Post-Meltdown Property Insurance Claims by Financial Institutions

Transcription

1 Post-Meltdown Property Insurance Claims by Financial Institutions Background and Reference Materials Webinar, October 27, 2010 Andrew B. Downs Bullivant Houser Bailey PC 601 California Street, Suite 1800 San Francisco, CA DISCLAIMER: The statements in this paper are those of the author only and do not necessarily represent the views of his employer, clients, the Federation of Defense & Corporate Counsel or the Property Loss Research Bureau 2010 Property Loss Research Bureau and Andrew B. Downs

2 I. Introduction These materials are intended to compliment and illustrate the discussion of the Mortgage Clause in connection with the webinar presented on October 27, Like the webinar, they are not intended to constitute a comprehensive discussion of the Mortgage Clause, but rather are limited to certain issues. The Mortgage Clause in its common forms operates to create a separate contract between the insurer and a lender. While the contract is separate in the sense that the rights of the lender are independent of those of the policyholder/borrower, the insurer-lender contract is engrafted onto the policy issued by the insurer to the policyholder. Many of its essential terms are taken from that contract. The modern practice is to include the Mortgage Clause language in the principal policy forms. In some portions of the country a separate endorsement, the form 438BFU Lender s Loss Payable Endorsement is still required by some lenders. II. Exemplar Policy Language A. HO 3 Form, ed. K. Mortgage Clause 1. If a mortgagee is named in this policy, any loss payable under Coverage A or B will be paid to the mortgagee and you, as interests appear. If more than one mortgagee is named, the order of payment will be the same as the order of precedence of the mortgagees. 2. If we deny your claim, that denial will not apply to a valid claim of the mortgagee, if the mortgagee: a. Notifies us of any change in ownership, occupancy or substantial change in risk of which the mortgagee is aware; b. Pays any premium due under this policy on demand if you have neglected to pay the premium; and c. Submits a signed, sworn statement of loss within 60 days after receiving notice from us of your failure to do so. Paragraphs E. Appraisal, G. Suit Against Us and I. Loss Page 1

3 Payment under Section 1 Conditions also apply to the mortgagee. 3. If we decide to cancel or not to renew this policy, the mortgagee will be notified at least 10 days before the date cancellation or nonrenewal takes effect. 4. If we pay the mortgagee for any loss and deny payment to you: a. We are subrogated to all the rights of the mortgagee granted under the mortgage on the property; or b. At our option, we may pay to the mortgagee the whole principal on the mortgage plus any accrued interest. In this event, we will receive a full assignment and transfer of the mortgage and all securities held as collateral to the mortgage debt. 5. Subrogation will not impair the right of the mortgagee to recover the full amount of the mortgagee's claim. B. CP Form, Ed. F. Additional Conditions The following conditions apply in addition to the Common Policy Conditions and the Commercial Property Conditions 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. Page 2

4 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 Coverage Part, the mortgageholder will still have the right to receive loss payment if the mortgageholder: (1) Pays any premium due under this Coverage Part 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. e. If we pay the mortgageholder for any loss or damage and deny payment to you because of your acts or because you have failed to comply with the terms of this Coverage Part: (1) The mortgageholder's rights under the mortgage will be transferred to us to the extent of the amount we pay; and (2) The mortgageholder's right to recover the full amount of the mortgageholder's claim will not be impaired. At our option, we may pay to the mortgageholder the whole principal on the mortgage plus any accrued interest. In this event, your mortgage and note will be Page 3

5 transferred to us and you will pay your remaining mortgage debt to us. f. If we cancel this policy, we will give written notice to the mortgageholder at least: (1) 10 days before the effective date of cancellation if we cancel for your non-payment of premium; or (2) 30 days before the effective date of cancellation if we cancel for any other reason. 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. C. Form 438BFU (used on the West Coast, Partial) 1. Loss or damage, if any, under this policy, shall be paid to, its successors and assigns, hereinafter referred to as "the Lender," in whatever form of capacity its interests may appear and whether said interest be vested in said Lender in its individual or in its disclosed or undisclosed fiduciary or representative capacity, or otherwise, or vested in a nominee or trustee of said Lender. 2. The insurance under this policy, or any rider or endorsement thereto, as to the interest only of the Lender, its successors and assigns, shall not be invalidated or suspended: (a) by any error, omission, or change respecting the ownership, description, possession, or location of the subject of the insurance or the interest therein, or the title thereto; (b) by the commencement of foreclosure proceedings or the giving of notice of sale of any of the property covered by this policy by virtue of the mortgage or trust deed; (c) by any breach of warranty, act, omission, neglect, or non-compliance with any of the provisions of this policy, including any and all riders now or hereafter attached thereto, by the named insured, the borrower, mortgagor, trustor, vendee, owner, tenant, warehouseman, custodian, occupant, or by the agents of either or any of them or by the happening of any event permitted by them or either of them, or their agents, or which they failed to prevent, whether occurring before or after Page 4

6 the attachment of this endorsement, or whether before or after a loss, which under the provisions of this policy of insurance or of any rider or endorsement attached thereto would invalidate or suspend the insurance as to the named insured, excluding herefrom, however, any acts or omissions of the Lender while exercising active control and management of the property. * * * III. Secured Lending Issues and Mechanics What is colloquially known as a mortgage is a loan that is secured by real property. In some portions of the country, traditional mortgages are not used, rather the borrower gives a Trustee appointed by the lender a Deed of Trust, when empowers the Trustee to sell the property in the event of a default. In those jurisdictions, most foreclosures are non-judicial proceedings; the lender does not have to sue to foreclose. The real property is the security for the loan in the event of a default the lender can sell the real property to recover the amount owed by the borrower. When we discuss a mortgage in this program, what we re really discussing is any loan where the borrower has given the lender a security interest in real property. Personal property can, and often is, given as security for loans, but a discussion of that issue is beyond the scope of this webinar. Mortgages generally are recorded with a public agency at the county level. For example, in California, they are recorded with the County Recorder in the county where the property is located. Recording puts other lenders and prospective buyers on notice of the lender s interest in the property. Traditionally recording occurred by presenting the original paper document at the Recorder s office where it was date and time stamped and entered into the Recorder s records. A growing number of jurisdictions now permit or require electronic recording of documents. Regardless of the manner of recording used in the jurisdiction, what matters is the date and time of recording because in most instances that sets priorities (there are some exceptions for tax liens, mechanics liens and other claims). A first mortgage is the mortgage with the highest priority. Generally, it is the one that was recorded first, although with a Subordination Agreement a later filed mortgage can take priority over an earlier one. A foreclosure by the holder of the first mortgage generally wipes out all lower priority mortgages. A second mortgage is the mortgage with the next highest priority. A foreclosure buyer from a second mortgagee buys subject to the rights of the existing first mortgage. Mortgage loans have been sold for generations that s what Fannie Mae buys. But the last decade or so, before the meltdown saw a huge growth of securitization where bundles of mortgages were sold off in slices to investors. Often they were sold in tranches with portions Page 5

7 of the same loan sold to multiple investors with different rates of return depending on the risk and term of the portion being purchased. When individual loans were sold intact it was common for the originating lender to retain responsibility for the servicing of the loan, the collection of principal and interest payments, and also for the buyer to have recourse against the originating lender in the event of a default. With securitized loans, no assumptions should be made about recourse. IV. Meltdown Issues A. Loss Happening Before Foreclosure When the loss happens before foreclosure and then the lender forecloses before the insurer is in a position to pay the claim, several issues arise. Among them: Is the policyholder/borrower entitled to any of the money (assuming it is a covered loss and the policyholder isn t guilty of fraud)? How are policy payments prioritized among lenders or between the lenders and the policyholder? What about non-fraudulent damage done by the policyholder before foreclosure? That third scenario, non-fraudulent damage done by the policyholder before foreclosure is arising with greater frequency with borrowers who took out loans to finance remodeling jobs then ran out of money before the work was finished, leaving a partially demolished, if not partially remodeled building for the lender. This was addressed in a case from California about eight years ago, Wilson v. Farmers Ins. Exch., 102 Cal.App.4 th 1171, 126 Cal.Rptr.2d 205 (2002). There, the borrower and policyholder began remodeling the home, with the knowledge of the lender. The borrower ultimately defaulted on the loan, with the remodeling incomplete. The lender sought to recover on the policy. The court held there was no coverage because of the exclusion for faulty, inadequate or defective workmanship, remodeling, construction, renovation or remodeling. The Wilson case should not be read too far. In that particular case, the insurer was able to prove that the remodeling was faulty and inadequate. Work that simply is incomplete because the policyholder cannot afford to complete it may not be faulty, inadequate or defective. B. Post-Foreclosure Losses Under these policy provisions, the lender has an obligation to communicate what it knows. If it doesn t communicate information that it, or its agents such as property managers or realtors, know, it has breached the policy s provisions. But, these are very fact intensive Page 6

8 inquiries and getting the necessary information from the lender or its agents is likely to be labor intensive. One area of importance is the Full Credit Bid doctrine. in simple terms, this doctrine reflects the fact that a lender who bids the entire balance due (a full credit bid in bank language) at a post loss foreclosure sale has been made whole for its interest in the property. Thus, it is not entitled to any payment by the insurer. C. Redemption Periods State laws vary, but in some states, the defaulting borrower has a right to redeem the property within a specified period of time. The adjuster needs to know whether the borrower has any redemption rights at the time payment is being made. V. The Government A. Failed Banks and the FDIC When a bank fails, the FDIC often will sell its deposits and certain of its assets to another bank, while keeping or selling elsewhere the bank s remaining assets. In some situations, the FDIC or a state regulator will become the Receiver of the failed bank. As Receiver, the FDIC is the successor in interest to the bank and it usually holds the same rights the bank held. B. Bankruptcy When a policyholder files bankruptcy, its financial existence becomes supervised by the Bankruptcy Court, and depending the type of bankruptcy, possibly by a Trustee who will assume the rights and interest of the policyholder. Upon the filing of a bankruptcy, there is an automatic stay of all litigation and similar action against the debtor. 11 U.S.C VI. Recovery Issues. A. Loan Servicing. The case of State Farm Fire & Cas. Co. v. Guaranty Federal Savings Bank, 916 S.W.2d 635 (Tx. Ct.. App. 1996) stands for the proposition that the insurer cannot impose duties on the loan servicer in exchange for payment that are greater than those imposed by the policy. B. Anti-Deficiency Statutes. A number of states, including California, Arizona, Montana and Minnesota have statutes which restrict the ability of the lender to obtain a deficiency judgment against the borrower following foreclosure. Page 7