This blog recently discussed the consequences for lenders of being carried on a borrower’s insurance policy as a “loss payee.” Recapping briefly, a lender who appears only as a “loss payee” on a borrower’s policy has very few rights and may find itself with no protection if the borrower allows coverage to lapse, fails to meet notice or proof of loss requirements or otherwise fails to comply with conditions in the policy. There is an alternative that provides enhanced (but not bulletproof) protection for lenders, however: being designated as a “lender loss payee.”
The “lender loss payee” clause, sometimes referred to as a union mortgage clause, standard union mortgage clause, or New York mortgage clause, generally is found in the “loss payable” provisions of a property insurance policy. The standard Insurance Services Offices union mortgage clause reads as follows:
7. Mortgageholders
a. The term mortgageholder includes trustee.
b. We will pay for covered loss of or damage to buildings or structures to each mortgageholder shown in the Declarations in their order of precedence, as interests may appear.
c. The mortgageholder has the right to receive loss payment even if the mortgageholder has started foreclosure or similar action on the building or structure.
d. If we deny your claim because of your acts or because you have failed to comply with the terms of this policy, the mortgageholder will still have the right to receive loss payment if the mortgageholder:
(1) Pays any premium due under this policy at our request if you have failed to do so;
(2) Submits a signed, sworn proof of loss within 60 days after receiving notice from us of your failure to do so; and
(3) Has notified us of any change in ownership, occupancy or substantial change in risk known to the mortgageholder.
All of the terms of this policy will then apply directly to the mortgageholder.
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f. If we cancel this policy, we will give written notice to the mortgageholder at least 10 days before the effective date of cancellation.
g. If we elect not to renew this policy, we will give written notice to the mortgageholder at least 10 days before the expiration date of this policy.
(The words “you” and “your” in this provision refer to the named insured, which typically is the borrower.) As can be seen, there is substantially more to this clause than to a loss payee clause, which states only that the insured and designated loss payee(s) will be paid as their interests may appear.
Courts have universally held that this clause creates an independent contract between the insurer and the mortgagee. This is important for many reasons, some obvious and others less so. The most obvious reason, and the reason most frequently cited, is that the borrower’s non-compliance with policy conditions—including abandoning the property (Lumbermens Mut. Cas. Co. v. Thomas, 555 So.2d 67 (Miss. 1989)), or destroying the premises by arson or other means (see, e.g., Nationwide Mut. Ins. Co. v. Clark, 2006 U.S. Dist. LEXIS 90181 (S.D. Miss 2006))—does not defeat the lender’s right to recover.
Just as important is standing to make a claim and, if necessary, sue. Damage to property does not always occur when the borrower/named insured has the resources to make a proper claim; some insured borrowers may be unwilling or unable to pursue further action in the event an insurer denies a claim. The “separate contract” concept potentially allows a lender named on the policy to step into the claim when the borrower cannot or will not do so. See, e.g., Philadelphia Ins. Co. v. SSR Hospitality Inc., No. 1:08-cv-0068-JRN (W.D. Tex. 2009)(allowing CMBS lender to intervene where borrower lacked resources to defend coverage lawsuit by insurer). By contrast a mere loss payee likely has no standing to sue. See, e.g., Ostrovitz & Gwin, LLC v. First Specialty Ins. Co., 393 S.W.3d 379 (Tex. App. – Dallas 2012, no pet.).
Subparagraphs (d)(1), (f) and (g) also allow a lender to protect itself in the event that the insured fails to pay a premium or when coverage cancels or non-renews. Section (d)(1) also is important when the insured has financed premiums but not kept up the payments. (Lenders should ask routinely whether property insurance premiums are being financed or paid in installments.)
The benefits of “lender loss payee” status are obvious, but there are potential pitfalls:
- Notice the way in which payment will be made. This can cause problems when the borrower has a blanket policy protecting multiple properties and a catastrophe loss (e.g., Hurricanes, Katrina, Rita and Sandy) affects more than one. In such a case lender A’s mortgage with respect to parcel A while the most senior on that property may not be senior to lender B’s mortgage on parcel B. (We will discuss problems from blanket policies in subsequent posts.)
- A lender’s payment protection extends only as far as its mortgage. This has two parts. First, a lender’s insurable interest only equals the amount due on its loan. If the loss is $1 million but the secured debt is only $10,000, the lender can only recover $10,000. Second, a lender may not have an interest in property that is not secured by its loan. There may be situations where a fire or other covered cause of loss destroys property secured by a mortgage and a separate secured loan for fixtures and equipment. Disputes between lenders for proceeds in such situations can be titanic.
- Third, the 60-day requirement for submission of proofs of claims is enforceable by insurers. It applies to lenders. The failure to act timely and in compliance with claim provisions in the policy may cause loss of benefits.
As with many other insurance provisions we have discussed in this blog, the “devil is in the details." A comprehensive policy review during loan underwriting is absolutely vital to ensure adequate protection. This is among the most important boxes to check off before the loan closes and at every policy renewal during the life of the loan.
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.
