Imagine the following scenario: You are a senior secured lender on equipment damaged in a fire. The owner of the property where the equipment is located files a claim against his insurance company for the loss. You, as the secured lender, are a loss payee on the equipment with the owner’s insurance company. If the insurance company denies the property owner’s claim because the policyholder breached the insurance policy by making misrepresentations on the insurance policy application, is the lender still entitled to receive payment for his lost equipment? Or does the lender lose out on payment because the insurance company denied the claim of its policyholder?

The quick answer – it depends on the language in the insurance policy. Generally, there are two types of loss payable clauses: (1) the “simple” or “open” loss payable clause; and (2) the “standard” clause.

The Simple/Open Loss Payable Clause:

With a simple/open loss payable clause, the lienholder’s right to recovery is no greater than the right of the insured; a breach of the conditions of the policy by the insured would prevent recovery by the lien holder. So, under the situation described above, the lender would be out of luck and would not be able to recover for its lost equipment.

The Standard Loss Payable Clause

To afford even greater protection to the secured creditor, it became customary to modify the simple/open loss payable clause to provide that the lender’s coverage could not be forfeited by the act or default of any other person, ultimately leading to the “standard” mortgage clause. Insurance companies have used standard loss payable clauses in real estate fire insurance policies since at least 1878.

Under the standard loss payable clause, a lien holder is not subject to the exclusions available to the insurer against the insured because an independent or separate contract of insurance exists between the lien holder and the insurer. In other words, there are two contracts of insurance within the policy – one with the lien holder and the insurer and the other with the insured and the insurer.

The typical consideration given by the lien holder in return for obtaining a standard clause is the lien holder’s promise to pay premiums on demand. The standard clause provides that the owner’s acts or neglect will not invalidate the insurance provided that if the owner fails to pay premiums due, the lien holder shall on demand pay the premiums. In return for incurring premium liability, the lien holder is freed from the policy defenses which the insured might have against the owner. The standard loss payable clause is then an agreement between the lien holder and the insurer independent of the policy contract between the owner.

A few examples of standard mortgagee clauses include the following:

“If a mortgagee is named in this policy, any loss payable under Building Coverage shall be paid to the mortgagee and you, as interest appear…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 under this policy on demand if you have neglected to pay the premium; (c) submits a signed, sworn statement of loss…”  Home Sav. of Am At 839.

Policy provided coverage for “covered loss of or damage to buildings or structures to each mortgageholder shown in the Declaration in their order of precedence, as interests may appear,” with another provision stating that even if the insurer denied a claim for “covered loss of or damage to buildings or structures” due to the insured’s acts or because the insured failed to comply with the terms of that Coverage Part, the mortgage holders would “still have the right to receive loss payment,” so long as certain conditions were met.  Najah v. Scottsdale Ins. Co., 230 Cal. App. 4th 125 (2014).

Where a standard mortgage clause is at issue, the policy is not avoided as to the lender by the misconduct of the insurance policy holder, as in destroying an insured building by burning it, or by otherwise intentionally destroying an insured property. Rather, the standard clause protects the lender against loss from any act or neglect of the insurance policy holder. Courts have found that an insured’s misrepresentations, intentional concealment or fraudulent conduct do not void a valid claim by the lender. In fact, many federal appellate courts have all determined (when interpreting state law) that standard clauses create insurer-mortgagee contracts divaricated from the original insurer-insured contract and that a standard mortgagee clause is unaffected by the misrepresentations or false statements of the insurance policyholder.

Knowing what provisions are included in an insurance policy is important – not only for policyholders, but for others that might have an interest in insured property. The lawyers at Mag Mile Law have been successful in analyzing insurance policy language and convincing insurance carriers that the lender of equipment is still entitled to insurance proceeds even if the insurance policy holder made misrepresentations in its insurance policy application.

For more information about our insurance coverage practice, contact Mag Mile Law at (708) 576-1624 or [email protected].