Real Estate Finance Notes 10/1/04

Fire insurance and eminent domain awards – Starkman v. Sigmond

Who gets the fire insurance proceeds if both the mortgage and insurance policy are silent? This case holds that the mortgagor gets the proceeds, assuming that the collateral isn’t impaired at the time before the proceeds are applied. Under the facts of this case, the security wasn’t impaired, but the loan-to-value ratio was affected. What if the mortgage says that the mortgagee gets the proceeds? Is that enforceable? There is a California case that says if the collateral is not impaired, the mortgagor has the right to use the money to rebuild. But that’s the only case to hold this. The Restatement says that you can make typical contract arguments about unconscionability or that you can point to the implied covenant of good faith and fair dealing. The overwhelming majority of cases say that if the mortgagee bargained for the proceeds, the mortgagee gets them. What if the mortgagee is named as an insured on the policy? The proceeds won’t be paid directly to the mortgagor, but rather will be put into escrow. What can be done with the proceeds? Can they be used to repair and rebuild, or must they be applied to the mortgage?

What are the limits on the mortgagee’s recovery of insurance proceeds? The mortgagee never gets more than the amount of the debt. Does the mortgagee get the full proceeds, or just enough to put him in the same position he would have been in as far as loan-to-value ratio if the casualty loss hadn’t happened? I missed the answer.

In a standard mortgage policy, the insurance as to the mortgagee (not affecting the mortgagor) will not be invalidated by acts of the mortgagor which would otherwise invalidate the policy. Insurance will be paid to the parties as their interests appear. The mortgagor’s interest may be invalidated if they do something wrong, but the mortgagee is protected. What if the mortgagor burns down the property? The mortgagee wants the proceeds from the insurance. What if the insurer says that arson isn’t covered? What if you have the standard or union clause? The mortgagee still gets paid. What if the mortgagor commits fraud in the mortgage application? No, that won’t affect the mortgagee’s insurance. Same thing if the mortgagor manufactures paint thinner on the property. What if the mortgagor fails to pay the premium? Usually the policy provides for some period of notice before the policy is cancelled due to non-payment. It will invalidate the policy and thus the loss payable or standard loss clause along with it.

So in Starkman, the Sigmonds buy a house in New Jersey. The seller takes back a note for $60,000. This is a purchase money mortgage, meaning that the proceeds were used to purchase the property, which was collateral for the Sigmonds. In this case, the court is just changing the default rule.

Let’s say that the place burns down. The mortgagee makes a full credit bid at the foreclosure sale, not knowing that the place burned down! Well, the mortgagee bid for the property as it existed on the date of the sale. They may have made a mistake, but they bid the full amount of the mortgage, so there’s no mortgage anymore! There’s no basis for the mortgagee to collect anything!

For eminent domain awards, use the Fannie Mae form. In a partial taking, the mortgage is reduced by the proceeds times the ratio of the pre-taking debt to the pre-taking fair market value. The problem is when the condemnation award undervalues the property taken, which makes the mortgagee worse off. If the award overvalues the property, then the mortgagor will be worse off.

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