When The Insurance Company Must Pay The Lender

When there is a fire or other hazard loss at mortgaged premises, there are two major mistakes insurance companies can make regarding payment of proceeds:  (a) Ignoring the existence of the lender as a loss payee – thus paying the borrower alone or (b) When a borrower is in default, making the loss check out to the borrower alone.  Fortunately for lenders, statute and case law provide rescue.

Support for this salvation is not new, but these situations are encountered often enough that highlighting the applicable principles can be helpful.

First is the carrier’s gaffe in issuing a check solely to the borrower, not in a default situation.  Law here is that:

1. When a lender is named in an insurance policy, it obtains an interest in the proceeds; and
2. If the policy contains a “loss payable to mortgagee” clause, the lender is a nominee, the appointee of the insured, to receive the money due under the insurance contract; but
3. If the policy is issued to a mortgagee and a mortgagor as their interests may appear, then the lender obtains a vested legal interest in the contract and the insurance is to the lender’s benefit to the extent of the debt and the lender can recover from an insurer up to the secured interest; thus
4. Once the insurer is given notice of the lender’s claim under a policy requiring payment to the insured borrower and the lender “as their interests appeared,” it pays the loss proceeds at its peril and assumes the hazard of resisting the lender’s claim.

In short, an insurance company is liable to a lender when the check is issued solely to the borrower.  [See discussion and citation in Everhome Mortg. Co. v. Charter Oak Fire Ins. Co., 2012 U.S. Dist, LEXIS 34516; Associates Commercial Corp. v. Nationwide Mutual Ins. Co., 298 A.D.2d 537, 748 N.Y.S.2d 792 (2d Dept. 2002).]

Next is the even more compelling instance of a fire loss when the borrower is in default or already in foreclosure.  Insurance companies will sometimes send the check to the borrower, or make the check payable jointly to the borrower and the lender/servicer.  The unfortunate consequences of this are obvious.  If the check in paid only to the borrower, he just might negotiate it, be pleased to have the funds and abscond.  Even if payable to both borrower and lender, such checks have sometimes been negotiated – or the borrower holds it for leverage and the lender remains unpaid.  Even if sent to the lender, where the check is payable to both the borrower and the lender, obtaining the borrower’s signature is sometimes difficult or impossible.

And so it is that the applicable insurance statute in New York [RPL §254(4)] addresses this.

The essence of the statute (lengthy with many other aspects) is that so long as there exists any default by the borrower in the performance of any terms or provisions of the mortgage, the lender is not bound to pay over any insurance money issued to it.

Case law then interprets – really clarifies – the statute to hold that the requirement is that payment of the loss be first made to the lender up to the extent of its interest, with only the balance, if any, to the borrower.  [See case law on the point, inter alia, Sportsman’s Park, Inc. v. New York Property Ins. Underwriting Association, 97 A.D.2d 893, 470 N.Y.S.2d 456 (3d Dept. 1983); Grady v. Utica Mutual Ins. Company, 69 A.D.2d 668, 419 N.Y.2d 565 (2d Dept. 1979).]

In the end, this supports a lender demand that when a borrower is in default, the insurance proceeds check must be paid solely to the lender.

Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.