Fire InsuranceandEminent DomainAwards

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 28 2006 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

UndamagedRequired cleaning

Damaged but stableSevere structural damage

DestroyedDanger of collapse

$31.6B in insurance payouts

Congress intervened to stabilize the insurance market. TRIA, passed in 2003, renewed for two years in

2005. 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?

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.

Starkman SigmondsBirnbaumMtg

Purchase price..... $150,000Mortgage.............. $ 60,000

Ins. proceeds...... $135,000Land 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 ableto 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 burnedthe 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.............. $100,000Debt..............$ 70,000

Proceeds....... $ 60,000

Debt reduction:$60,000 x 70/100= $42,000

New debt......$ 28,000New 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