Loan docs generally require Borrower to provide insurance on collateral in favor of Lender. Borrower presents Lender with a policy declaration page listing Lender as a "loss payee;" this is known as an open mortgage, loss payee or loss payable clause. Lender is protected if there is a covered loss, correct? To answer that question, we must first answer this one: what rights does a "loss payee" have under such a clause?
Virtually all commercial property policies contain "Loss Payable Provisions," sometimes on an endorsement (ISO form CP 12 18 is an example), and sometimes in the main text of the insuring agreement. A typical loss payee/open mortgage clause reads as follows:
For Covered Property in which both you and a Loss Payee shown in the Schedule or in the Declarations have an insurable interest, we will:
- Adjust losses with you; and
- Pay any claim for loss or damage jointly to you and the Loss Payee, as interests may appear.
This looks innocuous and comforting enough, but it needs unpacking.
First, consider "shown in the schedule or in the declarations." To have protection as a loss payee (or a lender loss payee), the lender's name must be listed in the policy. A lender must ensure that it is named—and correctly named—in the policy as a loss payee if it wants whatever protection being a loss payee provides. If the lender is "First National Bank of Anytown," a listing of "National Bank of Anytown" may be insufficient.
Second, "shown in the Schedule or in the Declarations" means what it says. If the loan is sold, the purchasing lender has no rights as a loss payee, unless it is named in the schedule or declarations. The same is true of servicers, because a servicer may have to be able to demonstrate that it is the lender's representative with rights to act on behalf of the lender to recover. (Check out the Florida residential mortgage foreclosure cases if you have doubts. E.g., BAC Funding Consortium Inc. ISAOA/ATIMA v. Jean–Jacques, 28 So.3d 936 (Fla. 2d DCA 2010).)
There is a possible workaround: if First National Bank of Anytown is to be the loss payee, the designation "First National Bank of Anytown ISAOA" can be use (although the author strongly prefers substitution of specific names at each transfer). The acronym "ISAOA" stands for "its successors and/or assigns," and its insertion in a designation may be sufficient to allow a successor lender or servicer to claim loss payee status. (But the successor may have to prove its status, which may entail court proceedings and considerable delay. This is what Jean-Jacques is about, and why the author strongly prefers specific changes at every transfer.)
Next, consider the phrase "pay any claim for loss or damage jointly to you and the Loss Payee." Under this provision, who negotiates a settlement if there is a loss? You are correct if you said the named insured/borrower, which means that the lender can be entirely excluded from the claim adjustment process. If the insurer interposes a thin or invalid defense to coverage that the borrower does not address or the borrower does not provide adequate support for a claim or just takes a low-ball offer, the lender can find that its collateral is damaged or destroyed and there has not been an adequate recovery.
Westfield Ins. Co. v. Talmer Bancorp, 545 Fed. Appx. 402 (6th Cir. 2013), gives an example of what can happen if the lender is not at the table. In Talmer, the insured had a vandalism loss to a building and inventory, both of which were secured in favor of Talmer. The borrower fraudulently told Westfield, its insurer, that there were no liens on the property. Smelling the proverbial rat, Westfield investigated. It found the bank's security interest on the building but not on the inventory. It issued a check to the borrower only on the inventory claim. The bank then sued. Held: the borrower's fraud barred recovery by the lender. The Sixth Circuit affirmed, thereby highlighting the fundamental problem with an open mortgage/loss payee clause: if the borrower/insured commits fraud or allows the policy to lapse, the loss payee has virtually no independent rights.
ViewPoint Bank v. Allied Prop. & Cas. Ins. Co., 439 S.W.3d 626 (Tex. App. – Dallas 2014, pet. denied), is a little more hopeful. There, the borrower had a covered loss from Hurricane Ike in 2008. The lender was named as a loss payee, and the borrower properly reported that interest. The insurer issued a check payable jointly to borrower and lender. So far, so good, but the borrower negotiated the check without getting the lender's consent or endorsement. The Bank sued, and unlike Talmer, it also made a claim under UCC Article 3 on the check. Held: the Bank could recover on its Article 3 claim. This sounds like a win, but remember that it took about five years and almost $89,000 in fees to collect. Hmmm...
To answer the question posed at the outset, even assuming the lender is properly named in the first place, an open mortgage/loss payable clause gives a lender no independent rights in a property insurance policy. The insured/borrower's fraud or wrongful acts may deprive the insurer of any right of recovery or force it to pursue expensive litigation. But this is not incurable. In our next installment, we discuss an alternative policy clause that provides much greater protection to a lender. Stay tuned.
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.
