When The Borrower Forges The Insurance Check (Relationship To Deed In Lieu And Deficiencies)

This title seems an obscure mouthful, but it presents practical, important principles for real situations which too often occur – all as revealed by a recent case:  Dave Bofill Marine, Inc. v. BNY Mellon, N.A., 98 A.D.3d 467, 949 N.Y.S.2d 439 (2d Dept. 2012).  To speed to the point, to then be placed in context, a lender was denied relief (it could not collect insurance proceeds) when a borrower forged an insurance check payable to the lender (and borrower) because the taking of a deed in lieu of foreclosure extinguished the lender’s insurable interest in the property.

Lenders well understand that hazard insurance must be maintained by the borrower upon the mortgaged premises for the obvious reason of protecting the property’s improvements from destruction and loss.  And if the borrower does not maintain that insurance the lender will pay it and add the advance to the mortgage debt – all standard practice.

Just as standard, when a loss is incurred, the insurance proceeds check is made payable to both the borrower and the lender.  If the mortgage is not in default, the lender will take the check and pay out the proceeds in accord with reconstruction.  If the borrower is in default, the check should be payable solely to the lender – in any event in New York the law is that the proceeds are due solely to the lender.

What happens from time to time, though, is that a borrower receives the check, signs its (or his or her) own name and forges the lender’s name so that the check can be deposited to the borrower alone.  When that happens – as it did in the mentioned case – the lender may have a cause of action for conversion against the drawee bank (where the check was deposited) and for breach of contract against the collecting bank (which ultimately paid the money).

But it did not work in the noted case.  When the borrower defaulted, the lender took a deed in lieu of foreclosure and resold the property, only thereafter suing the two offending banks.  By then, though, the lender’s insurable interest in the property was gone and so the action was dismissed.

To tie this together with the whole universe on this issue, it is normally encountered when there is a fire (or other hazard) loss in close proximity to the foreclosure sale.  There, the applicable principle is that a foreclosure sale wipes out an insurable interest, so that after the sale, the lender has no right to insurance proceeds.  The exception – that is, the way to avoid extinguishment of the insurable interest – is to pursue a deficiency judgment. [This subject is discussed in considerable depth at 3 Bergman on New York Mortgage Foreclosures §34.08, LexisNexis Matthew Bender (rev. 2012) and attention is invited there if further detail will be instructive.]

The final lesson here: Conclusion of a foreclosure, whether by deed in lieu or by foreclosure sale, can affect a lender’s ability to collect insurance proceeds.  Thus, a lender needs to be aware of the concepts whenever an insurable loss is encountered.

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.