13.5 Mortgagees and Additional Insureds

• Library: Insurance Law in Virginia (Virginia CLE) (2020 Ed.)

13.5 MORTGAGEES AND ADDITIONAL INSUREDS

13.501 Additional Insureds and Loss Payees. Any number of individuals or entities may be identified as insureds and designated as "loss payees" under a fire insurance policy, provided they qualify with respect to insurable interest and the other preconditions to the existence of a valid policy. However, with a few exceptions, ²⁶⁴ the rights of an additional insured under Virginia law do not rise above the rights of any other insured. ²⁶⁵ Therefore, where one insured has failed to comply with a policy condition, then absent specific language in the policy, no insured can recover. ²⁶⁶

The waiver of the violation of any such condition may constitute a waiver of that condition against all insureds. A rather extreme example of this principle may be found in A & E Supply Co. v. Nationwide Mutual Fire Insurance Co. ²⁶⁷ In that case, the court concluded that the payment of one "loss payee" under the policy waived any defense based on the "fraud and concealment" provision of the policy.

13.502 Rights and Duties of a Mortgagee.

A. In General. Although in many respects, a mortgagee of property jointly named as an insured with the owner is an "additional insured," policy language has been developed to provide the mortgagee with unique

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protections and rights. ²⁶⁸ In the absence of this language, no such protections exist and the mortgagee is nothing more than a mere loss payee. ²⁶⁹

B. Policy Language. Frequently, property insured against fire is subject to a mortgage. The conditions of the mortgage instrument typically require the borrower to procure fire insurance and name the mortgagee as an insured on the policy. Although the mortgagee clearly has an insurable interest and could certainly take out its own separate policy, it is frequently less expensive and more efficient for one policy to cover the rights of both the borrower and the mortgagee. However, as indicated in the preceding paragraph and the paragraph pertaining to "innocent coinsureds," ²⁷⁰ the mortgagee listed merely as an additional insured or loss payee runs a substantial risk of losing the insurance on its collateral through the improper actions of the borrower.

In an effort to address this problem, the General Assembly mandated the inclusion of the following language in all fire insurance policies issued in Virginia:

Mortgagee interests and obligations. If loss hereunder is made payable in whole or in part, to a designated mortgagee not named herein as the insured, such interest in this policy may be cancelled by giving to such mortgagee a ten days' written notice of cancellation. If the insured fails to render proof of loss[,] such mortgagee, upon notice, shall render proof of loss in the form herein specified within sixty (60) days thereafter and shall be subject to the provisions hereof relating to appraisal and time of payment and of bringing suit. If this Company shall claim that no liability existed as to the mortgagor or owner, it shall, to the extent of payment of loss to the mortgagee, be subrogated to all

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mortgagee's rights of recovery, but without impairing mortgagee's right to sue; or it may pay off the mortgage debt and require an assignment thereof and of the mortgage. Other provisions relating to the interest and obligations of such mortgagee may be added hereto by agreement in writing. ²⁷¹

As discussed in paragraph 13.2 of this chapter, section 38.2-2107 of the Virginia Code permits insurance companies to vary this standard language. Moreover, in the case of the mortgage clause, section 38.2-2105 specifically states that "[o]ther provisions relating to the interest and obligations of such mortgagee may be added hereto by agreement in writing." A common modification of the mortgage clause found in policies today may read as follows:

If we deny your claim, that denial will not apply to a valid claim of the mortgagee, if the mortgagee

1. Notifies us of any change in ownership, occupancy, or substantial change in risk of which the mortgagee is aware;

2. Pays any premium due under this policy on demand if you have neglected to pay the premium; and

3. Submits a signed, sworn statement of loss within 60 days after receiving notice from us of your failure to do so. Policy conditions relating to Appraisal, Suit Against Us, and Loss Payment apply to the mortgagee.

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. Subrogation will not impair the right of the mortgagee to recover the full amount of the mortgagee's claim. ²⁷²

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These provisions are referred to as a "standard" or "union" mortgage clause. ²⁷³ As pointed out below, this clause confers specific and important rights upon the mortgagee. By the terms of the statute, to qualify for this special protection, any loss must be payable to a "designated mortgagee not named herein as the insured." ²⁷⁴ That is, the mortgagee must be identified on the policy and must be specifically designated as a "mortgagee," not an "insured."

The Virginia Code does not require that the mortgagee's interest be insured in this manner, and the lender could opt to separately insure the property or be identified as a coinsured. While most modern lending institutions take full advantage of the special protections afforded by the "standard" or "union" clause, these alternative arrangements may be found in instances of individual or seller financing of property.

C. Rights of the Mortgagee.

1. When the Insured Has Not Breached the Policy. By virtue of the language of section 38.2-2105 of the Virginia Code, most rights of the mortgagee under the mortgage clause arise only when the claim of the named insured has been denied or at least is in jeopardy. The only exception under the Virginia Code is the fact that the insured is entitled to specific advance notice of any contemplated cancellation. "[S]uch interest [of the mortgagee] in this policy may be cancelled by giving to such mortgagee a ten days' written notice of [such] cancellation." ²⁷⁵ The mortgagee is entitled to this notice irrespective of whether the named insured has even made a claim.

In the event that the named insured is in compliance with his or her duties under the policy and his or her claim is accepted, most policies provide that payment shall be made to all entities listed "as their interests

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may appear." Frequently, insurers will satisfy this obligation by making a single payment for the total amount of the structure damage, ²⁷⁶ jointly payable to the named insured and the mortgagee. There is authority from other jurisdictions to the effect that this joint payment discharges the insurer's duty even where the insured forges the mortgagee's endorsement. ²⁷⁷

2. When the Insured Is in Breach of the Policy. A primary purpose for using the "standard" or "union" mortgage clause is to protect the mortgagee against the improper acts of its borrower. This is accomplished by the legal fiction that the mortgage clause gives rise to two separate and independent contracts, one in favor of the named insured and a second in favor of the mortgagee. The contract in favor of the mortgagee is, by the terms of the mortgage clause, immune to the insured's violations of the policy. ²⁷⁸

This protection extends to any violation of the policy by the insured. It includes acts of fraud as well as negligent and unintentional violations of policy conditions. ²⁷⁹

If payment is to be made to the mortgagee, that payment will, of course, be to the extent of the mortgagee's interest in the property. Although there are no Virginia authorities on point, most courts agree that it is the mortgagee's interest on the day of the loss that determines the amount of coverage owed. ²⁸⁰

An interesting issue that remains unresolved in Virginia and a number of other jurisdictions is whether this protection extends to the insured's conduct occurring before the issuance of the policy. For example, if an

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insured commits a material misrepresentation on the application for the policy, a court may declare that policy void ab initio. ²⁸¹ A policy void ab initio is rescinded and treated as if it never existed in the first place. ²⁸² Therefore, the question arises as to how the mortgagee can be protected if no policy ever came into existence.

While it is stated that the "majority view" on this issue is that the mortgagee is protected, ²⁸³ the Virginia Supreme Court made the following statement in New Brunswick Fire Insurance Co. v. Morris Plan Bank: ²⁸⁴

[The union mortgage clause] has been frequently construed, and the authorities are unanimous in holding that it acts as a separate and independent insurance of the mortgagee's interest, to this extent, at least, that no act or omission on the part of the owner, which occurs after the issuance of the policy, shall affect the mortgagee's right to recover. ²⁸⁵

In National Bank of Fredericksburg v. Virginia Farm Bureau Fire & Casualty Insurance Co., ²⁸⁶ the Virginia Supreme Court held that a lienholder bank was not entitled to "union mortgage clause" protection where the policy was no longer in effect on the date of loss, the insureds had failed

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to accept the insurer's offer to renew coverage, and the bank's coverage was subject to the policy's terms.

An argument exists, therefore, that the protections otherwise available to a loss payee or mortgagee under a "standard" or "union" mortgage clause should not apply to acts or omissions of the owner that occurred before the issuance of the policy (namely, material misrepresentation in the application) or where there is no valid policy in effect...