When to Include the Mortgage on a Real Property Loss Payment

The mortgage crisis has become a fixture in the media and affects more than just the mortgage and banking sectors. How does the mortgage meltdown affect the business of insurance with regard to settling and paying real property damage claims? Certainly, lenders and mortgagees may become especially vigilant in pursuing claims against insurers during economic times when cash flow is tight.

Many states, including Tennessee, have enacted statutory mortgage clauses which are designed to protect the interests of mortgagees in insured property. See e.g. Tennessee Code Annotated §56-7-804. In addition to the protection independently mandated by such statutes, most insurance policies contain what is commonly referred to as a “mortgage clause.” This type of clause creates a separate contract of insurance between the mortgagee and the insurer that may not be invalidated by any acts of the insured, including even fraudulent acts.

Although all policies are different, most modern mortgage clauses require an insurer to include the mortgagee’s name on real property loss payments issued to the named insured. This ensures that the claim payment will be used toward repairing or replacing the dwelling or building and ensures that the mortgagee’s collateral remains viable. In addition, in any real property loss in excess of $1,000.00, Tennessee Code Annotated § 56-7-111 requires insurers to name the general contractor of any uncompleted construction or building contract as a payee on the draft to the owner covering payment for the loss.

Despite increasing statutory and judicial protection of mortgagees, and in some cases despite specific policy language requiring it, many insurers do not include the mortgagee on partial loss payments, instead issuing payment only to the named insured or perhaps jointly to the named insured and the general contractor. This practice is risky business, especially in a climate of unprecedented decreasing values of the underlying collateral supporting home loans.

If an insurer fails to include the mortgagee on a real property loss payment, the insurer risks having to make the loss payment twice, even if the insured cashes the check. A financially desperate insured could decide he or she wants to spend the loss payment money rather than make repairs to his or her home, thus further diminishing the value of the mortgagee’s collateral. The insurer may further risk extra-contractual exposure to the lender for bad faith or pursuant to consumer protection laws. This is equally true for partial loss and total loss payments. Tennessee case law strongly suggests that if the loss payment is not spent toward repair of the insured property, a mortgagee will be able to recover against the insurer to the extent of the insured’s debt. See e.g.,Benton Banking Co. v. Tennessee Farmer’s Mutual Ins. Co., 1994 WL 111436 (Tenn. App. 1994), rev’d on other grounds, 906 S.W.2d 436 (Tenn. 1995).

When in doubt about whether to include the mortgagee on a real property loss payment, check the policy language—especially the mortgage clause– and applicable statutes. Always include the mortgagee on any and all real property loss payments, whether total or partial, if the insurance policy requires it. Insureds and general contractors may complain about the hassle in dealing with the mortgage company, but this procedure provides the best protection for your company, may help prevent breach of contract claims brought by mortgagees, and protects against payment of the same claim twice. Lastly, while this article focuses on real property losses, it is equally important to not include the mortgagee on drafts that do not require it, such as those that are specifically for the payment of personal property losses.

For additional information on this Tort & Insurance article, please contact:

Casey Smith

(731) 426-8122

csmith@raineykizer.com

Source: Rainey, Kizer, Reviere & Bell

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