Fire Insurance and Eminent Domain Awards

Why do lenders insist that borrowers carry insurance? If an uninsured casualty loss occurs, the security can be damaged or largely destroyed. (The land can’t be destroyed, of course.) How does the lender know whether the required insurance has been issued before the loan is closed? By provision of a “certificate of insurance” signed by the insurance agent.

The ACORD 28 Certificate of Insurance (2006 ed.)

ACORD Certificate Language (issued to lenders): “This evidence of commercial property insurance is issued as a matter of information only and confers no rights upon the additional interest named below.” “Should any of the above described policies be cancelled before the expiration date thereof, the issuing insurer will endeavor to mail __ days written notice to the additional interest named below, but failure to mail such notice shall impose no obligation or liability of any kind on the insurer, its agents or representatives.”

How can lenders deal with this insipid “proof of insurance?” Insist on use of an earlier, more comprehensive form. (This may violate state insurance regulations.) Get the original policies at the closing. Add “loss caused by amendment or cancellation of the insurance policies” as a non-recourse carveout.

Damage to buildings Degree of effect Undamaged Required cleaning Damaged but stable Severe structural damage Destroyed Danger of collapse $31.6B in insurance payouts

Congress intervened to stabilize the insurance market. TRIA, passed in 2003, renewed for two years in Shared payment of terrorism claims between insurance underwriters and the Federal Government. Passage of TRIA enabled a market for terrorism insurance to begin to develop because the federal backstop effectively limited insurers’ losses, greatly simplifying the underwriting process.

TRIPRA TRIA was replaced by TRIPRA (Terrorism Risk Insurance Program Reauthorization Act of 2007), with a 7-year term. Applies to violent acts causing damage within United States or to US flag vessel or air carrier (or mission premises) and certified by Treasury Secretary to have (1) been committed to coerce or influence US policy and (2) resulted in at least $5 million in insured losses (and not during act of declared war except for worker comp).

Litigation: Commercial borrowers throughout the country had covenanted to carry insurance that included terrorism coverage. In the aftermath of 9/11, the cost of renewing that coverage skyrocketed, or renewal became impossible. Some lenders argued that this constituted mortgage default.

Who gets the fire insurance proceeds? ●If both mortgage and insurance policy are silent? ●If mortgage says ME gets the proceeds? ●If ME is named as an insured on the policy?

What are the limits on the ME’s recovery of insurance proceeds? ●The amount of the proceeds ●ME’s impairment of security as defined for purposes of waste (unless there’s contrary mtg. clause) ●The full debt.

Standard mortgage policy: This insurance, as to ME, shall not be invalidated by any act or neglect of the mortgagor or owner of the property, nor by any change in the title or ownership of the property, nor by the occupation of the premises for purposes more hazardous than permitted by this policy.

What’s the effect on the mortgagee’s rights of... ●MR burning down the property. ●MR committing fraud on the insurance application. ●MR begins manufacturing paint thinner on the property. ●MR fails to pay premiums.

The mortgagee’s duty: “The mortgagee will: … (c) notify [the insurer] of any change of ownership or occupancy or any increase in hazard of which the mortgagee has knowledge.” Is commencement of foreclosure by the lender such a change? Kansas and Tennessee have held yes, while several other courts have held no.

Assume there’s a fire caused by the fault of the MR. The fire insurance company pays off the mortgage. What will it do next?

Take an assignment of the note & mortgage, and enforce them against MR.

StarkmanSigmonds Birnbaum Mtg Purchase price.....$150,000 Mortgage $ 60,000 Ins. proceeds......$135,000 Land value after________ loss $ 71,500

The Sigmond’s claim: Why did Sigmonds want the insurance proceeds? Was the Sigmonds’ security impaired? Would the case’s result be the same if the mortgage itself had given the Sigmonds the right to the insurance proceeds?

FNMA form: (p. 1208) Insurance shall be applied to restoration if... ●economically feasible and ●lender’s security (after restoration) is not lessened.

Should MR be able to force ME to become a “construction lender?” What if the building was a “nonconforming use” under the zoning ordinance?

Suppose ME makes a full credit bid at the foreclosure sale. Then ME discovers that the building burned the day before the sale!

What actions by a mortgagee are barred by making a full credit bid? Deficiency Pre-foreclosure rents Waste Casualty insurance Fraud in mortgage application(?)

Eminent domain awards: Fannie Mae form (p. 1292): In a partial taking, the mortgage is reduced by: Pre-taking debt Pre-taking FMV Proceeds x

Example: FMV $100,000 Debt $ 70,000 Proceeds $ 60,000 Debt reduction: $60,000 x 70/100= $42,000 New debt......$ 28,000 New L/V ratio:70%

Thus, the formula’s purpose is to preserve the actual pre-taking loan-to-value ratio. But if the condemnation award undervalues the property taken, the loan-to-value ratio will be worse (higher) than before.

Is it feasible to negotiate an insurance clause like the Fannie Mae form if you represent the borrower on a commercial mortgage? It’s possible; perhaps depending on the damage being limited to 20%-40% of value.

Why doesn’t the Fannie Mae form allow use of the eminent domain proceeds for restoration of the property, as it does for casualty insurance proceeds?

The end