§16.2 - Negotiating Insurance Provisions in Real Estate Transactions

• Jurisdiction: Washington

§16.2 NEGOTIATING INSURANCE PROVISIONS IN REAL ESTATE TRANSACTIONS

Insurance issues affecting real property most commonly arise in connection with sale or lease transactions. Both types of transactions involve more than one party, each of whom may have an insurable interest in the real property subject to the transaction.

(1) The purchase and sale transaction

In the purchase and sale transaction, the seller, the buyer, and the lender all have insurable interests in the property. Those interests shift as the transaction progresses from inception to completion.

The insurable interestand thus allocation of the risk of lossis particularly complex while the purchase and sale contract is executory: in other words, during the period after the earnest money agreement has been signed, but before the closing. A purchase and sale agreement does not vest title, legal or equitable, in the purchaser. Dysart v. Colonial Fire Underwriters of Nat'l Fire Ins. Co., 142 Wn. 601, 254 P. 240 (1927).

Washington courts generally will respect the allocation of risk designated by agreement of the parties to a purchase and sale agreement. Goldfarb v. Dietz, 8 Wn.App. 464, 506 P.2d 1322 (1973); Geranios v. Annex Invs., 45 Wn.2d 233, 273 P.2d 793 (1954); Dunseath v. Hallauer, 41 Wn.2d 895, 253 P.2d 408 (1953); Brown v. Nw. Mut. Fire Ass'n, 176 Wash. 693, 30 P.2d 640 (1934). When the intent to insure the interests of all parties to a purchase and sale agreement is clear, but the parties inadvertently fail to include all parties as insureds under the policy, equity may reform the insurance policy to effect the intent of the parties. Metro. Mortgage and Sec. Co. v. Reliable Ins. Co., 64 Wn.2d 98, 390 P.2d 694 (1964).

Absent agreement among the parties, the seller has the insurable interest in the property and generally is required to bear the risk of loss for damage to real property subject to a purchase and sale agreement. Johnson v. Stalcup, 176 Wash. 153, 28 P.2d 279 (1934); Capital Sav. & Loan Ass'n v. Convey, 175 Wash. 224, 27 P.2d 136 (1933). In fact, most purchase and sale agreements include a provision that the seller is required to maintain the property in the condition it was in at the date of mutual acceptance of the agreement. A purchaser in possession of real property subject to an executory purchase and sale agreement, however, may sometimes bear the risk of loss for damage to the property, rather than the seller. Such a circumstance should be explicitly stated in the purchase and sale agreement.

A thorough treatment of insurable interest in purchase and sale transactions is found in Gossett v. Farmers Insurance Co. of Washington, 133 Wn.2d 954, 948 P.2d 1264 (1997), in which the Gossetts signed a purchase agreement for unfinished property, intending to complete and resell it for a profit. They obtained temporary financing and obtained homeowners insurance as insureds, with the temporary lender as mortgagee. Then they assigned their interest in the property to the temporary lender, who took absolute title at closing. The Gossetts, intending to get long-term financing and take over ownership of the property, started work on the house until a fire destroyed it. The Washington Supreme Court held that the Gossetts had an insurable interest only in the improvements they made to the property and were entitled only to the insurance proceeds covering those improvements.

(2) Option to purchase and first right of refusal

An option is simply a contract by which the person granting the option agrees that the optionee may purchase real property at a fixed price. A first right of refusal gives a person the right to match an offer made by a third party. Unlike an executory purchase and sale agreement, neither an option to purchase nor a first right of refusal passes an interest in the property to the optionee Gossett, 133 Wn.2d at 971 (stating that optionee acquires no equitable estate or interest, and therefore no insurable interest, in the optioned land). However, once the option is exercised, or the first right of refusal is exercised, then in the event of a loss, the optioner or the person exercising the first right of refusal becomes a purchaser, and the obligation to insure is governed by the purchase and sale agreement, as is the disposition of any proceeds. Cf. Carnation Lumber & Shingle Co. v. Tolt Land Co., 103 Wash. 633, 175 P. 331 (1918).

(3) Assignments

A party sometimes may assign its interest in a purchase and sale agreement. When an insurance policy does not expressly restrict alienation of a seller's interest in real property subject to a purchase and sale agreement, the seller's assignee is entitled to indemnification pursuant to an insurance policy covering the property against fire. Metro. Mortgage & Sec. Co. v. Reliable Ins. Co., 64 Wn.2d 98, 390 P.2d 694 (1964). Further, the assignor loses the right to proceeds under the policy.

(4) Deeds of trust, mortgages, and real estate contracts

A lender generally does not have a duty to insure mortgaged premises on which it holds a real property security interest, such as a mortgage...