Chapter 7 Mortgage Clauses

• Library: The Commercial Property Insurance Policy Deskbook (ABA) (2018 Ed.)

CHAPTER 7 Mortgage Clauses

The Standard Mortgage Clause

Since properties are frequently encumbered by mortgages, most first party property policies contain provisions that protect the mortgagee's interest in the event the insured property is damaged or destroyed. Historically there have been two types of mortgage clauses:

• A loss payable or open mortgage clause, which only provides that loss shall be payable to the mortgagee as interest may appear. Most courts have construed the phrase, "as interest may appear" as referring not to the mortgagee's interest in the insured property, but rather to the amount of debt owed to it secured by the mortgage or deed of trust.
• The standard or union mortgage clause (Form 438 BFU NS), which states, in addition to the loss payable provision, that the mortgagee's interest in the proceeds of the policy shall not be invalidated by any act or neglect of the mortgagor.

Where an insurer issues a policy knowing that the property is subject to a mortgage, and in fact the policy itself contains a standard mortgage clause extending coverage to mortgage holders, there is no added risk. At the time the policy was issued, it was foreseeable that a mortgagee could take possession and control of the property in the event of default.

A standard mortgage clause creates an independent contract between the insurer and the mortgagee that prevents the mortgagee's interest from being invalidated by the conduct of the mortgagor.

In Canada, Royal Bank (RBC) attempted to enforce its mortgage rights against the defendants. While the defendants did not dispute that the mortgage was valid and in default, they argued, among other things, that the plaintiff and third party, RBC Insurance, negligently misrepresented the nature and quality of insurance sold at RBC's branch. The defendants alleged that RBC and RBC Insurance violated legal requirements regarding the provision of insurance products, as the plaintiffs had not obtained the applicable license. Factual issues remained for a determination by trial so RBC was unable to enforce the mortgage.¹

The standard mortgage clause creates a separate contract of insurance between the insurer and the mortgagee, and this clause provided that the interest of the mortgagee shall not be impaired "by any act of or omission or neglect" of the mortgagor owner—in the present case, being the negligent acts and omissions that resulted in the theft of the insured vessel.²

A standard mortgage clause "is unaffected by the misrepresentations or false statements of the mortgagor."³ And more still, "[a] standard mortgage clause has been held effective to protect the interest of the mortgagee even though the policy was itself void as to the mortgagor ab initio."⁴

In general, under the simple loss payable clauses, the mortgagee is merely an appointee of the insured to the insurance proceeds. The mortgagee's rights follow those of the mortgagor (the named insured). A breach of policy provisions by the named insured will deprive both the insured and the mortgagee of any right to the proceeds of the policy. For example, if the mortgagor commits arson and by that act forfeits his right to recover, the mortgagee also cannot recover. Because the simple loss payable clauses do not adequately protect the mortgagee's interest in the property, the use of the standard or union mortgage clause has become more prevalent over time. Almost every commercial lender will demand a union mortgage clause, if not a specific demand for a Form 438 BFU NS.⁵

The Loss Payable Clause

Where a loss precedes the foreclosure, the rule is different since the mortgagee may satisfy the mortgage indebtedness by two different means. He may recover up to the limits of the policy the full amount of the mortgage debt under the standard mortgage clause or satisfy the mortgage debt through foreclosure and then recover the balance due, if there is any, under the insurance policy as owner.⁶

In contrast to the simple loss payable clause, the courts generally have construed the standard mortgage clause as a separate insurance contract between the insurer and the mortgagee.⁷ A substantial body of case law discusses the relative rights and obligations of the insurer and mortgagee under this clause.

As one Louisiana court explained:

A simple or open loss payable clause is one of two types of loss payable clauses commonly used in Louisiana. The open loss payable clause may be distinguished from the other type of clause, the standard or union clause, by the language used in the clause. The open clause simply provides that the policy proceeds will be paid to the mortgagee "as his interest may appear," while the standard clause further provides that the interest of the mortgagee "shall not be invalidated by any act or neglect of the mortgagor."⁸ The loss payable clause making Seafirst a loss payee is an open loss payable clause because it only provides that the proceeds will be paid to Seafirst as its "interests may appear" and does not further provide that the proceeds "shall not be invalidated by any act or neglect of the mortgagor."⁹

The open loss payable clause simply states that "loss, if any, is payable to B, as his interest shall appear."¹⁰ It merely identifies the person who may collect the proceeds of an insurance claim. Not all such wordings are identical, but it will be seen that the open loss payable clause is distinctly different from the standard or union mortgage clause. In the union, standard, or New York forms, the mortgagee may become liable to pay the premium to the insurer—in return, it is freed from policy defenses which the company may have against the mortgagor. In the open form, the mortgagee stands in the mortgagor's shoes, and is usually considered subject to the same defenses. From the point of view of legal interpretation, it has been held that a mortgagee under an open clause is an appointee only to receive the funds payable in the event of loss; it is not an assignment of the contract, but an appointment only.¹¹

The Insuring Agreement

The language of the standard fire policy and the standard mortgage clause suggest two conditions precedent to recovery:

• that the claimant possesses a mortgagee interest; and
• that the claimant be designated as mortgagee in the policy.

Mortgage Interest: Nonmortgagees

Only those with mortgage liens or deeds of...