The Standard Mortgage Clause
| Publication year | 1991 |
| Pages | 731 |
1991, April, Pg. 731. The Standard Mortgage Clause
In many loans secured by personal property, and in most loans secured by improved real property, the lender will require that the borrower obtain casualty insurance on the collateral, which insurance is to include a "standard mortgage clause" in favor of the lender. This article describes the standard mortgage clause and its purpose in general, as well as its role in foreclosure. It also serves as a resource for counsel dealing with this clause. As is often the case, a good way to understand the nature of the standard mortgage clause, which is a form of loss payable clause, is by comparing it to its predecessor, the open loss payable clause.
The open loss payable clause, or open clause, provides that "loss, if any, is payable to the [lender] as his interest may appear." This language has been in use for many years. Over the years, the courts have interpreted this clause to be a mere appointment of the lender as the party to receive the insurance proceeds, which otherwise would be payable directly to the insured owner. As such, the open clause is not an assignment to the lender of the insurance contract between the borrower and the insurer. It neither creates a new contract of insurance between the lender and the insurance company nor changes any of the terms of the insurance policy between the owner and the insurance company.(fn1)
As a mere designee of the owner's right to receive the loss payment, the lender was left in a vulnerable position. Because the lender's rights were derived from the owner, the lender was ineligible to receive any loss payment if, for any reason, the insured owner was not entitled to receive the insurance proceeds. For example, if the owner could not recover under the insurance policy owing to (1) transfer or lack of title to the insured property,(fn2) (2) fraud or misrepresentation(fn3) or (3) arson,(fn4) the lender also was without insurance coverage. Out of this unfortunate circumstance, there developed in the late 1800s the "New York," "union" or "standard" mortgage clause.(fn5)
The standard mortgage clause sought to avoid the problems of the open clause with language such as the following:(fn6)
This insurance, as to the interest of the mortgagee only, shall not be invalidated by any act or neglect of the mortgagor or the owner of the within described property, nor by any foreclosure or other proceedings or notice of sale relating to 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 are permitted by this policy, provided, that in case the mortgagor or owner shall neglect to pay any premium due under this policy, the mortgagee shall, on demand, pay the same.
Although some policies continue to use language similar to that quoted above, a more typical, "plain English" version of the modern standard mortgage clause reads as follows:(fn7)
If a mortgagee is named in this policy, any loss payable under [the] Coverage A [described above in this policy] shall be paid to the mortgagee and you [the insured owner/borrower] as interests appear. If more than one mortgagee is named, the order of payment shall be the same as the order or precedence of the mortgages.
If we deny your claim, that denial shall 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...
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