@Daniel Hart
You are not going to like my reply. You need to speak to an attorney, one who is skilled with title insurance companies and practices real estate law exclusively.
While I am not an attorney, I used to work for a commercial litigation firm. Our main clients were large banks and lending institutions. Several times I saw frivolous lawsuits come across my desk demanding a lien or judgment against a debtor, simply because they could take advantage of a simple mistake or in retaliation of party who had filed suit against them. It was easy income for them.
In a nutshell, you are running with the big dogs.
Title insurance companies and banks have lawyers on retainer to fight people like you (and your partner) all day, every day. In fact, even if the company is in the wrong, one of their main strategies is to wear you out and drain your resources so that you can no longer pursue the suit. They make sure that this happens long before the case comes in front of the judge. In this case, your best hope would be a settlement.
Out of all of the professionals that dropped the ball, your best recourse of action may be against your attorney. However the chances of having a positive outcome are low at best, unless you have documentation saying that the there were no problems with the title...
Which brings me to the question:
Do you have documentation from your attorney saying the title was clear? Were your conversations mainly via phone or email? There is a big difference... Emails (in most states) can now be used as evidence... Did he say that he was 'unable to prove the other party's claims were true?' If so there is a big difference between being unable to prove something and saying that there are NO other claims on title. It would be similar to me saying that I can't prove aliens exist, and knowing for a FACT that they don't. One statement is based off of assumption, the other is based off of fact.
An attorney has a responsibility to represent you to the best of their ability. If you can prove that he misled you into thinking something that wasn't true or was negligent in his duties, you may have a case. Again, talk to an attorney.
The third, and most hopeful outcome, would be to come to some sort of agreement with the owner about the possibility of conveying the property into a duplex or adding on a garage with a mother-in law (sometimes still legal in areas were multi-family units are against code) to generate some income. I would also try to get him to sign a 'Right of First Refusal' contract for his interest in the property.
The last action, and the one your attorney is likely to suggest, would be to let the property go to foreclosure. It will damage your credit and hinder your ability to buy real estate, but it will not stop you from still being active in other methods of investing. However, if you go this route, I will advise you that most states award deficiency judgments (the amount owed on the note less the profit made at the foreclosure sale). This amount is considered taxable income by the IRS, and you can later be sued by the note-holder for the difference (at this point a judgment can be entered against you and your wages garnished or liens placed against properties owned, ect.). If you do decide to go this route, hire a good tax attorney. There are ways to protect yourself so that the IRS cannot claim income based off of a deficiency judgment. Also, before going to foreclosure, pressure the bank or note-holder to sign a contract saying that they will not hold you liable for any losses (it can be done, just be persistent and talk to many different people until you get something in writing).
As you may have noticed, I have not mentioned your partner in this post because frankly, I do not know enough about your partnership or agreement with him. Were the terms in writing? This is where options get tangled. Again, see an attorney.
This post is much longer than what I intended it to be... As I know that not knowing where you stand can be much more stressful than having some inkling of what may happen, I tried to shed some light on the situation. I wish you the best...
In the future, trust your gut! Our instincts have kept our species alive for centuries. They were developed for a reason. If something doesn't feel right, DON'T DO IT!
