (First National) (plaintiff). In August 1935, the Karnowskys transferred property located in Port Chester, New York, to Ike Nathan. At the time of the transfer, the property was subject to a $2,800 mortgage held by a third party. First National learned of this transaction, and because of the Karnowskys outstanding notes, attorneys for First National and the Karnowskys conferred to determine a solution. It was decided that Nathan would convey the property back to the Karnowskys. First National would accept the assignment of the $2,800 mortgage, and the Karnowskys would grant an additional $5,600 mortgage. The two mortgages would then be consolidated. First National applied to New York Title Insurance Co. (New York Title) (defendant) for title insurance. New York Title, aware of the mortgage consolidation, approved the transaction, examined title, and issued a policy insuring First National against all loss or damage not exceeding $8,400. The policy expressly acknowledged the mortgage consolidation and did not contain any exemptions regarding bankruptcy. In January 1936, a petition for involuntary bankruptcy was filed against the Karnowskys. In February, the Karnowskys were declared bankrupt. The property was sold for $5,650. At trial, First National’s witness established a fair market value of $9,000. The bankruptcy trustee set aside the $5,600 mortgage, asserting that it was a preference in violation of bankruptcy law. The trial court agreed and canceled the $5,600 mortgage, only validating the $2,800 mortgage plus interest. It was also discovered that First National had made a number of misrepresentations to New York Title regarding the Karnowskys’ financial status and failed to disclose the full extent of their debt. New York Title refused to pay First National more than the $2,800 due to the title defect caused by the illegal preference. First National filed an appeal.