By: D. Keith B. Dunnagan, Esq.
We want to let all families affected by the Camp Fire and Woolsey Fire that our thoughts and prayers are with them.
It is not by coincidence that today we look at the interplay between fire/hazard insurance and a mortgage. This scene of fire destruction in California has become far too common. More problematic though is the response of lenders related the ownership of fire insurance proceeds.
Under nearly every deed of trust or loan agreement is a provision that requires the borrower to maintain hazard/fire insurance and name the lender as an additional insured. The purpose of the clause is to give the lender an interest in the insurance proceeds in the event of a covered claim. An example, a forest fire that destroys your home. Most such deeds of trust contain language substantially similar to this:
“To provide, maintain, and deliver to Beneficiary fire insurance satisfactory to and with loss payable to Beneficiary. The amount collected under any fire or other insurance policy may be applied by Beneficiary upon any indebtedness secured hereby and in such order as Beneficiary may determine, or at option of Beneficiary the entire amount so collected or any part thereof may be released to Trustor.”
Lenders tend to argue, that because of this language, the borrower has contractually agreed to allow the lender to control the insurance proceeds and that the lender is within its contractual right to capture the insurance proceeds to discharge the loan at the demise of the borrower. In this situation if the lender obtained the proceeds it would functionally prohibit the borrower from accessing the funds it needed to rebuild their home. We have seen this scenario play out time and time again. All from lenders who do not understand or recognize how the law in California is applied.
In the 1978 case of Schoolcraft v. Ross, the 5th appellate district answered the question related to who has the benefit of the insurance proceeds. The court says that every contract had an implied covenant of good faith and fair dealing required between the parties. That in accomplishing this purpose, neither party will do anything that prevents the other from receiving the benefit under the contract. This rationale is important in the loan context, because when an individual takes out a loan, they are undertaking an agreement that allows them to perform the obligation of the contract over a long period of time.
The court rationalizes then that because the agreement calls for long term payments, that unless the security is impaired (ie. borrower not making payments, not going to rebuild or proposed rebuild will be of less value than security) the lender does not have the right to accelerate the payment obligations on the note. The court states that allowing lenders to capture the insurance proceeds acts as an unintended acceleration of the loan and deprives the borrower of certain property rights bargained for in the loan contract. What this means is that generally the borrower is entitled to the use of the insurance proceeds to rebuild a property that has been destroyed by a fire unless the lender can show through admissible evidence that the security will be impaired.
The use of insurance proceeds by a borrower is tremendously important. The insurance is designed to provide the relief needed to put the property back together, to make it useful or habitable again. If lenders were allowed to unilaterally intercept those funds it would render insurance meaningless to a borrower and would severely undermine the rebuilding of local economies impacted by fire and other hazards.
The attorneys here at BPE Law have a long history of counseling both business members and consumers related to their interests in real estate. This office has significant experience in both insurance and mortgage lending matters. Should you find yourself or someone you know in the unenviable position of having to work with a lender regarding the rights involved in insurance proceeds seek the legal assistance to assist in working through that situation. It is a difficult path to navigate and qualified legal counsel can help you work through the insurance and lender difficulties.
Source: BPE Law Group